Even after last week, it feels as if a lot of people think markets only go up. Buy the dip! Hold on for dear life! Feed the ducks when they’re quacking! Stocks. Bonds. SPACs. Real estate. Commodities. Crypto. $200,000 nonfungible tokens, known as NFTs, with clips of LeBron James. Even GameStop is flying again. The sentiment is: Assets go up; cash is for losers. That hasn’t been a bad bet. The March 2020 Covid insta-bear market quickly returned to an insta-bull market. So how do you know when to jump off the runaway train instead of being run over by one?
I don’t think I’m breaking new ground when I suggest that markets do go down. A lot. I was somewhat new to Wall Street when the crash of 1987 took 22.6% out of the Dow Jones Industrial Average. In retrospect, that’s nothing. A partner at an old-line investment bank once told me that you haven’t seen a real bear market until you’ve lost 90% of your money. . . .
How do these bull bashes end? When the last skeptical buyer finally sees the light and buys into the dream that every car will be electric, that crypto replaces gold and banks, that we overindulge on vertically farmed “plant-based steaks” while streaming “Bridgerton” Season 5 before we hop on an air taxi for our flight to Mars. Those last skeptics (maybe already) convince themselves there’s no longer any downside. And then boom, it’s over.
Bull markets need fuel. When the marginal buyer is done, there are no more greater fools to buy in, no matter how well companies actually perform. The dream is priced in, and firms can only meet, not beat, expectations.
For those lulled by today’s bull market, remember that you own a piece of paper. Low-yielding U.S. Treasury bills and bonds are safe because they are backed by the U.S. government, by cash flow of tax dollars and by the country’s assets (think land, not Fort Knox). Stocks are backed by expectations of future earnings, but if you overpay during periods of high expectations (like today), then your downside is huge. Crypto is backed simply by the faith of those who proclaim it is a store of value. Even art and exotic cars and silly NFT tokens are backed only by faith the wealthy will overpay for uniqueness. Faith becomes scarce when the selling starts.
I think we’re overdue for a big drop, but I tend to expect a crash too soon, and as a friend once told me, don’t scorn bubbles, you make your money in the bubbles. Well, sometimes. . . .