The Dawn of a New Investing 'Epoch'
The 'Bond King' recognizes the key to his 'greatness'... The importance of 'different epochs' in investing... Howard Marks sees the market this way, too... Two warning signs in recent history... If mindlessly buying stocks and bonds won't work, what will?... The dawn of a new investing epoch... Income is back...
When the 'Bond King' looks in the mirror, he can't help but see 'Lady Luck' over his shoulder...
Regular Digest readers know "Bond King" is the nickname for investing legend Bill Gross.
Gross is best known for founding asset-management firm PIMCO in 1971. He also ran its Total Return Fund, which was once the world's largest bond fund (with assets under management of $293 billion in 2013).
But the thing is, Gross realizes he wouldn't have been so successful without a key outside factor. He believes the same is true for many of today's mythological investing giants, too...
Luck.
Gross touched on this idea in a 2013 piece titled, "A Man in the Mirror." As he wrote...
There is not a Bond King or a Stock King or an Investor Sovereign alive that can claim title to a throne. All of us, even the old guys like [Warren] Buffett, [George] Soros, [Dan] Fuss, yeah – me too, have cut our teeth during perhaps a most advantageous period of time, the most attractive epoch, that an investor could experience. Since the early 1970s when the dollar was released from gold and credit began its incredible, liquefying, total return journey to the present day, an investor that took marginal risk, levered it wisely and was conveniently sheltered from periodic bouts of deleveraging or asset withdrawals could, and in some cases, was rewarded with the crown of "greatness." Perhaps, however, it was the epoch that made the man as opposed to the man that made the epoch...
In any case, [my point is] that different epochs produce different returns and fresh coronations as well.
A lot of today's investors fail to realize the importance of 'different epochs'...
In short, many folks seem to think the next 40 years will look like the past 40 years. They don't understand what an unusually easy time they've had in the markets since about 1980.
I (Dan Ferris) am not saying these investors are stupid...
It makes sense for folks to think that way. A lot of investors have done well over that span. They've all saved. And they've all invested in stocks and bonds in their 401(k) accounts.
Whenever the market fell, they just kept buying. And stocks have always recovered and gone on to make new highs. As a result, many of these folks have made plenty of money.
The problem is that these investors only know one way to think about the markets. I hate to sound like a crotchety old guy, but their problem is mostly that they're too young...
Most folks who do their own investing today likely didn't start until they were in their 20s. Likewise, there probably aren't a lot of folks above age 63 who manage investments...
Data from the U.S. Bureau of Labor Statistics puts the median age in the investment-management industry at 44 years old. And it indicates that less than 8% of finance professionals are age 65 or older.
So I'm comfortable asserting that most investors alive today were either not in the financial markets in the 1920s or if they were, they weren't old enough to understand them.
As a result, they have zero experience with any other type of market.
Unlike Gross, I bet most of these investors have no idea how lucky they are...
You see, the period from 1980 to 2022 was the best time in the past century to be in the stock market.
Artemis Capital Management founder Chris Cole discussed this idea in his 2020 piece titled, "The Allegory of the Hawk and Serpent." As he wrote...
By any measure of financial history, the last four decades were one of the most significant periods of asset price growth ever. A remarkable 91% of the price appreciation for a Classic Equity and Bond Portfolio (60/40) over the past 90 years comes from just 22 years between 1984 and 2007. 94% of the returns from Domestic Equities, 76% of the profit from Bonds and 72% of the performance in Home Values [of the past 90 years] were from this period as well... Any strategy that overweighted Stocks and Bonds did spectacularly well during this unique period of financial history.
Cole is simply sharing the numbers that prove Gross was right. The period starting in roughly 1980 was a better time to be an investor than any other time since the 1920s.
Of course, Gross isn't the only investing legend to see the market in 'different epochs'...
Oaktree Capital Management Co-Chairman Howard Marks is another great bond investor of our time. Like Gross, his net worth exceeds $2 billion.
Marks has invested in bonds since 1978. He co-founded Oaktree in 1995. And his frequent investor memos are some of the best readings in all of finance...
Marks wrote a memo to his investors in May called, "Further Thoughts on Sea Change." In the piece, he echoed Gross about what has happened in the epoch that started in 1980...
According to Marks, the most important event in finance in recent decades was "the 2,000-basis-point decline in interest rates between 1980 and 2020." And as he noted, "that decline was probably responsible for the lion's share of investment profits made over that period."
Marks went a step further than Gross. He hinted at what might undermine (and eventually end) the period he and Gross were so lucky to exploit...
