Warren Buffett has many great lines about the market, but there is one that stands out to be particularly apt for the current environment.
Now most of you will probably assume I am using this quote to warn about the dangers of the stock market. Although I am by no means one of those overly optimistic “everything is peachy” stock market bulls, I do not feel the stock market is where the real risk lies.
I have lived through a few different market manias. And although they were all different, the one thing they all had in common was that it was extremely hard to stay short. Whether it was the DotCom bubble, or the real estate mania, the pain from shorting the exuberance was always Quentin Tarantino intense. It is easy to think back about these times and claim the excesses were obvious, but it is much more difficult to be honest and remember these bubbles as they were; brutal agonizing rises that crushed anyone who dared suggest the bull market might end. Investors who chose to fight the bubbles are now viewed as legends, but at the time, they were pariahs. In the late 1990s as the DotCom mania was bubbling over, the financial press ran multiple articles questioning whether Buffett was simply too old for the new economy. Michael Bury, the unlikely star from the Big Short, was viewed as a naive fool who did not understand that housing prices never go down on a nationwide basis.
It is shockingly difficult to know you are in the midst of a bubble. If it wasn’t, it wouldn’t be a bubble. And it is even more difficult to short the mania while everyone labels you a fool who “just doesn’t get it.”
I have a question for you. If I told you that I was shorting S&Ps because a big decline was coming due to the unsustainable rise in the stock market, would you think I was nuts? Or how about if I was buying a big slug of VIX front month futures and would keep rolling them until VIX returned to the “proper” level of 25+?
Chances are that you wouldn’t view me as some sort of heretic as many smart (and some who just think they are) hedge fund managers have been quite vocal spouting this view to everyone who will listen. It takes little courage to talk about all the risk in the stock market. There is precious little pushback to this opinion. It is the consensus view.
In fact as Hugh Hendry learned, it is more difficult to embrace the bull side and argue stocks could head a lot higher. Poor Hugh was vilified with his switch from bearish to bullish a couple of years ago, but here we are within spitting distance of the all time high in US stocks, yet everyone is still trying to sell the top.
I contend that although stocks might be expensive, they do not lie at the heart of the current bubble. There are no parabolic graphs showing money pouring into equities. There are no shoe shine boys stories. In fact, it is just the opposite. Inflows into equities have been quite muted considering the massive rally US stocks have experienced.
But the same can’t be said of fixed income. Faced with a moribund global economy after the great 2007/8 credit crash, Central Banks throughout the world slashed interest rates to zero and below. Investors, starved for yield, have flocked into riskier and longer duration fixed income securities.
There seems to be good reason for this epic race to chase yield. No matter how much monetary stimulus is applied, Central Banks seem incapable of kick starting the global economy. Inflation, which was initially feared when the first QE programs were started, has failed to explode higher, and in fact, has sagged back to low levels.
Little inflation, falling growth, a reluctance from governments to use fiscal stimulus and Central Banks who think they can solve everything with ever lower rates and even more quantitative easing have created the perfect environment for fixed income bulls.
Combine this with a 35 year bull market in fixed income that has reinforced the idea that interest rates only head one way, and you have the perfect recipe for a bubble.
At this point you are probably shaking your head and thinking the MacroTourist just doesn’t understand all the powerful deflationary forces that will continue to ensure interest rates stay low.
Oh no, I get it. I understand how we got here and more importantly, why everyone thinks we will stay here. Fixed income has only been going one way, and the bodies of all those who tried to fade this powerful trend litter the investing landscape.
But we have long past the beginning when the “wise” were investing. We have now entered the end where the “fools” buy with both fists.
With negative yielding long duration fixed income securities, I can’t think of a more obvious signal we have entered the ponzi period of this bull market. The only reason an investor would buy a negative yielding asset is in the belief (hope?) that some fool will pay even more in the future.
Yet if one suggests that fixed income might be about to embark on a vicious bear market, investors scoff and dismiss it with a condescending “no way.”
Some of you will probably feel the desire to send me some data or a great report outlining all the reasons why bonds won’t go down. Don’t worry - I have heard them all. There is no inflation in the system. There is too much saving. There are too many people chasing too few jobs. Technology is driving down the costs of everything. Poor demographics will overwhelm all and drag down growth and inflation. Yeah, yeah - I get it - a bond bear market can never happen.
So let me get this straight. We have negative yielding fixed income in many countries after a 35 year monster bull market. Investors are chasing yield because there are precious few high yielding vehicles. Money is flowing into fixed income securities at an astonishing rate. Suggestions that this might not be prudent are met with guffaws that you don’t “get it.”
Yet despite all of this, there is no way bonds are in a bubble? Well, I remember all sorts of investors suggesting DotCom stocks were fairly valued in early 2000. And I remember lots of arguments that housing weakness would be isolated in 2007.
Remember, we will only look back in hindsight and claim it was easy to spot the bubble. In the midst of it, everyone, and I mean everyone, will tell you that you are wrong. If they didn’t, it wouldn’t be a bubble.
Now I know, I could have made this argument last year, or even 3 years ago. And I had meant to write about why the timing of the turn might be upon us, but I am running late, and I really should be getting back to work. For now, I will leave that for another day.
But don’t forget, after the fact everyone will say they saw it coming, but in reality, almost no one will…
Thanks for reading,