The Priority Is Survival
What would Peter do?... The only road to riches... History's contradictions... It's riskiest when you're right... 'A straight line rally to the moon?'... The trouble with rate cuts... Aggressive diversification... Poison dart frog stocks...
Everybody on Wall Street knew Peter...
You didn't even have to say his last name.
To the insiders on the Street, Warren could only mean Berkshire Hathaway's Warren Buffett... Jack was always Vanguard founder John Bogle... and Peter had to be the late, great Peter Bernstein.
Bernstein is probably best known as the author of two must-read books, Against the Gods: The Remarkable Story of Risk and The Power of Gold: The History of an Obsession.
Bernstein's writing reminds me a bit of Edward Chancellor, another financial author I've praised highly, because both men seem to have read absolutely everything on their topics. They dig deep into the detailed history and untold stories of the greatest and most consequential financial and economic trends and events.
I always wanted to know what Bernstein was thinking about markets when he was alive... and now that he's gone, I think it's important to learn what he said and wonder now and then... What Would Peter Do ("WWPD")?
About five years before he died at age 90 in 2009, Bernstein did an interview with the Wall Street Journal's Jason Zweig. I highly recommend reading the entire thing, but today I want to focus on something Bernstein said, which you've heard me say a few times over the years...
In general, survival is the only road to riches. Let me say that again: Survival is the only road to riches. You should try to maximize return only if losses would not threaten your survival and if you have a compelling future need for the extra gains you might earn.
My friend and fellow value investor Chris Pavese, president and chief investment officer of Broyhill Asset Management, made a similar point in a recent interview for an upcoming episode of the Stansberry Investor Hour podcast.
When asked about Broyhill's investing style, Chris said it prioritizes capital preservation, or as Bernstein would say, survival. (Broyhill's website has a lot of good reading on the subject for investors, including ideas about some of the stocks the firm owns.)
Survival is important because if your wealth doesn't survive, you'll have to get rich all over again. Once is hard enough, and most people can't even manage that. Twice is highly unlikely.
First, make sure you don't lose your hard-earned wealth. Then you can start thinking about how to get an adequate return.
Right now strikes me as a great WWPD moment...
In other words, if Peter Bernstein were alive today, I bet he'd make a point of reminding you right now to focus more on the survival of your wealth. Regular Digest readers can probably recite the reasons why I think this, but let's review the primary one anyway...
In my past few Friday Digests, I've told you about more than 20 different metrics that show the S&P 500 Index is somewhere between expensive and the most expensive it has ever been in history.
I've repeatedly emphasized that valuation is not a short-term timing mechanism. If it was, our only choice right now would be to sell short stocks aggressively. But reality is complicated, and history has taught us seeming contradictions...
On one hand, rate cuts like we saw this week have often accompanied recessions, bear markets, and financial crises. Low rates happen because investors get cautious, making debt instruments more attractive than riskier equities... in turn lowering borrowing costs at a time of slower or perhaps even negative economic growth.
On the other, the market being ultra-expensive doesn't mean it can't get more ultra-expensive. There's just no practical limit to folks' desire to throw their hard-earned savings at any asset whose quoted price never stops going up. And the bull market of 2009 to 2022 taught folks that falling and ultra-low rates mean stocks are going to the moon and that you can safely buy every dip.
And now that the Federal Reserve has begun what most expect to be a lengthy rate-cutting cycle, folks have (for the moment, anyway) once again lost their minds, abandoned risk aversion, and bought everything. Tech, value, growth, banks, mining companies, silver, gold, copper, platinum, bonds, bitcoin... everything.
It's the risk-off moment of 2024...
It may not end soon... but it won't end well.
And as I've also asserted more than once, though it's a lousy timing mechanism, valuation is the force of gravity for long-term returns. The more you pay for an investment, the less you earn from it. Paying more than has ever been paid in recorded history should therefore garner the lousiest returns ever.
The implication is potentially catastrophic for millions of investors. It means the money they're pouring into S&P 500 or similar index funds in their 401(k) accounts today is unlikely to earn much if any return over the next several years.
Add unstoppable inflation to the fix and investors buying the S&P 500 today are likely signing up to lose money over the next several years. You don't buy the S&P 500 at these levels if capital preservation is your priority.