Marks used bold type to emphasize the types of mistakes and imbalances that happen in periods with declining and too-low interest rates. In these times, capital gains come easy...
Importantly, this distorts the behavior of economic and market participants. It causes things to be built that otherwise wouldn't have been built, investments to be made that otherwise wouldn't have been made, and risks to be borne that otherwise wouldn't have been accepted. There's no doubt that this is true in general, and I'm convinced it accurately describes the period in question.
Then, Marks listed the likely outcomes of the "sea change" heralded by today's higher interest rates. I'm sure Digest readers will recognize some of the things on his list...
If the declining and/or ultra-low interest rates of the easy-money period aren't going to be the rule in the years ahead, numerous consequences seem probable:
- economic growth may be slower;
- profit margins may erode;
- default rates may head higher;
- asset appreciation may not be as reliable;
- the cost of borrowing won't trend downward consistently (though interest rates raised to fight inflation likely will be permitted to recede somewhat once inflation eases);
- investor psychology may not be as uniformly positive; and
- businesses may not find it as easy to obtain financing.
Marks referred to all that stuff as a return to "normalcy."
But if I just told you things were returning to normal today without telling you what that really means, I bet most folks would think, "Oh... good." I bet a lot of people would assume that I just meant the past 40 years were normal.
In reality, though, they were highly abnormal.
Gross and Marks understand how lucky they were, but most folks don't...
The further upshot of everything is that most investors probably think they have a lot more skill than they really do. They've made the classic error of confusing brains with a four-decade bull market that was fueled by an epic decline in interest rates.
Most investors likely have no idea that the investing epoch since 1980 was highly unusual when compared with other epochs over the past 90 to 100 years. They don't realize how historically unusual it was to be able to buy every dip with confidence and make money.
In his piece, Cole pointed out that it has rarely been so easy to make money in stocks...
The mantra of "buy on weakness" [buy the dip] and the popularity of passive indexation would not have worked for most of the last 90 years. For example, if you bought on market declines consistently between 1929 and 1970, you would have gone bankrupt three times. A passive index realized a -86% peak-to-trough decline in the 1930s and two decades of lost performance... We often forget the last forty years were an extraordinary time to allocate capital, and if you just held risk and applied leverage to growth, you did exceptionally well. History has rarely been so kind to investors.
In other words, what everyone has been doing for the past 40 years wouldn't have worked for most of the past 90 years. And what folks did over the past 40 years was really easy.
Unless that continues... investing is about to get harder for everyone.
Two warning signs in recent history suggest that this epoch has finally ended...
The first warning sign happened in December 2018.
As Marks noted in his piece, part of the concern in late 2015 was that interest rates were near zero. And they had been at that level since 2008. That didn't give the Federal Reserve enough (or any, really) room to ease credit conditions if another major crisis happened.
So the Fed started cautiously raising interest rates. The central bank successfully hiked the federal-funds rate's target range from 0% to 0.25% in 2015 all the way up to 2.25% to 2.5% in December 2018.
But at the first sign of trouble, the Fed abandoned its plans...
The market began falling in September 2018. And by Christmas Eve of that year, it had fallen almost 20%.
That was too much for the Fed. It started cutting rates again the following July. Then, it cut rates two more times in 2019. By that October, the target range for the fed-funds rate was down to 1.5% to 1.75%.
Then, of course, the COVID-19 pandemic happened. The related lockdowns sent the global economy into a death spiral. And in March 2020, the Fed slashed rates back to zero.
The first warning sign is clear...
The Fed couldn't even raise rates to 2.5% without the stock market tanking hard.
When you stop and think about it, something similar is happening in the stock market this time...
In March 2022, the Fed embarked on its fastest rate-hiking cycle in more than 40 years.
The S&P 500 Index soon lost as much as 25% from its peak. The tech-heavy Nasdaq Composite Index plunged as much as 36%. And three of the four largest bank failures in U.S. history occurred.
But one thing is different this time...
The Fed has made it crystal clear that it will keep rates higher for longer. And it will do everything in its power to create as much economic damage as needed to quell inflation.
The other warning sign came in March 2020 – and I previously mentioned it in my September 1 Digest...
Vanguard started putting investors into index funds before it was cool (starting at its founding in 1975). The company manages more than $8 trillion these days, with 79% of that money in index funds.
In a June 2022 report, Vanguard said...
During the 2020 downturn, despite the increase in trading, less than 1% of households abandoned equities completely.
