“This Time It’s Different”

A quote said thousands and thousands of times. Maybe one day it will come true. When the sun explodes.

Bonds were always going to correlate with stocks when interest rates rose—especially if/when rates rose a lot in a hurry. The fiction that bonds are an effective hedge against sudden equity declines has now decimated yet another generation of so-called “conservative” investors—who had, of course, meanwhile been lengthening maturities and trading down in quality because there was no yield at the short end.

Gold once again found a way to break the hearts of fresh legions of amateurs, moving their lips as they mumbled once again gold’s siren call, “Inflation means the dollar must lose value means gold must go up.” Surprise! The explosion in inflation which was supposed to tank the dollar set off such terror that the world panicked into the greenback as the ultimate (if not only) safe haven. And gold as I write is almost lower than it was last Thanksgiving. (Is my schadenfreude showing?)

Which brings us, finally, to cryptocurrency. Readers will know that I haven’t followed the crypto phenomenon closely—it lost me completely when they started trading joke coins with pictures of dogs on them—so, as Will Rogers famously observed, “I only know what I read in the papers.”

Specifically, I’m informed that a trillion dollars of cryptocurrency “value” has been wiped out in the last few months (WSJ); two trillion in the week to Friday the Thirteenth (!) of May (NY Times); one trillion in just 24 hours that week, as a “stablecoin” allegedly pegged to the dollar traded at 23 cents (WSJ again). These numerical snippets, even absent the details, were more than enough to render me speechless with happiness.

Of the smorgasbord of “alternatives” (hedge funds, private equity, secured notes, SPACs, NFTs and heaven only knows what else—“ideas” that run the entire gamut from silly to hateful), I can claim no specific knowledge. The carnage is said to be catastrophic. One certainly hopes so.

Meanwhile, we mainstream equity investors can only be watching all this with a certain bemused detachment.

Our core portfolio is in orbit around the S&P 500—such that for these purposes I use that Index as a proxy—then as I write—we’re down about 13% on the year and counting.

This follows, as I insist on reminding you, 12 years less two months of 17.6% annual compounding.

Let me remind you that the average intra-year drawdown from 1980 on has been 14.0%. So far, in other words, this temporary decline seems to us just a tad or two below average.

While, when we look out the window, it’s like the last day in Pompeii out there.

In sum, I believe:

1. The lost decade 2000–2009, bookended by two episodes in which the S&P 500 halved, put at least one and possibly two generations of Americans off mainstream equities.
2. Equities remained in net liquidation by the American household for ten years following the 2009 trough. Inevitably, this massive generational shunning empowered one of the greatest bull markets of all time.
3. Notably, when FOMO finally returned, it didn’t express itself across mainstream equities. To the extent that it was attracted to public companies at all, FOMO confined itself to the FAANGs and a relatively few unicorn IPOs.
4. But most of the FOMO impulse manifested in “alternative investments.” (Even that phrase speaks volumes: imagine an entire asset class marching proudly under the banner of what it is not.)
5. The more ridiculous—or perhaps just less comprehensible—these vehicles became, the more they went up in price. Even the greatest global public health crisis in a hundred years could not derail them; indeed, several manias grew even more intense throughout the pandemic.
6. Then inflation suddenly exploded, interest rates shot up, and the bubble popped. At this writing (see “stablecoin,” above) the capitulation seems to be ongoing.

Meanwhile, back here on Planet Earth, a couple of interesting developments—alternately ignored and pooh-poohed by the financial media—have quietly been taking place:

1. Forward earnings estimates for mainstream equities have continued, all but counterintuitively, to rise. (Don’t they know we’re in a horrendous recession?!?! It’s been in all the papers!)
2. As the market has declined, the 12-month-forward P/E of the Index has collapsed by nearly a third, to about its 10-year average.

Today, to the very limited extent they even acknowledge the spectacular collapse in mainstream valuations, the media are shrieking “Still not cheap!” Heaven forbid you should ever start feeling even a little bit comfortable about putting some cash to work in a reasonably valued market.

Because then you’d begin succeeding as an investor, and that journalism cannot allow.

I’m not saying any of this—however you define “this”—is over. I most strenuously am not saying that the equity market has bottomed, or soon will. I would have no basis for such a call, as that would require me to know:

1. The future paths of both inflation and interest rates.
2. Whether a recession is taking/will take place, and if so how deep and long it will be.
3. What said recession would do to corporate earnings.
4. How the equity market would or would not react to (1) through (3).

I know none of these things. (No shame in this; neither does anyone else.) Moreover, they are all perfectly irrelevant to our investment policy, which is centered on a steadfast refusal to interrupt unnecessarily the compounding of our equity portfolio.

The equity market is going to go down as much and as long as it needs to. (Unless of course it already has by the time you read this.) The longer and deeper it goes down, the more dynamic the ensuing advance. This is virtually a law of nature. It would take a paranoid schizophrenic or a financial journalist to believe in a W-shaped recovery, much less an L-shaped recovery.

Recession is the mother of all known unknowns. And “everybody” is mortally terrified of it. But it’s never the known unknown that gets you. And “everybody” is never, ever right.

Once you start thinking along these lines, you may decide that the real risk here isn’t being in the next 20% decline.

It’s being out of the next 100% advance. (And again: remember that the last time we beat inflation in 1982, it powered a 300% advance!)