But, of course, most folks never even entertain the possibility of doing anything different when the market is making new highs. And a market making new highs after a Fed rate cut... well... it makes me wonder why I even bother pointing to all the risk in financial assets right now.
WWPD? From the Zweig interview...
The riskiest moment is when you're right. That's when you're in the most trouble, because you tend to overstay the good decisions. Once you've been right for long enough, you don't even consider reducing your winning positions. They feel so good, you can't even face that. As incredible as it sounds, that makes you comfortable with not being diversified. So, in many ways, it's better not to be so right.
That viewpoint about winners pairs well with the way Bernstein thought of diversification. He said it was an aggressive strategy, because you never know where the next big winner will come from. So if you diversify, you can have your cake and eat it, too: survival and plenty of big winners over the long term.
Asking WWPD would also lead folks to a better appreciation of history...
In this case, I must point out that most folks buying with both hands today either don't know or don't care what happened the last time the Fed cut rates just before stocks made a new all-time high...
It was only 17 years ago, but I don't hear enough people talking about it now.
The subprime mortgage bubble had begun bursting by September 18, 2007, when the Fed issued a 0.5-percentage-point cut – its first since it tried to ease conditions during the dot-com bust (when junk bonds were weighing markets down).
A month later, the S&P 500 made a new all-time high, after which it entered a 17-month bear market, finally bottoming out at a 57% decline in March 2009.
Many folks will point out that today is not 2008. We are not in a giant housing bubble and its accompanying giant debt bubble built on credit derivatives filled with subprime mortgages.
Well, two quick things about that...
First, office-building debt is on fire right now and could be a harbinger of a larger rout in the debt market. Chad Carpenter, founder of real estate investment firm Reven Capital, pointed out on a recent podcast that defaults on commercial mortgage-backed securities in the office-building market averaged 20% losses in the past 12 months – and 62% so far in 2024. That's a massive acceleration in defaults. Carpenter said...
Mind-blowing. Absolutely mind-blowing. So lenders are losing more than 50% of their principal, right now. That's in the books.
Second, it doesn't have to be 2008 for things to go wrong... because history doesn't repeat, it rhymes. And we feel like we've seen this movie before.
Mirroring my own thoughts regarding the likely reaction to the Fed's decision... macro investor, "acid capitalist," and two-time Stansberry Investor Hour podcast guest Hugh Hendry recently pointed out on the social platform X...
Prices will swing. Volatility will be high. Signal? There will be no signal. Just don't get sucked in.
By the latter comment, he meant that the market's action in the wake of the Fed's rate cut should not be taken as a trading signal – and not to let the market's action suck you into making a big bullish bet. Hendry spelled out why you might not want to be knee-jerk bullish right now in the wake of a Fed cut...
Are we really in for a straight line rally to the moon? That would require the Fed to be battling the bond futures, [for] the bond futures [to be] saying, "No, don't cut, the economy is great." But guess what? The futures are screaming, the bonds are screaming, for cuts. Ladies and gentlemen, I do fear the risk market is broken.
In other words, if the macro picture of the economy, employment, and interest rates (among other factors) were a rosy one, rates would be higher (and bond prices lower).
The Fed tends to have the most influence over short-term rates. The market tends to have more influence over long-term rates. And the long-term rates have fallen about 25% over the past year. Here's a chart showing the 10-year Treasury note's yield...
I and many of my Stansberry Research colleagues have pointed out that a rate-cutting cycle isn't necessarily a good thing for the economy or the stock market, no matter how the market reacts to it initially. And the bond market doesn't like what it sees in the economy. Maybe the stock market won't like it at some point in the near future, either.
And when it comes to allocating capital in this environment, WWPD?...
Based on what he has said before, Peter Bernstein would stay diversified... And I believe he'd be highly sympathetic with Hendry's and my view. From his Zweig interview:
There is a tendency... for people to expect the status quo either to last indefinitely or to provide advance signals for shifting strategies. The world does not work like that. Surprise and shock are endemic to the system, and people should always arrange their affairs so that they will survive such events. They will end up richer that way than [by] focusing all the time on getting rich.
So right now, we have a market filled with people who believe deeply that rate cutting is bullish and means that the Fed has their backs... when we've shown with a fairly recent example that the exact opposite can be true.
The truth overall is that the Fed always gets it wrong. It has never had any ability to avoid bear markets, recessions, and financial crises – plenty of all of which have happened since its creation in 1913.
