The Hazards of Asset Allocation in a Late-Stage Major Bubble
gmo.com
gmo.com
GMO's assets under management have collapsed by well over 50% over the years as they've been consistently wrong about, well essentially everything, in the markets for 10+ years now.
But they wrap up their pessimism in technocratic mumbo-jumbo so it sounds like an objective take and a certain kind of audience eats it up.
> Far more typically, I was three years too early in the Japan bubble. We at GMO got entirely out of Japan in 1987, when it was over 40% of the EAFE benchmark and selling at over 40x earnings, against a previous all-time high of 25x. It seemed prudent to exit at the time, but for three years we underperformed painfully as the Japanese market went to 65x earnings on its way to becoming over 60% of the benchmark! But we also stayed completely out for three years after the top and ultimately made good money on the round trip.
It’s really really hard to call tops and bottoms but that doesn’t mean I just blindly invest no matter how irrational the market has become. Some of these things are just plain math, something Hacker News readers should be good at.
> As a Model 3 owner, my personal favorite Tesla tidbit is that its market cap, now over $600 billion, amounts to over $1.25 million per car sold each year versus $9,000 per car for GM. What has 1929 got to equal that?
This example shows how shallow this analysis is. They totally ignoring shift to green energy and that Tesla is a participant in this market. They are also considering Tesla as just another carmaker in the market, not paying enough attention to the many core differences. GM in my view is as far anti-Tesla as you can get.
If we assume Tesla will grow units sold while GM will remain about static AND we assume GM is fairly valued (while assuming unit margins are the same for both companies), then it tells us Tesla needs to sell about 140 times as many cars per year in the future to justify its current stock price. Now, if you assume Tesla’s cars will have a margin 4x as large as GM’s and that GM’s business is undervalued by half, then if my math is correct, Tesla needs to sell only 17 times as many cars per year ($1.25MM/4=$312k, $9k*2=$18k, $312k/$18k=17). That 17x increase doesn’t seem totally unreasonable.
Of course, this also assumes that Tesla will make its money off of cars sold and not some other wild Muskian idea: if he develops world-beating self-driving software selling at 90% gross margins or wisely acquires other companies like Henry Singleton did at Teledyne, we could all be saying a $5 trillion market cap is cheap for Tesla in a few years! That said, as an investor, I wouldn’t buy today’s Tesla at even half its current stock price nor would I bet against Elon Musk (especially by shorting!). A lot of things have to go right for Tesla to justify its stock price; I just don’t have any way of predicting what Musk will do next!
- seats - selling - soon batteries - ai chip - soon insurance - charge stations is like if GM could own the gas stations
This doesn’t even count the growth of the other product lines like utility grid storage and solar roof and Uber like services.
Yes, 1 million robotaxis by the end of 2020.
https://www.thedrive.com/news/38129/elon-musk-promised-1-mil...
But I still think there's a limit to what any one company can do. The insurance company Allstate could be worth $1T if they end up entering a business producing revolutionary proprietary alternative fuel technology! Obviously, I think Tesla with Musk at the helm has a better chance of creating new markets than GM, Allstate, Exxon, etc., but I realize that there's some limit to what one company can do.
Once your company's market cap gets in the trillion-dollar category, and the total market cap of the US stock market is 50 trillion, you shouldn't expect a 100-bagger.
Big deal, they barely produce any cars.
If Musk threatened to go to jail because a governor did not let him keep his plant open through COVID, he will be eviscerated by some UAW guy and will outsource the entire production ASAP.
At any one moment, there will overvalued, undervalued, and fairly valued stocks. All that changes is the ratio between them.
I don't think I really believe that case, but that's the way the valuation is justified. It's not something that can be captured easily in a discounted cash flow model, because after a couple years you're basically just inventing numbers there. But if you knew for sure that TSLA would succeed in dominating the electric car market, you'd probably buy it at much higher prices than we see today.
The price difference just isn’t that big in relative terms (the starting prices are all relatively high), but the difference in what you get is huge. And I think that’s part of the allure of Tesla - can a 2010-era-supercar be built for $25k? What about less?
I ended up getting a 2nd hand diesel BMW because I got the feeling that the market would move a lot in the next 5 years.
