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If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
So, let’s say you’re a prudent person who has concerns that our economy isn’t ‘recovering’ as robustly as you’d like.
Perhaps you still remember the speed and depth of the 2008 credit crisis’ arrival, and its toxic impact on asset prices, jobs, and overall trust in the financial system. Maybe you took notes during the preceding tech and housing bubbles and their aftermath. If so, you likely swore that “Never again!” would you put your wealth at risk during such obvious times of public mania.
Chances are, you’ve probably logged a lot of online hours over the past several years trying to read the economic tea leaves more closely. Are things becoming more stable, or less? What are “safer” measures for protecting and building wealth than simply putting all your chips into the paper markets (stocks & bonds) and real estate?
As a result, you’ve probably had a smaller percentage of your wealth in the stock/bond markets over the past few years than your peers. You probably also own some gold and silver, likely having bought much of it between 2009-2011 with the stock market collapse still fresh in your memory. Chances are also good that you’ve made a series of “preparedness” investments (stored food, etc.) as an insurance policy in case really tough times were to break out. Most of your family and friends didn’t take these steps, nor are they particularly interested in talking about your reasons for taking them.
So, if this sounds at all like you, five years after the 2008 crisis, how is the “prudent” strategy looking today?
Looking Like an Idiot
As one who took similar steps, I’ll confirm that it looks pretty lousy to the casual observer.
Stocks & Bonds
There has been an absolute party in the stock market over the past two years. The S&P is up nearly 40% (!) since early 2012 and has almost tripled since its 2009 lows. It’s been nearly impossible not to make money in the stock market recently (unless you’ve owned mining shares).
Bonds have remained at historically elevated prices. And although 2013 has seen prices come off slightly from their highs, prices are still substantially above pre-crisis levels.
The pumped-up performance of paper assets here is, of course, due to the staggering amounts of new money that the Fed has been creating since 2008. Starting with a balance sheet of $880 billion pre-crisis, the Fed has since expanded it by an additional $3 trillion, in less than 5 years. And it’s continuing to expand to the tune of $85 billion (some calculate $100 billion) per month.
Most of that money sits in excess reserves enriching the banks at zero risk, at high hidden cost to the public (a rant for another day). But enough of it is sloshing over into the markets where it does exactly what excess liquidity always does: rise all boats.
So, if you decided to stay out of the markets, you’ve watched the party boat pass you by. They say don’t fight the Fed, and so far, the Fed is indeed winning. In reality, it will likely prove to be the Charlie Sheen version of “winning”, but to the casual observer whose 401k is up 20% this year, the Fed definitely appears to be playing the better hand.
How soon we forget. Home prices have resumed climbing at historically aberrant rates. Case-Shiller just reported that year-over-year, its national home price index grew by 11.2%.
A number of markets have re-entered bubble territory. San Francisco, where prices are now higher than at their 2007 peak, saw a 26% year-over-year increase in average prices. Las Vegas, the poster child for housing price excesses six years ago, saw a 29% average price increase from 2012 to 2013.
The tell-tale sign of an overheated housing market – house flipping – is back.
If you’ve been holding off on purchasing real estate (as I have) – expecting that a stumble back into recession, or higher interest rates, could bring prices down to saner baselines – again, you’re watching prices get away from you.
Ugh. There’s no denying that it has been a very rough two years for gold and silver holders. As I’m writing this, gold and silver are dropping to near 4-year lows.
For those burned by the last crisis who purchased precious metals near their zenith in 2011, hoping to protect the purchasing power of their capital, the nauseating declines since early 2012 (especially in silver) have done anything but.
Those who bought PMs pre-2008 enjoyed a long stretch of validation while prices appreciated year after year. With a material percentage of that appreciation now gone, and month after month of relentless losses punctuated by vicious price smashes, it’s harder to feel as smart as it once was.
But it’s maddening. With the $3 trillion in new currency recently created by the Federal Reserve, shouldn’t precious metals be appreciating? Wildly? Isn’t that their central promise: to hold value as the purchasing power of paper money inflates away? But instead, they’re decreasing in dollar price, even as the money supply continues to expand. How is that possible?
