Q1 2020 Update



I continue to under-perform the S&P 500. I’m in year #4 of putting this blog together after setting out to out-perform the market with a value portfolio.

It’s not working so far. I believe this is because of where we have been in the market cycle.

I still believe that small value will demonstrate exceptional performance when it usually does: when we are emerging from a recession and bear market.

This is what we saw in years like 1975, 1991, 2003, and 2009. Small value delivered the following performance in those years:

1975 = +53.94%

1991 = +42.96%

2003 = +37.19%

2009 = +30.34%

Meanwhile, value always lags at the end of a bull market. It then goes down with the market during the recession.

Then, it delivers the out-performance emerging from the recession. This cycle doesn’t look any different to me.

Of course, we are not there yet. This is 2008 (small value -32%), not 2009. This is 1990 (small value -19%), not 1991. This is 1974 (small value -21%), not 1975.

We are only at the beginning of a recession and a bear market. Historically, this isn’t when the small value premium is delivered.

Based on the seriousness of shutting down large chunks of the global economy, this is likely to be a worse recession than the global financial crisis. The economy never grounded to an absolute halt during the GFC and that’s what is happening now.

What makes my under-performance even more incredible is that I anticipated a recession and went into the year with a significant amount of cash. Going into year end, I was roughly 30% cash and bonds. Going into March, I was nearly 50% cash.

Despite all of that cash and bonds, I still under-performed the S&P 500!

My assumption was that my cash would provide a nice cushion against the downturn I thought was coming in the market. The fact that I held so much cash and still under-performed is absolutely staggering.

Of course, this happened because most of my portfolio was in the deep value universe. Value is a universe that was annihilated this quarter.

Take a look at some of the popular value ETF’s this year:

QVAL – Down 40.23%

VBR – Down 34.98%

SLYV – Down 37.36%

Looking at the deep value EV/EBIT < 5 universe, the performance is even worse.


If I bought and held all of my stocks, then I would be looking at a very similar result today. My move to cash turned out to be the right decision.

Of course, my move to cash is not what a value investor is “supposed” to do. You’re not supposed to time the market, you’re not supposed to pay attention to macro, and you’re supposed to stick to the process no matter what. That’s what all of the mental models say and that’s what all of the experts say.

I’m done with all of that. I’m going to trust my own analysis going forward rather than mental models and superinvestor quotes.


I sold off most of my portfolio over concerns about the extreme recession and bear market that is unfolding.

I opened hedging positions with TAIL and SH to stay market neutral against the stocks that I still hold. I sold the short term bond ETF when rates went negative.

I bought one new position this quarter, American Outdoor Brands, a firearms manufacturer. You can read about the stock here.

The End of the Bull

How Bull Markets End

Since I started the blog, I have been worried about the next bear market.

Equities were rich and excess was everywhere. Venture capital firms were practically setting money on fire, as rich people gambled on the next Uber and Facebook, leading to situations like WeWork.

Private equity multiples and the leverage behind those deals grew more and more extreme.

We then had an ICO and crypto bubble, which bore many similarities to the dot com bubble. It was a mania. Manias are sure to end in tears.

Of course, market manias rarely end without a catalyst. That catalyst is typically a recession. In this cycle, we simply avoided a recession for longer than normal, so the mania grew more extreme.

I knew that once a recession came along, the market would be punished in an extreme fashion. I also knew that the frothy environment wouldn’t end until the recession came, so I stayed mostly long.

Now, the recession is here. It arrived faster and with more ferocity than I could ever have imagined.

Going into this year, I assumed that a recession was coming due to the yield curve inverting earlier in 2019.

The yield curve is the most reliable indicator of a recession that we have because it is a good proxy for how tight or loose the Fed is. I was really amused at everyone trying to rationalize the inversion earlier this year.

All of the “experts” lectured us about how inversions don’t matter, despite the yield curve’s excellent track record in predicting recessions. It’s different this time!

I expect the track record of the yield curve to remain intact. It will be even more useful during the next recession, because everyone will continue to dismiss the indicator.

Next time, they’ll say the 2019 inversion didn’t matter because what took down the economy was the Coronavirus. Then, a year later, we’ll have another recession.

We were headed into a recession and bear market without the Coronavirus. The Coronavirus is making a situation that was already unfolding into something more catastrophic to the global economy.

The Coronavirus is turning this from what would have been a normal, run-of-the-mill recession into the worst one that we’ve experienced since the Great Depression.

I do not understand the logic of the bulls who assume that the economy will just snap to life when everything re-opens. Will restaurant traffic immediately return to normal once everything re-opens? Will people return to movies, restaurants, and airlines right away? Will the millions of unemployed people suddenly get their jobs back?

Firms are going bankrupt right now. Their revenues are down 90%. Are they just going to spring back to life once everyone goes back to work? What about the deeper effects on the economy? Everyone’s spending is someone else’s income. Everyone’s debts are someone else’s assets. We’re witnessing a meltdown in asset values and income.

There is no way that is just magically resolved over a couple of months because the Fed is accommodative and some people get a $1,200 check and people can return to work. The bull case strikes me more as denial of reality than a valid thesis. It looks like an unrealistic fantasy to me.

Of course, this wouldn’t be the first time I’ve been wrong. I just think it’s highly unlikely that I am.


Valuation is destiny and the market has been overvalued since 2014.

The pundits have mocked bears since 2014.

