While it is logical that markets are complex, the reality is that the level of complexity changes over time. The level of complexity started to increase last year when now former Fed Chairman Ben Bernanke first introduced the idea of what has come to be called tapering.
It was at that point that bonds stopped being a one way trade but domestic equities kept on as a one way trade. The start of 2014 has seen complexity and uncertainty increase relative to 2013. Markets appear to be under the impression that the Fed is closer to the end of asset purchases and closer to the end of zero percent interest rates.
If equity prices were indeed propped up by Fed policy as many believe then when that Fed policy ends or markets start to see when it could end then markets will learn the extent prices were propped.
This raises many questions. Domestic equities obviously have made new highs but have done so without hoped for levels recovery in jobs, housing and GDP. All three have improved of course but less than was expected and US debt is now $17 trillion, up from $14 trillion at the onset of the financial crisis according to the US treasury.
A popular topic in the financial blogosphere has been whether or not there would ever be a consequence for borrowing so much money to pay for a lackluster recovery. While that remains to be seen, if there will be a consequence then logically the country is now closer to it.
The above may read like it has a bearish bias but that is not the way to take it.
No matter what is going on in markets there is always a bear case and there is always a bull case. This is a crucial point. Everyone knows the cliche of markets climbing a wall of worry which put another way is the market overcoming the bear case to higher prices.
The next bear market might be different in terms of what causes it–the consequences of Fed excess perhaps–but the market action will very likely look like every other bear market. It will probably start slowly over several months, catch people off guard because of the extent to which it starts slowly, it will finish with some sort of fast spike down and it will scare away investors who were emotionally unprepared.
Bear markets and other emotionally challenging declines are a normal part of the cycle. In terms of different ingredients resulting in a repeat of past market declines where this was true for the worst financial crisis in 80 years as President Obama referred to it, it will be true in future bear markets too.
The message of repeated behavior caused by different ingredients can help some if not all clients navigate through the next scary market event.
This article was written by AdvisorShares ETF Strategist Roger Nusbaum.