INVESTING WHILE INTOXICATED (January 17, 2021): We have experienced all-time record levels of speculative call buying, penny-stock chasing, massive percentage increases for marginally-profitable companies, IPO eagerness, and numerous other multi-decade and even multi-century records which in many cases have surpassed rare bubble extremes from periods like 1928-1929, 1972-1973, and 1999-2000. Far too many investors have embraced the perceived certainty of ever-rising asset valuations, resurging inflation, a slumping U.S. dollar, endless summer for cryptocurrencies, record-low spreads for high-yield corporate bonds over U.S. Treasuries, the second real-estate bubble of the 21st century, and other myths as though they were certainties. The most remarkable feature today is how few people recognize it as being both phenomenally extreme and completely unsustainable. All similar bubbles in past centuries have ended with nearly identical collapses and this is not going to be the first-ever exception to that rule.
The large-cap Nasdaq collapses of 1973-1974 and 2000-2002 are likely to be repeated along with severe losses for many other fluctuating assets.
From its March 10, 2000 peak of 105.12 to its October 10, 2002 bottom of 17.24, adjusted properly to include all reinvested dividends as StockCharts.com does, QQQ plummeted 83.6%. I expect a similar percentage decline, plus or minus several percent, within three years or less. This will likely be accompanied by notable percentage losses for high-yield corporate bonds, real estate, cryptocurrencies, art, and nearly all fluctuating assets. It won't be a smooth path down and there will be many rebounds along the way. Robinhood investors and Bogleheads will both suffer severe losses for somewhat different reasons.
Bogleheads are overreliant upon the glory of past decades.
John Bogle himself decried the existence of those who took his excellent idea about index investing and badly distorted it. John Bogle sold all of his aggressive-growth shares in 2000 and also unloaded most of his stocks shortly before his passing in 2018 because he astutely recognized that there is sometimes far too much risk in the financial markets. It's too bad that most of today's Boglehead investors haven't considered that if you had been invested in the U.S. stock market near the end of August 1929 then by August 1982--which was 53 years later--your portfolio would have lost an average of about 60% after adjusting for inflation depending upon exactly what you owned. The only true periods of dramatic outperformance for the U.S. stock market, not counting the bubble behavior since March 2020, were the incredible eight-year rally from August 1921 through August 1929 and the more recent huge bull market from August 1982 through March 2000 with a few minor bear markets along the way. Even with its huge gain in recent years, if you are long a basket of Nasdaq stocks which you have owned continuously since the peak on March 10, 2000 then you are only marginally ahead after adjusting for inflation.
People are repeatedly underinvested whenever bull-market gains are about to be greatest and dangerously overinvested near the beginning of all major downtrends.
Nearly all long-term analyses of the financial markets underrate the rarity of the atypical outsized gains of the above two periods of 8 and 17-1/2 years. They usually have an agenda, open or hidden, of creating an illusion that "stocks always go up in the long run." Actual records by brokerages and mutual-fund companies illustrate clearly that most people prior to these two major outperforming periods had historically very low allocations to risk assets; in August 1982, for example, only 13.2% of total household wealth was invested in stocks versus roughly five times that amount by early 2000. So the vast majority of investors got little benefit from the two huge bull markets of the past century while there was massive participation on the downside in 1929-1932 and 1999-2003. With everyone nearly fully invested today we are set perfectly for a massive aggregate loss of wealth over the next few years.
Safe-haven assets have quietly completed important bottoming patterns.
VIX, a measure of implied volatility, has been steadily making dozens of higher lows since the final months of 2019. The U.S. dollar index, a little-followed signal which has accurately forecast nearly all major market turns of the past half century, probably completed its lowest point since the second week of April 2018 at 90.209 at 6:30 a.m. on January 6, 2021, having made numerous higher lows during the past 1-1/2 weeks. The U.S. dollar index topped out on March 4, 2009, exactly two days before the S&P 500 began a historic surge higher, and the U.S. dollar index also completed a key peak on March 20, 2020 just before the March 23, 2020 bottom for many U.S. equity indices. In July 2008 the U.S. dollar index completed a key double bottom just before the S&P 500 suffered one of its worst-ever percentage collapses. It is probably no coincidence that the January 6, 2021 bottom for the U.S. dollar index preceded by a half week the 319.99 after-hours top for QQQ registered at 5 p.m. on January 8, 2021.
The most-experienced investors are among the few who have embraced the U.S. dollar and U.S. Treasuries.