They're talking about the COVID-19 crash of early 2020. You'll likely recall that the S&P 500 plunged nearly 34% in just 24 trading days from February 19 to March 23.
It was a rapid, brutal decline. The benchmark index lost value in 17 of the 24 trading sessions over that period. And 10 sessions (roughly 40%) ended in declines of at least 3%.
According to a Gallup poll in April 2023, roughly 61% of the 131.2 million U.S. households own at least some stocks. That works out to about 80 million households.
When you factor in Vanguard's reported "less than 1%" figure, it means less than 800,000 people abandoned equities in March 2020. As I asked in my September 1 Digest...
What would happen if 2% of households sold all their stocks? Or 5%? Or 10%?
This week, I can't help but wonder...
Is the greatest epoch to be an investor finally over?
Will it be a lot harder to make money in stocks and bonds over the next few decades?
I've written before about extended "sideways markets." That's when stocks don't make new highs for decades...
The Japanese stock market has fallen as much as 76% from its 1989 peak. And 34 years later, it still hasn't eclipsed that previous high.
The Dow Jones Industrial Average fell 89% from its 1929 high. And the index didn't exceed that level again until 25 years later.
The Nasdaq fell 78% in the dot-com collapse. And it didn't return to its 2000 high until 2015.
I believe we're in for something like that again...
The Nasdaq reached its most recent peak in late 2021. And the S&P 500 and Dow both peaked in the first few days of 2022.
Sideways markets after mega-bubbles always include a massive drop – often 50% or more – for stocks. I wonder how many U.S. households would abandon equities if they found themselves down 50% or more – without a recovery, year after year, for 5 or 10 years.
I realize I'm talking in long time frames here. But those long time frames get a lot shorter at major turning points in the markets...
If we're not at one of those turning points now, it sure has me fooled.
From 2020 to 2022, stocks and bonds hit their highest valuations ever by some of the most reliable measures (which I've discussed too many times in the Digest to need to repeat today). And now, interest rates are back at levels we haven't seen in almost two decades.
I could say a lot more about what happened over the past 40 years and what to expect for the next 40 years. But before I let you start your weekend, let me ask one final question...
If mindlessly buying stocks and bonds won't work anymore, what will work?
That's a huge question.
Our investing future depends on the answer. I could go on for days about what we can – and should – do as investors. But for now, I'll just hit a few of the more important points...
First, you need to get used to the fact that it will be harder to manage your own portfolio.
That's true because you can't just focus all your attention on stocks and bonds. They'll continue to play a role (maybe even a big one), but you need to know what else works well.
That leads me to the next big point...
You'll have to learn to stop trying to optimize your portfolio and expecting all of it to go up every year. Instead, you'll need to start learning how to hold a truly diversified group of assets.
Some assets will perform well at times. Other assets will do well at other times. And overall, if you diversify properly, you'll preserve and growth your wealth over the long term.
Just so I'm clear about what true diversification means...
Owning a diversified portfolio of stocks is just a single asset class. That won't cut it during our next investing epoch.
Rather, you need to invest in multiple asset classes that perform well in various environments. I've consistently recommended the following collection as a basic truly diversified portfolio...
- Cash
- Stocks and bonds
- Gold
The presence of cash and gold provides a hint to the final important point you need to know today...
Preserving your wealth is your new priority. Growing it must come second.
As I discussed in last Friday's Digest, one of the many bad things about interest rates at or near zero is that nobody is really an investor...
People can't earn a safe yield anywhere. So everybody takes on more risk and speculates for capital gains to grow their wealth. That frequently involves diving headfirst into stocks – and often at nosebleed valuations.
But now, we can earn a 5% yield on U.S. Treasury bills. That's an objective, risk-free benchmark for us to measure the attractiveness of all other potential investments.
In the end, that's part of the return to "normalcy" that Marks mentioned in his piece.
When we can earn 5% in T-bills or other government bonds, preserving our wealth becomes a little bit easier. We know we're going to get paid. And we know our principal is safe.
In short, income is back. And because of that, investing is possible again.
Look, I didn't say investing was easy. Those days are gone.
Investing requires work. But the good news is that we can now do it once again.
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The mailbag is still quiet. What's on your mind? We love to hear your thoughts, comments, and observations on the markets. As always, you can tell us at feedback@stansberryresearch.com.
Good investing,
Dan Ferris
Eagle Point, Oregon
October 13, 2023
P.S. I hope you've had the chance to read the latest issue of The Ferris Report...
But if you missed last Friday's Digest, I "unlocked" it for everyone. That's because I believe as many folks as possible should hear the message.
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