And Bitcoin! From almost out of nowhere, a new alternative currency skyrockets from nearly valueless to (briefly?) match the price of gold. It’s like adding insult to injury for the 99.9% of precious metals holders who don’t also hold Bitcoin. How can the world suddenly wake up to the advantages offered by non-fiat currency, and yet still treat the granddaddy of sound money like kryptonite?
In 2009 and 2010, those of us who had warned our friends of the lurking risks in our economic and financial system suddenly looked like geniuses, instead of the kooks that folks had dismissed us as. Now, we’re back to being kooks.
A chart Chris has been sharing recently with our enrolled members shows that at no time in the past 30 years has sentiment been this bullish, not even during the Internet stock mania of the late 1990s:
Faith in the current system is as high as it has ever been, and folks don’t want to hear otherwise.
This extreme optimism extends beyond the Economy. In the Energy sphere, in news headlines discussion of the “shale miracle” is still omnipresent – without, of course, any mention of net energy, extraction costs, or depletion rates. In the Environment, coverage of the real-time collapse of key fisheries or water shortages likely to impact food production rarely gets any mainstream notice.
In short: If you’re one of those people who thinks it prudent to have intelligent discussion on some of these risks– that maybe the future will turn out to be less than 100% awesome in every dimension – you’re probably finding yourself standing alone at cocktail parties these days.
The Madness of Crowds
Charles MacKay’s excellent classic reference book, Extraordinary Popular Delusions and the Madness of Crowds, explains the nefarious nature of public manias: They strive to suck in as many participants as possible before collapsing.
We are seeing classic signs of the abandonment of concern by the public in favor of not missing out on ‘easy gains’. In addition to the examples mentioned above, signals that the fear trade has given way to the greed trade are abundant these days:
- Stock chasing – Here’s a quote the WSJ recorded from an actual retail investor buying shares on the first day of the recent twitter IPO: I messed up not buying any Facebook so I want to get some Twitter. I’m just buying because everyone’s talking about Twitter. Not because of its product (which she admitted she didn’t use). Or its business model (which has never been profitable and unclear whether it ever will be). The purchase decision was based purely on hype.
- Priority abandonment – At Peak Prosperity, we speak with professional financial advisers frequently. The advisers we know best focus on risk mitigation and remain skeptical of the sustainability of the prolonged market rally. Many of their accounts signed on after 2008, clearly declaring that they prioritized protection of their capital over everything else. Yet a growing number of these investors are watching the continued rise in financial asset prices and are now pushing for more aggressive management. They’re abandoning the prudence that was so important to them just a few years ago.
- Bear capitulation – The path to a bull market peak is littered with the carcasses of bearish analysts that dared to challenge its rise. As the % bearish Investors Intelligence chart above shows, there are few bears left to be found anymore. Just last week saw a major defection from the bear camp, with the perennially critical Hugh Hendry throwing in the towel, exclaiming:
I can no longer say I am bearish. When markets become parabolic, the people who exist within them are trend followers, because the guys who are qualitative have got taken out.I cannot look at myself in the mirror; everything I have believed in I have had to reject. This environment only makes sense through the prism of trends.I may be providing a public utility here, as the last bear to capitulate. You are well within your rights to say ‘sell’.
- Warning sign dismissal – It’s not as if there aren’t clear alarm bells being sounded by the very experts the public looks to for such warnings. It’s just that these warnings are being ignored by the market. No one wants the party to end:
“All markets are bubbly”
“In many countries the stock price levels are high, and in many real estate markets prices have risen sharply…that could end badly. I find the boom in the U.S. stock market most concerning,”
“Now, five years later, signs of frothiness, if not outright bubbles, are reappearing in [at least 17 global] housing markets”
“What we are witnessing in many countries looks like a slow-motion replay of the last housing-market train wreck. And, like last time, the bigger the bubbles become, the nastier the collision with reality will be.”
