Don’t Be A Cowboy
Look, I get it. For nearly a decade now, every correction has met been met with bravado, chest thumping, and euphoria. “Awesome! Now things are on sale!” I can already hear the virtual cheers from the Twitter rafters echoing loudly as the flood of retail money buys the dip. And you know what? That has been absolutely the right call. It may be the right call on this correction. In fact, it probably is. The evening following yet another day in a month full of bad days, I think every investor should consider a few things.
Any investment strategy simply needs to acknowledge the Nobel prize winning work of Robert Shiller and fit it into its ethos or it is not a strategy. Unlike most Nobel prizes which are typically awarded for esoteric nonsense of no use to anyone, Shiller’s work is very easy to explain. In fact, a simple graph depicts it. It says that long term equity returns are nearly entirely explained by starting equity valuation:
This view is simply not congruent with any idea of “Time In The Market,” which suggests the general trend of a market is always upward but unpredictable. However, if the market is unpredictable, Shiller’s line (illustrated above) could and would not exist.
“Time In The Market” is, to my mind, therefore total bullshit. A fairy tale paradigm designed by those seeking to absolve themselves of the pain and guilt of having made crappy investment decisions. None of which is to say I (or anyone else) can predict the market today, tomorrow, or even a year from now. But current valuations must provide the investment bearings for longterm returns, and anyone’s plans MUST either incorporate or explicitly ignore Shiller’s work:
Two Bad Things
Growth in equity prices ultimately require growth in earnings. When earnings growth doesn’t occur (see Emerging Markets Are Trash for a case with zero earnings growth), returns are tepid and stagnant. Tax reform imparted a massive gain to corporate earnings and was priced in during the fourth quarter of 2017, so unfortunately that well is dry.
The current 2 stories dominating the economic news cycle are both bad for stocks: higher interest rates and tariffs. Higher interest rates increase the cost of financing for corporate bonds. Higher interest costs = less money in profits = less earnings. On the tariff front, money wants to run freely and unencumbered like some kind of Mongolian horde of old. Tariffs cause suboptimality to creep into the system; if it was profit maximizing to make a bunch of low margin added stuff in the US, it would have already been made here to begin with. Less profit maximization = less profits (by definition) = less earnings.
Upside / Downside
The landscape is therefore one in which 1) earnings are very expensive by historical standards and 2) the ability to grow earnings looks challenging. The downside case is therefore amazingly easy to envision. As this graph demonstrates, we are (by historical comparison) well into the cycle of rate increases which defines the very phrase ‘late cycle.’:
What is the upside for staying in the market? Perhaps a surprise trade breakthrough, accompanied by the Fed relaxing interest rate policy, all while Europe dodges a recession and US wage costs stay muted? And even if all that happens, how much time are you playing for before the next recession?
Know what your beliefs are and why you believe in them, even (perhaps especially) if you disagree with me. Don’t risk that which you do not need to risk. Do the analysis and formulate your plan now and not while economic catastrophe is unfolding.
Don’t be a cowboy.
This article is for informational purposes only and is not investment advice, nor is it a recommendation to buy or sell securities. Consult with an investment adviser for any actionable advice.