After graduating from graduate school and moving to Atlanta, I had my first official “corporate” job at Ernst & Young. Ernst & Young was and continues to be one of the world’s largest global professional services firms. But at that time in 1994, even with an MBA in finance and an undergraduate degree in accounting, it meant that between rent, car payments, food, dry cleaning my suits (remember those days?), parking downtown, student loans, utilities, and the rest of my living expenses, I was living paycheck to paycheck and barely getting by on $32,500/annually. The way I described it back then was, “I’m broke…I got no monies…”
To do activities on the cheap and earn a few extra bucks, I was in a few music bands that would play weekend gigs wherever we could find them. We never really turned down paid gigs. In hindsight, we should have screened a bit more carefully on a few of our jobs. That’s what desperation does to you.
For instance, we were playing at a bar one night, and they set us up on a stage behind some chicken wire. Alarm bells should have been going off, but I was young and naïve. I don’t drink and never really hung out in bars. About an hour into the set, I quickly realized what the chicken wire was for. It was for the band’s protection. Drunk patrons have a history of questionable behavior that isn’t limited to local Atlanta bars.
The way I would describe it is, “Liquids thrown at you can hurt your feelings, but bottles thrown at you can hurt you physically.”
I’m not going to lie, when people booed and yelled at us, it would hurt my feelings. I was there to be happy playing my music while trying to make others happy while they listen to my music, dance, and have a good time. When you become aware that others aren’t liking your offerings, it sucks and it’s hard not to take it personally.
I’m experiencing similar situations in my wealth management practice nearly three decades later. Things started getting insanely nutty in financial markets back in 2016. As the years passed by, market conditions for investing didn’t get better, market conditions got worse. Much worse. Economic distortions were everywhere. Debt was growing at unsustainable clips while global interest rates were driven to zero and below. Valuations became utterly detached from corporate earnings.
There I was, writing article after article warning people that we were in a bubble, and warning that when bubbles pop, people get hurt. I believed I was acting as a true fiduciary, protecting clients and others from financial harm and warning people to be alert. But, that didn’t stop many people from booing and yelling at me. Telling people things that they didn’t want to hear isn’t easy, but I did what I felt was suitable as a trusted financial advisor.
Very few people wanted to hear any of those warnings. They all thought it was nonsense. Many thought I had a screw loose and was a “Debbie-Downer.” People wanted to believe in the illusions of wealth. People wanted to believe in get-rich-quick schemes. Billions of dollars flooded into crypto, SPAC’s, meme stocks, tech stocks, crazy real estate projects, venture capital, private equity, ETF’s like ARKK, stock options. Kids wanted to brag about how they were making gains using Robinhood.
I’ve received some pretty disappointing emails, phone calls, and text messages over the past few years as investors shunned my message and told me I was crazy (amongst others things). Those words were like liquids being thrown at me back when playing in the band. They hurt my feelings.
But now that markets have cracked and people are losing real money, big money, and hard-core savings, the bottles are coming out. It’s time for the chicken wire. People are angry. People are stressed. People are worried. People are scared. Some are freaking out.
And here’s the scary part…
Mathematically, we aren’t even close to a bottom in financial markets. There’s still a long way to go.
How long will it take to get there? How many bounces will occur along the way? How low will it go?
Nobody can answer these questions with precision or absolute certainty. We can only rely on history, math, and probabilities to make good decisions with our hard-earned savings.
But if I were you, I’d find some chicken wire if you are around others who are losing big money in these markets. Human behavior can be shockingly bad at times.
Are We Close To A Bottom Yet?
The top question that I’m getting from investors recently is along the lines of these questions;
- Are we close to a bottom?
- Should we be buying now that markets are low?
- Is the bear market over?
To begin with, we welcome bear markets from a value investors’ perspective. It’s a lot easier to buy low in bear markets than it is in bull markets and certainly easier to buy low than when we are in extreme bubble markets. Our main objective is to buy good investments at good prices.
I want to start out by sharing something from Ben Carlson from “A Wealth of Common Sense.” Ben put together this snapshot that shows all the bear markets since 1950. The average bear market took 338 days to go from the peak to trough and the average decline was 30.2%. I remind you, that these are the average bear markets. These average bear markets took place in more moderate financial conditions that did not exhibit runaway bubble extremes prior to their respective bear markets.
We can see the number of days from peak to trough was longer than average after the tech bubble and the global economic meltdown from 2007 to 2009 (both previous bubbles).
