Popular Narratives And The Dangers Of Group-Think

"If the illusion is real
Let them give you a ride.
If they got thunder appeal
Let them be on your side.

Let them leave you up in the air,
Let them brush your rock and roll hair.
Let the good times roll."

The Cars

The good times have been rolling since March 23rd, 2020. 

It's been quite a ride, but is the illusion real? The bullish narrative has thunder appeal, but is it really on your side? I think we're up in the air, but I'm still waiting for someone to brush my rock and roll hair.

Most investors, including retail and professional, are optimistic by nature. This optimism bias is based on a long history of growth, innovation, and rising markets. The question I'm asking in this article is this - Will optimism bias help or hurt investors over the next 12 months?

For some thoughts on that, I'll take a look at three popular narratives that are dominating the media today, including the financial media, the mainstream media, the conservative and the liberal media.

Narrative #1. The bear market is over and a new bull market has begun

Let the good times roll. The market is up 28% from the low point on March 23rd. Some states are reopening businesses and relaxing shelter in place mandates. People are eager to get back to normal life. The market is anticipating a return to the good old times we had before February 19th. 

Those who are buying into this narrative apparently have enough buying power to keep this rally going, although it looks like it has lost some momentum lately.  And the aggressive sellers who dominated the market in February-March appear to have gone AWOL at least for the time being. 

In this narrative, the market has made a so-called "V-Bottom" which is a common occurrence for individual stocks but rarely seen in the market as a whole. The crash of 1987 has often been described as a V-Bottom. It was far from it. It was actually a triple-bottom, as the below chart illustrates. 

There were 3 bottoms in 1987, and it took nearly 2 years for the market to finally reclaim its previous high water mark.

Narrative #2. Central banks will rescue the economy and the markets

This is a widely popular narrative, and for good reason. The Fed, the Congress, and central banks all over the world are providing massive liquidity and fiscal stimulus in an effort to avoid a global depression. Nobody wants to go back to 1930's America.

How much faith do you have in the ability of central banks to rescue us from a deep and long-lasting recession and an extended bear market in stocks? If you have such faith, then you're an optimist. If you don't, you're a pessimist. The relevant question is which of these two camps is more firmly grounded in reality?

Being skeptical by nature, I guess I'm in the pessimistic camp. At some point, this government largess will have to be repaid. There are only three ways to do this - fiscal austerity, inflation, or higher taxes. Pick your poison.

Those in the optimistic camp say that we can simply grow our way out of this mountain of debt. But that will take time, which leads us to Narrative #3.

Narrative #3. Let's reopen the economy and get back to business as usual.

This is where things get political, and the debates can get ugly. I'll try to stick to the facts, but the facts are scarce at this point. 

We can reopen the economy, but we won't be able to get back to business as usual until Covid-19 is eradicated, which will probably take a year or two, best case.

But if we go too fast, we risk a second wave like they had in 1918. I don't think anyone wants that. Therefore, the reopening will (should) be gradual, monitored, and organized. Think about flying in an airplane. There's talk about keeping the middle seats empty. That means you would be sitting 3 feet from your row-mate. Not 6 feet. 

Think about going to your favorite restaurant. If the owner is a responsible person, they will arrange seating that respects the 6 feet distancing protocol. Can an airline or restaurant return to normal under these circumstances?

Now imagine all of the other places you used to frequent, and ask yourself what it would take in order for you and your family to feel safe? Everyone wearing masks and gloves? Seating that maintains a 6 foot distance from people you don't know?

It's going to take a very long time to get back to business as usual. So why is the stock market acting as if it will happen by the end of 2020? I just don't get it. That's why I'm keeping a very low exposure to stocks right now. I expect at least one more leg down, and maybe more after that.