This may be the toughest time to be an investor in the history of modern financial markets. It’s a perfect storm of stagflation and a popping everything bubble at the same time. This combination makes it almost impossible to eke out a real return.
In the spirit of having to admit the true extent of your problem before you can solve it, we’re going to measure just how big the challenge really is in today’s Daily Reckoning Australia Weekend edition.
The key difficulty is simple. The price of everything was bid up to nosebleed levels. And then it all began to crash. This robs investors of a place to hide their wealth.
Usually, diversification protects you from market routs. When stocks go down, bonds are supposed to go up, for example. When inflation is dragging you down, at least the economy is doing well and corporate profits surge.
But this time, the bubble bid up the price of all assets so broadly that even the usual hedges are plunging in value.
In fact, bonds, which are supposed to perform well when stocks crash, are leading the plunge…The Wall Street Journal calculated that ‘It’s the Worst Bond Market Since 1842’. And helpfully add, ‘That’s the Good News’.
Those who took refuge in their financial advisor’s reassurances about a 60/40 stocks and bonds portfolio have discovered that, sometimes, both parts crash at the same time. Those who have had enough of the stock market and stuck with bonds got wiped out in their supposedly safe haven.
The only asset which has held up ok is gold. Back to that in a second.
Usually, at this point, I dig into why this has happened. If central banks pump funds into financial markets, it bids up prices artificially and this always leads to a crash. But you’re probably sick of hearing about that.
Instead, let’s focus on something different, which is almost as interesting…to me.
What makes the everything bubble fascinating is how widely it was acknowledged going into the current downturn. Heck, even I saw it coming!
In 2019, I wrote the following in a Daily Reckoning Australia Weekend edition:
‘At this point, the everything bubble is pointing to an everything crisis in the works.
‘Which makes sense. If you keep bailing out but not solving whatever crisis comes your way, then eventually you’ll end up with an everything crisis.’
And in September of 2021:
‘Just as central bankers have inflated the everything bubble, and all bubbles in the past, they also pop them with tighter monetary policy…eventually.
‘This is what the market fears a repeat of in coming months.’
And what makes the everything bubble so dangerous was also clear before the fact in 2021:
‘Stocks fall as corporate debt becomes more expensive which reduces profits and bonds become relatively more attractive to invest in. The bid drops out of the property market and mortgage defaults begin. Bonds crash as yields rise.’
The point being that, if everything goes up, it must all come down, whatever your finance textbook might say about it.
Years ago, I found a 1970’s edition of Benjamin Graham’s Intelligent Investor book in a library of Fat Tail Media, or one our sister publishing companies in the UK. It’s the bible of fundamentals investing. The forward was by either Warren Buffett or his partner Charlie Munger — I can’t remember that either.
The forward declared that bonds would be a superior investment to stocks in coming years. I checked out whether this proved to be correct, and let’s just say it wasn’t the best advice.
The mistake was made because of how unusual stagflation is. In fact, I’m not sure anyone considered it possible before it struck in the ‘70s. And, when something is rare or theoretically impossible, professional investors aren’t so good at profiting from it.
But the conditions remind me of today. A time when stagflation crashed bonds and stocks. Heck, but the time inflation was brought under control, the US’s Dow Jones Industrial Average stock market index was at the same level as in 1915 once you adjust for inflation…
So much for ‘stocks go up in the long run’.
If I’m right about history rhyming, where do you hide?
Gold was my answer back in 2019 and 2021. And it has held up respectably…comparatively speaking anyway. Especially in currencies other than the US dollar, which surges during a crisis and has during this one.
Why gold? Because gold wasn’t bid up in the everything bubble, for a start. And that’s an important lesson about valuations. When the world goes mad for some sort of mania, find out what is unpopular and invest to protect yourself from the coming crash.
During the everything bubble, this was harder to do because so much was bid up wildly. Then again, that also made finding the exceptions easier.
And it worked. Unfashionable fossil fuel stocks and gold proved the right place to be. Until recently, when it comes to oil stocks. They’ve been caught up in the recession part of stagflation and joined the rest of the market in falling.
Gold is also a logical outperformer of recent times, in relative terms, for other reasons. You see, gold has a history of performing well during both inflation and crashes. So, when you’re getting both, it’s a good place to be.
The US dollar’s outperformance is also worth noting. If you own US dollar denominated assets, at least the currency moves work in your favour during a crash.
A friend joined a funds management company that held most of its investments in the US for this reason. The US stockmarket was booming, so it was the best place to invest for growth. But should there be a crash, the US dollar would rally and the Australian dollar sink, thereby hedging the losses.
So, you see, investing isn’t entirely hopeless. It’s just a matter of believing in the right mantras at the right times.
Until next time,
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Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekened
