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Where's the Bear?

posted by Adam Levitin

For all of the attention that has been given to the Fearless Girl and Charging Bull statues on Wall Street, I've been marveling at what's missing from the picture:  a bear. It's not just that an ursine addition adds whimsy to virtually everything. It's what its absence says about our market culture. 

The bull, of course, is the symbol of a rising market, the bear, a falling one. And Americans love bulls and hate bears.  When they "do the numbers" on the news (the biggest waste of airtime), it's always a good thing when markets are up, and bad when they're down.  This is idiotic.  We should want market prices to be right, which should mean an indifference between short and long positions.  I love the Fearless Girl statue, but if we're telling a market story, not a gender equality story, then the Charging Bull should be faced off by a Roaring Bear.  

But it's not just our culture that hates bears.  Our regulatory system does too.  Short-sellers are subject to various regulatory impediments in actually executing their positions, but more broadly, certain types of investors lack the ability to go short altogether.  I have a tax-deferred 403(b) retirement plan (sort of a 401(k) for academics).  It's restricted to mutual funds (and functionally means no ETFs).  This means that I lack short investment possibilities altogether.  Instead, I'm forced to go long whether or not I believe in the market.  The pro-long bias in our market is a real problem, because it encourages bubbles.  If we'd start facilitating more shorts, we might end up with a less volatile market because the highs would never get as high, so the crashes wouldn't be as big.  Decreasing such volatility would facilitate business planning and be a really powerful form of consumer protection.  

All of this brings me to a more concrete point: what the hell is going on the stock market right now?  We're in a market that continues to rise and rise without any change in fundamentals. I can't believe that the market is truly banking on some sort of Trump tax break (which will ultimately have ruinous consequences, but that's another matter). I haven't seen any convincing explanation of why the level of the Shiller PE Ratio (just shy right now of Black Tuesday levels) makes sense. I'm all ears, but until then, I think we're in a market-wide stock bubble.  

I don't know what will pop it (or when)--historically bubble tend to burst in the fall, but that's because of harvest-time movements of money; maybe today folks come back from summer vacations with a clearer eye. A piece of me wonders if we're in the Trump Market, a world in which stock prices don't respond to normal pressures, just as Trump got elected while violating every rule of normal politics. Still, I'm not going to bet against a perpetual suspension of gravity. 


A "roaring bear" sculpture? Perhaps the theme would be more accurately reflected by a statue modeled on something like this. https://s-media-cache-ak0.pinimg.com/originals/ea/46/e2/ea46e232230bba98c360ff0ab830d5d1.jpg

I think your statement that you're "forced to go long" shows an interesting behavioral artifact. You almost surely have access to bond funds; but even though you think we're in a "market-wide stock bubble", you feel forced to make your best attempt at a long stock investment, instead of a meager guaranteed return. That's perhaps a demonstration of the same human tendency to optimism ("I think the market is overvalued and will crash, but I still think I can personally achieve returns above the risk-free rate.") that creates the bias against short selling in the first place.

The world is net long. So a long investor's profit might mean that everyone's better off, but a short seller's profit necessarily means that in aggregate, everyone else lost. That probably explains a lot of society's distaste for it, no matter what economists say about the second-order social benefit.

Retail investors can trade options, though. You could go to Fidelity or whoever right now and sell a bunch of puts.

It takes more steps than investing in a mutual fund, which probably does produce a structural pro-long bias. But just because your 403(b) doesn't offer the opportunity to short doesn't mean you "lack the ability to go short altogether."

And I'm actually not sure that making it as easy to short as to go long for a retail investor would ultimately improve consumer welfare. Shorting often incurs higher transaction costs, and most people have no business trying to predict market movements at all, so I'm not sure you improve outcomes by offering people a costlier option to be stupid. And retail investors are, I think, far too ill-informed to contribute anything to price discovery. Just more noise.

What's special about options? Retail investors can sell stocks short too, or buy inverse ETFs, or sell futures. (Also, why would a bearish investor sell puts?)

His complaint is basically that his most tax-efficient account favors long investments, which I think is true--his 403(b) probably allows much greater contributions than any tax-deferred account he could set up on his own.

Even if retail investors were forbidden from anything but a long investment in a broad index, they'd still contribute to price discovery by their choice of when to buy that vs. cash, gold, real estate, fancy cars, etc. If these investors are truly uninformed, and the randomly bullish investors get to express their opinion through their trading and the randomly bearish ones don't, then that sets up a bias.

Sorry, finger-betrayal: obviously, I meant *buy* puts. I was just picking a random example of options available to retail investors for shorting the market.

I don't disagree with the idea that the structure of retirement accounts may produce a pro-long bias (although while people can't short in those accounts, they can choose to allocate their money elsewhere, essentially going flat). That's not precisely what the original post said, though. I do disagree, tentatively, with the idea that encouraging shorting by consumers will improve consumer outcomes, rather than just increasing transaction costs. And if one assumes that retail sentiment is essentially uninformed but not fundamentally random, I don't know how much removing certain constraints on its expression will help with price discovery to compensate.

I could have been clearer. ltk got what I was complaining about. Tax-favored investments don't enable true shorting. I can put my money in a money market mutual fund account, but that's about it. I can't even go with gold, real estate, etc. That really limits price discovery. And this isn't without considering the effect of automatic monthly contributions.

You can trade options in a self directed IRA. There are also inverse ETF's that are short. And they come in a vanilla version, 2x and 3x leveraged. I suppose you have to change employers to move to a self directed IRA.

As far as a bubble, I won't argue the point, but valuations are heavily influenced by the risk free rate benchmark -- for example the 10 year treasury. Which has been quite low for the last 8 years. 2% to 3%, which is a 'real' or after inflation rate of return of not much. http://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart . We live in a world with deflationary pressures. The latest and most impressive example being oil and commodity prices (including basic materials) beginning in 2014.

Most people in the world are lucky if they can save in a stable currency and have a good chance of simply getting their money back. Of the developed economies, the US has done the best since 2008. You probably have some sort of international option if you want to bet on non US economies.

However, I'm sympathetic ... its your money and you should have more freedom to invest as you wish.

@ITK ....

The bubble may be in bonds. Long duration bonds would prove painful if we had interest rates similar to those in the 95 to 2005 period. That leaves short duration options that barely cover inflation.

@Adam ... I am sympathetic. You get a tax break and maybe a matching contribution, so it is almost impossible *not* to invest in your available defined contribution plan.

As far as employer sponsored tax deferred plans -- There is plenty of unconstrained money floating around to facilitate price discovery. In my opinion.

One of the reasons for a bias toward long positions is that a function of capital markets is to actually raise capital. Price discovery is secondary. But I'm old fashioned, I suppose.

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