Suddenly – I mean the signs had been everywhere for a long time and “suddenly” doesn’t really apply – the whole house of cards came tumbling down.
This is the transcript from my podcast last Sunday, THE WOLF STREET REPORT:
I just listened to a friend of mine, telling me how he now feels comfortable with his investing skills and his strategies after two years of studying the markets. He retired two years ago, and that’s when for the first time in his life he started paying attention to stocks and bonds. He has stocks and bonds, and he feels really good about his portfolio, he said. There are going to be minor sell-offs in the market, he said, but his portfolio was designed to ride this out without damage.
And he was talking about his future. Clearly, the future success of his portfolio was starting to impact his decision-making today about the future, how, with this additional income from his portfolio, he could do all sorts of things, and the income from his portfolio would pay without sweat for the high costs of living in San Francisco.
This type of story has now become a constant theme. It goes like this: I’m really smart and know what I’m doing and will make money forever, because over the past few years I made money, and everything I touched made money, and now I’m a genius.
I remember feeling that way in 1999. Only this time, it’s a lot bigger and a lot broader, and a lot more leveraged, and a lot more people are involved in it. And all doubts have evaporated.
These kinds of conversations are popping up everywhere. It’s just a casual conversation among geniuses.
I was feeling that way in 1999. The market had taught us to do the craziest things because they made the most profits. Doubts evaporated. Just about everything made money, crazy things made more money, and the craziest things made the mostest. We knew what we were doing. We were self-anointed geniuses.
We had a big pile of “fuck-you money.” That’s the money that allowed you to blow off your boss and give the company you worked for the finger – because you had enough wealth to where you didn’t really need to work. Work was just sort of something you wanted to do but didn’t have to do, because your large income from your bets in the markets would make you more money than you could ever earn working. This “fuck-you money” was an escape hatch to a better place, and it was open and ready for you to wander through.
And other folks had early retirement in mind. And other folks did crazy stuff.
I quit my job at the end of 1995 and without actually meaning to or having planned it, ended up traveling around the world until January 1999, going to over 100 countries, including 25 in Africa [here’s my book about the first part of that journey, mostly in Japan, and how the "Asian girl” got it all started]. For three years, I was living out of a bag, and I had a blast. It was the best thing I’ve ever done. And my “fuck-you money” allowed me to do it. When I finally came back, in February 1999, the bull market was roaring, and everyone in it was a genius.
And people who thought this market was crazy, and who sat it out, were considered pitiful morons.
The conversations in 1999 were eerily like the conversations today. There was the same wise acknowledgment that there would be dips, but so be it, our portfolios and strategies were designed to get us through them without damage. There was the same notion that we have now mastered the future, and that our wealth wasn’t at all staked on highly risky, over-inflated iffy instruments, and that, even if something untoward happened, we could always get out in time.
Then suddenly – and I mean the signs had been everywhere for a long time for all to see and the word “suddenly” doesn’t really apply – the whole house of cards came tumbling down.
The infamous “fuck-you money” evaporated, early retirement plans were shelved, bosses had to be put up with, and life went on. But instead of fun and the aura of genius, people grappled with the loss of everything, and there was a growing sense of humility about these iffy bets that had been taken, and these folks were steeped in pain as dreams went up in smoke.
The Nasdaq, where most of the fun had been had, ended up plunging 78%. For people with leveraged positions and margin debt, the losses could be total. The S&P 500 plunged over 50%.
And after the S&P 500 had barely recovered, it was knocked down again by 55% during the Financial Crisis.
It took a coordinated effort by the major central banks around the world, to the tune of over $10 trillion of money printing and asset buying to bail out those investors, or make those folks immensely rich that were not in the market when the shit hit the fan and still had plenty of liquidity, borrowed or otherwise, to be able to jump in with both feet when the markets bottomed out.
And now the same conversations are back that were had in 1999, the same cock-sure self-confidence about mastering the future, about nothing being able to go wrong because we’re so smart now.
