Stop Being Stupid
The largest herd of bulls in history... Remember what a stock is... The government can't save you... The essential element of investing... Bumbling, risk-ignorant, blithering nincompoops... What I won't do right now...
Mom and Pop think the stock market is a sure thing in 2025...
In the latest Conference Board Consumer Confidence Survey, 56.4% of respondents said they expected stocks to rise over the coming year. That's the highest result since the question was added to the survey in 1987...
Since the report came out on November 26, the S&P 500 Index is up only slightly, but the Nasdaq Composite Index is up 3.5%.
And, of course, right when folks are more confident than ever... stocks' likely future returns have never been worse. As economist and portfolio manager John Hussman reported in a recent Financial Times article...
Among several valuation measures setting record highs is one that has reliably been a gauge for the subsequent returns and potential losses of the S&P 500 index over the following 10 to 12 years: the ratio of the market capitalisation of US non-financial companies to "gross value-added" or corporate revenues generated incrementally at each stage of production. Since early 2022, this metric has rivalled and now exceeds the peaks of both 1929 and 2000.
Returns are simply the inverse of valuations. When valuations are high, returns are low, and vice versa. All-time-high valuations indicate all-time-low returns from U.S. stocks.
Stocks are just fractional claims on the future cash flows of the underlying businesses. The more you pay for the cash flows, the lower your long-term return.
As Hussman explains, people often forget or overlook that point. He advises investors to "exchange extraordinary optimism for a calculator."
When everybody thinks an investment is a no-brainer, it's guaranteed to disappoint. That's a substantial chunk of the U.S. stock market right now.
Let's say the Conference Board survey respondents are right and the stock market does rise in 2025...
It would just have the effect of further ramping up risk and lowering long-term returns on their equity portfolios.
The only question left at this point, as we float merrily along in the third great speculative mega-bubble of the past 100 years, is... why don't folks learn?
You could easily argue that nobody alive today was an adult investing in stocks in the 1929 bubble, so they don't remember it. But lots of folks – including me and very likely you – were alive and investing during the 2000 dot-com bubble.
We remember the effect on our 401(k) accounts. We remember stocks like Amazon (AMZN) falling 94% from peak to trough as the Nasdaq lost 78% of its value... and how it took 15 years for the Nasdaq to make a new high. And unfortunately, I'm sure plenty of folks remember losing everything on stocks like pets.com, women.com, and peapod.com.
We vowed that we'd never invest in crazy bubble stocks again. We vowed to become better investors and remain more focused on real business fundamentals. We vowed to keep a close eye on valuations.
Then another huge bull market got going. We noticed our neighbors making tons of money, buying fancy stuff, and taking fancy vacations... and we couldn't help ourselves. We wanted to buy the stocks they were buying and make the money they were making.
We feared missing out more than we feared losing a lot of money like so many did in the last epic speculative bubble in 2000.
But, the poor fools of today might say, that was so long ago (nearly a quarter of a century!)... Surely we'll never have another bear market like that again.
And every time the market has fallen since then, it hasn't fallen that far. It quickly turned right around and made new highs.
The Federal Reserve always cuts rates in bear markets, anyway (except when it raises them faster than ever before like in 2022), and that always makes stocks go back up.
Clearly, nothing will go wrong ever again.
So here we all are once again... holding the most expensive portfolios ever held as stocks soar to valuations never before seen in history.
Folks who think they're smarter than the market will give you all kinds of reasons why you can't compare current valuations with those of previous eras... seemingly unaware of the fact that folks who think they're smarter than the market did this in all those previous eras.
Hussman quoted a 1929 Business Week article that said...
This illusion is summed up in the phrase 'the new era'. The phrase itself is not new. Every period of speculation rediscovers it.
In fact, he titled his article, "New eras, same bubbles: the forgotten lessons of history."
Trouble is, we don't know when it will all fall apart...
I know that mega-bubbles like the one we're living through right now have always fallen apart when they get this crazy, and there's no reason to believe this one won't end up the same way.
That doesn't mean there aren't opportunities along the way. I've always said that folks need to stay invested in the stock market.
But I don't have a way to accurately predict the timing of a big market reversal.
So I'll have to content myself with being wrong and with folks inaccurately referring to me as a "permabear" until the inevitable bear market arrives.
Even then, bears aren't given credit for predicting bear markets so much as accused of causing or worsening them.
Sometimes – like in 2008 – bear markets get so panicky that the government tries to ban short selling, one of its dumber moves (and the category of "dumb government moves" is a very high bar!).
