Category Archives: Macro

Predictions are Worthless

I hope you had a great Thanksgiving!

Macroeconomic Predictions are Worth Less Than Used Toilet Paper

This year, it finally became clear to me that the macro economy is truly unpredictable and most predictions are worth less than toilet paper.

I previously thought that you could predict the economy to a limited degree – i.e., you could use things like the yield curve and valuation metrics to show when animal spirits were high and a collapse was near. Now, I don’t even think that is possible.

The economy is more unpredictable than the actions of an individual that has recently consumed 10 shots of vodka and three red bulls. They’re not going to pass out – they’ve had 3 red bulls, after all. Of course, their brain is completely shut off from any semblance of rational thought. Who knows where the night will lead? Probably nowhere good, but the specifics will be quite unpredictable. Butchered karaoke? A fall on concrete? An ill-advised romantic liaison? An iPhone in a toilet?

Actually – scratch my earlier comment – 2020 showed that toilet paper can be quite valuable and worthy of brawls similar to those over big TV’s on Black Friday.

Let’s go with this: macro predictions are worth less than used toilet paper.

Who could have predicted in January that a pandemic would spread throughout the world and that governments would respond by completely shutting down their economies? An economic shutdown is something they didn’t even pursue in 1918. Shutdowns were like using shotgun blasts to kill a mouse. As fun as that sounds, it isn’t the ideal solution.

In April, who could have predicted that the pandemic wasn’t going to spread as fast as we feared? Who could have predicted that once restrictions were lifted that GDP would rapidly recover and unemployment would begin declining?

There are a bunch of people who did recognize COVID early on – but with rare exceptions, these are mostly the same people who have been predicting a Mad Max style economic apocalypse every day for the last 10 years. From a markets perspective, they had their day in the sun for a month.

There are also folks who “predicted” the turnaround in markets and the economy and went all-in on stocks in March, but how useful is that if they didn’t successfully predict the March crash ahead of time and have cash to deploy?

It was also quite possible that a 30% decline wasn’t enough. Market history would suggest that that the decline would be more like 50% if the recession were anything like 1973-74 or 2007-09.

My conclusion is simple: trying to predict this stuff is impossible and a waste of brain matter.

I suppose that prediction can be viewed as a fun little game. Maybe it’s financial entertainment (isn’t that an oxymoron – like vegan chili?).

Unfortunately, for many people (including me), it turns into a lot more than that and people start thinking they can predict macro like they’re the next Stanley Druckenmiller (they’re not).

Where is the hyperinflation?

Since 2010, I’ve consumed a lot of very bearish content.

The details differ but the same thread pervades all of it: The Fed and quantitative easing are insane, the Fed is fueling a debt binge and a bubble in stocks & real estate, and the system will eventually collapse because of it. Zimbabwe, hear we come.

When you consume enough of this content, you eventually want to sell every stock you own and load up on gold/puts/bitcoin. In more extreme scenarios, you may want to load up on guns, ammo, and canned goods. They’ll only take the Chef Boyardee from my dead, cold hands.

The trouble with this “the Fed is destroying the financial system” line of reasoning is that it has been wrong for a long time, even though it is quite convincing.

This was all of the rage circa 2010, as we emerged from the financial crisis. The Fed responded to that financial crisis aggressively. Back then, I thought that all of this “printing” would eventually have some kind of dire consequence.

After all, as someone who grew up Catholic, I always assume that any degree of fun or success will be swiftly punished.

This video became widespread around this time that sums up the zeitgeist pretty well:

There was also this letter to Ben Bernanke written by some of the greatest financial minds of the planet warning that quantitative easing must be stopped.

From the letter: “The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment.”

The problem is that the hyperinflation and dollar collapse never happened.

Here is a look at the inflation rates by decade:

The 2010’s actually had the lowest average inflation in the last six decades. This is quite surprising after a “money-printing” tsunami has engulfed the world after the financial crisis. The US dollar also strengthened in the 2010’s.

There are a lot of explanations for why inflation didn’t happen. I tend to think it has something to do with the declining velocity of money.

Whatever the explanation, the key thing is that everyone was wrong.

When I hear people complain about inflation today, I think it’s pretty funny. I remember as a teenager in the 1990’s that people were elated that inflation was so “low” because their baseline was the 1970’s. It was viewed as an economic miracle that inflation was only 3%.

It’s funny how three decades of low inflation can transform people’s perspectives. Now that memories of the 1970’s have faded, 2% inflation is viewed as unacceptable debasement that will trigger the collapse Western Civilization.

Meanwhile, 10% inflation in the 1970’s didn’t cause a collapse, but we were unfortunately subjected to disco.

The Doomers will go on to say that inflation is here, but the government is lying about inflation rates. They’re not wrong, the government is lying. Indeed. The higher numbers on my bathroom scale have nothing to do with the pasta I’ve eaten in quarantine – the scale is obviously broken and fraudulent.

Healthcare & Education

The Fed hating Doomers will often point to health care and education as examples of inflation that aren’t covered by the official statistics.

First off, healthcare and education are included in the CPI. If you want to read the actual methods that the government uses to calculate CPI, then read it here.

Of course, why bother reading about the BLS’s actual methodology when you can hate on the Fed and rely on anecdotes for inflation? Have you been to the grocery store lately?

But, whatever. Let’s take the argument at face value. Healthcare and education are examples of inflation that the government is misleading us about.

The relevant question is this: are the increases in healthcare and education caused by the Fed?

Healthcare costs have outpaced inflation since the 1960’s. Education costs have outpaced inflation since the 1960’s.

If the price increases of a good exceed inflation by a few percent a year – and you compound that over 50 years – it will become extremely expensive. That has basically been the story with healthcare & education since the 1960’s.

If these increases weren’t caused by the Fed, then what caused them?

I would argue that government policy caused them.

The Higher Education Act of 1965 made it very easy for students to borrow money to go to college. The government also started to back student loans in the 1960’s as a result of this legislation. This meant that a flood of money (with little price consciousness) poured into a limited resource – higher education. This made price increases outpace inflation.

Compound that for 50 years, and you get really high tuition rates.

Where does the money go? Anyone who has been on a college campus in the last 20 years can tell you. There are recreation centers better than most private gyms fully equipped with “free” saunas and personal trainers. There are administrators with titles like deputy vice president of community climate affairs that make $158,000/year.

Healthcare is a bit more complex but the dynamics are the same. There is little price consciousness in healthcare. No one directly pays for anything. Your health insurance company pays.

This dynamic came out of the high tax rates of the 1940’s. As tax rates increased during World War II, employers looked for ways to pay their employees in ways that wouldn’t be taxed. They found that health insurance was a good way to reward employees and avoid the tax man. Employees liked it.

The result was that health insurance became linked to employment. As health insurance became widespread, instead of going to a doctor and paying out of pocket, everyone started using health insurance for even routine treatments and check-ups.

When people stopped paying directly, they became less price conscious, and this helped fuel inflation in the healthcare sector. Before all of this, you would just pay out of pocket and would shop around for the best price. If your doctor charged you $500 for aspirin and a band aid, you’d say: “What the hell, man?”

With health insurance, you went anywhere you wanted and didn’t really care about the price because the insurance company was paying for it. Compound this for 50 years, and you get a situation where a Band-Aid costs $629 in a hospital.

I was briefly without health insurance and found it annoying how it was hard to get a cash price. When I called a doctor’s office to explain that I would pay with cash, it made their heads explode and they couldn’t quote me a price.

Also, in the 1960’s, the federal government introduced Medicare, which covered the healthcare of seniors. Seniors are the biggest consumers of healthcare. This – predictably – led to increases in the cost of healthcare.

The government kept trying to Band-Aid healthcare inflation over the following decades, but it only compounded the problem.

