(Bloomberg View) -- Great bull markets are the easiest time for money managers, right? Actually, not for most professionals, who are generally most comfortable looking for -- and finding -- in times of stress. In reality, the current environment poses a big psychological quandary.
It seems like all you need to do to be successful is just buy any stock, because it will inevitably go up. Buy high now and sell higher later. The truth is, smart investors don’t trade to maximize expected ; they trade to minimize regret. There is nothing worse than “buying the high” and then watching the market trade lower. You feel shame because you know you're the patsy.
Here's another dilemma: the masses tend to be fooled by the optical illusion inherent in charts. A graph showing the S&P 500 Index bumping up against the top of the screen gives the appearance that the index can’t go any higher. Convincing yourself to buy when the chart ends in the upper right-hand corner is a lot harder than it seems. If you had the ability to scale the Y-axis out about 50 percent, you'd probably be more bullish.
So the “smart money” crowd, which has been made to look very foolish the last two years, is plagued with self-doubt and a distrust of anything that appears to be easy money. There is something about being a professional investor and believing that making money should never be easy. If it isn’t hard, it isn’t worth doing. But there are long stretches where investing should be easy and "buy and hold" works. Why make it hard? Stocks usually go up, and even when they don’t, it is usually a good opportunity to buy more stocks.
Of course, there are plenty of institutions that tend to overcomplicate things a bit, such as hedge funds. Yes, they have different goals, namely to provide good absolute returns in all market environments. But bull markets are torture for most hedge fund managers because nobody is really satisfied with an 8 percent return. It seems people today aren’t even satisfied with a 9,000 percent return, like they were getting with the cryptocurrency Ethereum until recently. This is also when hedge funds get a lot of criticism for not outperforming the indexes. The times when hedge funds do outperform tend to coincide with bear markets, one of the few periods that people are satisfied with active management -- but only a little.
It’s not fair, though, to compare hedge fund returns with index returns because they are different strategies. Hedge funds are supposed to help minimize risk, but the comparisons are especially painful now because the index goes up a little bit each day and seemingly never goes down -- just like how a hedge fund is supposed to perform. And it does so on the back of “dumb” stocks such as the FANGs that are favored by retail investors, which means you either have to own the dumb stocks or underperform.
Hedge fund managers are praying out loud for the market to return to “normal,” which is more or less praying for a bear market -- or at least an environment where valuations begin to “make sense.” These people attract a lot of scorn because valuations don’t seem to matter much anymore. They are told that markets go up over time, so stop worrying and learn to love the bull. The fact is, some people are just better at trading in bear markets. It’s not a moral issue; bearish investors aren’t bad people. People just have different skills.
I consider myself to be one of those bear market investors. I started working in the capital markets in late 1999, and I started taking real risk in 2001. So, you can say I was “born” in a bear market -- one that lasted almost three years -- which has colored my thinking ever since. It’s a bit like people who grew up during the Great Depression. They tend to be pretty good at saving money. I made money in the last two bear markets and I tried to get by in between.
And that’s what most hedge fund managers are trying to do right now -- just get by, perhaps by buying some of the stupid stuff (OK, maybe not the really stupid stuff) and just try to ride things out until sanity is restored. But how long can that last? I thought things were pretty stupid six months ago. They are twice as stupid today. But I realize it’s kind of hard to have a bear market when interest rates are still at emergency levels. So, you can only underperform for so long before your investors lose patience and yank their assets.
The only solution is to have a group of investors who have bought in to your investment philosophy, but it’s hard to stick to principles when FOMO kicks in.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of "Street Freak" and "All the Evil of This World."
For more columns from Bloomberg View, visit https://www.bloomberg.com/view.
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