Everyone knows that everyone knows the Democrats will spend like there’s no tomorrow.
Everyone knows that everyone knows the Fed will not let anything bad happen to markets…the US indices will end this year and every year after that posting all-time highs.
Everyone knows that everyone knows that bitcoin is heading to US$100k and way beyond.
Everyone knows that everyone knows inflation is coming.
Everyone knows that everyone knows that valuations no longer really matter.
Everyone knows that everyone knows property prices are headed higher.
With all this collective knowledge, what could possibly go wrong?
So sit back, let out a collective sigh of relief and enjoy the ride.
A historic collapse is coming
Well…usually when everyone is thinking the same, it’s a case of no one is really thinking.
Life tends to spring surprises upon us…some good ones and some not so good ones.
The surprise everybody knows IS NOT coming is a historic collapse on Wall Street.
That’s why portfolios are so heavily weighted into shares (equities).
The current percentage allocated to shares is on par with the peaks of the 1950 to 1968 bull market and the dotcom boom.
Source: Sentiment Trader
Market history — going back for centuries — plays out a rather monotonous, repetitive and rhythmic story.
One of peaks being followed by troughs followed by peaks.
I know that everyone knows ‘it’s different this time’. The Fed has acquired powers far exceeding any Marvel comic superhero.
They sure better have.
Because holding back the forces of human nature responsible for creating history’s cycles of boom and bust is going to take super-super-superhero strength.
Every knows that everyone knows the US market cannot fall 70% or 80%. Absolutely impossible. Not going to happen. What hyperbolic rubbish.
The current market is more exceptional than ever before
History and mathematics tell a different story…it is entirely possible and not without precedent.
The Great Depression. The 1990 to 2010 Japanese share market. The Nasdaq from 2000 to 2002.
Granted these are exceptional cases, not your run-of-the-mill market corrections.
But did you know this current market is more exceptional than all those before it?
The indicator Warren Buffett described in a 2001 interview as ‘probably the best single measure of where valuations stand at any given moment’, is now standing in a league all of its own…well above the dotcom peak:
Source: Advisor Perspectives
Just a simple reversion to the mean requires a correction/collapse/crash of 60%.
But if a market can overshoot on the upside, what’s to prevent an ‘equal and opposite force’ pushing it well below the mean?
Possibly an 80% correction.
The prevailing mentality is one of ‘it simply won’t happen because…’ (please pick your reason from this list):
- It’s too preposterous to even contemplate.
- The Fed won’t let it happen.
- The Fed will go into QE overdrive.
- Markets are different today.
- There’s too much money on the sidelines waiting to buy (a reason so dumb it’s laughable).
- Companies will never be that cheap.
- Low interest rates support high P/Es (that is another one of THE dumbest reasons you’ll ever hear…but these are stories for another day).
That pretty much sums up the naysayer’s argument/s against a catastrophic fall.
These are nothing more than reasons of hope and an absolute belief in the Fed’s ability to thwart a cycle of human nature extending back to a time before Adam played fullback for Jerusalem.
Now, I ask you, which one of us is nuts?
Winning by not losing
Your investment strategy must be well reasoned. Suit your tolerance for risk. Reflect what stage of life you are at.
My investment motto is ‘winning by not losing’. Sounds simple, but it took years to figure this out.
The ferocity of a historic bear market can wipe out years, even decades of gains in the blink of an eye.
For me, successful long-term investing is more to do with avoiding catastrophic losses than it is do with rejoicing over unrealised gains.
The maths supporting ‘winning by not losing’ are:
Every 10% loss requires an exponential level of gain to recover.
It can reach the point where the losses become so great, recovery will never happen in your lifetime…or maybe even your children’s.
In the space of two and a half years, the Great Depression wiped almost 90% from the Dow Jones. It would take 25 years before the Dow would once again pass its 1929 peak.
In my opinion, the preferred strategy is to sidestep the majority of the loss and participate in the majority of the recovery.
This is far easier said than done.
Which is why having well defined investment guidelines is imperative to assist in achieving this objective.
I know from nearly 35 years in this business investors tend to focus on the upside…especially in a booming market.
‘How much money can I make?’ is a thought that’s never far from peoples’ minds in the good time.
Personally, I look at the downside…what level of loss can I tolerate before the pain and regret of loss becomes too much to bear?
If you know what level of loss you can stomach, then you can let the upside take care of itself.
Here’s a ready reckoner on the allocation you should have to shares based on your tolerance to loss.
If you suspect the next market downturn (and believe me, there is one coming) could be rather savage, then reduce your exposure into the range where the loss will feel more like a flesh wound than an amputation.
If the market continues to rise, take profits (pay the taxes) and rebalance your portfolio back to the exposure level you are comfortable with.
Do the opposite of the herd…sell into a rising market and buy into a falling one.
This disciplined approach is how you avoid the majority of the capital destroying losses and gives you the cash to buy back in at bargain-basement prices.
It ain’t rocket science.
Surely everyone knows the way to create lasting wealth is to buy low and sell high?
Based on the current market mood, it appears this crucial piece of knowledge is going to come with a very expensive price tag.
Editor, The Rum Rebellion