The third of the "Three Musketeers" safe-haven trio, TLT and other long-dated U.S. Treasuries, likely completed important bottoms around noon on January 12, 2021. Top U.S. corporate executives have set new all-time records for the ratio of the total dollar amount of insider selling relative to insider buying in the U.S. stock market. These very-experienced investors have been increasingly accumulating the safest havens while they are still significantly undervalued. In every bull market the most-capable participants buy first, followed gradually down the food chain until the least-knowledgeable novices are piling in near the top. In a bear market the savviest investors get out earliest, followed all the way down the line until the least-experienced traders end up setting all-time records for net outflows near the bottom of the cycle.
Real estate worldwide is completing its second major bubble of the 21st century.
The 2005-2006 real-estate bubble featured subprime mortgages and liar loans. The 2020-2021 real-estate bubble is notable for record-low mortgage rates and the easy availability of credit and zero down payments. The most important similarity between 2005-2006 and 2020-2021 is that the ratio of U.S. housing prices to average household income in both cases surpassed twice their long-term level in many neighborhoods. Much of this data including the detailed Herengracht study which began in 1628 and Case-Shiller backdating to 1890 spans centuries (and even millennia, since real-estate prices have been recorded throughout written history). In 2005-2006 one heard frequently about how "foreign buyers" would enable real-estate prices to be perpetually elevated; by 2010-2012 many of these buyers had become sellers. Today you hear repeatedly about how people "from away" are eagerly buying but no one mentions how those with no long-term connection to a place are much less likely to hold on during periods of falling valuations. No asset which is more than double its fair value can sustain such a high price regardless of whether it's real estate, stocks, commodities, or anything else.
Intraday behavior highlights eager opening-bell buying which characterizes nearly all tops.
If you look at intraday charts of most risk assets in March 2020 then you will quickly discover that the least-experienced investors who were panicking out of the market nearly all did so near the opening bell, especially on Mondays when investors had been worrying all weekend about how much lower the market might retreat and had placed massive market orders to sell. Near bubble peaks in March 2000 and again in recent weeks we have repeatedly experienced the highest prices of the cycle near the opening bell when the least-experienced recent investors are most excited about how much money they're going to make. During the final months of 1999 and the early months of 2000 I heard many people openly predicting--in person and on the internet--how much money they would make in the stock market, with an infamous survey in February 2000 registering the average investors' expectations of 30% annualized gains in the stock market for the following decade. Recently similar absurd extrapolations have become commonplace.
Many of today's investors were in high school or younger during the 2007-2009 and earlier bear markets.
The huge surge of new investors in less than one year, just as in 1972-1973 and 1999-2000, have mostly never experienced a bear market. Many of them were in school when the last bear market occurred so it seems emotionally distant. Now they'll have a front-row seat to the carnage which will affect so many of them directly.
It's not just the newby investors who are convinced of invincibility but many long-time baby boomers who should know better.
If you look at the comments below and on my other essays on Seeking Alpha then you will quickly discover that those who are most optimistic about future risk-asset valuations are not just those who have never personally experienced bear markets. Many investors who lived through the huge collapses of 1999-2003 and 2007-2009, and who may have lost significant percentages of their net worth during those bear markets, have convinced themselves that "because of the Fed" or "since you have to put your money somewhere" or "with all of that cash still out there" or "since assets have to climb in the long run" that they're going to come out ahead even if they enter or hold their positions near their most-overvalued levels in history. All major market tops and bottoms must be accompanied by widespread delusions that a current unsustainable over- or undervalued extreme can persist indefinitely. The biggest percentage losses have always occurred whenever there was the highest level of overconfidence in future gains while the most dramatic percentage gains have happened in an atmosphere of maximum pessimism.
All post-bubble collapses have nearly identical chart patterns as Charles Mackay pointed out in "Extraordinary Popular Delusions and the Madness of Crowds" which he first published in 1841.
QQQ's pullback from its March 10, 2000 zenith of 105.12 to its May 24, 2000 intermediate-term intraday low of 63.03--with both numbers properly adjusted for dividends by StockCharts.com--was just about exactly 40%. QQQ reached 319.99 at 17:00:01 Eastern Time on January 8, 2021 which if we round off to 320 implies an upcoming bottom, perhaps in the second quarter of 2021, near or below 192. This is nowhere near what its ultimate bear-market nadir will be in 2022 or 2023 but is merely a projection for its first significant decline. Usually bear markets have their second-largest percentage losses near the beginning and their largest percentage declines near the end with lots of bounces and other unknowable fluctuations in between. Hardly anyone would likely agree with this price target with the vast majority of forecasters expecting continued QQQ gains in 2021 and beyond.