The core problem with healthcare is that traditional laws of supply and demand don’t work because no one is directly paying for anything. If you compound something that outpaces inflation over 50 years, you get really high prices.

US healthcare costs are now 17.7% of GDP – which are the highest in the world.

The US has an odd healthcare system that combines capitalism with government-fueled taxpayer cash and no price consciousness. It’s like we took the worst aspects of both socialism and capitalism and combined them into an unholy hybrid – like orange juice and toothpaste.

Bottom line, I don’t think that the increases in healthcare and education have anything to do with the Fed, even though they are blamed for all of the problems in the world.

What to Do?

Perhaps you’re like me and you often worry about this sort of thing.

What if the Doomers are right and the economy is a ticking time bomb about to unleash a tsunami of hyperinflation?

They’ve been wrong for 10 years and never apologize for their failures or are held accountable – but let’s take these arguments at face value.

There are many ways to protect a portfolio from inflation without betting the ranch that it will actually happen.

Personally, I have 20% of my asset allocation in gold. Over time, gold will largely retain its purchasing power. It will also be worth something even if the US government collapses, as it has retained value for 5,000 years of human history.

Note: with gold, the road to “retaining purchasing power” is incredibly rocky and volatile, but gold prices have a track record of going bonkers when inflation rates are accelerating when interest rate sensitive assets are getting crushed.

I also have 20% in real estate. Real estate ought to also keep up with inflation. Not only will property itself increase with the inflation rate, but rents will increase with inflation as well.

Another solution is TIPS – or treasury inflation protected securities.

My preference is for gold instead of TIPS because I’m a worrier who is concerned with things like the collapse of the US government and the dollar. This is a side effect of downloading too many bearish predictions of doom into my brain.

If you’re not as worried as me about total collapse, then TIPS are a fine solution. TIPS are treasury bonds that adjust the principal balance for inflation. The coupon on TIPS are determined based on the inflation-adjusted principal of the bond, so both the interest and the principal are adjusted for inflation.

It makes a lot of sense to protect a portfolio from inflation. It ought to be a goal of every portfolio.

Inflation is certainly one of the greatest risks that an investor faces. Over time, a slow and steady rate of inflation will erode the purchasing power of currencies. This is very bad for someone whose asset allocation is cash-in-a-mattress or Walter White’s storage locker:

A rising inflation rate will also cause issues with other assets, as higher interest rates will lead to lower prices for stocks (P/E’s will decline) and bonds (interest rates will go up and bond prices will go down).

However, while inflation protection is essential for a portfolio, that’s different from making a one-sided bet that high inflation is a guaranteed outcome.

There are also plenty of ways to protect a portfolio from a sharp decline in stocks. I use long-term treasuries, but that is far from the only solution. Hedging strategies are also available. Cash helps. Most inflation solutions (TIPS, gold) also tend to hold up well in a crash.

Having these elements in a portfolio as insurance is different from trying to predict them.

As the last year and decade have demonstrated, this stuff is unpredictable. The best economic minds thought that higher inflation was certain in 2010 and they were completely wrong. In March, it looked like the US economy was headed into a second Great Depression. That didn’t happen, either.

The beauty of a good asset allocation strategy is that you don’t have to predict anything.

With something like the weird portfolio, I sleep well at night knowing that no matter what unfolds in the macro-economy, I’m covered. I own an asset class that will do well in most macro environments.

I think that’s the better way to approach this stuff rather than pursue the fool’s errand of attempting to predict the future.

Also, the weird portfolio isn’t the only solution. There are plenty of others. I learned a lot from Harry Browne’s Permanent Portfolio, which you can read about here.

The key takeaway is that macro is completely unpredictable. Anyone selling you a prediction is either a fool (this is the case with my predictions) or has an agenda – like pumping up the price of an asset, selling ads on a podcast with provocative content that boosts ratings, or selling books.

Don’t get swept up in it.

Shut it off.

Prepare, don’t predict.


If you are looking for a different take on the Fed (from someone who actually got it right in 2010), then I highly recommend the work of Cullen Roche. This is an excellent post he wrote addressing common misconceptions about the Fed.

One of my favorite TNG episodes:

Eat any good books lately?

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.

Is it crazy to own gold?

I hope you had a great July 4th!

Gold is a controversial asset.

Feelings about gold tend to be separated into two camps:

  1. Stock people who hate the asset. They don’t understand why anyone would invest in an asset that generates no income with no future prospects for growth. Stocks pay dividends and generate earnings. Bonds at least pay interest. For gold, there is no intrinsic value other than what other people are willing to pay for it. I was in this camp for a long time.
  2. Perma-bears who love the asset. The Fed is destroying the monetary system and blowing up bubbles. So, the only safe haven from a dollar that is being slowly decimated by the Fed is a hard asset, like gold.

My asset allocation has a 20% allocation to gold. I don’t go all-in the asset, but I think it serves an effective role in a portfolio. It tends to cushion drawdowns, although not as well as treasuries.

Long term treasuries remain the champion of performance during massive stock drawdowns:

With that said, I’m not comfortable putting 40% of my portfolio in treasuries. I don’t believe treasuries are truly “risk free.”

The greatest risk to treasuries is inflation. Inflation would prompt the Fed to increase interest rates, which would crush treasury prices. Inflation would also make the interest and principal payments more and more worthless.

I previously had TIPS in my asset allocation as my inflation protection, but this is flawed because TIPS rely on official government statistics on inflation.

If the US government wanted to hurt TIPS investors, it could simply manipulate the inflation statistics and change the inflation yardstick. I’m not going full “shadow stats” and don’t think the government is currently doing this, but I don’t think it it outside of the realm of possibility in the future.

Meanwhile, gold is a defensive asset. Like treasuries, gold can cushion drawdowns. Unlike treasuries, it has a track record of performing well during periods of dollar weakness and high inflation.

I don’t advocate a massive allocation to gold and I don’t think that the global economic system is about to unravel because of the Fed’s insanity, but I have 20% of my portfolio in gold because inflation (and a weaker dollar) is a real danger and gold is also an effective way to contain this risk.

I think a good way to demonstrate the usefulness of gold in a portfolio is to look at it through the perspective of a truly crazy portfolio: 50% US market cap weighted US stocks, 50% gold.

This portfolio is indeed crazy. I don’t actually advocate putting 50% of a portfolio in gold, but I think that this crazy portfolio helps demonstrate why gold is a useful asset in a portfolio.

Before I looked at the data, I assumed that a massive allocation to gold would weigh down on returns. Shockingly, it does not. In fact, the 50/50 portfolio slightly outperforms the returns of 100% stocks with less severe draw-downs and less volatility.

On its own, gold is an absolutely terrible investment. Massive volatility, an extremely long drawdown & recovery (gold entered a drawdown in 1980 and didn’t fully recover until 2007), and it has little promise to ever outperform US stocks.

But – in a portfolio – gold can do extraordinary things. It helps reduce drawdowns and it tends to do well in decades when stocks are not doing well.

Gold demonstrated extraordinary performance during the 1970’s, but it also did well during times like the early 1930’s. Gold prices tend to rise during periods of growing fear, as investors flock to “hard assets.” The flock to hard assets is what occurred during the Great Depression. As people gathered gold, the price rose, rising from $20.63 in 1929 to $26.33 in 1933, a 27% increase during a period when stocks were down nearly 80%.

When rebalanced with stocks, it helps deliver a great result: less volatility and cushioned drawdowns.

The interaction between stocks and gold in the 50/50 portfolio is something I’ve noticed with a lot of asset allocations: an investor gets a result that is greater than the sum of the parts.

One would assume – for instance – that the return would simply be an average of the return for the two asset classes. Gold has a CAGR of 7.8% since 1972. Stocks have a CAGR of 10.25%. Averaged together – it is 9.025%.

However, in a portfolio, the actual result is 10.29%. It’s greater than the expected average of 9.025%. It’s greater than the return of either asset. The result is greater than the sum of the parts.