This is just more abstract phrasing.
They make good, albeit expensive, cars that their fan-base seems happy with. They lead in a few things(tech, batteries) and are behind in others (maybe self-driving, definitely quality). Where is the 1000-mile lead?
So Tesla is Nokia in this analogy? I agree, their 1000-mile lead can disappear.
Nobody is saying Tesla won't have a pullback, and it could be a serious pullback, but over the next 5 to 10 years, a lot of investors can see the company being a multi-trillion market cap.
I assume it's because everybody is too afraid to short their stock after what happened to the shorters before.
Kind of a self-fulfilling prophecy for any company that ramps up a stock price like that and doesn’t have a CFO asleep at the wheel.
Yeah, we should follow the Morgan Stanley sum-of-parts valuation model for their client (Tesla), who values Tesla Insurance, which has never written a single policy, as one of the most valuable insurance companies in the US.
That's the kind of "deep" analysis I'm looking for!
No, they don't.
Actually, this notion that Tesla is somehow going to beat every other car company is shallow.
What very high valuations mean is lower ROI in the future, only that. I'm 99% certain that Total Return (TR) from stock markets 2010-2020 >> 2021-2030. SP500 TR is 13.97% annualized for last 10 years (price return 11.64%). I'm surprised if it's above 5% annualized for next 10 years.
That does not necessarily mean rapid decline in valuations (as bursting or crash). It can be stagnated stock market. It can be market boom that continues next 5 years and then fall back little above 2020 levels.
Can you point out where in the writing their commentary is not intelligent?
You seem to be attacking the author of this article but make no commentary about the weakness of their arguments. This makes me more inclined to believe them over you. I'm not saying you're wrong, but as someone who doesn't know much about the market, I do not see the implicit/obvious points that would prove the article wrong. Furthermore, being wrong in the past does not preclude someone from being right about the future, and vice versa.
Valuations are a non-stationary process with no defined mathematical mean, so the entire concept of "mean reverting valuations" is nonsensical.
Their entire investing philosophy isn't based on some deep understanding of the market but is simply an "end of history illusion" that the past (in this case the era in which the principals of GMO came of age) will continue unchanged indefinitely into the future.
It isn't just they they've been wrong about US valuations and US returns. They've also been wrong about Emerging Market valuations and those returns. It can't just be handwaved away as "US investors went crazy for FANG and Tesla" because that only addresses half their failure.
Do you have a source for this? It looks like they've been hovering at $64B discretionary AUM since 2014, and that hasn't changed through 2020. [1][2]
All I could find was this article, which I think might be misleading. [3] It seems like it might be conflating GMO's total AUM with the AUM of its asset allocation business, but I'm not sure.
1. https://web.archive.org/web/20150408043537/http://www.gmo.co...
2. https://www.gmo.com/globalassets/documents---manually-loaded...
3. https://www.google.com/amp/s/www.marketwatch.com/amp/story/i...
A tale of the worlds worst market timer: https://awealthofcommonsense.com/2014/02/worlds-worst-market...
Play stupid games, win stupid prizes.
But purchased on their own as a stand-alone bet, all options and futures contracts are by definition zero-sum games.
So 99.999% of the retail investors (robinhood et al.) trading options are playing a zero sum game. Hence why I didn’t feel the need to elaborate.
Maybe you're confusing options and "binary options"?
I think you might be confused by the name "binary options."
The word "binary" doesn't refer to the fact that they are specifically zero sum. This doesn't need to be called out, because again, all options and futures are zero sum.
The "binary" qualifier refers to the fact that they result in "yes/no" outcome. Did the thing you bet on happen? Yes? You win. No? you lose everything.
It's not true that no value is created or destroyed on transfer. Transferring or obtaining the asset might be extremely valuable to someone. Market conditions change. And so on.
The simple fact that you can create value for others without stealing that value from someone else means the economy is positive sum.
If all economic transactions were zero sum, then growth would be impossible.
Things like GDP, the stock market, etc grow every single year on average because they are positive sum.
That’s why it’s most smart to just buy-and-hold boring index funds. You’re taking advantage of the positive sum nature of all business in aggregate, instead of playing the zero-sum game of short term trading against other market participants.
