The Hazards of Asset Allocation in a Late-Stage Major Bubble

> I think I remember someone saying that in 1929 when the shoeshine boys were giving stock advice that that's how someone knew the bubble was about to burst.

President JFK's father:

> While sitting in the shoeshine chair, Kennedy Sr. was alarmed to have the shoeshine boy gift him with several tips on which stocks he should own — yes, a shoeshine boy playing the stock market.

> This unsolicited advice resulted in a life-changing moment for Kennedy Sr. who promptly went back to his office and started unloading his stock portfolio.

> In fact, he didn’t just get out of the market, he aggressively shorted it — and got filthy rich because of it during the epic crash that soon followed.

* https://www.businessinsider.com/how-to-spot-stock-market-bub...

* https://en.wikipedia.org/wiki/Joseph_P._Kennedy_Sr.#1929_Wal...

Or, it could just be that far more people are investors today than there were in 1929. According to this site, only about 10% of Americans owned stock or speculated in the markets in 1929.

>In fact, only approximately 10 percent of American households held stock investments and speculated in the market; yet nearly a third would lose their lifelong savings and jobs in the ensuing depression.

https://courses.lumenlearning.com/atd-hostos-ushistory/chapt...

Yet, this poll seems to indicate that around 55% of Americans now hold stocks.

>Thus far in 2020, Gallup finds 55% of Americans reporting that they own stock, based on polls conducted in March and April. This is identical to the average 55% recorded in 2019 and similar to the average of 54% Gallup has measured since 2010.

https://news.gallup.com/poll/266807/percentage-americans-own...

So if slightly more than one out of every two people you meet owns stocks, I would assume you're bound to run into a lot of people talking about stocks.

The 2021 signal is all the high school students telling you what altcoins to buy.

And just wait till you see what is going on with Decentralised Finance.

https://coinmarketcap.com/yield-farming/

Sort that by Highest APYs. It fluctuates all the time but the numbers are getting as high as 1,000,000% APY. There is no world in which that can be anything but a Ponzi scheme.

People are actually buying into these things.

If I'd taken the advice of one of the guys I hired to move my home back in 2017 and bought Bitcoin like he had, I'd be up 25x today. I thought he was nuts, and still do, but if he's still holding on to his Bitcoin then the joke's on me. Shrug.

The quote at the beginning of the article is right:

> The one reality that you can never change is that a higher-priced asset will produce a lower return than a lower-priced asset. You can't have your cake and eat it. You can enjoy it now, or you can enjoy it steadily in the distant future, but not both – and the price we pay for having this market go higher and higher is a lower 10-year return from the peak.

With a bit more mathematical rigor: For each of us there will be only one future. In that future, each asset -- company, property, etc. -- will earn a finite cash flow yield. If we pay more for that future cash flow now, our rate of return will be lower in the future.

Yeah, this has been my impression for quite some time now. Future projection for company equity seems fine enough, though quite obviously overvalued (but good luck betting against uncapped QE).

Corporate debt on the other hand has been scary for a few years and is getting ridiculous. Your point lowest possible bond ratings is a solid one, I think, and one I hadn't considered.

The chaining effect of some failures will be significant given how much leverage is inherent in the system. I think bond market spreads will become quite large as liquidity dries up.

Wouldn't this force the fed to become the lender to these zombie firms or let the institutions take a bath?

I can't imagine corporate bankruptcies resulting in corrective change if the fed is the principal lender.

Just in case not everyone clicks it, the forecast from 2009 is actually bullish.

A potentially more productive view is that the fed cannot support the bubble indefinitely.

It's becoming clear that money can be printed without causing inflation if its unevenly distributed in the economy. This amounts to large scale wealth redistribution to support asset price increases. If you earn dollars for a living, your purchasing power in terms of future dollar income is being eroded. You will purchase a home later or never, you may not be able to afford an education, and your medical expenses will rise ( as will anything that affects future earning power ).

When this ends is anyones guess, it's entirely plausible that we revert to the social systems of prior less equal times, foreign trade moves off the dollar, assets converge to an effective price of infinite dollars, or populists demand their own redistributive policies such as UBI or wealth taxes.

Or the fed meets tomorrow and cuts QE entirely. What is assured is that the current trend is unsustainable and must end eventually.

Yes, the bubble readers seem to ignore the money creation.

However that said, the default bubble is potentially a lurking time bomb, so it's a race between inflation and loan defaults, essentially. (Inflation tends to make loan defaults less likely as it reduces the relative cost of existing loans.)

> Two can play at this game. I predict that at some future date the stock market will be higher than it is today.

If you said that about the Nikkei 225 in 1990, you’d still be waiting for it to come true. Though as of a few hours ago it’s within 30% of the peak: https://www.bloomberg.com/news/articles/2021-02-15/japan-s-n...

His quote, like the whole article, is just feigned insight. I guess if stocks go down 6 months or five years from now he can say: "see I told you so".

>> That concludes that this bubble will continue as long as interest rate remains near zero.