Participation in recent weeks has been concentrated in the least-reliable and most-dubious sectors of the financial markets.
The most-speculative sectors in the financial markets today have enjoyed by far the greatest increases in both participation and percentage gains, thereby encouraging many others to climb aboard these highly-uncertain assets. Penny stocks, cryptocurrencies, and out-of-the-money call options have become the darlings of recent months to an extent not even approached during past bubble peaks. Here is a chart of participation in penny stocks during the past decade:
The disappearing Trump mystique provides an emotional excuse for "huge" asset losses.
Most of the irrational increases for risk assets occurred since Donald J. Trump was declared the winner of the 2016 U.S. Presidential contest. Whether this is fundamentally meaningful or not, Trump is associated in many people's minds worldwide with wildly-overpriced assets. Now that Trump is out of favor, and soon to be out of office, this mystique has reversed. Many will subconsciously tell themselves that since Trump has gone there is nothing to prevent asset valuations from declining dramatically.
The most noteworthy aspect of the current asset bubble is how--as with every bubble peak in history--so many perceive it as being normal and sustainable when it is neither.
A few people in the media and on chat sites including Seeking Alpha have mentioned the rarities of the current situation and sometimes use the word "bubble" but most investors are convinced that nothing extraordinary is going on. A century from now, and perhaps two or three centuries from now, the current mania will be analyzed as to how it could have been created in the first place and why so many more people piled in near the top rather than prudently reducing risk. The 1929-1932 bear market might still remain as the premier historic collapse but 2021-2023 will provide some serious competition and will likely be much more closely scrutinized partly since data and analyses from the current century are far more numerous and pervasive than a bear market from a previous century of mostly mass print media. Most people have been investing while inebriated with the liquor of potentially unlimited gains, not realizing the severe hangover which is approaching.
When in doubt use the Martian test.
Suppose that you had just arrived on planet Earth from a trip to Mars where your internet connection had been broken. What looks absurd and what looks normal? If you are living through a period where the value of cryptocurrencies gradually climbs for months then you begin to accept it as being typical regardless of how high it gets. If you were thinking about selling on the way up but you didn't sell and the price climbs higher, you keep getting positive psychological feedback telling you how smart you were for waiting longer. Eventually you won't be able to sell at any price, no matter how high, since you've gotten so many pats on the back attesting to your brilliance in doing nothing. Many of the recently-minted rich from being fortunate enough to hold bubble assets have proudly declared that they're not selling a single share, thereby ensuring that they will end up poorer than when they began. I personally know several people who had suffered this fate in 1999-2003.
The bottom line: today's investors are like small animals blissfully eating by a pond, not recognizing that they are surrounded by hungry alligators.
One of the most important principles of investing is that if you are long anything and a massive concentration of inexperienced investors are joining your trade while insiders and commercials are heavily selling then you must get out regardless of what might happen in the long run. That is why I bailed out of GDXJ with an average price of 62.50 - 63.00 in the morning of July 27, 2020. Similarly, if you are short or in cash and investors are making all-time record net outflows while insiders are buying at their most intense pace in eleven years, as had occurred in March 2020, then you must buy aggressively even if you don't see any light at the end of the tunnel.
Disclosure of current holdings:
I have gradually increased my short positions in XLK, TSLA, and especially in QQQ while increasing my long position in GEO and more than quadrupling my now-substantial long position in TLT. I closed out all of my long positions in value shares; while I like many value sectors long-term I expect substantially lower prices sometime during the next half year.
Here is my asset allocation with average opening prices adjusted for all dividends: 65.7% cash including TIAA Traditional Annuity paying 3% to 5% (only available for legacy retirement accounts) and Discover Bank high-yield savings paying 0.50% (available for all U.S. residents); 18.5% short XLK (112.5968); 11.5% long TLT (154.68); 10.2% short QQQ (292.8835); 9.6% short TSLA (491.9117); 3.0% long GEO (8.76); 2.4% short ZM (293.16); 0.9% short AAPL (125.5481); 0.6% short IWF (223.0119); 0.5% short SMH (170.7813). It doesn't add up to 100% since short positions require less cash; there is no margin involved.