> No value is created or destroyed (outside of trading fees), just transferred between parties.
That transfer is the value. In fact, that's pretty much the point of finance in its entirety - moving around capital/risk is valuable in and of itself.
> in late 1997, as the S&P 500 passed its previous 1929 peak of 21x earnings, we rapidly sold down our discretionary U.S. equity positions then watched in horror as the market went to 35x on rising earnings. We lost half our Asset Allocation book of business but in the ensuing decline we much more than made up our losses.
For the average investor it might be overly bold to step out of the stock market entirely in times like these. However, there's nothing wrong with moving to a more conservative allocation that will do better in crashes, but still perform reasonably well if you hold it that way forever. A great place to start is the sample portfolios at portfoliocharts.com.
If you're 25 and saving to retire at 65 then maybe don't worry about it, but if you're 50 that's another matter.
Rates of return are not the only reason to hold an particular type of asset, which is why bonds may be worth having even if yields are low:
* https://awealthofcommonsense.com/2020/08/why-would-anyone-ow...
nitpick: the price went up 15%, but not necessarily the return, which can be much higher due to distributions.
A 7% average annual return over 24 years is not necessarily bad. On an absolute average basis that trails the market by 3%. [3] That return could still be legitimately superior to investing in SPY, depending on risk goals, if its volatility and beta exposure is sufficiently low that it beats SPY on a risk-adjusted basis. Then you may even be able to beat the S&P on a total basis, safely, with leverage, depending on the volatility ratio.
Therefore the point you're trying to make would be better construed with an analysis of the beta, volatility and Sharpe of GMWAX. By definition the beta of SPY is 1, and the historical Sharpe is around 0.72. It's correlation with the market is about 1 and it has (again, almost by definition), 0 alpha.
GMWAX has close to total correlation with the market, with a beta of 1.02 and negative alpha less than that of SPY. It has a Sharpe ratio of only 0.34. That means this GMO asset allocation fund is not beating the market, even on a risk adjusted basis. Moreover the explicit mandate of the fund, to avoid market downturns but otherwise track the market's upswings, is not being met. It is both underperforming the market and highly correlated with the market.
1. https://www.schwab.com/public/schwab/investing/investment_he...
But I also don't think their predictions have sufficiently precise timing to beat the market. I agree with the thrust of your point, and I probably wouldn't invest my money with them. I think of GMO a lot like AQR in that sense.
I see this posted from time to time, but the assumptions are kind of silly. A huge portion of the "miraculous" returns come from the fact that this fictional person was able to put an entire year's worth of salary into the market in one go, 50 years ago. In 1970 the average salary was about $6,000, but he managed to save one third each year to invest?
So, sure it demonstrates the power of compounding. But, to me, an alternative lesson is that you can be an incredibly diligent saver and, through sheer bad luck, have barely enough to retire. I mean, it's not like $1MM in retirement money means "set for life" anymore.
It absolutely does, unless you are planning on living in a mansion eating nothing but caviar.
HN needs to live in the real world and learn what most people retire with
Most people retire with barely anything, I don't think that's disputed. Doesn't mean that $1M is a lot of money to retire on.
I just mean for the vast majority of the world, retiring with that sort of wealth is an unattainable goal. I’m sure most people can arrange their life to live incredibly comfortably with $1m.
That's not to say you can live any life in any location, but assuming you use money wisely you can live with an amazing standard of living!
Further, if you believe the historical data enough to rely on that, you should also believe the same data which says when CAPE ratios are high, the safe withdrawal rate goes to 3% or less.
And if you can perpetually have the type of holiday most people only dream of, I would say you are doing ok!
https://www.investopedia.com/articles/retirement/101416/how-...
So to fit that budget you'd be constantly hustling for last-minute cruise deals, and for a cheap place to stay when you can't find a cheap cruise ready to go at your current port. That's not exactly what I'd call "set for life."
Also note their estimate is "per person." Cruise lines price rooms for at least double occupancy so they're actually saying you'll need $200/day, unless you're splitting with someone who has their own money.
On top of cruise fees, you'll need some budget to just buy stuff now and then. You might even want health insurance.
I think you misread the article - it assumes you have a one person cabin and then says you could do it cheaper if two of you are together.
