Most of us have learned, over and over, sometimes painfully, that a healthy mix of stocks and bonds may drop in price, but will soon bounce back. And the drops aren’t even that bad, because stocks and bonds become anti-correlated during bad times. Well, all this is now wrong – or at least not to be trusted.
I’m writing this because my gut is telling me to buy lately, and I have been nibbling, but my brain is telling me to calm down. Writing helps me think things through.
It looks to me like we’re at the beginning of a “run on the bank” – the “bank” in this case being all assets with long duration. Lots of factors are pointing that way. (1) We’re still near the peak of a global bubble in nearly all asset classes. (If you’re relying on “forward PEs”, you need to read a few Hussman articles, whether you think he’s too pessimistic or not.) (2) After 40 years during which problems could be solved by just lowering interest rates, that is no longer true. Nearly everyone has adjusted their intuitions about investing based on the old system. (3) We have older investors (in the US anyway) holding far more duration than they should be, just because they need high-single-digit returns to maintain lifestyle. Which applies to most investors, but at least some of the young ones may choose to just ride out a big drop (others might panic anyway, and make the drop worse). (4) People are coming to understand that with high inflation, you want zero duration in a sense – any consumer items you know you’ll need in the short to medium term, you should buy immediately, even if it means selling investments to do so. (5) Inflation may well be stickier than most of us think; the Fed sure isn’t in a big hurry to get rates over 8%. (6) And it also scares me personally that no one seems to be even considering a large, persistent drop in asset valuations on the order of a decade or more to break-even. Everyone thinks Hussman is some pathetic weirdo. Just like with covid, I worry more when others aren’t worried. It means they’re still over-invested.
Now normally, at least based on the last 40 years, the Fed would not allow a huge drop in asset prices. But this time it finally is different: everyone around the world – not just investors – has experienced painful inflation, and the Fed has made it clear that they will not let it persist. Maybe they’ll pause their tightening if inflation seems to be dropping, but one thing they won’t do, I think, is what they always did in the past when assets dropped: make money dramatically cheaper. If they did that now, they’d risk shouldering a massive amount of blame if/when inflation heats up again.
Of course there’s still some point at which investor and recession pain outweighs the pain of severe inflation on everyone – and when truly mouth-watering values draw those with cash back in. Who knows where that point is, but it’s very possibly well below fair value of investments. I think it’s reasonable to look to past secular bottoms, when the Fed wasn’t very relevant. If it’s anything like the secular bottoms of the 1930s or 1980s, that could be something like S&P below 1000, and a decade or two to return to prior peak. Not that I’m personally putting all my eggs in that basket, but I want to be financially and psychologically prepared for it. I have some stocks (always love BRK), some precious metals, and more cash than feels comfortable.