The Securities and Exchange Commission banned short selling of 797 financial stocks for 14 trading days, from September 19 to October 8, 2008. Not only didn't it work, but financial stocks peaked on the day the ban began and fell straight down, bottoming out on October 9 – the day after it was lifted. You can see it plainly on this chart of the SPDR S&P Bank Fund (KBE)...
The market saw how scared the government was and it took what it believed was appropriate action. Maybe if the government had left the bank stocks alone, they wouldn't have instantly lost nearly 40% of their value.
Good businesses and financial enterprises don't need government rescues...
Those that do need this help are obviously lacking in some vital aspect and should probably be avoided by the public. And yes, that includes every business that receives government subsidies to stay afloat, no matter how "essential" it may seem. (And yes, I realize that many thriving companies don't need government help but get it anyway.)
During the ban on shorting bank stocks, the market realized that the government's intervention meant the situation was more dire than previously thought. Folks know the government is hiding important information from them all the time, so they react decisively when it accidentally shows its hand.
No doubt the next financial crisis will repeat this same dynamic, with the government stepping in to help and causing more panic.
Then, when the help doesn't work, the government can bail out the big players whose risky loans fell apart, like how it helped the Wall Street megabanks pay out lavish bonuses to their executives after the financial crisis.
The lesson here is that a huge bear market is inevitable, and not only will the government help the folks who caused or exacerbated it and not help you – you don't want or need the government to step in to help you.
You're far better off taking full responsibility for preparing for such an event and refusing to rely upon anybody helping you. I've made such preparations a main feature of The Ferris Report's model portfolio.
Until then, investors have once again fallen head over heels in love with risk...
Certified financial analyst Mike Zaccardi recently posted a chart by Bank of America titled, "Investor sentiment is euphoric: Global Equity Risk-Love currently at the 90th percentile of its history since 1987."
Folks can only fall this deeply in love with such a high level of risk by having absolutely no ability to understand and recognize risk. They're not risk tolerant... They're risk oblivious.
"Understanding Risk," "Recognizing Risk," and "Controlling Risk" are the titles of chapters five through seven of investor/author Howard Marks' must-read landmark 2011 book, The Most Important Thing: Uncommon Sense for the Thoughtful Investor.
Chapter Five begins:
Investing consists of exactly one thing: dealing with the future. And because none of us can know the future with certainty, risk is inescapable. Thus, dealing with risk is an essential – I think the essential – element in investing... You're unlikely to succeed for long if you haven't dealt explicitly with risk. The first step consists of understanding it. The second step is recognizing when it's high. The critical final step is controlling it.
If Marks is right and dealing with risk is the essential element of investing, then one thing is clear about today's herd of investors...
These guys are the most bumbling, risk-ignorant, blithering nincompoops in all recorded history...
They've run stocks up to their most expensive valuations in history, which means they're willing to accept the lowest potential returns in all recorded history.
Today's investors seem never to have heard of bear markets.
They seem never to have heard of sideways markets (like the ones that followed the other two great speculative episodes, the Dow Jones Industrial Average from 1929 to 1954 and the Nasdaq from 2000 to 2015).
Folks seem to have no idea what investing is really about: understanding an asset's fundamentals so you can decide whether or not to take on the risk of owning it for the purpose of earning a return.
In fact, having no idea what they're buying isn't a bug of most investors' primary capital-allocation strategy. It's the primary feature of the strategy.
What is the one strategy more folks are following than any other today?
So-called passive investing, which of course is just another word for buying stocks with absolutely no reference whatsoever to underlying fundamentals.
If you read enough financial news and information, you've probably heard of "algos," meaning the algorithms professional investors use to buy and sell stocks under quantitative strategies.
By far the biggest algo in the stock market is the passive algo. It's the one all index funds use, and it's very simple. It says that if an investor or asset-management firm receives $1 of capital, they buy $1 of equity, no matter the equity's underlying fundamentals or valuation. Just buy, buy, buy...
Nobody seems to understand that buy, buy, buy could one day become sell, sell, sell.
I promise you, folks have just as much capacity to sell without regard for value or other fundamentals as they do for buying that way. Right now, nobody thinks the selling will begin any time soon (if ever).
And yes, regular Digest readers will recognize the passive-investing discussion from past issues. And yes, it's that important and well worth repeating.
One of the biggest mistakes folks make due to 'new era' thinking is believing that valuation no longer matters...
For example, folks buying software provider Palantir Technologies (PLTR) today are paying 65 times sales and more than 350 times earnings. Presumably, they think there's some set of circumstances that makes that a good bet. In this case, the stock is associated with AI, and everybody thinks any AI connection is reason enough to abandon all reason when buying stocks.
