The Fallacy of the ‘Broken Clock’ and the Art of Contrarianism

Traders work on the floor of the New York Stock Exchange in New York City on March 30, 2022. (Michael M. Santiago/Getty Images)

Commentary 

It gets stated that “bears are like a ‘broken clock,’ they are right twice a day.” While it may seem true during a rising bull market, the reality is that the “broken clock syndrome” owns both “bulls” and “bears.”

The statement exposes the ignorance, or bias, of those making such a claim. If you invert the logic, this becomes clear.

“If ‘bears’ are right twice a day, then ’bulls’ must be wrong twice a day.”

In the game of investing, it is the timing of being “wrong” that is most critical to your long-term goals. As I discussed recently in “The Best Way to Invest,””

“There is a massive difference between AVERAGE and ACTUAL returns on invested capital. Thus, in any given year, the impact of losses destroys the annualized ‘compounding’ effect of money.”

(Source: St. Louis Federal Reserve/Chart by Real Investment Advice)

Bull market cycles are only one-half of the “full market” cycle throughout history. Such is because, during every “bull market” cycle, the markets and economy build up excesses that are then “reverted” during the following “bear market.” In other words, as Sir Issac Newton once stated:

“What goes up must come down.”

(Source: Dr. Robert Shiller/Chart by Real Investment Advice)

Bulls Are Wrong at the Worst Time

Recently, Nick Maggiulli penned an interesting article on “the broken clock.” He noted that Robert Kiyosaki, author of “Rich Dad, Poor Dad,” had predicted a giant stock market crash. Kiyosaki had made incorrect predictions in the past, Nick said:

“But the real tragedy here is that he will be right one day. One day a crash will come, and Kiyosaki will take a victory lap for all to see.

“Will his prior incorrect calls matter? Not at all. You can try to point out his poor track record, but it won’t make a difference. Most people aren’t going to see your reply. But what they will see is his tweet. They will feel the pain from the crash after it happens, and then they will think, ‘Kiyosaki knew it all along.’

“Oh, he got it wrong eight times before? Who cares? He is right now, isn’t he?” Nick is correct. No one will remember the “bears” wrong calls when the crash eventually comes. But where Nick is incorrect is that the same applies to the “bulls.”

Few remember Jim Cramer’s “Top 10-Picks” in March of 2000 or the numerous bullish media analysts who said “buy” all the way down the crash in 2008. No one remembers those wrong calls, but they do remember the “buy” recommendation was correct. Unfortunately, few investors had capital left at that point.

We give Nick a pass because he is young and has not lived through an actual bear market. Anyone who has will tell you that it is not an adventure they care to repeat.

The problem with being “bullish all the time” is that when you are eventually wrong, it comes at the worst possible cost; the destruction of investment capital. While being “bearish all the time” also has a cost, it comes only at the expense of underperforming markets during a bullish phase. A lack of performance is quickly recovered; a loss of capital is not.

While the “bulls” seem to have their way during rising markets, there is a problem overlooked by the consistently bullish media. Over the past 120-years, the market has indeed grown. However, the markets spent 85 percent of that time making up previous losses. The markets spent only 15 percent of the time making new highs.

The importance of this point should not be overlooked. For most investors, their investing “time horizon” only covers one cycle of the market. Suppose you are starting at or near all-time highs. There is a relatively significant possibility you may wind up spending a considerable chunk of your time horizon “getting back to even.”

(Source: Dr. Robert Shiller/Chart by Real Investment Advice)

The Fallacy of the ‘Broken Clock’

I previously quoted John Hussman, who made an excellent point on the importance of understanding the “full market cycle”:

“Put simply, most apparent ‘opportunities’ to obtain investment returns above zero in conventional assets over the coming decade are based on a misunderstanding of valuations, total returns, and historical yield relationships. At current valuations, virtually everything is priced for a decade of zero. The unwinding of these speculative extremes is likely to be chaotic and will likely occur over a shorter horizon than investors imagine. That chaos, driven not by central bank tightening but by an emerging default cycle, will usher in fresh investment opportunities in conventional assets, where presently there are none.

“Looking beyond the near-term, my view is that a ‘permanently high plateau’ is unlikely, and we will instead see a violent unwinding of recent speculative extremes over the completion of the current market cycle, even if central banks ease aggressively, as they did throughout the 2000-2002 and 2007-2009 collapses. The completion of this cycle won’t arrive because central banks suddenly become enlightened enough to abandon their recklessness. It will arrive precisely because they have sustained yield-seeking speculation for too long already; because they have amplified the vulnerability of the debt and equity markets to normal economic fluctuations; and because the consequences of this fragility are now fully baked in the cake.” While John is correct, he is often dismissed because of his “bearish” tone. In my opinion, this is a mistake. However, it is precisely that dismissal that is indicative of the willful blindness to the underlying problems and the inherent disaster to long-term goals that awaits many unwary individuals in the markets currently.

Yes, the markets have corrected somewhat this year, but the majority of the mean-reverting event needed to clear the system has yet to occur.

As I have often stated, I am not bullish or bearish. While my discussions of “risk management,” market conditions, and valuations are often perceived as bearish, with many assuming we are all in cash, such is never the case.

My job as a portfolio manager is simple; invest money in a manner that creates returns on a short-term basis but reduces the possibility of catastrophic losses that wipe out years of growth.

In our view, you should not be “bullish” or “bearish.” While being “right” during the first half of the cycle is important, it is far more critical not to be “wrong” during the second half.

We aren’t sure the second half of the cycle has begun. But if it has, it isn’t too late to make adjustments and consider the consequences of ignoring the potential for a “reversion to the mean.”