The "Exit" Problem

Authored by Lance Roberts via,

Last week, I discussed the issue of “bubbles” in the market. To wit:

“Market bubbles have NOTHING to do with valuations or fundamentals.”


Hold on…don’t start screaming “heretic” and building gallows just yet. Let me explain.


Stock market bubbles are driven by speculation, greed, and emotional biases – therefore valuations and fundamentals are simply a reflection of those emotions.


In other words, bubbles can exist even at times when valuations and fundamentals might argue otherwise. Let me show you a very basic example of what I mean. The chart below is the long-term valuation of the S&P 500 going back to 1871.”

“First, it is important to notice that with the exception of only 1929, 2000 and 2007, every other major market crash occurred with valuations at levels LOWER than they are currently. Secondly, all of these crashes have been the result of things unrelated to valuation levels such as liquidity issues, government actions, monetary policy mistakes, recessions or inflationary spikes.


However, those events were only a catalyst, or trigger, that started the ‘panic for the exits’ by investors.”

Market crashes are an “emotionally” driven imbalance in supply and demand. You will commonly hear that “for every buyer, there must be a seller.” This is absolutely true. The issue becomes at “what price.” What moves prices up and down, in a normal market environment, is the price level at which a buyer and seller complete a transaction.

The problem becomes when the “buyer at a higher price” fails to appear.

The markets function much the same way as yelling “fire” in a theater filled to capacity with only one exit. Those closest to the exit will likely get out safely, but once the “bottleneck” forms, there is an inability to exit before the damage is done.

The “exit” problem is exacerbated when everyone is in the same theater.” 

Dana Lyons observed this last week.

“The percentage households’  financial assets currently invested in stocks has jumped to levels exceeded only by the 2000 bubble.


Updating one of our favorite data series from the Federal Reserve’s latest Z.1 Release, we see that in the 3rd quarter, household and nonprofit’s stock holdings jumped to 36.3% of their total financial assets. This is the highest percentage since 2000. And, in fact, the only time in the history of the data (since 1945) that saw higher household stock investment than now was during the 1999 to 2000 blow-off phase of the dotcom bubble. Perhaps not everyone is in the pool, but it certainly is extremely crowded.”

“Note how stock investment peaked with major tops in 1966, 1968, 1972, 2000 and 2007. Of course, investment will rise merely with the appreciation of the market; however, we also observe disproportionate jumps in investment levels near tops as well. Note the spikes at the 1968 and 1972 tops and, most egregiously, at the 2000 top.


Yes, there is still room to go (less than 6 percentage points now) to reach the bubble highs of 2000. However, one flawed behavioral practice we see time and time again is gauging context and probability based on outlier readings. The fact that we are below the highest reading of all-time in stock investment should not lead one’s primary conclusion to be that there is still plenty of room to go to reach those levels.”

Sitting Closer To The Exit

Howard Marks once stated that being a “contrarian” is tough, lonely and generally right. To wit:

“Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, particularly when momentum invariably makes pro-cyclical actions look correct for a while. (That’s why it’s essential to remember that‘being too far ahead of your time is indistinguishable from being wrong.’)


Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it’s challenging to be a lonely contrarian.”

The problem with being a contrarian is the determination of where in a market cycle the “herd mentality” is operating.

The collective wisdom of market participants is generally “right” during the middle of a market advance but “wrong” at market peaks and troughs.

This is why technical analysis, which is nothing more than the study of “herd psychology,” can be useful at determining the point in the market cycle where betting against the “crowd” can be effective. Being too early, or late, as Howard Marks stated, is the same as being wrong.

The chart below is a historical chart of the S&P 500 index based on QUARTERLY data. Such long-term data is NOT useful for short-term market timing BUT is critically important in not only determining the current price trends of the market but potentially the turning points as well. 

