Losing The Plot

Losing the plot

“It’s all over. They’ve gone and lost it.”

This was just one of the comments that popped up in my Facebook feed on March 15th, the day the Fed cut interest rates to zero and launched a massive stimulus program.

“They have nothing left in the tank! No more ammo to fight the battle!”

As the markets kept tanking the following week, the chorus of voices was getting louder and louder.

How could the central banks muck it up like that? Why would you waste all of your bullets at the very beginning? What kind of absolute idiocy is that?

Except, of course, that it wasn’t.

A week later, the S&P bottomed out at 2,237 and began its inexorable, hated march upwards.

Turns out the Fed didn’t get it wrong. Everyone else did.

It’s happened countless times before. It will certainly happen again. As much as we hate to admit it, periods of extreme uncertainty and volatility like the one today cause most of us to lose the plot.

And unlike the stock market, which typically regains its footing relatively quickly, it is going to take the rest of us much longer to see the light again.

This Time It’s Different

“A man-made catastrophe.”

“Did you see those jobless claims?”

“We’ve never seen anything like this before.”

Of course we haven’t.

No two days in history are the same. No two crises are the same. And yes, the Covid pandemic is very different from the Great Financial Crisis, the dot-com bubble, the Gulf War, Black Monday, the nuclear war near-miss, and any other crisis in the history of humankind.

And yet, there is a common theme that weaves all of these situations together.

It’s the fact that the human spirit is absolutely irrepressible. As a species, we’ve faced down moments much, much worse than the temporary hiccup we are facing today.

Time and again, we’ve found a way forward, a way to overcome whatever challenge was in front of us. Despite everything that has been thrown at us, we’ve found a way to build a life of unprecedented comfort and prosperity.

Is it even remotely realistic that a virus will stop us?

“The World Will Never Be The Same”

Really? How does that work? Can we really imagine a world in which we are going to stop traveling, eating out, exercising, and doing whatever else it was we used to do because of Covid?

Sure, some airlines will go bust. Ticket prices might go up. Business travel activity might come down once people realize that on many occasions, a simple Zoom call will suffice.

But is that necessarily a bad thing?

Well, let’s ask ourselves the following question: was replacing the once-weekly, twelve-day-long Kangaroo Route with a daily non-stop Quantas flight at 10% of the price a bad thing?

Kangaroo Route

Looks cool but I still prefer my economy class seat… or Zoom

Was it somehow detrimental to our economic progress? I beg to differ.

Replacing an inefficient, expensive, carbon footprint-heavy flight with a Zoom call won’t be either.

Instead, it will free up our scarce economic resources, which we can then re-route into more productive activities, further improving our quality of life.

Whether it’s online shopping, remote workouts with your favourite fitness trainer, or using a video app for a 15-minute consultation instead of taking a screaming toddler to the GP practice, this kind of progress is good.

The same applies to the broader argument that somehow there will be a wholesale re-engineering of global supply chains. You know, let’s decrease our reliance on China and all that good stuff.

Let’s be realistic: there is simply no way of getting around the economics of producing goods and services in lower-cost, emerging economies.

It’s called comparative advantage. Alongside global trade, it’s one of the key factors underpinning the unprecedented prosperity of today’s world.

Now, that doesn’t mean that there won’t be any re-engineering.

It’s a near-certainty that some of the more sensitive areas (biotech, medical supplies, semiconductors, high tech more generally) will see a significant reorientation towards onshore research and production.

In fact, it’s happening already.

Just don’t expect a broader resurgence in domestic manufacturing – and that’s a good thing for all of us.

The way to make economic progress is to own the most attractive pieces of the value chain, not insource the low value-added activities.

House Of Pain

A lot has been said about real estate recently, what with the rent strikes and everything.

I honestly feel it for the small-time landlords (full disclosure – I am one of them) that have been squeezed between non-paying tenants and those pesky mortgage payments.

There is no doubt that some will go bust and have their properties repossessed.

Yes, it’s unfortunate. But it doesn’t mean that real estate as an asset class is a bad investment.

No, what makes it a bad investment is buying a property that doesn’t cash flow. Hoping for price appreciation as the only factor that will make your numbers work.

Assuming a 100% occupancy rate, zero maintenance expenses and rock-bottom interest rates for the rest of our days.

The book of real estate investment is simple – and it has been written many decades ago:

  1. Buy a property with a true cap rate that exceeds your mortgage interest cost by a sufficient margin
  2. Lever up (conservatively) to amplify your equity returns
  3. Have a reserve fund (!)
  4. Stay on top of your property management company and tenants
  5. Make money

If you are buying real estate without understanding the very basic concepts above, please do yourself a favour and don’t. Hope is not a strategy.

Nowhere To Run

Amongst all the criticism being leveled at the stock market, the bond market and real estate, it’s easy to lose track of a simple fact:

We don’t have that many options.

