Prepare, Don't Predict
'Love to lose money, hate to make it'... The roundabout approach... The coming 'death spiral'... We're seeing mega-bubble valuations... It's the dot-com bubble all over again... Great businesses, lousy returns... Roundabout thinking...
Editor's note: Our Stansberry Research offices are closed today as our team enjoys some deserved time off and celebrates the holiday season. So we're republishing a missive from regular Friday Digest essayist and Extreme Value and The Ferris Report editor Dan Ferris.
While originally published back in February of this year, we think you'll find the insights – about "roundabout" thinking, lessons from the dot-com bubble, and more – as timely as ever and the kind of long-term, thought-provoking view only Dan can provide. Enjoy...
'You've got to love to lose money, hate to make money, love to lose money, hate to make money'...
It sounds insane, but don't worry. I (Dan Ferris) am not going to tell you it's good to lose money... I'm simply sharing the mantra Chicago grain trader Everett Klipp repeated to himself and his protege many years ago.
Klipp acknowledged that humans tend to think in direct ways, so most of us assume that the goal of investing is to make money on every trade. Klipp wanted to "overcome that humanness about us."
Trader and author Mark Spitznagel uses this same mantra as the opening line in his 2013 book The Dao of Capital: Austrian Investing in a Distorted World.
Spitznagel – a past Stansberry Conference speaker – is best known for founding Universa Investments, a Miami-based hedge fund that champions "the roundabout approach," represented by Klipp's paradoxical mantra. As he explains:
Rather than pursue the direct route of immediate gain, we will seek the difficult and roundabout route of immediate loss, an intermediate step which begets an advantage for greater potential gain.
Other folks might call this "tail risk hedging," but it all means the same thing: accepting regular and small losses – perhaps by holding put options – in exchange for the chance to occasionally make massive returns that more than make up for the losses. It's almost like a lottery ticket, except that guys like Klipp and Spitznagel seem to have dramatically reduced the role of luck over the long term... enough so to make a living at it.
I don't recommend the roundabout approach for human investors...
Most folks just can't pull it off. It requires too much discipline to keep losing and losing, waiting for the day when you'll finally make it all back and more. It's as unnatural an act as jumping out of a fully functioning aircraft (with or without a parachute). It reminds me of stereotypical rich people lighting cigars with burning $100 bills in old movies.
Can you imagine explaining to your spouse that you've found a wonderful way to make money, but that it'll require losing money most of the time, year after year, until one day when the market drops and you can make a fortune?
That'd be an interesting talk in most households...
Just repeat after me, honey, "I love to lose money, hate to make money, love to lose money, hate to make money..." See how easy it is?
Or worse yet, imagine using the roundabout approach for a few years, and then your spouse learns what you've been doing. I bet divorce is statistically higher among novice "roundabout" households.
So don't attempt this at home. I only want you to know that this approach exists, it's hard to do, and that folks like Spitznagel and trader and author Nassim Taleb are well-versed in its ways. So when you hear them talk about the coming horrors for the market and economy, remember that it's their job to prepare themselves and their clients for such events.
Taleb is famous for betting on Black Monday 1987, when the Dow Jones Industrials Average fell more than 22% in one day. Taleb had been buying Eurodollar options for pennies leading up to the crash. When it finally happened, he sold them for $3, $4, $5, or more, sometimes making a hundred or more times his money.
Spitznagel and Taleb also started a roundabout fund called Empirica in 1999 that made a fortune when the dot-com bubble burst. By 2008, Spitznagel and Taleb had formed Universa Investments, which made a $1 billion profit as the greatest financial crisis since the Great Depression unfolded.
While roundabout funds clean up in a crisis, the rest of the time, they lose money and chant softly to themselves, "hate to make money, love to lose money". Again, that's why this approach is ill-advised for most investors. Instead, I recommend focusing on "roundabout thinking" with a different mantra...
Prepare, don't predict...
Taleb was in the news this week suggesting that there's a massive "death spiral" event coming due to uncontrolled government borrowing and spending. At a Universa Investments event on Monday night, Taleb said:
So long as you have Congress keep extending the debt limit and doing deals because they're afraid of the consequences of doing the right thing... eventually you're going to have a debt spiral. And a debt spiral is like a death spiral.
With one phrase, Taleb painted a terrifying picture of what's happening in Washington, D.C. It's simply way too politically difficult to convince enough members of Congress to stop allowing the government to endlessly pile on more debt.
If they make debt reduction a priority – reducing the amount of government spending in the economy – the outcome could easily be a painful recession that would hurt millions of Americans, and politicians don't want the backlash. Yet, allowing debt to continue piling up only makes the inescapable reckoning worse, whenever it might arrive.
Taleb isn't predicting a death spiral will occur at a particular moment. He's just being a good roundabout trader. Thinking about these events is part of his mindset. After all, his most famous book is the 2007 bestseller, The Black Swan: The Impact of the Highly Improbable.
Now, Taleb focuses on the debt market, while I tend to focus more on the stock market. So let me tell you what scares me today. It's not quite a "death spiral," but I do expect it'll end with a crash all the same...
It has been the central theme of my career...
I'm talking about valuation. Valuation is not price. Price is simply how many dollars per share you pay for stocks. Valuation is the price relative to the value of the underlying business. A stock price can rise and get cheaper (if the company's intrinsic value goes up more than the stock price). Likewise, a stock's price can fall and get more expensive (if intrinsic value falls more than the stock price).
