Sep 27th, 2017
The most unusual bull market
It might have been the least exciting, and the hardest-to-beat bull market, and its crash couldn’t be more anticipated.
Our current, highly durable bull market is characterized by three qualities: it might be the least exciting bull market in history, it’s been possibly one of the hardest to beat, and when it ends, the resultant crash will have been anticipated for months if not years.
We used to have fun
To look at a comparable example it’s not necessary to go back to the days of Tulip Mania in the 17th century. Investment bubbles are always driven by excitement and novelty. The vibrant stories of the roaring 1920s are still very much alive: we can almost hear the jazz, see the dancing, admire the big, powerful cars. It was an era of sudden success that inspired such notable books as The Great Gatsby.
Some thirty years later, we had the Nifty Fifty, when the most popular large-cap stocks on the New York Stock Exchange captured people’s imaginations. Among them were Eastman Kodak, Polaroid, Xerox, and Sears. For a while, you couldn’t go wrong buying those companies: they offered never-ending growth perspectives provided by exciting technological and consumer trends.
More of us remember the internet bubble of the late 1990s. Companies with no revenue, no profit, no real business plan, consisting of little more than an exciting web domain, were reaching billion-dollar valuations. These were the fastest, the most successful IPOs. A short-lived phenomenon, that bubble nevertheless sparked investors’ imaginations. New waves of entrepreneurs got rich overnight, and online trading spread that wealth among day traders who swapped the security of salaries to turn their hard-earned savings into fortunes. A nationwide, even worldwide frenzy took over.
Even more recently came the 2000s housing bubble. You could make an instant fortune flipping homes, condos that could be bought with no money down and no discernible credit. Once again, people quit their jobs to pursue the latest strategy to get rich quick.
What all of those exciting bubbles had in common is the jealous neighbor mentality. It really doesn’t matter what the stocks or homes sell for until your neighbor starts bragging about making a fortune overnight while you are still punching the clock and counting your change carefully at the supermarket.
It’s different this time
But this bubble is not like the previous ones. First of all, the current equity, bond, and real estate bull market -- in the US as well as globally -- has lasted a good deal longer than most. What’s more, while Europe suffered from the debt crisis spreading across Southern Europe, and emerging markets have been buffeted by weak prices in the commodity markets, the US market has had a relatively smooth ride to ever higher highs.
Second of all, because it’s been slow in making, this bull market didn’t create overnight fortunes for many investors, as previous bubbles did. While we’ve experienced one of the biggest dollar and percentage increase in our nation’s net worth, it has gone mostly to those who were already “sitting” on assets: their homes, stocks, retirement accounts, bond portfolios. Obviously, there were those who took advantage of cheap credit and boosted their returns over the last decade, but most of the spoils went to truly passive investors.
Here at Sicart we can’t say we haven’t enjoyed the ride. Many investments that we expected to double in 5 years tripled in 3 instead. We won’t complain – but we can’t take full credit either. The bottom line is that those who held assets and did nothing benefited the most. There was no need to day trade or flip homes. What’s more the process took almost a decade, so the excitement of overnight fortunes never occurred.
Let’s keep the training wheels on
Most of us know how to ride a bicycle, and we learned using “training wheels.” I remember the day and the moment when mine came off. They helped you balance until you knew what you are doing, and soon you were shouting, “Dad, Dad, look! No hands!”
The American and global economy experienced one of the most dramatic recessions in history less than ten years ago. There’s been much discussion about the causes and possible prevention of future events. Our take is simple: if money gets too cheap because of generous monetary policy, and if lending standards are relaxed for political reasons, there is trouble ahead.
To avoid a 1930s-style Great Depression, and taking advantage of all monetary and fiscal might that paper money, central banking, and fractional reserve banking allows for, this country avoided the worst damage by making money even cheaper, and relaxing lending standards even further. Ben Bernanke played the father-figure role: stern but finally relenting. He wasn’t the only one. The federal government played a major role, and so did central banks and governments around the world.
We can look at our economy as that kid learning to ride a bike. But, if I can extend the metaphor, our training wheels are still in place. Mr. Bernanke, as Dad, never got to see the economy free-wheeling on its own. Unfortunately, neither has Janet Yellen, who succeeded Mr. Bernanke. The same experience was shared by almost all key central bankers of the world. Neil Irwin named them appropriately in the title of his book: The Alchemists: Three Central Bankers and a World on Fire. One of the three, Mervyn King took this designation to heart, and called his own book The End of Alchemy: Money, Banking, and the Future of the Global Economy. It is a little bit disturbing to some of us to hear banking compared to magic.
As I wrote this article on September 20th, everyone was holding their breath before Ms.Yellen’s press conference. We all want to know if the training wheels will stay on! A few days later, I think we are still confused about the next steps, and their consequences.
We might be grateful to our wizards for avoiding the next Great Depression, but it is that very assistance that has produced the least exciting bull market on record. And while their policies which might have fixed one problem they have clearly created another.
When is it going to burst?
It’s not only been the most boring bull market, but also the most questioned. As early as mid-April of 2009, the US equity market hit bottom, and hope was seeping back while the huge monetary and fiscal stimulus was underway. At that moment, famous market guru Jim Rogers told Barron’s that he didn’t believe in a U.S. stock recovery.
