Managing Risk Is More Crucial Than Ever Amid Bullish Exuberance, Complacency

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Stocks Analysis by Lance Roberts covering: S&P 500. Read Lance Roberts's latest article on Investing.com

In 2022, we discussed the market’s deviations from long-term growth trends. That discussion centered on Jeremy Grantham’s commentary about market bubbles.All 2-sigma equity bubbles in developed countries have broken back to trend. But before they did, a handful went on to become superbubbles of 3-sigma or greater: in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in housing in the U.S. in 2006 and Japan in 1989.

excess valuations and price deviations from long-term norms are solely a function of investor psychology.More importantly, when valuation metrics are excessive, it is a better measure of ‘investor psychology’ and the manifestation of the ‘greater fool theory.’ Furthermore, extremely low levels of volatility suggest a high level of complacency among investors. Historically, low levels of market volatility tend to reverse suddenly..We can infer psychology from investor behavior. That allows us to understand how risky the market is, even though the direction in which it will head can never be known for certain.We must remember to buy more when attitudes toward the market are cool and less when heated.

Managing risk is far more crucial if you are nearing or have entered retirement. The reason is that your investment horizon is shorter than that of those much younger.There are some simple steps you can take to prepare yourself.Do your research and avoid “confirmation bias.”Diversify your portfolio allocation model to include “safer assets.”Resist getting caught up in “what could have been” or “anchoring” to a past value. Such leads to emotional mistakes.

 

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