When valuation is high, return expectations should be low. When valuations are in mega-bubble territory, you should put on your roundabout-thinking cap and prepare for bad times ahead.
Given the degree and persistence of overvaluation and speculation in the stock market in recent years, I suspect the S&P 500 Index and Nasdaq Composite Index will eventually wind up falling 75% or so from their all-time highs, but that's just a guess.
Mega-bubbles always include voices telling you to ignore valuation. For example, certified financial analyst charterholder Jonathan Levin published an opinion piece in Bloomberg on January 19 titled, "This Isn't Your Father's S&P 500. Don't Worry About Valuations."
I was planning to quote the article, but it uses the same tired arguments from all mega-bubbles: Stocks are expensive because they're worth more now and they're worth more because the underlying companies are – wait for it – growing faster. And they'll grow even faster due to the – wait for it – widespread use of AI.
It sounds suspiciously like Levin is saying the stock market has hit a new "permanently high plateau" – just like economist Irving Fisher famously said just before the crash of 1929. And mentioning AI driving overall valuations higher smacks of the "new era" that is touted near the peak of every great crash.
In the end, it's just another "valuation doesn't matter" chorus and a typical sign of the times.
The anonymous financial and political commentator known as Rudy Havenstein (a must-follow on social platform X), recently reminded me of disgraced Internet-era analyst Henry Blodget's comments on valuation from January 4, 2000:
For the past five years, valuations haven't mattered a bit. Over the last five years in technology, deciding something is overvalued has been a terrible reason not to buy. Look at Microsoft, or Cisco, or Yahoo.
Based on the above comments alone... maybe the roundabout traders are in for a good year in 2024... 2025... or whenever the world wakes up and realizes that paying more than 30 times 10-year average inflation-adjusted earnings for stocks simply guarantees you'll earn lousy returns for longer than most folks can tolerate them.
Speaking of dot-com darlings...
Investor, blogger, and Stansberry Investor Hour guest Harris "Kuppy" Kupperman recently compared today with another exorbitantly overvalued moment in recent history:
Do you remember the first quarter of 2000?... We all remember Pets.Com. What's less remembered is the mad rush into mega-cap tech names. Plain vanilla funds had spent years ignoring these names as they were overvalued. Eventually, they had no choice but to pay crazy multiples for the big liquid names that dominated the indexes... They had to close their eyes and buy overpriced tech. Cisco, Nortel, Microsoft, Sun Microsystems, AOL, JDS Uniphase, Yahoo, etc. These stocks went up every day, relentlessly. Everything else got sold to fund it. Even the greats of our industry, guys like [Stanley Druckenmiller], got sucked in. He simply couldn't stand to underperform. That pressure is powerful, and it makes guys do stupid things.
At the time, there was an overwhelming consensus that those stocks were absolutely no-brainer, can't-miss, must-own stocks. If you went to a cocktail party and said it was all a massive bubble, you would have been laughed out of the room.
Everybody knew they were the best stocks you could buy at that moment. And everybody was wrong.
Sun, AOL, and Yahoo all crashed hard in the dot-com bust, never regained their dot-com era highs, and are no longer public. Nortel went bankrupt in 2009. JDS Uniphase, now called Viavi Solutions (VIAV), trades more than 95% below its March 2000 high as we write. Cisco Systems (CSCO) declined 89% in the dot-com bust and still hasn't reached its March 2000 peak closing price of $80.06 per share.
Microsoft (MSFT) declined 65% in the bust... although it did eclipse its 2000 high in 2015, and recently overtook Apple to become the largest market cap company in the world. As we write, it's up about more than 600% from its December 1999 dot-com era high of $59.56 per share.
Just like back then, folks today are 100% certain that the big popular stocks are the best ones to own, especially the "Magnificent Seven" – Microsoft, Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), Nvidia (NVDA), Meta Platforms (META), and Tesla (TSLA). Everyone seems to believe these companies will rule the world forever.
Surely Google-parent Alphabet will continue to be a wonderful business 10 years from now... just like Cisco was the undisputed king of the Internet in March 2000... right before it became one of the worst investments in history.
Losing money owning the greatest businesses in the world is as unfathomable today as it was in early 2000. After all, everyone seems to understand just how incredible these businesses are. But the market has a perverse tendency of sucking in as many true believers as possible near big tops, then cutting them off at the knees with a painful decline.
Cracks are opening up in the Magnificent Seven...
Alphabet lost $110 billion of market value on Wednesday [January 31], when the stock fell 6% after weak advertising revenues marred quarterly earnings results. Is it the beginning of the end of Alphabet's dominance of search-based advertising?
I don't know, and it doesn't matter. In a few years, all that will have mattered is that everybody agreed these stocks couldn't lose. Also by then, roundabout traders will have made plenty of money preparing for the inevitable decline.
In the end, I have no idea if Taleb's death spiral will crush the stock market... or if it'll even materialize over the next several years. It's probably not imminent, but like the aftermath of the current mega-bubble in stocks, it is inevitable.
You can navigate these events without being a roundabout trader. But I doubt you can do it without doing some roundabout thinking.
With our offices closed today, we're taking a break from our 52-week highs list and the mailbag. But, as always, we love to hear from you. Send your comments and questions to feedback@stansberryresearch.com.
Good investing,
Dan Ferris
Medford, Oregon
December 20, 2024