Hubris is often on parade in the market as we approach long term market tops. And, history is replete with examples of such hubris as we have approached major market tops in the past.
Now, before you run out to mortgage your home to short the market, keep in mind that we have only begun to see the hubris I expect to be building as we move towards the major market I top I expect in a few years from now. But, I think it is something of which we need to begin to be aware, as the parade seems to be starting.
For those that know their stock market history, you would know that those “in the know” were absolutely certain about the impossibility of a market crash just before the market crashed and lead us into the Great Depression. Let me show you a few examples:
"We will not have any more crashes in our time."
This was said John Maynard Keynes in 1927, two years before the stock market crash which lead to the Great Depression.
"Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as they have predicted. I expect to see the stock market a good deal higher within a few months."
This was said on October 17, 1929, a few weeks before the Great Crash, by Dr. Irving Fisher, Professor of Economics at Yale University. Dr. Fisher was one of the leading US economists of his time.
"I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future."
- E. H. H. Simmons, President, New York Stock Exchange, January 12, 1928
"There will be no interruption of our permanent prosperity."
- Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928
And, these are just a few of the popular quotes of their day. And, by the way, has anyone heard of the Pierce Arrow Motor Car Company? You have not? Well, that is because they went bankrupt during the Great Depression. But, I digress.
So, let’s take a look at how the floats are lining up in our current parade of hubris.
Recently, Larry Kudlow, the Director of the National Economic Council, boldly exclaimed on television that "recession is so far in the distance, I can't see it.”
Last year, Fed Chair Janet Yellen said that the banking system is "very much stronger" due to Fed supervision and higher capital levels. She then followed that up with what I believe will be a history-making statement. Yellen also predicted that because of the measures the Fed has taken, another financial crisis is unlikely "in our lifetime." While some of you may point to the fact that Ms. Yellen is approaching her 73rd birthday, she did say in “our” lifetime.
What is simply astonishing is that this is the same Janet Yellen who said the following after the financial collapse we experienced in 2008-09:
“despite volumes of research on financial market metrics and weighty position papers on financial stability, the fact is that we simply didn’t understand some of the most dangerous systemic threats. Meanwhile, things went so well for so long that the common belief came to be that nothing could go disastrously wrong. . . We were left with the mirage of a system that we thought was invulnerable to shock, a financial Maginot Line that we believed couldn’t be breached. We now know that this sense of invincibility was mere hubris.”
What is it about the markets which causes such amnesia? Well, it would seem that the euphoria engendered by high stock market prices has its herding effect upon even the highest levels of the professional echelons.
In 1996, Robert Olson published a study in the Financial Analysts Journal in which he studied the effects of herding upon “expert” fundamental analysts’ predictions of corporate earnings. After studying 4000 corporate earnings estimates, he arrived at the following conclusion:
“Experts’ earnings predictions exhibit positive bias and disappointing accuracy. These shortcomings are usually attributed to some combination of incomplete knowledge, incompetence, and/or misrepresentation.”
Mr. Olson’s article suggests that “the human desire for consensus leads to herding behavior among earnings forecasters,” with the herd always looking for the current trend to continue unabated and indefinitely.
So, let’s look at a few more floats in this current parade.
I am now seeing comments like this to my public articles:
“I am thinking my target of 4000 in 2019 and 5000 in 2020 is MUCH too conservative at this time. I'm thinking we can see the S&P near 100,000 by 2029- that's 5 doubles in 10 years.”
This past week, a CNBC interview of Chamath Palihapitiya, a venture capitalist of whom I have never heard before this interview, was making the rounds, in which he echoed Ms. Yellen’s statement above:
"The odds that there’s a recession anymore in any Western country of the world is almost next to impossible now...”
Yes, my friends, the floats have been built and the parade has begun. The belief in the invincibility and strength of the central banks to control the business cycle has become intense and pervasive. This has certainly led to a feeling of invincibility of the stock market. Do you really think the outcome will be any different than in past history?
As George Santayana wisely said, “those who do not remember the past are condemned to repeat it.”
I have often quoted Professor Hernan Cortes Douglas (a former Luksic Scholar at Harvard University, former Deputy Research Administrator at the World Bank, and former Senior Economist at the IMF) many times in the past, but it certainly is worth the repetition:
“financial markets never collapse when things look bad. In fact, quite the contrary is true. Before contractions begin, macroeconomic flows always look fine. That is why the vast majority of economists always proclaim the economy to be in excellent health just before it swoons. Despite these failures, indeed despite repeating almost precisely those failures, economists have continued to pore over the same macroeconomic fundamentals for clues to the future. If the conventional macroeconomic approach is useless even in retrospect, if it cannot explain or understand an outcome when we know what it is, has it a prayer of doing so when the goal is assessing the future?”
While you can feel free to watch the parade for the next few years, as they are often quite entertaining, please do not become a participant. History suggests that it would not be beneficial to your financial well being.
You see, the amnesia which seems to have afflicted those I have quoted above allows them to ignore the fact that we have experienced a significant amount of 20%+ market declines over the last 30 years. I have outlined the Fed’s inability to prevent these declines in this prior article:
And, if you still believe in the Fed’s ability to stem the tide of negative market sentiment, I want to leave you with one final quote from Irving Fisher, who was one of the top economists of his time, and was completely surprised by the onset of the Great Depression:
“The Federal Reserve System, from February to December 1931, increased the issue of Federal Reserve notes by 80%. These issues were due to bank failures which made necessary a larger use of cash. Yet, after a wave of bank failures . . . both banks and their depositors began raiding each other in a cut-throat competition which more than defeated the new issues of Federal Reserve notes.” Irving Fisher, Booms and Depressions, 1932