As David Swensen points out, asset allocation is the only free lunch in investing.

This is because gold and stocks are truly uncorrelated. They are almost inversely correlated.

By regularly rebalancing, an investor is able to sell gold when it is up and then buy stocks when they are down. This regular process of rebalancing enhances returns by buying each asset class after poor performance and selling each asset class after strong performance. Meanwhile, thanks to the interaction of the asset classes with each other, drawdowns and volatility are reduced.

Just to reiterate: a 50% allocation is too much for my tastes, but I think this is a useful experiment to show how an allocation to gold isn’t completely crazy and it can serve as an effective defensive asset in a larger portfolio.

For my portfolio, my defensive allocation is split between long term treasuries and gold. Long term treasuries perform better during large drawdowns. However, long term treasuries will be decimated in a period of rising inflation and interest rates. For that reason, I split the “defensive” slice of my portfolio between both gold and long-term treasuries. You can read about my passive allocation here.


U2 at Live Aid in 1985.

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.

Q2 2020 Update


Year to date, I am down 17.77% and the S&P 500 is down 3.9%.

This is actually pretty good in context of my deep value strategy. VBR, the Vanguard Small Value ETF, is currently down 22% YTD. QVAL, the deep value Alpha Architect ETF, is currently down 26% YTD.

The deep value universe of stocks with an EV/EBIT multiple under 5 is currently down 30% YTD.

17% isn’t all that bad in this context.

Due to my large cash position going into the crash, I was only down 26% at the lows, while most of this universe was in a nearly 50% drawdown.

With that said, I missed my chance to gobble up bargains at the lows because I thought the worst wasn’t over.

A Mixed Bag: Good Decisions & Bad Decisions

In the last year, I made some key decisions. Some of them turned out to be good moves and some look like mistakes.

I started accumulating cash last year when the yield curve first inverted. I thought we were going to have a run-of-the-mill recession and I thought due to the overvaluation of the market that this would be enough to cause at least a 50% crash.

I went into the March crash nearly 50% cash. This was a good decision. When I saw that the recession wasn’t going to be a run-of-the-mill affair and was turning into the worst recession since the Great Depression, I started selling my cyclical positions aggressively. By the bottom, I was nearly 80% cash.

I was also convinced that the selling wasn’t over. I saw an index at internet bubble valuations hitting the worst economic event since the Great Depression and assumed that the crash would continue. Value stocks aren’t a place to hide during a crash, so to stay market neutral, I bought a position in an S&P 500 inverse ETF to stay market neutral. This was not a good decision.

What I didn’t anticipate was the extent to which fiscal and monetary policy were going to go full-throttle in an all out effort to boost the stock market and the economy. As a result, the S&P 500 rocketed upward and my short position was beat up.

As a result, I lost about 15% on the short position. I finally got out of it when the S&P 500 went above the 200 day moving average. Fortunately, it wasn’t enough to hurt my overall YTD results.

At the lows, net-net’s started to re-appear and the number of stocks below an EV/EBIT multiple of 5 increased. I didn’t buy any of them, thinking that the economic downturn was going to continue melting down the market with no regard to valuation. I didn’t buy enough at the lows. This was not a good decision. There were many stocks I should have bought and I didn’t.

One position I bought near the lows has worked out marvelously – AOBC, which has turned into SWBI. This is a gun manufacturer. You can read my write up here. I noticed that AOBC was trading at a low multiple to book value while simultaneously background checks were surging due to COVID. Gun sales continue to be strong, and this continues to skyrocket due to the unrest currently gripping the country.

I’m currently up 189% on this position. Obviously, buying SWBI was a good decision. I sold a piece of this position when it grew to 10% of my account from 5%. I plan on doing the same thing once this happens again.

I recently purchased a net-net, Friedman Industries. You can read my write up here. It is yet to be seen if this was a good decision, but I think that the risk-reward makes sense.

Looking Ahead

Currently, the market continues to be strong and seems invincible.

I’m not short after getting my butt kicked in my short position, but I’m still not bullish. I’m currently 80% cash and still only have a handful of positions.

It’s still yet to be seen how COVID is going to shake out.

I am finding it hard to figure it out. On one hand, the lockdowns worked, we flattened the curve. On the other, now that the economy is being re-opened, cases are surging. Skeptics say that this is simply because of more testing. Those who sounded the alarm on the virus say this is concerning.

I don’t know how this shakes out. What I do know is that the the present state of the economy is not good. Unemployment looks poised to reach its highest levels since the Depression in the 1930’s. Many businesses have been completely destroyed, and the number of businesses that are being destroyed continue to mount.

On the other hand, unprecedented levels of fiscal & monetary stimulus might create a new economic boom as the economy re-opens.

I don’t know how the economy shakes out, either. My instincts tell me that the economy is screwed, but my instincts can be wrong. We went into this with unprecedented levels of leverage and the only way that a lot of businesses are surviving is by taking on even more debt, making them even more fragile. On the other hand, the fiscal & monetary stimulus might work.

I don’t know how the virus shakes out and I don’t know what’s going to happen to the economy. The way I see it, the current situation is replete with massive uncertainty.

Uncertainty is something that an investor should get paid for with a cheap valuation.

Investors aren’t getting paid for that uncertainty.

What I know for certain is that the market is not cheap by any stretch of the imagination. From a market cap to GDP perspective, the market trades at 147% of GDP. At the peak of the internet bubble, we were at 140%. That’s right – we are beyond the valuation of the most extreme bubble in American history and we’re in the midst of the worst economic calamity since the Great Depression.

If the market were to return to 100% of GDP – the S&P would crash to near 2,000. If we were to return to the lows of the last two nasty bear markets, we would fall to nearly 1,500 on the S&P.

The CAPE ratio is at 29 – higher than the peak of the real estate bubble although not as high as it was during the internet bubble.

Looking at the value universe I operate in, it is currently only an average opportunity set. There were many stocks in the EV/EBIT < 5 universe at the lows, which was a pretty decent opportunity but not as big as 2009. There are now 75, which is a pretty average opportunity set.

An average opportunity set and a market trading at internet bubble valuations is not compelling. It’s definitely not an opportunity when we face the wide range of possible outcomes that we face today.

As a result, I’ll continue to be cautious and hold a lot of cash. If I find more stocks like SWBI or FRD that look like big opportunities, I’ll buy. What I won’t do is fill up my portfolio with subpar opportunities.

The large cash balance definitely weighs on my mind. Cash is a terrible investment long term, but I want to have the dry powder if the market crashes again.

I’ve considered deploying it into my passive asset allocation that you can read about here, but haven’t made up my mind on that yet.

My goal when I started this blog was to focus on Ben Graham’s low P/E, low debt/equity strategy during the good times. When the bad times arrived, I was going to buy net-net’s. The net-net’s started appearing in March and I didn’t buy enough of them. I barely had time to research any of them before they disappeared.

My instincts tell me this isn’t over and I’ll get another chance to buy them. We’ll see.

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.

Portfolio Position in Troubling Times


Goodbye, shorts

I dumped my short position yesterday. It looks like I screwed up with this bet. Fortunately, it wasn’t a fatal bet.

I lost 15% on the position and I’m up slightly over the last few months overall, thanks to the performance of the stocks that I still own. I owned it mainly to stay market neutral and didn’t make a big bet on it, so it’s an outcome that isn’t the end of the world.

I’m still happy that I have been cautious this year. I’m down only 22% YTD, which is a lot better than the deep value universe that I operate in. The universe of stocks with an EV/EBIT multiple under 5 is down 40% YTD. It was previously down nearly 50% and I avoided nearly the entirety of this drawdown. I also outperformed this universe last year, when I was up 32%.

I still badly lag the S&P 500 since I started this blog in December 2016 – which is very disheartening – but I’ll take the good news where I can.