Shortly afterward, when the European debt crisis sent shock waves across all markets in 2011, a new wave of skeptics surfaced. John Mauldin published Endgame: The End of the Debt Super Cycle and How It Changes Everything. As the title implies, more debt is not a solution, and may cause a massive crisis in the near future.
In 2013, John Mauldin followed up with another great book: Code Red: How to Protect Your Savings From the Coming Crisis. I greatly enjoyed both books and many others published around the time, in part since I share Mauldin’s views. More and cheaper debt will not solve the economy’s problems. Instead it will eventually catch up with us in some ugly way.
Mauldin is far from the only author to take this position. In 2010, A. Gary Shilling authored The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation. In 2012, Richard Duncan wrote The New Depression: The Breakdown of the Paper Money Economy. In 2013, James Turk & John Rubino published The Money Bubble. In 2014, Willem Middelkoop released The Big Reset – War on Gold and the Financial Endgame.
Are we there yet?
The last six months have produced an even wider range of skeptics. Now even the major banks like Goldman Sachs, JP Morgan, Deutsche Bank, and major investors like Howard Marks, Paul Singer, George Soros, Jeffrey Gundlach, Carl Icahn, David Tepper among others, have shared their concerns with the public. Even the legendary Julian Robertson had to join the choir.
What I find most convincing about their opinions is that they are based on their worries about their own fortunes. Thanks to their success, they themselves have become the biggest clients of their own firms.
Actions speak louder than words, and Warren Buffett – who has been cautious about identifying a market “bubble” in recent interviews – has begun accumulating a significant position of uninvested cash. If we’re not in a bubble, why the caution?
Being right and making money
All of the doomsday scenarios, from 2009 until the most recent, are correct. In a world where 2+2=4, we should already have a had a major market crash, and probably a major global recession. The economy would have cleansed itself from excess debt, and we would have started fresh in a more sustainable economic position. It would have been a painful experience to all, no doubt about it. But if the world must choose between less pain earlier or more pain later, there can be no doubt which is the better option. The one unavailable option is total escape.
Nevertheless, for the last decade the logic and common sense that normally undergird the market have been suspended. Monetary policy and fiscal stimulus (which have become intertwined in the last decade) are re-writing the rules and shaping a brave new world --
- without risks
- without economic, market, business, or credit cycles
- where capital can be created by printing presses
- where central banks become huge unfair competitors to private capital, distorting the natural pricing mechanism
Active investors can fall into a trap in a market like this. Benjamin Graham, the father of value investing, famously said, “In the long run the stock market is a weighing machine. In the short run, it is a voting machine.” Active investors (and we count ourselves among them) assume that the market can be irrational at times, but rational in the long run. What if the questionable rationality lasts a decade?
When the math doesn’t work
This least exciting bull market might be also the hardest to beat. Active investors are being outperformed and even the smart, well-funded hedge fund world has struggled in the last few years.
Some reports claim that hedge funds haven’t generated alpha since 2011: a date that coincides with the wave of doomsday-scenario books cited above. In 2016, hedge fund managers as a group earned the least since 2005, which is remarkable in a bull market.
Many big hedge fund managers are shutting down their funds, shrinking their operations or stepping down. Among those falling from hedge fund stardom is John Paulson who brilliantly predicted and benefited from the housing bubble crash. The world’s largest hedge fund, Bridgewater, seems to be also out of sync with the current market.
Sicart won’t try to time this market
We are more of a tortoise than a hare in our investing approach. We build and trim our positions slowly, and take the same approach when it comes to portfolio construction.
Accordingly, at least three steps are necessary in this climate:
First, an honest, diligent, and thorough review of all holdings, followed by the sale of the overleveraged, weakest, or riskiest securities.
Second, a higher-than-usual cash ( or equivalent) position – the US dollar may not be a great store of value over the next hundred years but in the near term, $100 is likely to remain $100.
Third, look into diversifying away from overpriced, overvalued assets through both inverse ETFs (which go up when the specific asset class goes down), and/or precious metal exposure. Gold has been considered a store of value for 5,000 years.
We’d rather err on the side of caution. As Meb Faber in Global Asset Allocation reminds us, most individuals do not have a sufficiently long time to recover from large drawdowns from any one risky asset class. What if they are ALL at all-time highs?
We have focused too much on the last 40 years as a model of what the markets can deliver in the long run. Yet if we expand the study to the last 200 years, passive investing has a very mixed record.
Our leaders want to convince us that they have the power to defy business cycles, outlaw recessions, and wipe out risk premiums. They’d like us to believe we live now in a risk-free, recession-free, ever-growing financial world. We have our doubts.
At Sicart we have a different mandate than risk-seeking, alpha-generating hedge fund investors. They try to maximize returns in the shortest of times, we want to minimize losses in the longest of times. We take care of family fortunes.
Hedge funds open and close, lose all the money, find new clients and start over. In contrast, we are in the business of nurturing family fortunes over generations. We must remain vigilant, disciplined, and conservative.
We are not in the business of making fortunes overnight. Instead, we are in the business of preserving them for as long as possible.
Bogumil Baranowski, September 22nd, 2017
MUSIC: Bensound: A New Beginning.
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.
Photo: Hans Eiskonen