Here's what nobody seems to understand: Even if Palantir keeps going up after you pay that much, it's still an awful, highly speculative bet. The company was founded in 2003 and went public in September 2020. Its revenue growth peaked at 47% that year and has fallen to 25% in the past four quarters. That's still high, but it's headed in the wrong direction for such an insane valuation.
Not that any amount of growth could justify such a crazy price tag... I'm just saying that the hypergrowth phase of its life is already flagging badly, and the stock price will inevitably follow. It has recently been as much as 1,172% above its December 2022 bear market bottom. Anybody who thinks it can keep this up is delusional.
I won't predict when the passive algo will go into reverse, kicking off an epic bear market, likely followed by a sideways market in which the S&P 500 fails to make a new high for more than a decade.
I will simply point out that such a scenario is well beyond just about everyone's imagination today.
The S&P 500 rises endlessly. Every dip is a buying opportunity. Nobody believes otherwise. A 50%-plus drop in the S&P 500 – which makes up more than 80% of the market cap of U.S. stocks – would shock the daylights out of the overwhelming majority of investors who own stocks today.
While I won't make any predictions, I also won't thoughtlessly pour money into the S&P 500 every two weeks...
Most folks have probably forgotten where their 401(k) contributions are going. Mine are going into value stocks and gold stocks. Value stocks tend to outperform after speculative bubbles burst, and gold has a decent track record of doing well from peak to trough in an equity bear market.
Both value and gold have drastically underperformed now egregiously expensive growth stocks. That won't last forever. And when it goes into reverse, I'll seem a lot less stupid for anticipating.
Buying what's not popular always seems stupid until it seems brilliant. At the moment when the unpopular becomes more popular, it is usually embraced as the next new thing, and the whole cycle starts over again.
It's hard to go the other way and bet against the general trend. It's like the late Berkshire Hathaway Vice Chair Charlie Munger used to say...
Investing isn't supposed to be easy. Anyone who finds it easy is stupid.
Problem is, folks can think it's easy for a long, long time until one day they realize they were stupid the whole time.
We all need to stop being stupid now, when it counts the most.
New 52-week highs (as of 12/12/24): Ciena (CIEN) and Twilio (TWLO).
In today's mailbag, a question about Federal Reserve policy and interest rates stemming from yesterday's edition... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"I find it interesting how there is so much focus on the Fed to continue to cut interest rates. Isn't it true that the economy used to run perfectly fine when interest rates were in the 3 to 5% range all the time?" – Subscriber Joe S.
Corey McLaughlin comment: Thanks for the note, Joe.
That depends on what you consider "perfectly fine," of course. I'd argue the devaluation of the dollar in any form for an extended period – like we've seen for decades even with more "normal" rates like you point out – isn't fine.
But I get your general point about how rates have been higher in history, and people have found ways to live and do business.
To be sure, the more unusual thing over the past 80 years or so in the U.S. has been the period of low interest rates after the financial crisis, which distorted a lot of things in the economy... making capital cheap for a decade and debt as easy as possible to take on.
I think that period set the stage for what happened after 2020 when trillions of dollars' worth of monetary and fiscal stimulus got dumped into the economy at near-zero rates. Inflation spiked to a 40-year high amid continued strong demand for products and services and the ability to provide them.
Only in 2022 did the Fed finally raise rates above 2.5% again as it attempted to cool price growth in the economy. The federal-funds rate topped out above 5% in 2023, slightly above where it was before 2008.
And this is the first time the Fed has tried to cut rates since then... So this is why I'm guilty of focusing on the issue. Like the high inflation we saw starting in 2020, I'm not sure many people are prepared for a possible reacceleration of high(er) inflation (and rates) over time as a result of what looks like the Fed's "business as usual" approach.
I believe we'll look back on 2020 as the trigger for a turnaround in long-term inflation trends (and rates) that we're only in the beginning stages of. As Dan has said, decades of steadily falling rates are over. "You should invert your experience of the last 40 years," he has written.
I'm not saying a return of high(er) inflation is definitely going to happen, but it's at least worth thinking about.
Didn't the brutal year for stocks and bonds in 2022 – in response to rates going higher than many thought – catch a lot of people off guard? And that happened because enough people wanted to believe the Fed when it said things like inflation was "transitory" for more than a year.
Now they're saying the pace is still on a path back toward 2%, when it's not.
So, if your point is that the Fed doesn't need to keep cutting rates... I'm with you.
Good investing,
Dan Ferris
Medford, Oregon
December 13, 2024