Terry Burnham on the crazy things people believe at market tops

Terry Burnham wrote the excellent book, “Mean Markets and Lizard Brains” in 2008 where he pointed out the behavioral biases that make most people perfectly inclined for repeated financial demise when investing. In this clip he advances a bold call on why he believes Dow 5000 is a probable outcome in the not too distant future. Here is a direct link.

Of course there is no certainty in any prediction, and the other long-always manager and CNBC hosts in this clip have an understandable urge to dismiss his comments as unbelievable. After all none of them have any strategy other than buy and hope; so they have no tools or method to protect capital from declines or respond tactically to the opportunities that always present over every full market cycle. It is understandable then that they cannot consider the potential downside and have to dismiss such thoughts as crazy. And a 75% decline in the Dow is no doubt huge. Our own downside thesis is for the probability of at least one more 50% decline (ala 2001-02 and 2008-09) before this secular bear in stocks completes, but we are open to a range of outcomes and will take evidence as it presents.

That said, the points Burnham makes here about the mirage of the present free money policies today are all very rational. Other market bubbles including the Nikkei, the tech bubble in 2000, the Dow in 1929, Chinese stocks from 2006 and commodity prices after 2008–all saw prices fall more than 70% before the necessary process of mean reversion was complete. So to suggest that this type of downside again in the Dow is impossible or a doomsday prediction is naive or ignorant at best. As Burnham points out, previous declines of this magnitude in over-levered asset prices certainly did not bring the end of civilization or capitalism. Much to the contrary, price discovery at the end of asset bubbles is the historical norm not the outlier. The implosion of leverage finally reveals investment value and restores free market forces that then bring organic and sustainable growth cycles back to the economy.

We don’t have to be doomsday or naive victims today. We can understand the history of market cycles and resolve to exercise discipline in our financial habits and responses. Doing so, is the opposite of crazy. Sticking our head in the sand, or believing that market conditions today are normal, organic, or sustainable, or that Central Bankers can control them indefinitely–now that is crazy.

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