At the same time, the market is more leveraged than ever. Corporate America – that’s your stocks and bonds and loan funds – is more leveraged than ever, with even weak companies being able to pile on debt.
Back in 1999, the exuberance was largely limited to stocks, and focused in particular on what was called tech stocks, which was anything with a “.com” near its name, given that this was the first big bubble of the internet. Hence the word, Dotcom Bubble.
Now the exuberance is everywhere: In the stock market nearly across the board, in the housing market, in the huge credit market that includes bonds of all kinds and leveraged loans and Collateralized Loan Obligations and Mortgage Backed Securities and subprime auto-loan-backed securities, and rent-backed securities, and old bicycle-backed securities, and other credit instruments. And, of course, in the derivatives market. Everyone is chasing yield. Risks don’t exist.
We call it the Everything Bubble for good reasons. In fact, the Dotcom Bubble, as huge and crazy and irrational as it was, pales against the Everything Bubble.
So there are two guiding principles now: One, nothing can go wrong. And two, there are no risks.
And if those two guiding principles fail and things do go wrong and risk suddenly exist and trample on everyone’s dreams, then the third guiding principle kicks in: The Fed will always bail us out.
So I invite you to look at the stock markets where central banks have tried everything in the book to inflate them and bail everyone out, with strategies such as negative interest rates and massive QE.
Turns out, US stock indices, such as the S&P 500, are the exception rather than the rule. Not because American corporations are so much better – far from it – but for other reasons that may no longer apply in the future. And we’ll get there in a moment.
In major markets where stocks are denominated in currencies that are relatively stable against the dollar – such as the euro, the yen, the Chinese renminbi, the pound sterling, and the Canadian dollar – we discover a universe that has been a shitty long-term investment.
Currency matters when we look at other markets, because, for example, the stock market in Venezuela has shot to astronomical highs simply because the currency those stocks are denominated in has totally collapsed due to hyperinflation.
I also exclude from this comparison countries like India whose currency has lost close to 50% against the dollar over the time frame.
So here are the biggest non-US markets denominated in currencies that are relatively stable against the US dollar. Starting with Asia:
In China, the Shanghai composite is now back where it had first been over 12 years ago, and it’s down 53% from its peak in Oct 2007.
Japan’s Nikkei index is back where it had first been in 1986, and is down nearly 50% from the peak in 1989. That was 30 years ago. And the index is also down from two years ago.
In Germany, the DAXK which is comparable in its structure to the S&P 500, is back where it had first been in 1999.
In the UK, stocks reached a new high in May 2018 but have since fallen off. Currently, the index is just 7% above where it had first been in December 1999. So it made 7%, not per year, but over the course of two decades.
The French stock index is back where it had first been in 1999 and is down 24% from its peak in 2000.
Italian stocks are still down 60% from their peak in 2000.
Spanish stocks are down 45% from their peak in 2008 and are below where they’d first been in 1999.
The Canadian stock index, the TSX, is up about 10% from its prior peak in 2008, with a huge plunge in between. So that’s a gain of less than 1% a year. Not even keeping up with inflation.
The entire world as come to invest in the S&P 500 because it was the only big index that was thought to be going anywhere, and this money-flow from around the world has helped inflate it.
But American companies are no better than German or Japanese companies. Far from it. They are, however, very good at financial engineering – which is not a beneficial long-term strategy.
And the fact that the S&P 500 has continued to surge, while nearly all other markets with stable currencies have been shitty, is not proof that this outperformance will just continue in the same manner.
The blind exuberance about stocks and just about all other asset classes in the US tells me that there may not be a lot of eager buyers left to keep inflating every corner of the vast Everything Bubble. Signs of that are already everywhere.
Central banks have not been able to levitate those other stock markets, despite all their efforts. This includes the efforts by the Bank of Japan, whose huge QE program includes buying equities. In the end, there is no cure for a bubble other than unwinding the bubble. And this – as those other stock markets have shown – can take decades of down-trends, where buy-and-hold is a losing strategy, and where lucky market timing is the only thing that works, but where unlucky market timing is profoundly destructive.