A new bull market can’t start until investors give up

Calling a market bottom obviously is more art than science. An NYSE sign is seen on the floor at the New York Stock Exchange in New York (AP)
Calling a market bottom obviously is more art than science. An NYSE sign is seen on the floor at the New York Stock Exchange in New York (AP)


  • For a new cycle to begin, people who bet on the market need to capitulate. Problem is, they’ve forgotten what that feels like.

“In order for the stock market to live, Cathie Wood has to die."

The Wall Street veteran who uttered those words about the star fund manager said he has no ill-will, but he said he isn’t comfortable betting on a new bull market until the poster child for the last one has had her comeuppance.

Despite Ms. Wood’s flagship ARK Innovation exchange-traded fund losing more than three-quarters of its value between its peak in February 2021 and last month’s nadir, that hasn’t exactly happened. It still has pulled in about $2 billion in fresh money so far this year. Likewise, despite billions lost on JPEGs of apes and meme stocks like GameStop, a hard core of believers in bets like these continue to “HODL," or hold on for dear life, viewing downturns as brief setbacks.

Dipping a toe back into the most-speculative assets because you believe everyone else has panicked isn’t the sentiment that underpins sustained turnarounds. In May, Google searches for “capitulation" hit their highest since October 2008, the month following the collapse of investment bank Lehman Brothers. The S&P 500 had by then lost a gut-wrenching 38% from its peak a year prior and it seemed like things couldn’t get much worse. They did: The bottom wouldn’t come until early March 2009 after another 31% loss for the index. Even that month, investors yanked billions more from equity mutual funds according to the Investment Company Institute, fearing that they were in yet another suckers’ rally.

Bear markets can be cruel. Following the bursting of the tech bubble in March 2000, the Nasdaq Composite Index had eight rallies over the ensuing two-and-a-half years, averaging more than 30%, that ultimately fizzled. The crash of 1929 was followed by seven bounces over three-and-a-half years, by which time a whole generation had become disgusted with stocks.

Some measures suggest that investors are sufficiently pessimistic today. For example, the Bull-Bear Sentiment Survey from the American Association of Individual Investors registered two of the seven most pessimistic readings in its 35-year history recently and the University of Michigan’s Consumer Sentiment Index hit its all time low last month.

But a lot of that has to do with the shock of record gasoline prices and scary geopolitical headlines. Stocks’ peak-to-trough drop of 23% scarcely qualified as an official bear market and the previous one, when Covid-19 surfaced in 2020, wasn’t typical. It was the shortest on record by far as central banks and governments unleashed massive stimulus. Stocks didn’t merely bounce back in record time—the best bets were the lowest quality ones. A Goldman Sachs index of unprofitable technology companies jumped by an eye-watering 423% in the 11 months following the March bear market bottom.

Not just that episode but the mostly happy experience of the past 13 years have set individual investors up for what could be sharp disappointment. The thinking goes that the Federal Reserve will soon see the error of its ways and reverse course, setting off a rally. There is a fear of missing out on that rebound and a sense that stocks have become cheap, according to Chris Senyek, chief investment strategist at Wolfe Research.

“Investors only know the quantitative easing and low interest rate environment," he says. “They have very much been conditioned to buy the dip."

One measure that does say “capitulation," complete with a financial news headline this past week using that word, is a closely watched measure of professional investor sentiment. Bank of America’s monthly fund manager survey shows the highest percentage who claimed to be taking lower-than-normal risk since October 2008.

But extreme pessimism by pros back then gave no clue to how distant the bottom still was. A framework developed in the late 1990s by analysts at fund manager GMO tries to. Their “Comfort Model," based on more than 100 years of data, explains with remarkable precision how relaxed investors are paying a high multiple for stocks based on profits and the economy. The upshot? The market’s price-to-earnings ratio at the end of June was still about 50% higher than it should be.

Calling a market bottom obviously is more art than science. Russell Napier, whose 2005 book “Anatomy of the Bear" studied 70,000 articles from The Wall Street Journal two months before and after four major market bottoms, debunks the notion that it is objectively darkest before the dawn. There typically is some good news—it just isn’t featured prominently, and most investors are too scared to act on it.

Guessing the exact start of a new bull market might be a fascinating intellectual exercise, but it is nearly impossible and not a great idea financially to try. Instead, buy in early rather than late, or ideally both. For those wondering if the bottom is in, though, Ms. Wood’s enduring popularity is a sign that it probably isn’t. Her funds are often compared with tech bubble highflier Janus Twenty, which at one point was taking in an incredible 70 cents of every dollar invested in U.S. mutual funds. More incredibly, its manager Scott Schoelzel asked for the fund to be closed to new investors in 1999, saving potential clients billions of dollars when the fund erased years of gains.

And Mr. Schoelzel? He stuck around until near the peak of the next bull market and then rode off into the sunset, managing family money and living on a farm in Colorado.

This story has been published from a wire agency feed without modifications to the text

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