  • The 12-period (3-year) Relative Strength Index (RSI),
  • Bollinger Bands (2 and 3 standard deviations of the 3-year average),
  • CAPE Ratio, and;
  • The percentage deviation above and below the 3-year moving average. 
  • The vertical RED lines denote points where all measures have aligned

While valuation risk is certainly concerning, it is the extreme deviations of other measures to which attention should be paid. When long-term indicators have previously been this overbought, further gains in the market have been hard to achieve. However, the problem comes, as identified by the vertical lines, is understanding when these indicators reverse course. The subsequent “reversions” have not been forgiving.

The chart below brings this idea of reversion into a bit clearer focus. I have overlaid the real, inflation-adjusted, S&P 500 index over the cyclically-adjusted P/E ratio. 

Historically, we find that when both valuations and prices have extended well beyond their intrinsic long-term trendlines, subsequent reversions beyond those trend lines have ensued.

Every. Single. Time.

Importantly, these reversions have wiped out a decade, or more, in investor gains. As noted, if the next correction began in 2018, and ONLY reverts back to the long-term trendline, which historically has never been the case, investors would reset portfolios back to levels not seen since 1997.

Two decades of gains lost.

With everyone crowded into the “ETF Theater,” the “exit” problem should be of serious concern.

“Over the next several weeks, or even months, the markets can certainly extend the current deviations from long-term mean even further. But that is the nature of every bull market peak, and bubble, throughout history as the seeming impervious advance lures the last of the stock market ‘holdouts’ back into the markets.”

Unfortunately, for most investors, they are likely stuck at the very back of the theater.

With sentiment currently at very high levels, combined with low volatility and excess margin debt, all the ingredients necessary for a sharp market reversion are currently present.

Am I sounding an “alarm bell” and calling for the end of the known world? Should you be buying ammo and food? Of course, not.

However, I am suggesting that remaining fully invested in the financial markets without a thorough understanding of your “risk exposure” will likely not have the desired end result you have been promised.

As I stated often, my job is to participate in the markets while keeping a measured approach to capital preservation. Since it is considered “bearish” to point out the potential “risks” that could lead to rapid capital destruction; then I guess you can call me a “bear.” 

Just make sure you understand I am still in “theater,” I am just moving much closer to the “exit.”


EscondidoSurfer Mon, 12/11/2017 - 12:57 Permalink

I am creeping out the exit, just not sure about the safe theater to enter. PMIs appear logical, but after what FDR did to gold, I cannot consider them a safe investment. 

crazybob369 EscondidoSurfer Mon, 12/11/2017 - 13:16 Permalink

A concern, but not probable. The Gov will go after the low hanging fruit, if it comes to that. And that fruit is not PM's (easy to hide, hard to find), that fruit would be IRA's and 401ks. They could simply mandate that those be converted into Gov Bonds and faster than you can say "changeo, presto" the gov has your money and you have an IOU. There was a bill a couple of years back to do just that. Not sure if it ever made it, or got attached to some other bill, but I'm betting it's in there some place.

In reply to by EscondidoSurfer

Righttoarmbears EscondidoSurfer Mon, 12/11/2017 - 13:38 Permalink

there is no safe exit, the people in power have spent most of their time since the WWII ensuring that every loop hole of financial freedom is closed unless you are rich enough to afford a guide to show you the ways around the financial labyrinth. or willing to go and live in a free but unstable country, bitcoin is on borrowed time and any other alternative to their game will be shut down. the house always wins!

In reply to by EscondidoSurfer

Righttoarmbears 83_vf_1100_c Mon, 12/11/2017 - 14:05 Permalink

they are watching that sort of behaviour in just about every country, in NZ it is illegal to buy a wood burning stove that can be completely shut down to stop pollution, it must have a minimum air flow for burning unless you have a lifestyle plot = over 2 hectares. and that has to be on a register!! i believe in parts of the US it is now illegal to buy certain wood-burning stoves and to be fully self sufficient for power and water! no joke. 

In reply to by 83_vf_1100_c

WatchingRomeBurn Mon, 12/11/2017 - 13:11 Permalink

Exit to what? The singularity already happened its all fake and there is no where to run! The black cube has won again, this time we used glass and steal instead of stone and bone. There is no future, all hope is dead 

Snaffew Mon, 12/11/2017 - 13:13 Permalink

it looks like a melt up going into the fed hike followed by a blow off top right after the announcement, and hopefully a strong reversal.  One can dream...

