Pain Aversion

As the equity market continues to rally, the consensus among investors has called for a 3-5% pullback. Unfortunately for the market bears, “the pain trade remains higher right now.”i There are many who claim that equities are “overbought” or that stocks are “too extended.”ii As market strategist Barry Ritholtz stated, “We find it hard to believe that after hiding under a rock for nearly five years, that a few months of equity inflows means investors have gone from petrified to exuberant. That process in our opinion is a longer arc, not a singular event.”iii Although a market may have pullbacks from time to time, Ritholtz adds “the overbought chatter comes from many investors rationalizing aloud why they are under-invested.”iv If we take some historical perspective, Jeffrey Kleintop of LPL Financial states that the current bull market has legs, as the alternative would suggest that the S&P 500 is topping out at the lowest earnings multiple (roughly 14.5x earnings) of “a bull-market peak since World War II.”v

For the market strategists that try to develop their investment strategy based upon their economic outlook, the “stock market has its own logic,” according to Ned Davis As there is very little correlation between nominal GDP and the S&P 500, stock returns “are largely driven by crowd psychology. And human nature drives the crowd from fear to greed and back.” vii As one analyst put it, “Investors are not risk-averse, they are pain-averse. They fear the pain of losing money and the pain of not making money when others are.”viii Renowned investor Seth Klarman consistently takes advantage of market volatility as he states that "investing is the intersection of economics and psychology." ix When there are gyrations in the market, we have the opportunity to buy something cheaper. Cambria Investment Management has written in the past how “all of the stock market returns occur when the market is already up-trending,” while “the volatility is much higher when the market is declining."x These are all factors that contribute to an investor’s “pain-aversion.”

Although there is a low correlation between the GDP and the stock market, market strategist Dave Rosenberg highlights that a high correlation exists between the Fed balance sheet and the S&P 500. A correlation of “85% is more than 4x what it has been in the past.” xi Historically, Rosenberg adds, when the Fed is easing and the economy is expanding (as we are currently), “the stock market has an 88% chance of being in a bull phase,” in contrast to “periods when the Fed has inverted the yield curve” when the market is in a bear phase.xii He notes how the goal for wealth managers is to deliver the “best anxiety-adjusted returns.” Lastly, some have signaled worries about the impact of rising bond yields on the equity market. Milton Ezrati of Lord Abbett recently wrote, if “bond yields were to rise appreciably, the effect on stocks would likely be muted. Dividend and earnings yields on stocks are relatively so high, from a historical perspective, that a jump in bond yields would more likely adjust the relationship back toward historical norms than affect stock prices.”xiii Overall, the extremes in stock and bond yields suggest that the equity market continues to maintain considerable upside potential.

Pamela Rosenau is Managing Director & Equity Market Strategist at HighTower; Co-Chair of the Steering Committee of HighTower Group Investment Solutions; and Chief Investment Officer of The Rosenau Group. Ms. Rosenau is a macro, visionary, non-consensus thinker that places an emphasis on risk minimization and misunderstood market moving signals. With over 25 years of experience in the financial industry, her tenure in investment management is best reflected in her core strategy which has historically outperformed the S&P 500 benchmark in down markets. Prior to joining HighTower she worked for various sell-side firms beginning her tenure with Wertheim & Co./Schroders Plc. She was recently ranked #15 in Barron’s 2012 Top 100 Women Financial Advisors, and was also chosen for Barron’s 2013 Top 1,000 Advisors list, ranking #42 out of all financial advisors in California.

The Rosenau Group is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, MSRB and SIPC & HighTower Advisors, LLC, a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.

This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of HighTower Advisors, LLC or any of its affiliates. In preparing these materials, we have relied upon and assumed without independent verifications, the accuracy and completeness of all information available from public and internal sources. HighTower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them.

This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. Carefully consider investment objectives, risk factors and charges and expenses before investing.


iStrategas - February 7, 2013.

iiBarry Ritholtz. The Big Picture. February 8, 2013.



vKopin Tan. Barron’s. February 9, 2013.

viNed Davis Research. March 1, 2013.



ixBusiness Insider. Insights from Seth Klarman. February 20, 2013.

xCambria Investment Management. August 2011.

xiDavid Rosenberg. Gluskinsheff. February 12, 2013.


xiiiMilton Ezrati. Lord Abbett. January 31, 2013.

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