(Source: Ben Carlson of “A Wealth Of Common Sense”)
For calendar anchor points, we can use the following if these turn out to be the peaks on the relative indexes;
- Dow peaked on January 5, 2022 at 36,952.65
- S&P 500 peaked on January 4, 2022 at 4,818.62
- NASDAQ peaked on November 22, 2021 at 16,212.23
So here is where we are today on May 11, 2022:
If we look at the number of days that have passed since the peak, we aren’t even halfway to the long-term average of bear markets.
If we look at the % decline on the major indexes, we are maybe halfway there compared to a “run of the mill average bear market.” (I don’t believe that we are going into a run of the mill average bear market…)
Based on history, the numbers don’t point to a bottom. This is especially true when compared against “average bear markets,” versus bubble bursting bear markets like we are most likely in presently.
Thus, it’s possible that we could put in a low and that the market starts going back up to set new all-time highs. It’s possible. It’s just not probable based on this analysis.
Valuations
Beyond looking at the recent decline in terms of the number of days since the peak and the % decline since then, it’s also essential to know where we are compared to historical valuations.
Average of the Four Valuation Indicators
(Source: Jill Mislinski of Advisor Perspectives)
The above is where we are now on U.S. equity valuations as of the end of April 2022. The data goes back over 120 years of modern financial market history. The above chart shows zones based on standard deviations from the historical mean. We know that markets usually trade within 1 standard deviation from the mean. The only times that we went beyond 1 standard deviation was in 1929 prior to the Great Depression, in the late 1990’s during the frenzy of the tech bubble, and in the mid-2000’s prior to the Global Financial Meltdown. (This is only the fourth time ever that we have been above 2 standard deviations above the mean).
We also know from history that we have come back into the 1 standard deviation mean the previous times that we’ve been in bubble territory.
As you can see from the above, the average of the four valuation metrics stood at 150% above the mean at the end of April 2022. That means that we were still higher than the absolute peak of the tech bubble in the late 1990s. I remind you that during the tech bubble’s collapse, the NASDAQ 100 came down an impressive 82% from its peak.
Regression To Trend
(Source: Jill Mislinski of Advisor Perspectives)
One certainty in the stock market is that, over the long haul, overperformance turns into underperformance and vice versa. We’ve been on a multiple year run where the markets undeservingly over-performed based on underlying economic data and corporate earnings. The above chart which shows a regression to trend line clearly indicates that we’ve never seen extreme valuations and deviations this high before. We are in unchartered territory. We have a long way to go to get back to baseline trend.
The Buffett Indicator/Corporate Equities to GDP
Another useful valuation indicator is the Market Cap to GDP. It is a long-term valuation indicator made popular by Warren Buffett who previously stated that, “It is probably the best single measure of where valuations stand at any given moment.” Below is where we are on a Market Cap to GDP basis;
(Source: Jill Mislinski of Advisor Perspectives)
Blowups Galore
We are certainly seeing many examples of financial blowups in the markets all around us.
Crypto fans are having a really bad week (again) as the third largest stable coin has now collapsed. LUNA peaked at over $115 last month and had a $40 Billion market cap. It collapsed 95% one day and then another 99% overnight and was priced at $0.03 (three pennies as I am writing this). This is “EXHIBIT A of fragile wealth that was just an illusion.” It is becoming more and more clear that crypto hasn’t been a source of anti-fragile wealth over the past few quarters.
More random examples of fragile wealth from our current financial bubble bursting (shown from behind the chicken wire!)
AMC Stock (Ticker: “AMC”)
ARK Innovation ETF (Ticker: “ARKK”)
Coinbase Global Inc. (Ticker; “COIN”)
Netflix (Ticker: “NFLX”)
Beyond Meat (Ticker: “BYND”)
Beyond Meat, the previous darling of Wall Street in 2019 is now down about 90% from the peak value in 2019. These are catastrophic losses that remind me of math realities.
Do you know what a 90% loss is? It’s an 80% loss that fell another 50%.
Let’s go through a math example with Beyond Meat. Let’s say you were one of the investors who got sucked up into the hype of the stock at the peak in 2019 when it reached a price of $239.71. Pretend you invested $100,000 into the stock at the peak.
Now imagine that the stock fell 80% in value. An 80% drop would mean that your $100,000 investment is now down to $20,000.
Now let’s pretend that another investor was convinced that the bottom was in and they wanted to “buy the dip” (A really huge dip of course). So they invested invested $20,000 after the stock was down 80%. Now you and the new investor both have $20,000 invested in Beyond Meat.
Now the stock drops another 50%. Your $20,000 and the new investor’s $20,000 are cut in half by the 50% decline leaving you both with $10,000 worth of Beyond Meat stock. The second investor is down 50% from when they invested $20,000. But your $20,000 also came down another 50% to bring you down to $10,000. But remember, you originally invested $100,000 into Beyond Meat (which is now worth only $10,000.)