And yes, you will have to look for a good deal. This is the reality of cruising too, there are always heavy discounts which long term cruisers will take advantage of. My parents are avid cruisers and have enough money to not need to be frugal, and even they do this - because what buys them a stateroom without a discount can sometimes buy them a suite with one.
People can live 30 years from retirement. A million doesn't go far like that. There's no safe returns on that money anymore.
I just mean on a world scale I’m hot feeling pity for someone that “only” retires with a million and will have to try so so hard to make ends meet.
You won’t struggle to live on a million dollars (in the real meaning of the word struggle).
3% of 1M is $30,000, before taxes on any investment gains. That's basically a little less or a little more than a minimum wage job, depending on where you live. Most likely both you and your spouse will need to live off of that.
I don't think 1M is enough to retire in any manner of comfort. 2-3M would be a lot safer. And that's if you move to a cheaper locale and avoid any of the first-tier cities.
Also you've ignored everything else I said just to harp on one thing - which is rude considering the time I took to reply to you.
You're saying that $1MM in retirement isn't as much as you'd like...so...it'd be better to have nothing and have saved zero?
If this is what you got from my comment, it's probably pointless to engage with you.
In the off-chance you're sincere: the thought experiment in the article is interesting, I get that. But it's trotted out as evidence that you can be the worst investor in the world and still make money. Okay.
Now examine the assumptions. This fictional person started with $2,000 at age 22 (about $15,000 today. No student loans, nice windfall. Sound like the 22-year-olds of today?), and assuming they were making the average salary in 1970 (unlikely as a young person), they managed to save a substantial proportion of their salary every year. This gets invested, instantly cut in half, but then compounds for 45 years, with more dollars added along the way.
Yes, you can be the worst investor ever and get reasonable results over 45 years if you're a really good saver. So what? This person managed to 6x their money over half a century. In my opinion that's a devastating result. Now imagine if you're one of those people in between the best/worst saver/investor? Without some luck your results will be similar, ie not great. And this doesn't account for the fact that past results != future results.
It also doesn't account for when you need to disinvest. This article was written in 2014, with stocks near record highs at that time. Pretty convenient for this calculation. What happened if retirement came a few years earlier, in early 2009?
So to answer your question, of course something is better than nothing. But the other lesson I see there: saving what you can and investing it blindly in an index fund isn't a guarantee of a cushy retirement, even though that's what the population is being sold. This is a crisis in the making.
And you missed the point that this is the worst you could do. If “Bob” had simply invested every year, his end result is likely 2-3x.
He started with $2,000 and was saving $2,000 per year...in 1970. That is a lot. If you are able to do that as a 22-year-old entering the job market, good for you. It's unrealistic for the vast majority of people.
The average savings rate in the US is about 7%. "Bob" managed 30%+ in the most important (read: earliest) years, allowing it to compound for a long time. His savings was front-loaded. This is not normal. Most people don't start saving anything of significance until they are into their 40s.
>And you missed the point that this is the worst you could do.
You missed my point that this isn't nearly "the worst you could do". This fictional person started with incredibly privileged circumstances: A substantial windfall, apparently no debt, apparently a great job straight out of college, that allowed them to invest significant funds very early in their career.
The unrealistic investing scenario is countered by the unrealistic saving ability. Not a particularly valuable thought experiment.
And, once again, I don't disagree with the premise: save what you can and invest it in a diversified portfolio and allow it to compound over your life. This is the best option for 99.9% of the population. But, it also doesn't guarantee a comfortable retirement for that 99.9%, which is scary.
There was also a study done by Vanguard which showed that historically, dollar-cost averaging underperforms lump-sum investments which was just as interesting to me.
I'd be very interested to read the study, but the only text I've found so far is this: https://investor.vanguard.com/investing/online-trading/inves...
It seems logical to me that lump sum investing > dollar-cost averaging (which is why I do the former), but I'd be curious to see empirical research.
* https://ofdollarsanddata.com/even-god-couldnt-beat-dollar-co...
If you know when the peak and the trough will be, then you can jump in an out. The thing is by missing the worst days you tend to miss the best days:
* https://theirrelevantinvestor.com/2019/02/08/miss-the-worst-...