When this latest global asset bubble bursts as Roubini reminds us, by definition, it must; the public will cry,“Why didn’t anyone warn us?” The media will reflexively utter, “Nobody saw this coming,” But the truth is, there is evidence galore for those who choose to look for it.
The Wisdom of Looking Like an Idiot Today
The other key characteristic about popular manias/bubbles is that they collapse suddenly. Much more swiftly than they took to build.
The resultant carnage catches the masses like deer in headlights. The Kubler-Ross stages of grief begin quickly, and since Denial is Stage 1, most folks delay taking action out of disbelief. Soon the Bargaining stage is reached, and they continue to delay reaction as prices continue falling – praying for the chance to get out if a reversal would just happen. It’s not until Acceptance that most will take action, selling after the down draft has largely run its course.
Here are some useful stats to keep in mind that show how sudden and savage the 2008 market collapse was:
- Week of Oct 6, 2008 – The Dow Jones drops 18%; its worst week ever in terms of both absolute and percentage loss.
- March 6, 2009 – The nadir for the stock market. By this date, 5 months after the crisis began, the Dow was down 54% since October
The takeaway here is that the wealth destruction caught most investors flat-footed. Most were unprepared –both psychologically as well as with their portfolio positioning – to react.
Many investors thought themselves savvy and nimble enough to avoid the losses they ultimately suffered, telling themselves an ill-fated narrative similar to what Charles Prince told his shareholders:
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,”
Most readers remember how Citigroup’s price dropped from over $500/share, when Prince made this comment, to $10/share in March 2009. Prince was booted from his CEO role in late 2007 due to emerging losses resulting from the bank’s MBS and CDO positions, investment classes which proved to be at the heart of the 2008 crisis.
So, a smart question to ask at this time is: Is the moment in time we’re in today closer to January 2006, when there were several years left of exuberance to ride? Or is it more like September 2008, poised at the precipice?
A smarter answer is: There’s no way to know with acceptable certainty.
Like grains of sand piling up or snowflakes falling on a cornice, we can assess the growing level of risk, but we can’t identify the grain of sand or snowflake that will cause the eventual cascade. We can’t predict the collapse timing with confidence. We can – and will – continue to make our best-educated estimates, but the exact timing is unknowable.
So, given that fact, as John Hussman so pithily captures, bubble markets force us to make a choice:
The problem with bubbles is that they force one to decide whether to look like an idiot before the peak, or an idiot after the peak.
And so your choice is upon you. Look at the evidence around you – a movie nearly identical to one you saw in 2000 and again in 2008 – and either decide to party with the herd while the music plays (look smart today), or park yourself in safety now (look smart tomorrow).
Since the timing of the next correction is unknowable, the prudent choice is obvious. But it’s not easy, for all of the reasons mentioned at the start of this article.
A helpful question to ask yourself is: If I could talk to my 2009 self, what would s/he advise me to do?
For most of us, our past self, recently reminded of the anguish of wealth destruction, would say, “Run to safety!” at the first whiff of anything bubblicious. Research has shown that when the chips are down, the benefits of loss aversion are always preferred to the joys of gain.
Don’t put yourself in a position to relearn that lesson so soon after the last bubble. Exercise the wisdom to look like an idiot today.
The Need for Discipline is Greater Than Ever
Okay, so what should today’s “idiot” focus on doing?
- Build cash – It’s not sexy. And it’s not fun to see the dollar price of nearly every asset known to man escalate while you hold cash. But bubbles are designed to take as much as possible from as many people as possible. During the popping of a bubble, the real wealth (underlying assets like companies, land, minerals, etc.) doesn’t vaporize like the high prices do. Those assets are simply transferred at a lower (more attractive) price to those people who still have money. Be one of those people.
- Hold on to your precious metals – I know. It’s painful right now. For most PM owners, just hold onto what you have right now. Those with stronger stomachs should be dollar-cost averaging. Remember, the fundamentals for owning gold and silver have not changed AT ALL over the past few years. Stay largely with physical bullion. Don’t speculate with the mining stocks at this time unless you’re a risk junkie (or masochist?) and then only with money you can afford to lose.