My passive approach (small value, long term treasuries, gold, international small caps, and real estate) has handled the crisis excellently, down only 5% YTD after being down only 20% in the worst of the crisis. I’m often tempted to put this brokerage account into that passive approach, but I still enjoy the hunt of picking stocks and trying to figure out the macro picture.


I bought only a couple stocks during the depths of the crisis – VLGEA (super markets) and AOBC (guns – now SWBI). VLGEA is flat, but AOBC has been an outstanding performer. I am up 80% on the position. It looks like my thesis – that COVID would drive higher gun sales – is proving to be correct. I couldn’t have anticipated nationwide riots, but that appears to be helping out the position, as well.

While I am no longer short, I still hold a lot of cash. 78% of my portfolio is still cash. Needless to say, I am still quite bearish on the market, even though I don’t want to be short it.

The Market

If I’m bearish, why aren’t I holding onto the short position?

I know that a trend following element is absolutely essential to shorting.

I walked into the short with an eye on the market’s 200-day moving average. Recently, the S&P 500 crept above the 200 day moving average.


As a value investor, I have always talked a lot of smack about trend following, but I have been changing my mind after examining the evidence.

A great resource on trend following is Meb Faber’s paper – A Quantitative Approach to Tactical Asset Allocation. The approach advocates owning asset classes only when they are above their 200 day moving average. The approach reduces drawdowns while still delivering the market’s rate of return.

A trend following strategy like that gets out of the market when it falls below the moving average and stays invested when it is above.

Looking at the S&P 500 over the last decade, an investor would have only been out of the market a few times. They mostly turned out to be false alarms that didn’t see the market make a massive move lower. This includes the 2011 debt ceiling showdown, the oil market chaos in 2015-16, and the December 2018 meltdown.

Where a trend following strategy helps is during the big, nasty draw-downs. An investor following a trend system would have sold in February, avoiding all of the mayhem that occured in March. It would have also kept an investor out of the market during most of the 2000-03 50% drawdown. It would have also kept an investor out of the market from 2007-09 during that 50% debacle. Trend following buys in late in the game – but who cares? They avoid the cops showing up to the party, and then arrive a little late to the next one.

When a market is solidly above the 200 day moving average, it usually continues rallying higher, even when the fundamentals don’t support it.

Paul Tudor Jones is probably the most vocal advocate of using the 200 day moving average as a trend indicator. He had this to say about the approach:

My metric for everything I look at is the 200-day moving average of closing prices. I’ve seen too many things go to zero, stocks and commodities. The whole trick in investing is: “How do I keep from losing everything?” If you use the 200-day moving average rule, then you get out. You play defense, and you get out.

Historically, it is a very bad idea to be short the market when it is above this level.

While it is often maddening to value investors like me, the fact of the matter is that there is nothing to prevent something absurd from getting a lot more absurd. This is a lesson that value investors who have been short stocks like Tesla have learned the hard way.

It’s something that people who were short the Nasdaq in the ’90s also learned the hard way. An investor could have looked at the market in early 1999 and concluded that it was absurdly overvalued. They would have been correct. Even though they would have been correct, it wouldn’t have stopped the market from wiping them out by doubling before melting down from 2000-03.

Unrelated: “The Hard Way” was a pretty funny early ’90s flick.


There is nothing to keep an absurd market from getting more absurd.

As a value investor, I have a visceral hatred of following the herd, but I think it’s important to keep tabs on the movements of the herd to prevent me from getting trampled by it.


Make no mistake: I think what’s going on is completely absurd, but I’m not going to fight it.

The real economy has been eviscerated. We have Depression level unemployment – approaching 20%. America’s corporations are surviving by leveraging up, making them even more fragile than they were before the crisis. Even the tech giants that have enjoyed the biggest gains of the rebound have seen their earnings dissipate.

The Fed is providing liquidity, but that’s all that the Fed can do. Jerome Powell isn’t a sorcerer who can create a 1999 economy out of 1930s unemployment. The Fed is preventing the system from collapsing, but that’s not the same thing as fixing the damage that has been done to the actual economy. The Federal government is providing fiscal stimulus, but that isn’t enough to replace a job or re-create the actual productive economic activity that has been eliminated.

Wall Street doesn’t care. It has doubled down on its commitment to the Fed put – the idea that the Fed will have the power to prevent any further meltdown in the market. The actual earnings capacity of the market has been decimated, but the markets are completely ignoring this.

The bear thesis of the last decade – that the markets are fraudulent and being manipulated by the Fed – has now turned into the bull thesis. Buy stocks because the Fed will make it go higher. Earnings and the economy don’t matter. This is dangerous and absurd thinking.

One take is that the market believes we will swiftly return back to normal with the economy re-opening. Maybe, but I think this is a dubious bet. I’m sure activity will resume and life will go back to normal, but it’s not going to be 100% of where we were before. There will be a number of businesses (like bars & restaurants) that will not re-open, because they couldn’t survive a 100% drop in revenues. Meanwhile, furloughed employees won’t be immediately re-hired, as businesses take a wait-and-see approach to bringing them back on board.

Nor will everyone in the economy immediately leap back to normal. Everyone isn’t going to re-book their vacations, even if 70% of them do. Businesses aren’t going to resume all of their business trips and conferences. Older people will likely wait until it’s clear that the virus has either been overblown or that we have a vaccine. They also command most of the disposable income, so that’s a major hit to the economy.

There also isn’t a guarantee that there won’t be a resurgence of the virus once the lockdowns end. We flattened the curve, but who is to say this won’t start spreading all over again? This virus started with a handful of people in China and spread all over the world. Once we resume normal activities, won’t it start spreading all over again?

Most of the damage from the Spanish Flu occurred during the second wave of the virus. Will we have a second wave of this virus? Will that trigger another round of economically destructive lockdowns? I don’t know, but the probability of that happening is not zero.

Call me a pessimist, but I don’t see a lot to be optimistic about these days. The market is partying like it is 1999 while the economy is in 1932.

I’m still holding a lot of cash even though I am no longer short, simply because I think that the risks are massive and the market is behaving like they don’t exist.

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.

Thoughts on the 2020 Berkshire Meeting

Like most value people, I was glued to my TV on Saturday night to the Buffett meeting.

It was one of the best and the most candid Berkshire meetings I have ever watched. Becky Quick did a great job at filtering questions. The questions were all of high substance, without a lot of fluff. There was not an opportunity for people asking “questions” to give 15 minute speeches, for instance.

I also got a real kick out of Buffett’s black-and-white and all-text slide presentation. It’s a sharp departure from what most of us experience in our day jobs.

With a slide deck, how much attention do we pay to presentation? Does any of that style really add any value to the presentation? Probably not. Buffett is a guy who doesn’t care about that sort of thing. He always gets across his point as simply as possible. The rest of us – me included – tend to over-complicate it.

Anyway, Warren Buffett needs to tow a fine line when commenting on markets and the economy. His words can move markets. He was very careful with his words this year, expressing short term caution and long term optimism. He didn’t give an exceptionally candid call on markets.

The last two times Buffett was exceptionally candid about his views on the market were 1999 and 2008. Back in 1999, he gave a famous speech at Sun Valley in which he questioned investor’s expectations and was quite bearish. He called out the internet bubble and overall market extremes. In 2008 and 2009, he took a different point of view and was extremely bullish. In October of 2008, he wrote an opinion piece called “Buy American, I Am” in which he talked about how stocks were cheap and poised for a great future.

This year, Buffett didn’t outright express his bearishness, but I think it was buried in there. If Buffett were outright bearish, he could trigger a crash. I think he’s aware of this. His words expressed caution.

He noted that he hasn’t been buying stocks and sold out of one industry (airlines) completely.

