There is an argument going on these days that future crises will be of shorter
duration than the past, as the central banks have learnt this from 2008 and
they are quite swift in response to a fall in market prices or a panic. The
average length of a bear market was 26 months. However, seeing the speed of
the recovery from March,2020, many people have started to view that future
crises will be more frequent however, less in duration.
Now lets think if we assume the same is true, and actually people who are
claiming this really believe the above thesis, then it means if there is a huge
market fall, they will expect the fall to limited to few months and allocate
much more in the first few falls than they used to do it before. If they really
mean to translate this into action.
Is the market really changed? Talking about statistics it has a good
tendency to fool us. Statistics are good at telling us the properties, Markets
losses are following fat tailed power laws since past 100 years. There is no
change in basic properties. I refer to you a very simple and interesting talk by
Robert Frey. If you understand basic stats- 1929, 13 year bear markets was not
an anomaly its in the behaviour of markets. Speaking in very very basic and
rudimentary sense, Losses (Drawdowns) in markets follow power laws
meaning few infrequent events cause very very huge losses and generally
one can’t say this – “In the past maximum height of a tsunami wave was 100
ft, so I have to protect for 100 ft. No, this means there is high likely chances
next one would be way higher.” Past only tells us about the statistical
properties particularly in extreme events. (Nassim Taleb, Raphael Douday,
Benoit Mandelbrot have done wonderful work in the same)
Now lets return to the argument what people are making, that the duration
of bear markets will be shorter. I am highly skeptical of the same. In no way,
when the market makes the first big fall, I would recommend anyone to go
100% all in one go (Though it depends on the personal circumstances). One
should always be prepared for worse. If for 13 years there was a bear market or
more will you be able to survive? Keeping this in mind one can allocate better not betting his or her personal funds. Its practically useless to think the
duration of bear markets will be shorter, even if you think so allocate a bit
more, but never bet too much on a theory. I may be wrong anytime.
This argument is similar to a famous one going on between Steven Pinker
vs Nassem Taleb, where Pinker claims that risk of wars have reduced as there
has been no war from a long time. It is confusing absence of evidence with
evidence of absence. Taleb calls it the Pinker problem. Just because wars have
reduced never think a small war can’t turn into bigger one. Precaution is
better than cure.
Argha Investment Advisers 