Blankfuck Mon, 12/11/2017 - 13:16 Permalink

The fed reserve fuckers have a plan. Keep the ponzi going and banksters rich. Let the poor ones pay the interest on trillions of debt owed 

Righttoarmbears Mon, 12/11/2017 - 13:24 Permalink

Bubbles used to be driven by all of the above, but this time it is different for all the wrong reasons, don't think you can apply historic data to the current situation as some of the primary inputs are different. firstly QE/QE2, the buying/propping up of ever more risky bonds and securities and just the shear volume of money that has been magicked from thin air means that currency of any major central bank is now worth in real terms about half of what is was prior to 2007-8! so if a stock is double what it was is that over valued? and with the ever diminishing returns on savings and the banks traditional business model, combined with algorithms doing most of the significant trades this ever rising market may well carry on, i honestly believe that all of the primary governments of the world know how bad things are, but have become financial prisoners of their respective central banks hubris and haven't got a fucking clue how to solve it, but are way to scared to find out what is on the other side, if they stop playing the Rothschild's game. Think some have a good idea of what is to come if a correction is allowed to play out fully, and it will probably make Venezuela look like utopia.

khakuda Righttoarmbears Mon, 12/11/2017 - 13:43 Permalink

Nice point. I have said all along that excessive gains in stocks is not about business or economic fundamentals, it is all about the destruction of the purchasing power of currency by excessive printing and sub inflation rates set by fiat. This bubble is the bubble in fiat currency and central bank PhD geeks with formulas.

They are hoping to stoke large real world inflation to debase the debt. It will come, as it did in Venezuela. The problemis that they created so much new deb in the process, it will be hard to avoid outright defaults and leveraged financial systems can't survive defaults.

In reply to by Righttoarmbears

khakuda Righttoarmbears Mon, 12/11/2017 - 14:11 Permalink

Because the negative results, outside the enormous increase in the wealth divide, have yet to be seen overtly. It has in appearance all been a free lunch so far. We hear very little about pension plan devastation, retirees burning their seed corn, malinvestment or the fact that a money printing central bank takes the limits off politicians overspending. There are no bond vigilantes to reign in deficits because there is no bond market as the Fed monetized the spending. With a central bank rigged bond market, rates don't rise as deficits increase, so there is no limit to government expansion.

I watch the increase in dividends in my stocks as a proxy for true, sustainable value creation and it is mid single digits. That is what I keep. That is my long term return.

In reply to by Righttoarmbears

crazybob369 Mon, 12/11/2017 - 13:33 Permalink

Back when I was young and stupid (yes, i know, oxymoron), I thought I had an exit strategy for my meager investments, in case the market crashed. I place some stop orders about 30% below the price of my stocks, thinking that this would protect me (like I said, young and stupid). When the collapse finally happened, I smugly patted myself on the back, for my genius foresight, only to discover, to my horror, that most of my stocks (including the quality ones like AAPL, Msft) had been sold at a price much lower than my stops. Even worse, many of them quickly rebounded back above my stop prices, but by then they had already been sold.Lessons learned:1. Never enter your stops into the market with your broker. Your stock will be taken from you.2. The only way to win, is not to play.3. If you choose to play, make sure you know the rules.4. Remember who makes the rules.

TuPhat crazybob369 Mon, 12/11/2017 - 15:38 Permalink

I have had the same problem.  Bought a bond for 5k (I'm not a 1%er) from a broker.  A year later I decided to sell and I got 4,600 for it.  Read the fine print on the contract later and it said the broker could sell the bond to themselves at a price determined by them.  I have stayed away from brokers since then but have been cheated in various other ways.  I'm not even sure the market is like a casino.  I think it is a game designed by the bankers and common people always lose, there is no chance involved.  Your rules are correct, especially number 4.

In reply to by crazybob369