I saw a post from a financial advisor the other day. You remember the day probably; it was the one where the Dow Jones fell over 1000 points. He was making the point that investors shouldn’t panic, that they should be in for the long haul and how if you take your money out and miss so many days in the market, your returns are nearly cut in half.
I understand the point he was making, and I certainly agree that you can’t panic and sell just because you feel nervous. His point was you should do absolutely nothing and this too shall pass.
That’s ok if you’re under 50 let’s say. But if you’re retired or nearing retirement a market meltdown, especially a prolonged one, could be devastating. Maybe you have lived through several other “adjustments” and don’t think you can do another one at your age. I get it.
I do agree that MOST of the time market movements are totally irrelevant. But at the extremes they can matter a lot.
And today I believe we are at or near an extreme.
It is not business as usual my friends. You should position your portfolio today differently than you normally would. You should be ready for a wide range of outcomes.
The 1,000 point drop on Monday August 5th should be a warning sign. Let me explain:
As an investment firm we pride ourselves on being research-oriented long-term investors. We have owned Berkshire Hathaway and Microsoft through several recessions and it’s likely we will continue to own them through the next one. But, let me ask you this, are you really prepared (I’m speaking to you at or near retirement) to live through another 50, 60, or 70% draw down in your account?
Let me tell you why I believe this.
I am not a predictor or prognosticator. But I am an avid student of financial history. And it’s an understanding of market history that gives you clues about what is ahead. That’s because markets tend to run in cycles.
But as Jeremy Grantham, a value investor just like myself, and a highly experienced market historian has cited. “This is the most vulnerable market in history.” There are several reasons for this.
One, the massive increase in debt that we’ve taken on as a society. John Maynard Keynes told us that taking on debt stimulates an economy. This is true up to a point. Even Keynes pointed out that there are limits. The US debt to GDP ratio has tripled since 1989. One would think that economic growth would triple as well but in fact it has done the opposite. It has slowed. What that tells us, and I believe Keynes would agree if he were pounding the pavement today, is we have lost our ability to work our way out of economic problems. The Federal Reserve is clearly having more difficulty stimulating the economy. The grand experiment is nearing an end.
Secondly, the markets have been juiced by abnormally low interest rates that such an experiment produces. This has in effect pulled forward returns from the future. The US stock market today sells at very near the highest multiple of earnings in history. For a template of what occurs after we can look at Japan.
In 1989 stock prices in Japan neared a record high of 25 times earnings. At the time one would have thought that this would lead to a correction in the market and a return to more normal prices. But it did not, in fact the Japanese stock market would go up another 150%. So, the fact that they were near record highs was not immediately predictive of where their market will move in the near future.
However ultimately you have to pay the piper, and the Nikkei did indeed correct. The Nikkei index would peak in 1990 at just over 38,000 and over the next 13 years the market would fall below 10,000. A 70% drop. It would not touch the previous high until 2024 nearly 34 years later.
Japan would experience stagnant growth for decades. Stimulating the economy by lowering rates did absolutely nothing.
The US may not experience such a historic malfunction but one needs to understand that US investors have been spoiled. Indexes have marched upward with only minor corrections since the lost decade of 1999-2009 . And any correction has been followed by a fast recovery. We’ve all heard “buy the dip,” it’s worked well. Until it doesn’t.
The US market is not a machine where you pump in dollars, and it pumps out 10 or 12% in annual return. Older investors forget and newer ones cannot grasp that your return is not automatic. We’re not anointed because we live in the US to have our 401ks double every 5 or 6 years.
The US stock market today sits at an all-time high, but also at an all-time high valuation. The Shiller PE ratio sits at 36 times earnings and has only been higher once, just before the market crash of 2008-2009.
As Japan tells us high valuation alone doesn’t necessarily mean that a market crash or lost decade lies directly ahead. But understanding that history should be instructive.
And that, dear reader, is why investing is hard. The more you grasp the history of markets and cycles the more you worry about what’s around the corner.
Many of my colleagues and competitors have taken the buy the dip theory. And that’s fine for long term investors. I don’t disagree with it. But I do disagree that today is business as usual.
We are in an unusual place and things are not normal.
As an investment advisor and investor, for over 40 years, I do not believe predicting the market is productive. But one should PREPARE for what might be lying just ahead.
As one of my investment colleagues likes to say “We don’t predict but we do prepare.”
At CSH we are positioning our clients today for the possible lost decade ahead. If you think we are wrong or your investment advisor says, “there’s nothing different here.” I still wish you the best. Maybe it will work out for you in the long run.
If you want to invest away from the crowd, give us a call:
Taylorville (IL) 217-824-4211
Columbia (MO) 573-808-1959
or send me an email at steve@cshinvestments.com.
Thanks for reading this far.
C Steve Henry