The Dice Man Cometh
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Of all the arguments put forth by market pundits and talking heads about the coming end of the current bull market, the weakest is that it is “long in the tooth.” I get this argument, but it doesn’t make sense. Other bull markets have lasted far longer than this one.
Take 1877-1907 for instance. That one went on for 29 years. More recently, the great bull market of 1982-2000 lasted for 18 years. By comparison, the current bull market is only 10.7 years old – still a relative youngster in historical terms. Is that an argument for going all-in at this point? No, because that would be just as dumb as going all-out, simply based on the age factor.
Bull and bear markets since 1877
Before we get to the full history of bulls and bears, let’s look at the averages. The data prior to WWI is suspect, because the stock market was mostly railroad and steel stocks. The first Ford Model T came in 1908 and didn’t reach full production until about 1912. After cars became widely available, the composition of the stock market broadened out considerably.
Average duration of bull markets since 1877 is 15.1 years.
Average duration of bear markets since 1877 is 10.4 years.
Here’s the full record. (This table is from an article by Jill Mislinski published on AdvisorPerspectives.com, January 2, 2020.)
Why this fascination with the age of the current bull market?
Psychologists say that we’re hard wired to look for patterns, and that includes winning streaks. Streaks are fascinating to us. Home runs in a season, Jeopardy winners and all kinds of stock market streaks, including the number of up days or up weeks in a row, or the duration of a bull market.
With every streak, the “faders” come out to bet against their continuation.
These contrarians can do very well by betting against streaks because most streaks stick close to the historical average, plus or minus the standard deviation of said average. But a skilled contrarian wouldn’t bet against the market just because it was long in the tooth. They might bet against a market that became overbought, but only in the short-term, and only if there was sufficient evidence of excessive bullishness.
But when it comes to streaks of luck, look no further than Las Vegas – specifically, the craps tables at Binion’s Horseshoe Casino. That’s where you’ll find the longest winning streak of all time.
[The following is an excerpt from an article in GamingToday.com from Aug 27, 2002.]
In 1979 Jack Davison set the world record for consecutive passes (winning bets) at the craps table – 34 — without throwing a single craps (a 2 or 12 on the come-out roll). Over the course of one hour and 45 minutes, Hollywood Jack made 34 straight passes, which included about eight 7s and four 11s on the come-out, with the rest point passes. The feat, which has been honored with an entry in the Guinness Book of World Records, still stands and, with odds in the multi billions, will probably remain for many years to come.
He says the 34 straight passes took more than luck.
"The key is getting to the table limit as fast as you can," Davison says. "You have to play with a certain state of mind, and I have a belief in numerology, that certain numbers come in sequences, which brings more numbers."
He also believes in a positive outlook, that he is there to win and that he will win.
"It starts with the power of concentration, and when I’m in the midst of a run at the table, I’m oblivious to what’s going on around me," he says. "The concentration is almost like a trance, and it can be very draining, it can leave you exhausted."
Davison says, "I became a student of the game, studying with such masters as System Smitty, who was a mathematical genius. But the key has always been having a winning attitude. If you expect to lose, you shouldn’t play."
Davison doesn’t ever expect to lose, but he’s realistic about the whims of Lady Luck.
"Don’t ever buck the odds when they’re against you," he advises. "My personal limit is three in a row. If I have three straight losers, I make a change. You have to be able to ‘clock’ the action — the table, the dice, the shooter — and get a feel of where things are going," he continues. "Once you can do that, you’ve taken the guesswork out of it. Then everything falls into place and runs in your favor.”
Serial run of luck
Hollywood Jack had what statisticians call a, “serial run of luck.” He may believe that his record run was more than luck, but was it? Does having a winning attitude or a penchant for numerology really matter in craps? Was there even a scintilla of skill involved here?
No. It was a serial run of luck, and nothing more.
