What the wise do in the beginning, fools do in the end

Tuesday, 17 October 2023 — Gold Coast, Australia

[7 min read]

Dear Reader,

‘There can be few fields of human endeavour in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.’

- John Kenneth Galbraith ‘A Short History of Financial Euphoria’

When it comes to markets, our collective memories tend to be short.

In November 2008 (two months after Lehman Brothers busted), The Wall Street Journal published its post mortem on the US Housing Bubble.

To quote…

‘When it comes to booms gone bust, ‘over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money.’

What did we learn from the worst economic crisis since The Great Depression?

Absolutely nothing. The lesson has been completely ignored.

Debt levels have never been higher

To quote from last week’s The Daily Reckoning Australia…

‘This chart should have you quaking with fear

‘The last time the US 10-year bond rate was around the 4.7% level was in late 2007…just before the GFC.

‘The difference between then and now?

‘An additional US$44 trillion (that’s 44,000 billion dollars) has been added to the US debt pile.

‘Wow. The worst financial and economic crisis since The Great Depression was triggered by a debt load that was a little over half of what it is today…and, everything is ok?

‘Have we collectively lost our senses?
‘That’s a rhetorical question.’

We have just lived through a prolonged period of ‘over-investment and over-speculation’ caused by excessive levels of borrowing and expect it to end without serious consequences?

That’s insanity writ large.

We have lived in a bubble for 40 years

For the vast majority of us, our adult lives have been lived through the most extraordinary period in history.

Our lived experience has been one of share markets in the ascendency…be patient, higher highs are coming.

We have lived in an asset bubble for 40 years.

But that has not always been so…

Why revisit market history?

With hindsight, we can see how long-term trends — both positive and negative — evolve and, eventually, exhaust themselves.

These trends — like interest rates falling from 18% to zero — exert influence over market performance.

Producing gains ranging from five to 48-fold through to price stagnation.
When we talk about the ‘market’, it often gets forgotten that we (you, me and millions of other punters out there) are the market. We’re the ones making the choices to buy, sell or hold.

Are those choices always based on sound reasoning and referenced to long-term fundamentals?

To quote Friedrich van Schiller

‘Anyone taken as an individual is tolerably sensible and reasonable — as a member of a crowd, he at once becomes a blockhead.’

When things are booming, temptation can prove to be irresistible…especially the longer the boom lasts. When things are busting, fear takes hold and to hell with ‘shares for the long term’…sell now.

Over the years, there have been numerous studies on ‘funds flow’ into and out of markets.

The data proves conclusively that the majority ‘buy on a (market and emotional) high and sell on a (market and emotional) low’.

Markets are tidal

Money flows in towards the tail-end of boom and flows out during a bust.

The purpose of revisiting market history (since the Second World War) provides context for the following charts.

The chart we’re focused on is the middle one…US Household Stock Allocation (includes Mutual Funds and Pension Funds).

The orange line tracks the percentage allocated to shares by US Households since 1950.

The longer the period of post-Second World War prosperity, the more confident investors became in allocating a higher percentage of their portfolios to shares…topping out around 55% in 1968/69.

By the early 1980s (when the S&P 500 was about to take flight) households had fallen out of love with shares as an investment. Portfolio allocation was down around 25% to 30%...and stayed within that zone until the early 1990s.

Then came a succession of bubbles…Dotcom, US Housing and The Everything Bubble.
Each bubble has tempted investors to adopt an overweight allocation to shares.

When the US Housing Bubble busted, fearful investors (either voluntarily or involuntarily — due to margin calls) reduced portfolio exposure to less than 40%.

In early 2022 (when the S&P 500 peaked around 4,800 points) portfolio allocation to shares was on par with the peak of the Dotcom bubble.

The sell-off in 2022 has slightly reduced the allocation, but not to any meaningful extent.
The current level — 57.5% allocation — slightly above the level reached at the peak of the US Housing Bubble.

The pattern of ‘over and under’ allocation is all-too-familiar and predictable.
Why?
Because, irrespective of the era, humans are the market.
While the 1945 to 1966 boom was modest compared to what we’ve experienced since the early 1980s, we have to remember, at that time, it was quite something.
Here was an asset class that had appreciated 400% over a 20-year period.
You can understand why people were thinking ‘we must have some of that action’.

The same principle applies to each of the last three bubbles.

During the peaking process (which can last longer than you think) more people want a greater slice of the action. It’s basic human nature.

Based on the above chart, it appears that when households allocate greater than 50% to shares, the market is living on borrowed time.

‘What the wise do in the beginning, fools do in the end.’

- Warren Buffett

History clearly shows that reducing exposure to an over-valued markets at a time of your choosing, is the wise choice. Otherwise, after the collapse has happened, we know that people will foolishly sell at a time when the wise will be buying.

Until next week…

Regards,

Vern Gowdie,
Editor, for The Daily Reckoning Australia

Dear Reader,

Last week, all of a sudden, explosions…gunfire…bodies…mayhem — and as the dust settled, there was Truth, blindingly obvious…yet, still shocking. Truth about the past…and a warning about the future.