His actions, as opposed to his words, speak volumes. He didn’t back up the truck like a lot of investors did in March. Through his comments about the wide range of probabilities with the virus, I think he was preparing everyone for the fact that the ugliness might not be over for the markets and the economy, which is a sharp contrast to the actual behavior of the markets, which seem to be predicting a swift return to normalcy.

He praised the Fed’s actions to contain the crisis and put Jerome Powell in the same place as Paul Volcker. I agree with him on this point. I think markets are expensive, but I also don’t think that the Fed should let the world burn so I can buy stocks below net current asset value.

With that said, even while praising Powell’s decisive action in ending the crisis, he did take note that today’s unprecedented actions will have long term consequences. I also agree with him there. We are in uncharted territory with monetary policy.

Of course, Buffett also spoke about America’s bright long term future. This was the focus of his initial presentation. Starting off with this speech was a careful move to put his short term caution into context. He expressed his long-term optimism in the future of the country and the prospects for our economy, despite his short term caution about markets and the economy.

Also, Warren talked about how Ben Graham was one of the three smartest people he had ever met. He didn’t mention the other two, but I suspect they are Bill Gates and Charlie Munger.

If you didn’t watch it, I’d recommend checking it out at the below link. Buffett starts in the video at 1:00:33 with his presentation about the long-term future of the country. The really good part – the Q&A – starts at 3:07:20.

I’ve never been to a Berkshire meeting before, but I definitely want to attend in the future.


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.

Stocks are Expensive, Volume 1,863


Every macro valuation metric available shows the same thing: markets are ludicrously expensive.  Stocks are as expensive as they were during the internet bubble.

Every bull has their argument against each macro metric.

One of the better arguments against these metrics is that most of the index is composed of mega tech companies like Amazon, Google, Netflix, and Facebook.

The compounder investors tell us that these companies are growing rapidly and accumulating the market share of smaller companies. As a result, they can grow faster and earn high margins, which justifies higher valuations.

More rational investors agree these stocks are ludicrously valued and will eventually mean revert, but also point out that there are other securities which command more respectable valuations. FANG is not the entire stock market.

For this reason, I took a look at 17 non-tech businesses to get a snapshot at how they have been valued over the last twenty years.

All of these companies are dividend aristocrats. The key criteria for a “dividend aristocrat” is that the company has been around for at least 25 years and has consecutively increased their dividends for the last 25 years.

Naturally, this provides a population of non-tech, high quality companies.

The metric I decided to focus on was EV/Sales.

Here are the 17 companies I looked at and their EV/Sales multiple at different points in time:


Most of these companies are on the expensive end of their history. Even Exxon (during an era of negative oil prices!) is more expensive than it was in 2008 and around the valuation in 2005!

Let’s take a look at the median EV/Sales for this group of stocks:


The group is 16% more expensive than it was in 2000.

If you thought that 2000 was a bubble, then how is this not a bubble?

They’re 65% higher than they were in 2008, which was the last generational buying opportunity. Most are more expensive than they were in 2016, which wasn’t exactly a cheap market.

It’s also worth noting that the economic outlook was a lot better in 2000, 2005, and 2016 than it is today. Hell, by some metrics, the current outlook is even worse than 2008.

It seems absurd to me that anyone thinks there is “blood in the streets” or that this is the beginning of a wonderful bull market. Bull markets begin from cheap valuations. These are the valuations from which bull markets peak.

It seems equally absurd to me that stocks should be priced like this during a global pandemic when unemployment is near 20%, the highest levels we have seen since the Great Depression.

These companies are all going to be adversely affected by double digit unemployment rates and they’re currently more expensive than they were during some of the best economies of my lifetime.

It’s all completely absurd.

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.

Market Update


The Market

The overall market continues to rally. I think ya’ll are crazy.

Let’s look at where we are today:

  • Market cap/GDP is 132%. This is near the 139% level at the peak of tech bubble in 2000. GDP is also likely to decline significantly this year, so this is likely even higher.
  • Price/sales is 2x. The median since 2001 is 1.48x. This also represents a 20-year period where stocks have been historically expensive. For the entire period from 2003-2017, the market traded below this price/sales ratio.
  • The Shiller PE is currently 26.81. Not quite at internet bubble extremes, but still crazy considering the contraction that is taking place in the real economy. This is where the Shiller PE was before the crash of 1929 and in 2007 before the market fell apart.

Price/sales and market cap/GDP are near internet bubble extremes. This is really crazy.

I remember 1999 and 2000. It was a pretty incredible boom. I remember that it wasn’t about whether or not you could get a job – it was about whether or not you wanted one. The economy was in incredibly awesome condition.

I would not describe the condition of today’s economy as “awesome”.

I expect markets to trade at these kind of valuations when the economy is red-hot and everything is going swimmingly. I don’t expect these kind of valuations during a global pandemic in which unemployment is surging to 20% and we’ve eliminated a decade of job creation in a few weeks.

It’s like we’re selling a house that’s on fire on yesterday’s estimate of value from Zillow.

I think of valuations in terms of expectations. It tells you what the market expects to happen. Right now, the market is predicting a very optimistic future. This likely assumes that stimulus will work and the economy will quickly re-open, with unemployment dropping to 5% or so in short order.

This strikes me as an unrealistic fantasy. An unrealistic fantasy like winning the lottery, or scientists inventing chocolate sundaes that don’t make me gain weight.

It would be one thing to bet on that fantasy if I were being paid for that fantasy with a cheap valuation, but that’s not the case.

The bull case is that reality doesn’t matter and we should buy stocks because the Fed is providing so much stimulus.

Counting on the Fed to prop up an expensive market with deteriorating fundamentals doesn’t strike me as investing. It strikes me as speculation.

Maybe I’m wrong. It wouldn’t be the first time. Most people certainly seem like they disagree with me.

I don’t see why I need to participate in what I think is absolute madness.

I’ll continue to seek out positions where the risk/reward makes sense to me and hold cash if I can’t find these opportunities. Maybe I’ll under-perform. I don’t really care. No one has a gun to my head and is forcing me to participate in what I think is absolute madness. I don’t have a mandate forcing me to be fully invested.


Value investors are pumped.

Unfortunately, I think they’re like a starving man who is presented with a Snickers bar and thinks it’s an all-you-can-eat buffet. We have spent years out in the desert trying to find opportunities in a rich market where growth is rewarded at any price and value has been taken to the woodshed.

We’re jumping for joy at the first semblance of a bargain. I get it.

Of course, I’m talking about deep value investors. The value investors that succeeded in the last five years are those that quote Buffett’s 10x investment in Coke and 5x investment in See’s as a rationale to buy some SaaS company at a P/E of 200.

During economic calamities, we ought to be presented with a 2009-style opportunity. During a moment of total economic metldown the likes of which we haven’t seen in 100 years – we ought to have a 1974 style opportunity.

What we’re getting is a 2000-style opportunity.

I don’t think this is 2000. Value performed well in the early 2000’s because value was cheap and the economy wasn’t so bad. In the early 2000’s, unemployment peaked around 6%. The fact that the economy was doing alright caused value to chug along and deliver returns. Pricey stocks were annihilated because they were priced for the ’90s boom to last for 50 years.

Unemployment is likely to peak above 20%. I think that cyclical value stocks will continue to get killed in that kind of environment.


Goldfrapp – Felt Mountain




The new Dune movie looks awesome.

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.

The value of the market, the value of value, and some soul searching


Macro Valuations

I’ve written a lot about how the market is really expensive, no matter which way you slice it.

Meanwhile, we are facing a grim economic reality in which 6 million people are losing their jobs every week and cash flows are evaporating for American companies. Some estimate that unemployment will hit 20% (Great Depression levels) and GDP will take a massive hit, making the Great Recession look like a footnote.

Call me crazy, but I think valuations should be a lot lower in this environment.

My theory about market valuations is simple: the higher they are, the harder they fall.

