Preparing for the Opportunity of a Lifetime

Posted August 15, 2021

 I think it’s critical to consider the disproportionate potential of the markets today. We have today:

·    The most overpriced US Equity market in history, according to Jeremy Grantham, reasonably priced only relative to bonds

·    The most overpriced bond market in 4,000 years, according to Jim Grant of Grant’s Interest Rate Observer

·    The housing market priced at the same multiple to median family income as it was at the peak of the housing bubble in 2006

·    The commodity market recently matching the historical peak of 2011, as measured by the Goldman Sachs Index of non-energy commodities

·    Speculative fervor that rivals or exceeds 1929 and 2000 (see Robinhood below)

·    Current inflation that greatly exceeds the Fed’s stated 2-3% target.

Regarding the speculative fervor of today’s market, consider the disclosures from the Robinhood IPO. As many as 50% of all new retail accounts opened in the U.S. since 2016 have been on the Robinhood platform, 47% of Robinhood’s users access the site daily and look at it an average of seven times a day, 47% of Robinhood’s transaction-based revenues in 2020 came from options, and, straight from the Robinhood S-1: “A substantial portion of recent growth in our net revenues earned from cryptocurrency transactions is attributable to transactions in Dogecoin.” Robinhood also noted that clients held approximately $12 billion in crypto assets, yet in the first quarter of 2021, $88 billion of crypto were traded on the platform. By conventional standards, that’s serious portfolio turnover. I’m making the assumption that most of Robinhood’s clients haven’t enjoyed the experience of a bear market. A cynic would suggest that this won’t end well. 

(Note: Robinhood's IPO was priced at $38 on July 28, 2021. It traded at $85 on August 4 and closed January 18 at $14.50.)

A 5% real (inflation-adjusted) return has long been the accepted target for institutional investors. From January 1926 through June 2021, a 60/40 portfolio (S&P 500/5-year Treasuries) had an annualized inflation-adjusted return of 5.65%. But there have been at least four 10+ year periods in which the 60/40 has failed to meet the 5% real return hurdle:

 6/1929-6/1938     4.08%  (Helped by cumulative deflation of 2%)

1937-1947          -0.03%

1969-1982          -0.05%

2000-2012           1.37%

Furthermore, in each of the periods above, either the stock component or the bond component was, according to GMO’s research, reasonably priced at the beginning of the period. Today by contrast, both components are substantially over-priced. (This is the subject of the Chiappinelli link below). I fear we will be adding the next decade to the list above, and this has practical implications for people in retirement, expecting to pull the “safe withdrawal” of 4-5% from their portfolio each year. 

You may be able to make a little more money in the stock market as (if) the rally continues, but I doubt that it will be incrementally life-changing for you and your family. On the other hand, if Stanley Druckenmiller, Jeremy Grantham, Ray Dalio and Larry Summers, and Peter Chiappiarelli are right, are right, not having the proper financial structure in place could have a disastrous impact on your equanimity and financial health, and leave you on the sidelines for one of the greatest opportunities in stock market history. 

The bear market is inevitable; only the timing is in question. I believe it is essential to prepare for it, and the time to do it is when you have the wherewithal to do it thoughtfully, not in the throes of a market freefall. Better to be early on this!