Stephen Pinker famously argues that we are all becoming lambs now. But now the wolf is back…snarling; and what big white teeth he has. All the world startled awake last week. Yes, it was an old-fashioned eye for an eye…mass murder in the Holy Land. Hamas attacked Israel. Israel retaliated. Now, with the whole world on edge, the Israeli Defense Forces are preparing what threatens to be a massacre…ethnic cleansing…genocide. We don’t know exactly what is happening because the Israelis cut off food, water and electricity to Gaza. Nothing gets in. But no information comes out, either.

We are also watching ‘the West’ handle a major foreign policy problem. Pay attention, because this is how it will handle its major domestic challenge (debt) too.

Rules of Engagement

Over the weekend, the Israelis marched along the walls of Gaza, carrying aloft the Ark of the Covenant and lobbing explosives at apartment buildings, hospitals and shopping malls. How many were killed, we don’t know. They also cut off vital supplies to the Palestinians — including medicines for the very young and very old. When Russia targeted Ukrainian infrastructure, Ursula von den Leyen, EU jefe, described it as a ‘war crime.’ But this time it must be different! The Israelis ‘have a right to defend themselves,’ she says.

Sooner or later, Israeli ground forces will attack. It won’t be easy going. House to house; they will face traps, explosives and small arms fire. Hamas must have known how the Israelites would respond. They must have planned for it.

The Israelis too. With all of their sophisticated monitoring…and so many Israeli agents infiltrated within Hamas itself…it is almost unbelievable that they didn’t see this coming. Perhaps they did.

In the Biblical account of the attack on Jericho, with God’s blessing the Israelites wiped out men, women, children, donkeys, oxen and sheep.

The only exception was a prostitute who had betrayed her neighbours by helping Jewish spies.

In January, 1943, the Jewish Ghetto of Warsaw was invaded by German and Ukrainian troops. But the Jews had been preparing a defence — they had a few guns and Molotov cocktails. The Nazis were beaten back. It took them until April to finally pacify the city…and cart the survivors off to Treblinka concentration camp.

‘Israel upholds the rules of war,’ says Joe Biden.

Ultimately, the outcome doesn’t depend on right or wrong…or on the rule of law…or sanctimonious declarations of support. People want to argue about who’s good and who’s bad. But what counts is firepower…and staying power. As in the Warsaw ghetto, the besieged city of Gaza has no chance of victory.

‘Get out now,’ says Yoav Gallant, Israel’s Defense Minister, advising the people of Gaza, who have nowhere to go. ‘We will act everywhere and with full force.’

Collective Guilt

Many students — innocent of the ways of the world, but informed by the leftish press — showered their sympathy onto the Palestinians. They decried the ‘collective guilt’ put upon a whole nation of people and the death sentences handed down to thousands of women and children, who had nothing to do with terrorism or the resistance movement.

Major governments in ‘the West’ generally, take the Israeli side. After all, that’s where the power and money are. Sen. Josh Hawley:

‘As far as I’m concerned, Israel can bounce the rubble in Gaza. Nothing should be off the table…we will protect our interests.’

What interests? Which way do they cut? Pro-Israel? Pro-Palestine? The satirical journal, The Onion, decided to support the Jews, ‘because we’re less likely to get into trouble that way.’

Taking his cue was one member of Congress. The Hill:

‘Rep. Brian Mast (R-Fla.) arrived Friday on Capitol Hill wearing his military uniform from his service in the Israel Defense Forces (IDF) in a display of unity with the country following the Palestinian militant group Hamas’s surprise attack last weekend.

‘“As the only member to serve with both the United States Army and the Israel Defense Forces, I will always stand with Israel,” Mast wrote in a post on X, the platform formerly known as Twitter, alongside several photos of him wearing the uniform Friday.’

No one seems to have asked Mr Mast where the bulk of his divided loyalties lay — with the US or with Israel. So far, no member has dared to wear a Russian army uniform…or an Iraqi military uniform in the halls of Congress.

It scarcely matters. Outside of the killing zone, it is all theatre.

Lambs to Slaughter

But for our purposes, we are focused neither on the wolves nor the lambs, but on the shepherds. In a civilised world…leaders of countries such as the US, France and Germany would be trying to protect the sheep. They would urge restraint. Calm. Negotiation. Deliberation. Most importantly, they would at least make it clear that they could not in good conscience provide aid — guns and ammunition — to be used to slaughter innocent civilians.

This would be deeply hypocritical on their part. But hypocrisy is the proper role of the elites — to preach virtue in public, while enjoying whatever vices they choose at home. Almost all nations at one time or another slip into Old Testament kind of warfare, where they authorise, promote, or overlook the ‘collateral damage’ they cause. But while major nations may not be able to avoid it in themselves, they have the power to curtail it in others.

What is so alarmingly on display in the Levant is the abject failure of The West’s leaders. Even at hypocrisy, they are a flop. Instead of calming people down, they incite them to even more outrageous acts of violence.

And when the next financial crisis comes, it will be, grosso modo, these same corrupt and incompetent leaders who react. Will they urge monetary restraint and economic self-discipline? Not likely.

Stay tuned...

Regards,

Bill Bonner,
For The Daily Reckoning Australia