Valuations don’t matter until we have a recession. When expensive markets run into a recession, they get annihilated. Because we can go for a decade without a recession, that’s a lot of time for valuations to run up to unsustainable levels. It’s also plenty of time for investors to get complacent and think valuations don’t matter. That was the prevailing attitude at the end of the ’90s and it has been the attitude recently.

The history of markets shows that markets move with earnings and cash flows over the long run and then exhibit speculative extremes in the multiples that investors are willing to pay for those earnings and cash flows.

Markets tend to extrapolate the present and assume current conditions will last forever and then get surprised when the environment shifts.

My goal (in my active account, anyway) is to take advantage of these sentiment shifts for individual stocks and the broader market. I want to buy from Mr. Market when he is depressed and sell to him when he is euphoric.

With market cap/GDP presently at 131%, macro valuations suggest that the market will deliver a negative return over the next decade. History suggests this negative return doesn’t happen in a straight line and that there will be a big bull market and a face-ripping bear somewhere in there. I think that the face-ripping bear is happening right now and we’re in the middle of it.

Right now, the markets are rallying because investors are realizing that the Fed won’t allow the system to collapse (I agree with this). They also think that the Fed they can engineer a quick and rapid recovery and pepper over rich valuations (I don’t agree agree with this).

Everyone seems to be getting very bulled up and cocky.

I think they are making a mistake.

It’s also possible that I’m making a mistake, so I decided to take a look at some additional data to figure out if that’s the case.

Value Investing Vs. The Market

Value purists would say that I shouldn’t pay attention to all of this nonsense.

They would argue that I’m not investing in the market. I’m investing in individual businesses. I’m not investing in the stock market, I’m investing in individual value stocks.

Unfortunately, it is impossible to assemble a group of 20-30 stocks that are not correlated with the market. Whether I like it or not, my stock portfolio is correlated with the market. The market matters.

To get around this and be less correlated with the market, I could concentrate in 5-8 of my “best ideas.”

I think this is a path that can cause permanent impairments of capital. A blow up in one or two positions can endanger the entire portfolio.

I’m also skeptical that I really have any “best ideas.” The best ideas of the best investors in history often blow up.

This is why diversification is the path I’ve chosen and I think 20-30 stocks is the best way to prevent portfolio blow ups while still offering the opportunity for outperformance.

The disadvantage of diversification is that I am more correlated with the market’s returns.

The Value of Value

With all of that said, I am worried that my focus on the valuation of the overall market is blinding me to the bargains within the deep value universe.

For this reason, I decided to take a look at the absolute valuation of the cheapo segment of the market. To do this, I used Ken French’s free data available on his website.

I restricted the data to the post-1990 universe. I’m considering the post-1990 period to be the modern era in which valuation multiples have been elevated.

I’m not expecting to be able to buy stocks at 1980 single digit CAPE valuations, for instance.

Let’s start by looking at cash flow/price.

Cash Flow/Price


At the end of 2019, the value segment of the market was close to its mean.

Not particularly exciting.

VBR (the Vanguard small value ETF) is down about 30% year to date, so I’d estimate that this is probably close to 20% now from 15% at year end 2019. That’s really encouraging, as it implies that the value segment of the market is close to its 2009 and early 2000’s levels. Those high levels will probably set the stage for tremendous performance in the upcoming years.

Interestingly, value was very expensive for most of the 2010’s. I think this is the key factor in value’s under-performance in the last decade. Value was expensive versus its long-run mean.


Meanwhile, in compounder-bro-land, the market is more expensive than it was during the internet bubble. No surprise there.

Something interesting to note: this glamorous segment of the market was cheap in 2010 and the early 1990’s, likely setting up the excellent performance for glamour in the 1990’s and the 2010’s.

Book to Market

In most environments, last year’s cash flows are a good proxy for what’s happening next year.

In Quantitative Value, Wes Grey and Toby Carlisle found that trailing-twelve-month earnings work better than normalizing them. It’s a very surprising result, but it suggests that last year’s earnings tend to be a good proxy for next year’s.

Of course, we are not in a normal environment. Many businesses are seizing up and revenues are collapsing with economic lockdowns in place. This makes this current environment unlike any recession we have experienced since World War II.

For this reason, I think book value is useful in this kind of environment. When earnings disappear, different metrics of value are useful even though earnings-based metrics work better in the backtests.


From this perspective, the value segment of the market was very cheap relative to its mean in the early 1990’s, the early 2000’s, and 2009. This makes sense, as those periods coincided with tremendous performance for value.

Like cash flow to price, this was also expensive through most of the 2010’s, explaining value’s woes during the last decade.

By this metric, at the end of 2019, value stocks were expensive.

With VBR down 30%, I estimate this is probably up to 190%. That is pretty good. It’s not as cheap as it was in 2009 or the early 2000’s, but it’s getting there.


Meanwhile, in compounder-bro-land, the market was more expensive at the end of 2019 than it was during the internet bubble.

Interestingly, it’s also evident that this segment of the market was cheap at the dawn of the 2010’s. This likely drove the tremendous performance of this segment of the market for the last decade.

Considering that QQQ is flat year to date, this segment of the market likely still beyond internet bubble extremes.

Good luck, compounder bros. I think you’re going to need it.

Soul Searching

Looking at this data, it suggests to me that I might be too cautious right now.

While the broader market is overvalued, the value segment of the market is approaching levels of cheapness last experienced in 2009.

On the other hand, this can get a lot cheaper, especially if the broader market tanks. This is particularly true considering that cash flows are about to disappear for a lot of businesses.

I could be allowing my emotions to blind me, which is a classic behavioral investing mistake. I am concerned about losing my job, for instance. I have a sizable emergency fund, but the idea of losing my job still worries me and can be clouding my thinking.

Earlier this year, I was contemplating selling my house and moving in search of another opportunity.

Now, I worry if I will be able to sell my house at a decent value. What job opportunities will even exist with the economy in lockdown?

Emotional stress might be interfering with my ability to see things clearly.

When I launched my blog, my hope was that I could build a portfolio of net-net’s when the next bear market arrived. During the boom, I’d stick to low price-to-earnings stocks and then shift my focus to net-net’s and negative enterprise value stocks.

There were net-net’s two weeks ago, but many of those bargains have since disappeared.

Is it possible that the opportunity to buy net-net’s emerged and disappeared in two weeks?


My gut tells me this is not the case and I will have an opportunity to purchase a portfolio of 20-30 high quality net-net’s and negative enterprise value stocks, but this French data makes me second guess that.

During this meltdown, I’ve been tempted to simply throw everything into my asset allocation which is down only 7.9% year to date. This allocation doesn’t try to predict the future and has caused me no stress.

If this market truly has passed me by and I’m wrong about everything, then I need to do some serious soul searching and re-evaluate my approach.

For now, I’m not ready to give up on my active account just yet. I do think there will be an opportunity to buy net-net’s and negative enterprise value stocks at some point during this bear market.

If not, I may need to simply pursue my asset allocation strategy and stop trying to pick stocks and predict the future.

It could also make more sense to focus more on arenas of the market where I can have more of an advantage, such as dark stocks and international net-net’s.

With that said, I don’t think I’m wrong, even though I’m open to that possibility.

I think it’s a bit of a fantasy to think we’ll have a 1987-style decline and 1988-style bounceback. After all, during 1987 and 1988, it was a time in which the economy was booming and we didn’t have a recession. Mr. Market was just being crazy. We faced a similar outcome at the end of 2018 and throughout 2019, another period in which we didn’t have a recession. Mr. Market was just being crazy.

This does not strike me as a comparable situation.

We’ll have to see, I guess.

This is a hard game, indeed.

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.

