Taking the Most Money from the Most People
JANUARY 14, 2024
For the last quarter of 2023, Bitcoin led with gold mining second, Nasdaq third, Russell 2000 fourth, gold fifth, twenty-year treasuries sixth, and the S&P 500 seventh. It was an interesting collection of (at least temporary) winners.
Positive bond returns were especially notable since three years of decline had wiped out half their value, creating the worst bear market for bonds in several hundred years.
Such a devastating bear market in a “safe” asset in turn imperils pension and insurance company funds, some of which have sought refuge in “private credit.” This has the presumed advantage that you don’t get the portfolio constantly “marked to market,” and Wall Street has been selling it like hotcakes.
The S&P 500 return of 24% for the past year, fueled by the top seven to ten stocks, brought the index close to its previous high, although not in real (inflation adjusted) terms. This meant the two-year return entered positive nominal territory of .08%. A standard balanced portfolio 60% S&P 500 and 40% longer term treasuries did well during the last two months of 2023, with both assets up 11% for the quarter, but remained deep in the hole for the last two years.
To earn the S&P 500 return for the quarter and year, you had to be in the index or in the top seven to ten stocks. By the end of May, virtually all the return for the year had come from seven stocks. On December 10th, prior to the Fed “pivot,” 97% of the year’s return had come from ten stocks, a new record for concentrated return. These stocks at current valuations do not meet a reality test.
The market long term is all about numbers, which if honest (unlike China’s or the U.S. CPI) express reality. Short term it is about emotion. Investing may be defined as an attempt to get to reality before others.
It may also appear that the market will do whatever is necessary to take the largest amount of money from the largest number of people at a given time. What we should keep in mind is that the market is not a malevolent being or force. It is all of us. We defeat ourselves by our wish to conform.
To use a nautical analogy, some of us like the view from starboard. Gradually everyone on the boat moves to that side, at which point the boat nearly capsizes. Some of us move back. Then more of us crowd over again and the boat does indeed capsize. We climb back out of the water and start the whole process over again. An alternative metaphor would be to think of too many people getting on the same boat, which ultimately sinks.
Other descriptive metaphors include the chain letter and the bubble. Eventually everyone has put their money into the chain letter and there aren’t enough people left to keep it going. If the buyers are exhausted, only a little selling will pop the bubble.
High valuation in itself does not move a market or stock up or down. High valuation however makes fear, once it sets in, much more contagious and damaging. High valuations are an accident waiting to happen.
Diversification can provide protection against falling markets or stocks. The most powerful diversification is between the four economic asset classes: equity, debt, real property, and commodities. Owning extremely overvalued “diversifiers” does not, however, provide the hoped for protection, as bond holders learned over the last three years.
Speaking broadly, there are two kinds of bear markets, v shaped and sawtooth. During the latter, the market falls and rises but highs are generally lower until the final waterfall and capitulation. 2000 is the classic example. It took years to reach the bottom.
An extended bear market does not require a recession or a rise in rates. During the extended 2000 bear market, there was a very mild and brief recession, most likely triggered by the market rather than vice versa, but fundamentals cannot explain what happened. Valuations and psychology explain it better.
At the conclusion of an extended bear market, there are unimaginable opportunities. Coming out of the 2000 bear market, some stocks rose 5-6X.
WRITTEN BY:
HUNTER LEWIS | CHIEF INVESTMENT OFFICER