Another parameter is whether you’re free to spend your money. Currently in lockdown, all my money doesn’t buy me a dinner with friends in a restaurant (okay, I could pay a hefty fine, so restaurant dinners have inflated 1000%s in price!).
It’s not clear to me how the future will unfold and therefore I spread my worth in various assets and consume what may be unavailable soon.
1) The monetary perspective, in which stock prices are what they are, but there's a broader game (the real economy) of primary concern
2) The stock market analyst perspective, in which stock prices ebb and flow within a given range according to somewhat understood patterns
The issue is that (1) has been taking monetary actions never before seen (not even to support WWII), and (2) is crying from the rooftops that nothing makes sense when analyzed under historical pricing standards.
Well, yes. Both of these are true.
You have Jerome Powell telling you that "stocks are not that high" considering that the risk free rate just collapsed: https://www.cnbc.com/2020/12/16/powell-says-stock-prices-are...
If they want to go by history, they just have to look back at the last decade to see what this does to a stock market. There is no alternative.
The Fed has pumped a few trillion dollars into the global economy. This will inflate some prices somewhere.
The inflation has hit equities and real estate but kept consumer prices mostly intact.
The trillions aren’t going anywhere for a long time...
Our world would be a lot more interesting if that had went directly into the hands of citizens instead of the hands of real estate and Wall St.
Is the Fed buying real estate now? I knew they expanded to ETFs and bonds, but are they actually buying land/buildings or REITs?
Money has to go somewhere. The feds and gov of the world have ensured that no one can be in cash for long. So, money must go into equities, gold or bitcoin
Monetary velocity is collapsing.
Literally everyone seems to have turned into an Austrian economist lately.
Nobody remembers "pushing on a string" these days and the "Fed Put" is so accepted that it isn't even discussed, it is just assumed the world works that way.
https://en.wikipedia.org/wiki/United_States_v._$124,700_in_U...
Keynesian policies have been all the rage in the western world in the last decades - we'll pay the price at some point.
https://www.goodreads.com/book/show/27191691-the-only-game-i...
Bonds... 10-year treasury after tax amounts to less than inflation.
Holding cash... The USG keeps giving out money for nothing, meaning more money chasing the same amount of goods, services and investments.
Index funds... Earnings yields are at all time lows, about 3%.Now a lot of what they say has some truth to it, and they might actually be right. But they might also continue being wrong for years to come. Timing the market is a fools errand. Good advice is invest mostly by value or underestimated growth stocks, invest continuously, and only with money you don't need for at least 10 years. And finally, when the inevitable plunge does come, don't sell no matter how bad it gets. You only lose or make money when you sell, before that it's just points on paper.
[1] 2018 https://www.institutionalinvestor.com/article/b1743d0x0ms3yx... [2] 2017 https://www.gmo.com/americas/research-library/is-the-u.s.-st...
Plus > The single most dependable feature of the late stages of the great bubbles of history has been really crazy investor behavior, especially on the part of individuals.
That trend is even "truer" today, fostered by Robinhood and Co (eToro, Revolut, etc.). The access to markets was not as easy in 2008, limiting the role individuals could play in a bubble.
The fundamental fundamental is the house always wins, and the leaders of the US have indicated they will do whatever it takes to maintain broad market asset prices.
If you have substantial amounts of that, I’d look into diversifying by obtaining desirable land, especially commercial real estate that will be able to generate cash flow.
"my definition of success for a bear market call.. It is simply that sooner or later there will come a time when an investor is pleased to have been out of the market.. requiring that you get the timing right is overreach. If the hurdle for calling a bubble is set too high, so that you must call the top precisely, you will never try. And that condemns you to ride over the cliff every cycle, along with the great majority of investors and managers."
Of course it's just a summary of conventional thought about bubbles, but it's a good summary.
https://www.ft.com/content/faedd2a1-2008-4f1e-9198-7694fba79...
You believe Epic Bubble is nigh? Then you know how to make the most of it. Don't just preach, lead by example.
Currency kept getting printed by idiotic governments and distributed to mainly rich people which invest in stock, crypto and gold, overinflating their value.
Shorting the market is risky, how long can you keep shorting until you run out of money?
I don't see a slam dunk anywhere even if you think there's a epic bubble