What the Perma-Bulls and Perma-Bears Get Wrong


Perma Bulls and Perma Bears

Right now, it feels like the financial world is divided into two camps:

  1. “End the Fed” Perma Bears: They think that the Fed engineered a series of asset bubbles and is responsible for the subsequent crash of those asset bubbles. We just had a big asset bubble and this bubble is now collapsing. The Fed is an unholy abomination that does more harm than good. “Fiat” is a cursed word. The perma bear view of monetary policy is best channeled by this Onion article. The old ones like gold. The young ones like Bitcoin. They both think stocks are terrible to own.
  2. “Always Buy Stocks” Perma Bulls: They think that the market is mostly efficient and the Fed helps the market avert crises and is a positive force. Buy an index fund and stop obsessing over the Fed, they say. Earnings will increase over time, stocks will pay dividends, and it’s best to just ignore the noise, buy-and-hold. They like to advertise that they don’t bother with macro forecasting and focus on the long term trajectory of stocks.

The two camps disagree with each other pretty intensely. Perma bulls look at most perma bears as either idiots or charlatans. Perma bears look at perma bulls as naive fee-hungry AUM gatherers.

I disagree with both camps about a lot of things and I agree with them about a lot of things.

I think they both have valid points. I also think there are things that they’re wrong about.


I value flexibility.

I occasionally find myself dragged into a dogma or a point of view. I think it’s really important to fight that tendency.

This is a pretty good quote from Charlie Munger on the subject:

“Another thing I think should be avoided is extremely intense ideology, because it cabbages up one’s mind. You’ve seen that. You see a lot of it on TV, you know preachers for instance, they’ve all got different ideas about theology and a lot of them have minds that are made of cabbage.

But that can happen with political ideology. And if you’re young it’s easy to drift into loyalties and when you announce that you’re a loyal member and you start shouting the orthodox ideology out what you’re doing is pounding it in, pounding it in, and you’re gradually ruining your mind. So you want to be very careful with this ideology. It’s a big danger.”

As someone who has had my own dalliances with intense ideology, I can completely relate to this.

Once I develop a worldview, it is very easy for me to be trapped by that worldview, particularly when I only absorb content from sources that I agree with.

I have my biases and so does everyone else.

I don’t think there is a silver bullet to avoid hot-blooded emotional biases completely, but I think it’s important to always consider how I might be wrong.

Perma Bulls and Perma Bears would probably benefit from a similar approach. I’m usually perplexed by the iron-willed certitude that they’re right. Ya’ll really never have doubts that you might be wrong?

What I think the perma bulls are right about

1. Markets are efficient over the long run

Bulls often point out that markets, over the long run, reflect economic reality. Over the long run, they are mostly efficient.

They are mostly correct.

Markets, over the long run, are going to reflect economic reality. This is even true during the last 10 years: the era of quantitative easing and zero percent interest policy.

Perma-bears argue that this boom has been all smoke-and-mirrors and doesn’t have anything to do with what’s happening in the real economy.

Well, what’s a pretty good proxy for what’s going on in the real world?

I think truck tonnage is a pretty good example. Truck tonnage closely tracks actual stock market performance.


It seems like stocks mostly track what’s happening in the real, physical, economy.

Over the long run, the S&P 500 closely tracks the earnings growth of the companies within the S&P 500. This includes the boom of the last 10 years that the perma-bears think is utterly nonsensical Fed manipulation.

Earnings grow over time. This does provide an upward trajectory to the market over time.

Peter Lynch sums this up pretty well in this clip:

2. The Fed does a decent job

Cullen Roche had a great tweet thread the other day, in which he examined the role of the Fed in the nation’s economy.

To sum up the tweet thread, the role of the Federal Reserve is to serve as a clearing system between banks and ensure that the system continues to function correctly.

Before the Fed, busts were always horrifying. This is because any contraction in the US economy turned into a banking crisis, which made everything worse than it needed to be.

The Fed prevents this from happening.

From Cullen’s thread:


As the above chart shows, the Federal Reserve largely succeeded in reducing the volatility of the economy. Now that the Fed intervenes when the turds hit the fan and prevents the banking system from falling apart, recessions are a lot less severe than they used to be.

The Fed was created out of the panic of 1907. JPMorgan stepped in and saved the system. Realizing that we couldn’t rely on one man to save the system forever (JPMorgan wasn’t an immortal Highlander, as far as I know), we needed an institution to prevent these panics from raging out of control.

(Side note: I love at the center of the 1907 panic was the “Knickerbocker Trust.” Is there a more old-timey name for a financial institution?)

Another reason that the booms and busts are less severe is the fact that the Fed generates inflation.

Perma bears hate inflation and usually cite inflation as the reason that we should end the Fed and tear the whole system down.

The reality is that a little inflation isn’t a bad thing. In fact, it’s a wonderful thing. One of the reason that those 19th century recessions were so severe is because when recessions arrived, prices usually declined. This means that everyone was incentivized to delay purchases, hoping for cheaper prices later. This magnified the decline further, creating a deflationary spiral.

Does $1 need to buy the same amount of goods from one year to another? Why? What’s the point? If wages and financial assets increase with the rate of inflation, what does it matter if cash stuffed in a mattress can buy the same goods that they could in 1955?

Even though the Fed existed in the 1930’s, they didn’t intervene appropriately. They let banks fail and it was their job to make sure that the system didn’t collapse. They allowed the money supply to shrink, making the deflation worse.

They had a role and they abdicated it.

No one explains this better than Milton Friedman:

In other words, by abdicating their role, the Federal Reserve allowed what would have been a very severe recession to mutate into the Great Depression. If they stepped in and did their job, they could have saved the system. Instead, by allowing the money supply to shrink and banks to fail, they made the problem worse.

It’s also worth noting that the Great Depression was exacerbated by the gold standard, which prevented us from expanding the money supply in a manner that was necessary.

There is a reason we ended the gold standard: it never worked particularly well. It also broke down in the early 1970’s, when 40 years of an artificially suppressed gold prices started to lead to problems with the US treasury.

What the perma bears are right about

1. Markets enter bubbles

Efficient market theorists will outright deny the existence of bubbles. In fact, they did a good job of bullying everyone from using the term until the early 2000’s after the internet bubble shook out. After the financial crisis, we went to another extreme and started calling everything a bubble.

Eugene Fama, for instance, claims that there wasn’t really an internet bubble. Or, more specifically, that it was impossible to identify the bubble until after the prices collapsed.

This is obviously wrong. Many people predicted there was a bubble.James O’Shaughnessy is one example.

There are often very obvious extreme bubbles. Japan in the late 1980’s is one example, which John Templeton correctly identified. The internet bubble is another. Bitcoin in 2017 was another very obvious bubble. Housing was another bubble, which was predicted by a number of people, including Michael Burry.

The wild swings in the multiple that investors are willing to pay for stocks is a sign that markets are not perfectly efficient and don’t always carefully estimate the present value of future cash flows.

The below is from the data on Shiller’s website:


Does this look like a market that is always rationally calculating the present value of future cash flows, or one that often gyrates between bouts of extreme greed and despair?

The change in multiples reflects that bubbles happen. They aren’t a figment of people’s imagination.

In fact, at extremes, bubbles are predictable. They do happen from time to time and they are possible to identify before prices collapse.

The market in the late 2010’s entered bubble territory. By pretty much every metric available, the market in the late 2010’s was at an extreme of valuation.

2. The Fed makes mistakes and contributes to bubbles

Does the Fed contribute to the cyclical nature of the US economy? Does the Fed contribute to bubbles? Does the Fed make mistakes?

Yes, yes, and yes.

While the Fed does a very good job at containing the effects of panics and ensuring that the system doesn’t go off the rails, they do make mistakes. This isn’t because they are evil. It’s because they are humans. Humans have biases, make errors, and get things wrong.

The Fed probably contributed to the bubble of the 1920’s.

