Since I entered the business in 1997, I have experienced several significant financial market booms and busts. Asset bubbles inflating, over-inflating, then popping and overshooting on the downside. Since 2000, the largest public equity market in the world, the S&P 500 (SPX) has risen to great heights and then be cut in half on two occasions causing a knock on effect in other risk assets resulting in two massive recessions that were not contained to just the U.S. This may sound like an obvious observation. Markets rise and fall, right? But what we’ve experienced over the past 20 years or so is somewhat unique, with fewer “normal” market corrections of 10% and as a result longer booms and deeper busts. This chart is few years old now but the last few years have continued in trend:
With a boom and bust cycle the norm now, the fascination with identifying bubbles, riding the waves both up and down, and attempting the Big Short will remain sport for market participants, pundits and financial journalists for some time. I see no reason to believe why this should not be the case for private investing. I read the same article in the New York Times yesterday that Nathan Bashaw highlighted on his Twitter and immediately had a very different thought than he and famed venture capitalist Marc Andreessen:
“Silicon Valley start-ups were set to face a great reckoning in 2016. Yet the crash hasn’t happened.” https://t.co/XPJLGbiAVY
— Nathan Bashaw (@nbashaw) August 29, 2016
And 2015 and 14 and 13 and 12 and 11 and 10 and 09 and 08 and 07 and 06 and 05 and 04. 😶 https://t.co/L7ByM7PcXP
— Marc Andreessen (@pmarca) August 29, 2016
Bashaw is being provocative and highlighting something interesting and I suspect that Andreessen is being snarky. Andreesen’s point is you can sit around forever waiting for these reckonings when all the important stuff is happening during the boom. He after all, was at the forefront of one of the biggest booms we’ve ever seen with the IPO of Netscape in 1995, the beginning of the dotcom boom. Andreesen knows as well as anyone that there will be a day of reckoning after a period of over and/or mal-investment. His point is that being the carnival barker for said impending doom serves little purpose.
My response to this discussion is a bit of reflex after nearly two decades of being on the trading side of booms and busts:
@nbashaw @pmarca PTSD… Nasdaq declining 80% from highs in 2000 to its lows in 2003 will be a time long remembered. pic.twitter.com/Bf9EJ7XLh8
— Dan Nathan (@RiskReversal) August 29, 2016
@nbashaw@pmarca well its like this, from its 2007 highs to its 2009 lows the $XLF lost 85% pic.twitter.com/wbAFYYdia2
— Dan Nathan (@RiskReversal) August 29, 2016
@nbashaw@pmarca and then from its highs in 2013 to its lows earlier this year Crude oil lost 75% of its value pic.twitter.com/sNblBR7OTW
— Dan Nathan (@RiskReversal) August 29, 2016
That won’t help you make money today or tomorrow, but recognizing that investment cycles over the last couple decades resolve themselves in very different ways than they have in the past is important. We go from long periods of euphoria to desperation. The engine knows no other way to resolve itself.
SO I have no idea whether the SPX at all time highs is in a bubble, or Facebook (FB) with a public market value of $363 billion is a bubble, or Uber’s private market value of north of $60 billion, greater than General Motors or Ford is a bubble. The more important thing is figuring out what is driving those valuations so you recognize the signs of its undoing. Remember that the prime ingredient to bubble inflation over the past 20 years has been ever lower interest rates. How many tens of trillions of dollars have been made and lost in the last 20 years while the cost of borrowing has melted to nothing?
It’s impossible to know when a cycle like this will come to an end. Even the most obvious manias in the world like the dotcom bubble and the housing bubble went on far longer and more fiercely than most of the “smart money” could stand. They key is recognizing when it’s coming undone, being able to tell the 9% corrections from the 50% ones. In the past few years we’ve seen the “buy the dip” strategy in full effect. The reason is that each mini correction has extended the timeframe of what’s behind the boom in the first place. And that’s lower for longer interest rates. But eventually that Goldilocks situation resolves itself one way or the other. Either the economy heats up enough and rates must rise rapidly, or the low rates are no longer able to prop the economy up. And those are the signs that will distinguish the next 9% buy the dip from the next Big Short. And a lot of money can be made and lost on both sides of that cycle.