That’s right. Unfortunately, retail investors like you and I don’t have a multitude of asset classes to choose from. Let’s break it down:

Cash: as an asset class, it’s going from bad to worse. Given the direction of interest rates, we should all strap in and prepare to watch the real purchasing power of cash literally evaporate in front of us.

Long term interest rates

Bonds: great hedge against deflation and a fantastic cushion if the G-force in the stock markets is a bit too much for you.  This won’t change.

But unless interest rates continue their descent into negative territory, bonds are unlikely to perform nearly as well as they have in the past.

Gold / other commodities: nope. Why would you even consider buying an asset that doesn’t produce any income AND costs money to store?

And before you say it, there are much better ways to hedge against inflation.

Here is a great explanation of why gold isn’t an attractive investment.

That isn’t to say that it cannot rise in value over short periods of time. But over a long time horizon, it’s likely to be a stinker.

Crypto: let’s not even go there.

Real Estate: see above.

Which leaves us with… stocks.

Back To Basics

Yes, stocks are volatile. Yes, we could well be entering an era of depressed returns. But make no mistake – the stock market is still your best ally in that never-ending race against inflation.

No, it’s not perfect. But in abscence of a magic wand, it will have to do.

Last year, I ran a little analysis figuring out the worst-case scenario for a long-term stock market investor.

As it turns out, over a period of ten years, the probability of losing money (in real or nominal terms) is just 6%.

stock market investing - 10 year annual

Extend the time horizon to fifteen years, and you simply cannot lose in real terms. In nominal terms, the chance of loss is down to 4%.

On the flip side, there was a 80% probability of realizing an annualized return of 7% or more. 

stock market investing - 15 year annual

This is through a period of multiple wars, a full nuclear escalation, the Great Depression, and more crises than we can count.

There are no guarantees in life. But make no mistake – an eventual economic recovery is a given. We’ve done it before; we’ll do it again.

The only question is – will you get a piece of the action?

Happy investing!

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Banker On FIRE is a London-based M&A (mergers and acquisitions) investment banker.  I am passionate about capital markets, behavioural economics, financial independence and living the best life possible.

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8 Comments

    • Nice read, thanks for sharing!

      It’s an uncomfortable time to go long(er) equities. Then again, there is never a time when everyone says “boy, stocks sure seem like a good bet right now”

      • The day you hear everyone recommending stocks and shares is likely going to be just before a crash!

        Over the past couple of years Bitcoin has been suggested to me as an investment opportunity but have steered well clear in favour of the slow and steady approach.

        • Yeah, once everyone agrees on something it’s probably too late 🙂

          I think blockchain truly has revolutionary potential. There’s probably a place for crypto in tomorrow’s world as well. That doesn’t make it a great investment though, and even if crypto as an asset class does well (for reasons beyond me), I don’t see what makes Bitcoin so special vis-a-vis other currencies.

          Which leaves me with the slow and steady approach as well.

  1. Thought-provoking read. I agree with so much of this. We have seen tremendous progress and innovation in such a short space of time, as a direct result of this crisis.

    But I am struggling with one point, which perhaps I’m misunderstanding. What is your measuring stick for a successful stimulus programme from the Fed here? The S&P 500 bouncing back?

    While I think we can agree that QE seems to be a remarkably effective means of inflating the stock market, the objectives of the Federal Reserve are maximum employment and stable prices for goods and services. The naysayers are almost always wrong to differing degrees, but it seems an early call in the absence of much positive data on the real economy.

    • Agree, very relevant questions.

      On the Fed point, my yardstick is whether they are able to smooth out the stock market volatility and therefore avoid a drastic near-term demand shock.

      S&P 500 is a function of the Fed having succeeded in underpinning consumer demand, which in turn supports employment and stable price levels. Of course what this should mean in theory is a muted level of stock market returns going forward, but who knows.

      As far as the real economy goes, the question is – what is “real” these days? You can build a case that car dealerships, restaurants, and movie theatres no longer represent the “real” economy. Instead, Paypal, Adyen, Amazon, Shopify, Alphabet and Microsoft do. All of them are doing very well in the current environment, so perhaps we are using a dated yardstick?

      • Stock volatility certainly seems to have calmed down, whether a result of QE or not.

        I suppose with the “real” economy I am referring to the full spectrum of employment. I don’t think QE can be adjudged at this stage to have been a success by the Fed’s own measures without an improvement in the employment statistics – though I agree that preventing a more severe stock market shock will probably help.

        But more worrying is the potential that the adverse effects of QE are exacerbated when combined with forced small business closures, effectively widening the imbalance between capital and labour in the economy.

        Of course, there is an argument that all of this is just speeding up the direction we were headed in anyway, but that’s probably a different conversation – or article!

        • Agreed. I do think we are due for a policy reset to fix some of the imbalances.

          That being said, experience shows it will probably just scratch the surface while leaving structural causes intact.

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