You don't know what'll happen next, and there will be no signal to tell you what to do. You must prepare for a wider variety of outcomes – wider now that the Fed is in market-meddling mode once again. (Astute readers will notice that I just said the Fed doesn't reduce risk. It creates it, both by amplifying existing risks and creating new ones.)
None of this means there's nothing to buy...
A 2011 book about another late, great Peter – value investor Peter Cundill – is titled There's Always Something to Do... which was the attitude Cundill maintained toward finding value throughout his career.
I agree with that sentiment and, like Bernstein, I've preached diversification consistently to readers of The Ferris Report. Its model portfolio contains stocks, bonds, managed futures, currencies, and precious metals bullion. It has tech, energy, mining, value, and growth. Bernstein might call The Ferris Report portfolio aggressively diversified.
Right now, with the Nasdaq Composite Index and the S&P 500 sharply higher in the past two days, it seems that diversification is unpopular... and maximizing returns while taking on more risk is back on the menu for most folks.
The stocks that dominate the Nasdaq and S&P 500 remind me of the brightly colored poisonous animals you see on TV nature shows...
Monarch butterflies' orange wings and poison dart frogs' blues, yellows, and other vivid colors act as warning lights. They attract attention, but it's not an invitation. It's to tell predators not to even try to consume these animals because doing so could kill them.
They're like the logos of the five largest and most popular mega-cap tech stocks...
I'm not saying the businesses are poisonous. They're wonderful cash-gushers, some of the greatest businesses that have ever existed.
Problem is, absolutely everybody knows that and thinks it means they'll grow and provide investors with great returns forever. That's not how reality works, as Bernstein might say. These stocks' universally acknowledged wonderfulness is as much a part of the warnings they're putting out as their colorful, monarch-butterfly-like logos.
And of course they're currently priced for perfection...
And as Chris Pavese pointed out during our recent interview, whenever investors are so concentrated on a few stocks, it has often tended to precede very poor performance in those stocks and the overall market. (His firm published a great presentation called "Equal Opportunities," which includes that and other valuable insights.)
What's so poisonous is the idea that these stocks are such no-brainers because of the wonderful returns investors have achieved with them so far. They get your attention, but consuming them with your capital might not work out anything remotely close to how you expect.
Like Bernstein said, folks can't even allow themselves to consider that these stocks won't continue to be the huge winners they've been for so long. It's when you're most right that you're most vulnerable to a big loss.
Summing it all up today...
- Read Peter Bernstein's two books we mentioned and his Zweig interview.
- Learn to ask What Would Peter Do?
- Don't take the market's reaction to the Fed's rate cut as a trading signal.
- Diversify aggressively.
- Avoid monarch butterfly and poison dart frog stocks.
- Have a great weekend.
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In today's mailbag, feedback on Thursday's edition by Corey McLaughlin that discussed the Federal Reserve's rate cut... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"[Fed Chair Jerome] Powell repeated the economy is strong, inflation is continuing to [slow], jobs market is actually strong, reduction [in employment rate] is due to immigration, 100k job additions per month good, not great, but everything looks good.
"Why didn't anyone ask him if it is all good, why recalibrate now?
"Inflation is not at 2%, jobs market is showing weakness, unemployment is up (as he said due to immigration, yet at historical full employment), wages are rising – but he wants them to slow down... Seems weird." – Subscriber William O.
"Corey, Thank you for your honesty. You stated, 'Personally, we're skeptical,' talking about the Fed.
"I am waiting for that Volcker moment (17% [fed-funds rate in 1980]) especially with his 30% debt to GDP vs. 123% or more today, if I put that correctly? Their bandages won't work. Two totally different scenarios. Ours is much worse.
"Make it simple. Jerome, when is the last time you personally bought a dozen eggs rather than just eat them? He's lost and doesn't even know which aisle the eggs are on! Stansberry, keep up the great work..." – Subscriber Jeff B.
Corey McLaughlin comment: Thanks for the note, Jeff, and I appreciate your sentiments. And yes, you're more or less correct about the U.S. debt-to-GDP ratio today. The federal debt level is 120% of GDP. That's actually down from when it spiked to 126% in 2020, but for four years, the U.S. has racked up amounts of debt well higher than the value of things the country actually produces.
Good investing,
Dan Ferris
Eagle Point, Oregon
September 20, 2024