Hussman Weekly: The Data-Generating Process
Ultimately, what benefits stocks is a movement from being utterly loathed to being highly desired. Once that has occurred – once stocks are overvalued, overbought, and investors are overbullish, one has to rely on the idea that even more eager investors will enter the fray, and take those shares off the hands of already speculative holders. In general, the data-generating process produces the extreme of an advance exactly at the same time that it produces the highest confidence about the continuation of the advance. It produces the extreme of a decline exactly at the same time that it produces the greatest fear about the continuation of the decline. As a result, the point that investors are most inclined to think about the market in terms of the “trend” is exactly when they should be thinking about the market in terms of the “cycle.”
Keep in mind that the bear-market portion of the market cycle typically wipes out more than half of the gains achieved during the bull-market portion. During “secular” bear market periods, the cyclical bear markets wipe out closer to 80% of the prior bull market advances. Risk-management is very forgiving of missed gains in late-stage bull markets. The lack of risk-management is equally punishing to investors who overstay.