Yeah, I think that is the generally accepted understanding of what's happening right now especially with additional stimulus / QE methods.

Think you are already seeing equity escape into other asset classes in commodities and cryptocurrency, too.

Why were bond interest rates ever that high in the first place?

Not only do bonds yield nothing, they yield less than zero once you consider inflation. And long bonds yield near zero but...you have huge bond price risk if rates rise again.

There is no real choice now, you have to park the cash somewhere...and so it ends up everywhere from stocks to commercial real estate to VC (and eventually into our tech salaries, into rent, to the landlord, to the bank, and back into MBS in institutions :-)

Exactly. Asset prices are not determined by central bank actions, there is a third component that pushes both asset prices and central bank policy - the global supply/demand of savings vs investment opportunities. Which is driven mostly by demographics. China's massive working class, and the unprecedented rate at which they are getting wealthier, and their savings rate which is like >10x the average US citizen means there is a huge increase in the global supply of savings. Which bids up asset prices and pushes down yields, as savers compete with each other to buy up the extant profitable and safe opportunities. Central banks are the on the receiving end of this too: over-saving pushes down the natural rate of interest, which means policy rates must be lower to respond (unless you want to condemn some working Americans to unemployment).

I'm not sure if they're still around, but I remember back in the 1990s there was a family of mutual funds that aimed to do exactly what you're describing. They actually advertised the fact that they won't have the best returns in bull markets because they were protecting people in down markets.

The idea was that people benefitted more from staying in the market over a long period of time rather than maximizing their returns in any particular year.

So the fund was aimed to smooth out the peaks and valleys along the ride so investors would be more inclined to leave their money parked in the fund rather than getting a statement that said that they're down 30% and going to cash and missing the next run up.

Gold is not a suitable comparison to stocks - it gets brought up on here all the time. Gold is not uncorrelated to the market. Gold is not a store of value. Gold is a speculative investment with a great marketing team.

Why do you believe this is a predictive measure?

> Your overall net worth is not what makes you happy, it’s the CHANGE in net worth (up).

Two unfunded assumptions that seem to be based on your own experience.

Here's another, based on my own experience: a component of what makes you happy is to not have to worry about money at all, either because you live a lifestyle that require little of it, or because you have enough that a 50% change in wealth has zero impact on your life.

Emerging markets and value stocks are historically cheap on a relative basis, see the What to Do? section at the end of the article.

It always does? It's partly a psychological phenomena and partly just a question of running out of greater fools. The first one is that once there's a change in mood for some reason (some event happens, e.g. a recession which in some ways is its own psychological phenomena) everyone convinces themselves that equities are too expensive, the prices start declining and that feeds a further decline. Just look at the GME stock as a microcosm of that situation.

In terms of the greater fool thing, you can only keep buying and selling the same thing for a 10% profit every year without eventually running out of people who will buy it. I guess see also the GME stock as a microcosm of that?

And so, all bubbles must burst.

I don't think it needs to burst. Though there will certainly be times when it goes down there is no reason it'll even go below current prices.

Historically prices have always gone up, so as long as you aren't near a peak it's probably the lowest the total market will ever be.

The tunnel has been flooded with QE methods' light. The tunnel is hardly dark... for asset owners.

This bubble started well before Covid. I do agree that if the vaccination campaign is successful the mood will be such that it might sustain it a little longer. That should factor into the calculation. Though on the other hand, governments may hold back a little on stimulus once that happens as they've been throwing money all over the place during Covid.

This line of reasoning assumes the future looks like the past. Which is generally a solid mode of thinking.

But, if the future looks like the past, shouldn't it give you pause that on many metrics markets are substantially more richly valued than at any peak in the last 100 years?

You can't have it both ways. Either the past is useful or it's not. If it's useful, then you have two conflicting data points -- market timing doesn't work, and we're at the top of a big bubble. If the past isn't useful, then neither data point is valid.

Now, you'll probably argue that even if it is a big bubble, the past suggests it always comes back. Setting aside the obvious fact that it's mathematically better to buy after the bubble bursts than before, you're in the same conundrum. Does the past matter or not? If it does, then yes you should expect to recoup the money eventually from buying at the top (though, if you bought at the top in 1929, you had to wait until the 1950s to get back to even). If the past doesn't matter and this time is different, then you can't say anything productive about the future.

On the other hand, if you bought into the Nikkei in the late 80s/early 90s, you'd still be in negative returns 30 years later.

The probability of the bubble bursting now though is higher than in 2017 (can't argue with that?) ... Rebalancing is a form of market timing, why not be 100% in equities and never rebalance? There is some evidence to suggest that's a good idea.

The way I approach this is that I take these sorts of macro bets with some portion of my portfolio. In a sense I adjust or rebalance my portfolio to partly reflect what I believe are better investments at that time, but not radically so. That way I get to have the fun of maybe timing the market and making an extra buck while also mostly being continuously invested. Being diversified also helps.