The overarching attitude has been: “You keep talking about the CAPE ratio, but the market went up 20% last year, so you’re wrong and valuation doesn’t matter!”

The bulls were wrong in thinking valuation no longer mattered. The bears were wrong in assuming that valuations would come down without a recession. Based on the yield curve, a recession wasn’t a serious thing to worry about in the mid-2010’s. It wasn’t even a major concern at the end of 2018.

Overvalued markets don’t come down to Earth on their own. There needs to be a catalyst. In market history, the catalyst is typically a recession.

Valuation alone doesn’t push the market down. The multiple-compression comes during the recession.

The extent of a big equity drawdown is a combination of the overvaluation of the market and the severity of the recession. The bears miscalculated in the mid-2010’s because they didn’t take into account the fact that a recession was unlikely. The bulls miscalculated last year because they didn’t realize a recession was baked into the cake and a severe re-adjustment was likely going to happen based on how frothy the market was.

And yes, the market was insanely frothy. It was even worse than the internet bubble.

Last year, market cap/GDP went above its internet bubble highs.

Market cap/GDP is very good at predicting 10 years worth of returns.

What it doesn’t tell you is the sequence of those returns.

Usually, the sequence of those returns is wild and correlated with the timing of recessions and recoveries. In 2000, market cap/GDP suggested a .4% rate of return. The actual result was a .9% rate of return from that level. Market cap/GDP was a pretty damn good indicator through this lens.

Of course, the market didn’t return .9% per year for a decade in a straight line. This return happens in extreme bull and bear runs. When a very mild recession came in the early 2000’s, an overvalued market was knocked down to Earth.

From 2000-2003, the market went down 44%. Then from 2003-2007, it went up 90%. Then, from 2007-2009, it went down 50%. Then, from 2009-2010, it went up 50%. The market never moves in a straight line.

Let’s look at another decade with sky-high valuations that suggested poor returns: the 1970’s.

From 1973-1974, the market fell 45%. 1975-1980, it went up 200%. Due to inflation, all of these moves were null and the market was essentially flat over that period.

These returns were predictable based on valuations. What was less predictable is the sequence of those returns based on the timings of recessions.

An even better indicator of market valuation is Jesse Livermore’s indicator: the average investor allocation to equities.

The indicator predicted the poor returns of the 1970’s. It also predicted the poor returns of the 2000’s. It also anticipated the significant bull runs of the 1980’s, 1990’s, and 2010’s.


There is always a lag with the data for this indicator, but the latest data in Fred showed a 46% average investor allocation to equities at the end of last year. This was not as extreme as the internet bubble, when this went up to 51%.

Plugging this model into my equation based on this metric, this suggest a .7% return for equities for the 2020’s. Pretty similar to the 2000’s.

Market cap/GDP was at an all time high at the market peak this year, at 151% of GDP. This also suggests flat to negative returns to the 2020’s.

Will the path to these returns look like a straight line for a decade, or will it be like Mr. Market’s insane mood swings . . . that has always been the case through the history of markets?

Right now, we’re facing the worst recession that we’ve experienced in 90 years at record valuations.

We should see at least a 50% drawdown from the highs. We had a 50% drawdown during less serious recessions with less overvalued markets. Why won’t it happen this time? Because markets are more efficient? Give me a break.

Does the last 30 years look like an efficient market to you?  Does it look like investors carefully calculate future economic prospects and cash flows during periods of prosperity and bear markets?

1990-2000 – Up 300%

2000-2003 – Down 45%

2003-2007 – Up 90%

2007-2009 – Down 50%

2009-2020 – Up 250%

Rather than carefully and rationally calculating future cash flows, it looks to me like markets simply extrapolate what is going on at the moment and assume that it will last forever, leading to extreme swings.

The bull case seems to be based on the idea that markets look forward and will see past this.

When has that ever been the case in markets? Looking at market history, I don’t see a group of rational actors that can see past the noise and look at the long-term picture of an economy.

At the peak of every expansion, markets get bid up to multiples that suggest it will never end. During most recessions (at high valuations, anyway), markets crash like prosperity will never come back.

Markets aren’t this efficient mechanism that we read about in finance textbooks.

This is how markets work. During prosperity, we have a wonderful bull market where multiples expand. Then, they come crashing down once we have a recession, based on how high multiples are and how bad the recession is. Fear and greed. It’s an eternal cycle of human emotion.

Why won’t this happen again, when we are facing the worst economic crisis we’ve had in a century? Have we broken the economic cycle? Are investors seeing the world more rationally than they did in the past?

This sounds absurd to me.

The Future

Of course, once all this is over, if history is any guide, we’ll have another rip-roaring bull market. We had a nice bull market from 1932-37 and we had a great bull market from 2003-07.

The good news is that the yield curve has un-inverted. Short term rates are now negative. I would expect this to continue.

Once the bond market begins anticipating a recovery, I would also expect longer term rates to start increasing again. This is happening now, but there is always a lag between the shift in monetary policy and its impact on the real economy. In the next year or two, markets will rebound. Of course, rebounds don’t happen after a mere 20% drawdown in the S&P 500 and at the opening gates of a recession.


The virus isn’t going to last forever. At some point, we’ll have a vaccine. At some point, the lock-downs will end. At some point, fiscal and monetary stimulus will have an effect on the economy. That doesn’t seem like it will happen anytime soon, though.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.