- Scout out locally-based hard-asset investments for the future – Once this bubble pops, higher interest rates and lower prices will result. Look around your local area for assets (businesses, housing, farmland, livestock, etc.) that you would consider holding at least a percentage ownership in. Calculate what price would make you an interested investor. While that price may be years away, when the impact of a market correction hits, you’ll be poised to move ahead of the other savvy investors to secure the opportunities you want (and play a role in stabilizing the community in which you live).
- Design your trading plan for a market downdraft – What steps will you/your financial adviser take if the market starts cratering? If you don’t currently have a plan in place, now is the time to design it. Will you employ stops? What “safe assets” will you move to? (Treasurys, cash, other currencies?) Will you strictly be a sidelines observer, or will you take any active short positions on the downside? Will there be opportunity to generate income using vehicles like covered calls? Whatever makes sense for you, devise your strategy in the calmness of today vs. on the fly while the markets are melting down around you and everyone is panicking. And if your financial adviser is unable to provide you with a comforting answer as to his/her strategy for captaining your money through another 2008-like (or worse) correction, we have a few recommended advisers you may want to consider talking with.
- Build your roof while the sun is shining – So many of the most valuable investments are not financial (emergency preparedness, energy efficiency, community, health – to name just a few). Use the gift of time we have now to invest in expanding your degree of resilience. If it’s been a while, take a fresh skim though our What Should I Do? Guide to identify any areas where you aren’t satisfactorily prepared. These are the investments that it’s infinitely better to have in place “a year early vs. a day late.”
- Increase emotional fortitude – Being “wrong” in the eyes of society is trying. And it’s stressful for many, especially if your partner or others of those close to you don’t share your views. Keep learning by reading this site and a wide range of others, including those with opposing commentary. Develop your opinions based on the data you determine is most accurate – your ability to stand resolute against popular sentiment will be grounded in your confidence in the “big picture.” Seek support from the thousands of other Peak Prosperity readers who are wrestling with the same issue set you are, by participating in our Groups. We created them to help people support each other both virtually and “in person” within their local communities.
- Develop an income loss plan – If we’re correct in our prediction of a major downdraft, a return to deep recession is likely, and with it, a return to higher unemployment. Loss of income is a stressful trauma, especially if it happens unexpectedly and is compounded by a hobbled job market. Take some time to assess your job’s level of vulnerability to another recession. If it’s higher than you’d like, ask yourself what you would do if a sudden layoff occurred. Start doing the work now to at least sketch out the path you would take if that happened. If possible, develop some relationships or related skills now that would give you an exceptional advantage, should you ever need to head down that route. The first third of our book, Finding Your Way to Your Authentic Career has a number of exercises that provide useful guidance for those looking to do this.
- Develop an income enhancement plan – The resilience that comes with multiple income streams really helps you sleep at night, as you’re less vulnerable to having your entire life upended if a sudden pink slip appears. Also, having extra income to direct to other goals (retirement, education, homesteading, etc.) enables you to reach them faster. We’re all busy, but thinking creatively for a moment: What could you start doing today to secure extra income streams in the future? This is a topic that Chris often helps folks think through in his consultations.
Essentially, the approach here is to dismiss what is not in our control and focus on what we can best do with what is.
Be practical. Be prudent. Be dull to those watching you from the dance floor.
John Hussman signed off his latest report with the advice: “Risk dominates. Hold tight.” I agree. Now is the time act with the courage of our convictions.
As Kipling put it, at the end of his poem:
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: ‘Hold on!’
If you can talk with crowds and keep your virtue,
Or walk with Kings – nor lose the common touch,
If neither foes nor loving friends can hurt you,
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds’ worth of distance run,
Yours is the Earth and everything that’s in it,
And – which is more – you’ll be a Man, my son!
~ Adam Taggart