Your Beyond Meat stock is now down 90% after falling 80% followed by another 50% loss from that point.
Math is crazy.
Remember…Hide behind the chicken wire when talking about these things because people are haters especially when they are losing their money.
Retail Investors Continue To Buy The Dips
Wall Street Firms refer to retail investors (small individual investors) as “the dumb money.” Wall Street Firms know that the most emotionally driven investors are small individual investors who chase hot money, buy at high prices and then sell in panic at low prices. Rinse and repeat as cycles do their thing.
We are seeing signs that this is true even today. TD Ameritrade is confirming that their retail investors continue to buy the dips.
This could have tragic consequences for thousands (perhaps millions) of small individual investors.
“In bull markets, buying the dips is a ticket to heaven.
In bear markets, buying the dips is a ticket to hell.”
Paul Kindzia
Rip Your Face Off Rallies
One thing that I will try hard over the next few months and quarters is to remind investors that the strongest “rip your face off rallies” happen in bear markets. In bear markets, sell-offs can be violent and sudden. Investors all head for the exits at the same time which creates sudden down drafts in the markets.
But eventually markets become short-term over-sold. Trader’s jump back in and remarkable rallies take place. These rallies give investors a false sense of security. Not only do they make you feel like you are missing out on easy gains, they make you feel like the bottom is in. But in bear markets, the rallies fade as the traders sell the rip higher. The market then rolls over again and goes on to make lower lows.
Keep an eye out for these rip your face off rallies during a bear market.
The Challenge Today
The challenge today is that we can’t invent the world we live in nor the market conditions in the present. We must play the cards dealt to us. But that doesn’t mean you bet the pot regardless of the cards you were dealt. Instead, you bet based upon the probabilities of winning (and protecting your stack when the probabilities of loss are significant.)
Markets move in cycles. Valuations move from high to low points and back again. The proven principle of success is to buy low and sell high. One of the proven principles of success over the long-term is NOT to “buy high and endlessly hope that another sucker will come along to pay us an even higher price.” But that is exactly what investors did over the last few years in this bubble market.
Many investors are under the illusion that they will just sell out when it counts. The question at that point will be, “Sell to who?” Somebody must hold every single share of stock in existence at all times. That’s why prices in stocks can drop far faster during bear markets than people anticipate. When the speculators disappear (or get margin calls forcing them into being forced sellers,) there aren’t any willing buyers at extreme prices. The investors who eventually come in to save the day are the value investors who want to buy quality assets at good prices (or even reasonable prices). The difference between today’s prices and reasonable prices is rather significant.
Does anybody know how all of this is going to play out? Does anybody know the exact timing that the valuations reset? Does anybody know how the systematic risks in the markets will alleviate themselves? The answer to these questions is, “No.” Nobody knows the short-term future.”
Prudent and anti-fragile investors should be wise enough to know that market conditions constantly change and evolve. What is over-priced today can become under-priced tomorrow.
During a transition from bull to bear markets, many investors will rush the process. They will want to leap back in, buy dips, and believe that the bottom must be in since markets or their stocks are down a certain amount.
However, that wouldn’t be making good decisions based on building anti-fragile wealth. History provides us with financial metrics for comparison. Our objective is to make good decisions over a lifetime and do this consistently. Knowing that markets are still very over-valued DOES NOT MEAN that they will drop in a period that we decide is appropriate. Markets act on their terms.
We will never be able to time the absolute bottom when it does arrive. We know through history and the behaviors of humans that bottoms come when fear and disgust have reached their maximum pain points. Investors will talk about how dumb investing is, how the stock market is a loser’s game and how you would have to be a moron to put your hard-earned savings in the stock market.
I don’t believe we are anywhere close to being there yet. Patience will be critical no matter how hard it will be to be patient.
The Good News
We know from market history that when markets do the nutty things they are doing now, it ends poorly for investors that ignore all success principles when it comes to investing. However, it doesn’t mean that investors are stuck without options for the next decade. Sure, the outlook for U.S. stocks over the next 10-12 years looks very bleak IF YOU WERE TO BUY AND OWN AT THE PRESENT LEVELS. But things change as time progresses. Prices and valuations adjust over time, even if that seems like forever forcing you to lose patience with rational logic. As cycles proceed, good assets get repriced lower giving those with cash to deploy excellent opportunities to earn impressive rates of returns with outstanding probabilities.
We will be ready, willing, and able to deploy cash when favorable probabilities and prices eventually present themselves. For those with cash, bear markets are welcomed events.