Furthermore, the gamblers who were betting the “don’t pass” line got wiped out. And the unskilled contrarians who are now betting against the current bull market, based solely on its age, will only be proven right if they happen to be lucky guessers. The odds of making a pass are less than 50-50, otherwise casinos would go broke. The odds of making 34 consecutive passes are astronomical. Hollywood Jack actually did a service for Binion’s and for Las Vegas. His winning streak encouraged countless punters to flock there and try their luck.
Luck and the stock market
Is the stock market just one enormous casino? It can be if you enter with nothing but Lady Luck to guide your decisions. But serious investors put some thought into it, and when they do, they can increase the odds of achieving a positive outcome. I didn’t say they could beat the market or make a ton of money. I said a positive outcome.
Serious investors enter the stock market game with a plan. They know what their objectives are, how much risk they can handle, and most importantly, when and how to play defense. A positive outcome depends as much (or more) on smart defense as it does on good offense. In a bull market like we have now, it’s too easy to mistake luck for skill. Many are tempted to buy into the idea that the current winning streak will continue for years to come, and they could be right.
The odds don’t support this view, though.
Unlike the game of craps, where each roll is an independent event with negative odds of winning, the stock market is linked to corporate earnings and dividend growth, which are in turn linked to the overall health and direction of economic growth. You can’t decouple the stock market from the economy. It just doesn’t work.
Regression to trend (mean reversion)
One of the reasons why market pundits cite the long-in-the-tooth argument when they predict the end of the bull market is the idea of mean reversion. This idea has merit, but not when it’s based solely on the passage of time. The idea has merit because of the nature of stock market returns. The market swings from over- to under-valued states, based primarily on changing economic conditions. During boom times, investors become optimistic and bid up stock prices, often to unsustainable levels.
When the economy is slowing or contracting, pessimistic investors push prices down to levels that are just as extreme. This cycle repeats throughout history. In a purely random environment, like a coin flip or a crap game, mean reversion can also be observed but in a different way. Flip a coin 10 times and you might get 10 heads in a row. Flip the same coin 100 times and the outcome will revert to something closer to 50% heads and 50% tails. That’s mean reversion of a different kind than what we see in the stock market.
While the coin flip or the roll of the dice are independent events, stock market returns are not fully independent. They depend on investor sentiment, which depends on earnings and dividend growth, which depend on economic growth. This dependency leads to mean reversion of a different kind.
It can show up in valuation measures. An overvalued market can become much more overvalued, which is why it doesn’t pay to bet against an expensive market in the short-term, any more than it does to bet against another heads after flipping 10 of them in a row. But it does make sense to bet against an expensive stock market when other dependent variables like earnings revisions, employment trends and interest rates are factored into the calculation.
The chart below shows the tendency of the market to swing from over- to under-valued states over time. As of today, the market is trading at 130% above its long-term trend. Should you get out? Not based on this chart alone. But it should be taken as a note of caution.
(This chart is from the same article by Jill Mislinski.)
Hollywood Jack believed that his skill set had something to do with his historic run at the craps table. It didn’t. His skills as a gambler probably helped him to capitalize on the run by managing his betting strategy and position sizing, but the run itself was created by Lady Luck and her alone.
It’s different when it comes to investing. Skill is very valuable, and it is what separates winners from losers. You don’t need a winning attitude or a PhD in numerology to do well in the stock market. You have to pay attention to things like earnings, employment, inflation, and interest rates.
Don’t buy the long-in-the-tooth argument. And don’t buy the “this time is different” argument.
I’ll leave you with a quote from Buddha. (Gautama Siddharta, the founder of Buddhism, 563-483 B.C.)
“Do not believe in anything simply because you have heard it. Do not believe in anything simply because it is spoken and rumored by many. Do not believe in anything unless it agrees with your own logic and common sense.”
Erik Conley is the former head of equity trading at Northern Trust Co. in Chicago. After a 30-year career in trading and portfolio management, he now runs a nonprofit investor education and advocacy organization called ZenInvestor NFP. His website is www.ZenInvestor.org and you can reach him at [email protected]