They let the party go on too long and let things rage out of control in the late 1920’s. They should have taken the punch bowl away. Like a 20 year old managing risk at a frat party, they spiked the jungle juice with more Everclear instead of letting things calm down. Then, in 1929, someone called the cops and the fun was over.

The Fed also contributed to the inflation of the 1970’s.

Richard Nixon was dead set on winning his 1972 election and did everything possible to ensure victory. While he was having his cronies break into hotels to help make this happen, he also put pressure on Arthur Burns to ease monetary policy.

We were already experiencing the early stages of inflation, but Nixon wanted to win and didn’t care. He did not want the Fed to apply the brakes. He wanted a booming economy by the time that the election came around. Arthur Burns complied. The economy was doing well once election day came and Nixon won in a 49 state landslide.

Inflation then grew out of control and the Fed started raising rates to deal with it. Then, as if delivered by fate, we faced an oil crisis at the same time. The economy plunged into the horrible recession of 1973-74.

Scrambling to end the recession, the Fed started easing again. They never really got the inflation under control, but ending the terrible recession was a bigger concern.

The recession ended, but the inflation came back.

Inflation didn’t stop until Paul Volcker stepped in and engineered a recession in the early 1980’s to break the back of inflation. This is the recession we probably should have had in the early 1970’s, but Nixon and Arthur Burns didn’t have the political will to do it. Volcker and Reagan had the backbone that Burns and Nixon lacked.

The Fed typically contributes to the cyclical nature of the US economy. I think that the yield curve predicts recessions and booms because it’s a good proxy for how tight or loose monetary policy. They overshoot in both directions.

The Fed usually overshoots when they are raising rates, triggering a recession. Meanwhile, they can leave rates too low for too long, contributing to asset bubbles and inflation.

My Views

The bulls have points and the bears have points.

I agree with the bears that the Fed makes mistakes, but I also agree with the bulls that the Fed, for the most part, reduces the severity of booms and busts in the US economy.

Even though they make mistakes, they should also get credit for correcting those mistakes. Yes, the Fed was helmed by Arthur Burns and generated inflation. But doesn’t the Fed get any credit for Paul Volcker ending it?

I think that the 2008 recession could have turned into another Great Depression, but an aggressive policy response prevented that from happening. At the same time, I also think that the Fed contributed to the housing bubble.

I agree with the bears that markets enter bubbles, but I don’t think that the Fed is the sole cause of it.

Bubbles have been happening throughout the history of civilization, with or without a Federal Reserve. The South Sea Bubble and Tulipmania happened without a central bank, after all.

Bubbles happen because humans set prices in markets and humans are emotional beings.

Usually, bubbles start with a kernel of truth like:

1. 1999: The internet is going to the change the world. The companies that embrace the internet are going to dominate our future.

2. 2004: Real estate is a rock solid investment. It only occasionally declines violently. It’s less volatile than the stock market. You can apply leverage to it and generate income.

3. 1988: Japan is outperforming the United States. The country has a highly educated population and they have created an excellent and efficient business model.

4. 2017: Blockchain is a transformative technology.

5. 1980: Gold is a good hedge against inflation.

People take those kernels of truth and go too far with it.

Have you ever gone too far with a good thing? I certainly have! Markets  do the same thing.

Does the Fed contribute to these bubbles? Does the Fed contribute to booms and busts? Of course, but they’re not the sole actor here. In fact, they’re probably not the dominant actor.

Our limbic system is probably more to blame for the internet and housing bubbles than Alan Greenspan.

Bubbles are a feature, not a bug, of financial markets. This is because fear, greed, euphoria, and despair are features of the human condition.

Markets are increasingly dominated by computers and algorithms, but that doesn’t stop the fact that the money belongs to human beings and human beings are intensely emotional. This is particularly true when it applies to money that they have suffered to earn.

The perma bears argue that the Fed is both the arsonist and the fire department, channeling the plot of Backdraft.

I’d argue that it’s an institution that has mostly done good for the country and occasionally makes mistakes because they’re controlled by human beings and nobody is perfect.

Today’s Market

I think that we had a bubble at the end of the 2010’s and it is unwinding now. On this front, I agree with the bears.

I think the Fed probably made a mistake and waited too long to start raising rates. By 2013-14, the financial crisis was over and it was probably time to start tightening. The low rates led to mal-investment. The low rates probably contributed to the fracking boom, for instance.

I also think that the Fed is responding as it should to the current crisis, agreeing with the bulls.

The Fed is responding to the crisis aggressively, which is what they should be doing when faced with the worst recession in the last 90 years. They are throwing the kitchen sink at a brutal problem. They are doing everything they can to prevent the system from collapsing.

This is exactly what they should be doing!

However, I don’t think that the Fed is an all powerful wizard. For this reason, I don’t think that the Fed can prevent this bubble from unwinding, any more than the Japanese could prevent their market from eventually falling to a fair value.

(And yes, I know that the Japanese bubble was far more extreme than anything we experienced in the late 2010’s. I’m simply using this as an example that central banks aren’t all-powerful and mighty.)

It’s probably best to not be “perma” anything. I try to objectively look at the situation tactically and not through the lens of an ideology. There are times to be bullish about stocks and times to be bearish.


My favorite Pink Floyd song from an album that doesn’t get any respect.

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.

Quick Note


I bought TAIL yesterday. I basically bought this as a hedge against the stocks that I still own that I can’t bring myself to sell. This helps me stay somewhat market neutral during this bear market.

I’m not taking an outright short position on the market. Yet, anyway. Still struggling with whether I want to actually do that.

Deep Value

The good news is that the deep value universe of stocks in the Russell 3K with an EV/EBIT multiple under 5 is now over 200 stocks, which is the best environment we have seen since the financial crisis.

Under normal circumstances, I would be a buyer. I just don’t think markets bottom when a recession is only just beginning.


Market Valuations

Other good news, after yesterday’s decline, market cap/GDP is now down to 110%. This isn’t cheap, but better than where we were. There are a range of outcomes from here depending on where valuations are 10 years from now:

Market cap/GDP = 40% = -6.3% CAGR

80% = 1.7%

120% = 6.7%

The outcome is largely unknowable. Future valuations strongly depend on what interest rates are 10 years from now.

I think you could make a strong case for both outcomes: interest rates will be lower as we emulate the Japan example, which suggests valuations can be higher.

It’s also possible interest rates will be higher. I think that’s the likely outcome, as our demographic situation is different than Japan and I think money velocity will likely pick up as Millennials enter their peak earnings years. It’s also quite possible that, thanks to quarantines, we’ll have a baby boom in 9 months which is also bullish for the long term prospects of the economy.

In any case, we have to look at the range of outcomes. The base case is 1.7%, which isn’t really too exciting compared to the risk of owning equities.


Markets don’t bottom at the beginning of a recession when unemployment is low.

Of course, there isn’t anything normal about what’s going on right now. This was a violent move down, and for all I know the market could make an equally violent move up when this is all resolved.

I turn to valuations and history for guidance. In the last two recessionary drawdowns, market cap/GDP got down to 75% in 2003 and 57% in 2009. That means this likely really isn’t over until we get down to at least 80%.

The yield curve is currently un-inverted. That’s good news. I’m unusual among cranky market bears in that I want the Fed to ease and try to stop this recession aggressively and think they’re doing the right thing by throwing the kitchen sink at this. I also think that the federal government needs to pursue hardcore fiscal stimulus to end this.


Markets don’t bottom when the yield curve just starts to un-invert. They bottom when we have a large spread between the 3-month and 10-year. That’s a pretty good indicator that an economic boom and turnaround is in our future. We aren’t there yet.

Buuuut . . . at least we’re starting to get there and are headed in the right direction.

More good news is that the vaccine is being tested. Let’s make sure this works and roll it out and defeat this thing.

Stay safe and healthy. Hug your people. Well, those you’re safely quarantined with. 🙂


Electric Youth is great.


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.