Lessons from 35 years in the investment industry

Wednesday, 4 August 2021 — Gold Coast, Australia

[8 min read]

Dear Reader,

The past three and a half decades have been fascinating to be involved in investment markets.

From its humble beginnings in the early 1980s, the investment industry has evolved into a multitrillion-dollar industry.

It’s not been all smooth sailing. This phenomenal growth has come with its fair share of heartache and setbacks. Each market downturn and product failure provided valuable learning experiences…for those willing to learn.

Many drivers have contributed to the industry’s growth — compulsory superannuation, massive credit expansion, baby boomers moving towards retirement — but, in my mind, the industry’s success has largely been underwritten by the US share market’s 35-fold increase in value.

This history-making performance supported the industry’s narrative of: ‘In the long run shares always go up’. Investors and industry players had little reason to doubt the legitimacy of this storyline.

While the market went from record high to record high, interest rates were falling from 18% to zero. Absent these dynamics; it’s my contention the investment industry would not have prospered to the extent it has.

The TINA (there is no alternative) mindset is music to the ears of the industry. What a difference to the caution investors exercised during the 1980s.

That music TINA is playing could actually be a bell tolling. When almost everyone thinks they should be ‘all in’, that’s usually when surprises happen…a reversal in the trend.

Last year provided us with a glimpse of how quickly markets can change course. They fall much faster than they rise. Yes, the Fed managed to turn things around that time. But, can they do it again and again and again? Unlikely…no, on second thought, it’s actually impossible.

To assist you in preparing for a future that could be a complete contrast to what we’ve been conditioned to believe, here are a few lessons from my 35 years in this business.

Humility

Being respectful is an important quality in life. Pride and arrogance often lead to spectacular falls — as demonstrated by the long list of failed entrepreneurs.

The world’s central bankers would do well to exercise a little humility. The hubris on display from the world’s central bankers have been particularly galling.

They have taken us to a very dangerous place (emphasis added)…

‘Years of ultra-loose fiscal and monetary policies have put the global economy on track for a slow-motion train wreck in the coming years. When the crash comes, the stagflation of the 1970s will be combined with the spiralling debt crises of the post-2008 era, leaving major central banks in an impossible position.’

Nouriel Roubini, 30 June 2021

Their overblown egos and arrogance have blinded them to what they’ve created…the greatest bubble in history.

There are no new ways to go broke — it is always too much debt

‘Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.’

John Mills, On Credit Cycles and the Origin of Commercial Panics, 1867

More than 150 years ago, John Mills recognised the folly of man, money and mania. Nothing has changed.

Hyman Minsky said, ‘Stability breeds instability’. The longer a trend is established, the greater the certainty in the investors’ minds of its permanence. What has gone up or down will continue to go up or down.

The failure to recognise that all trends are transient was on display during the last boom.

This edited version of the RBA’s spreadsheet on margin lending shows how debt levels continued increasing throughout 2007…even though there were serious concerns over subprime loans.

15 months after the Dec 2007 peak debt, margin debt fell in half as indebted portfolios were liquidated.

Too much debt cost investors dearly when markets changed trend…abruptly.

Patience

Patience truly is a virtue. In this fast-paced world, instant gratification has become embedded in our society. The thought of taking 20 years to pay off a home or 40 years to build retirement capital is completely at odds with the ‘want it now’ attitude.

‘Buy in haste and repent in leisure’ is so true. Exercise patience when considering investing — rarely are ‘once in a lifetime’ opportunities the shortcut to riches you thought they would be.

Patience is needed after you’ve invested. Markets do not always behave the way you want them to. They can take their own sweet time…irrespective of your desires.

Do not chase returns

The TINA (there is no alternative) mindset reflects a need to chase returns.

Give me anything…something, but not zero on my money.

But what downside risk comes with that anything or something?

Investments can be like icebergs — it’s what you don’t see that usually causes the most damage.

Opaque product offerings — with promises of higher returns — breed like rabbits during a boom. Be careful.

Simple and transparent investments may not set the adrenalin racing during your waking hours, but you will sleep a whole lot better.

Always take profits

You never go broke taking a profit. The greed in our DNA often blinds our objectivity. The desire to squeeze the last drop out of a winning investment can be very overpowering. Ignore the voice of greed in your head and be happy to leave some for the next person.

Besides greed, the other reason people don’t take profits is ‘I’ll pay too much tax!’. This is just plain dumb, dumb, dumb. Got the picture. Paying tax — at a pre-determined rate — is a cost of successful investing. Live with it.

On the other hand, the market does not give you a formula on what it will extract — it can take away all your profits and some or all of your capital. The market can be far more brutal than the taxman.

Taking profits locks in your gains and adds to your capital base. Even if you take out your original capital and leave the profits to ‘ride’, at least this way you’ve protected your downside.

Busts always, always follow booms

Since Tulip Mania became folklore, we know booms always bust. Yet, when the animal spirits capture society’s emotions, this logic is abandoned in the chase for the almighty dollar. Night follows day, and booms always bust. When the heat is on in the market — get out and stay out. The market may get even hotter, and you may experience seller’s remorse — get over it. The hotter the market becomes, the more violent the snap back to reality will be.

Never in the course of history has there been a boom without a bust. Human nature dictates that these two go ‘hand in glove’.

Transparency of investments

Only invest in something you understand. There are so many ‘iceberg’ investments out there. You think you see the risk, but most investors have no idea what lurks beneath the surface.

The rule of thumb is ‘if you don’t understand it, don’t do it’.

Simple, easy to understand investments — cash, term deposits, an index fund tracking the ASX 200, gold bullion etc — may be boring, but what you see is what you get. There are no exorbitant management fees, no fancy promises and more importantly, no nasty surprises.

Sure, an ASX 200 Index fund can fall heavily in a bear market — but you know that is a risk. Whereas an individual share could fall much further due to internal gearing levels, poor management or other corporate shenanigans. Unless you are on the inside, you are not fully apprised of these matters.

KISS is the overarching style in my model portfolio. If you feel tempted to pursue a ‘once in a lifetime’ opportunity, invest only what you can afford to lose.

If it sounds too good to be true

Listen to your inner voice — if it’s saying ‘this is too good to be true’ — take the advice. You may genuinely miss out on the once in a lifetime opportunity, but from my experience, you have more than likely dodged a bullet.

The prospect of a quick road to riches or instant wealth is tempting. The harsh reality is ‘the too good to be true’ is a salivating wolf in sheep’s clothing.

The magic of math

There is an old saying, ‘The market goes down by the elevator and up by the stairs’. If a market loses 50%, it has to recover 100% for you to breakeven.

The 50% loss can happen in a blink of an eye, whereas the recovery process can take years. Calculating your downside is far more critical than focusing on your potential gains.

Summary

In a boom, investors (inexperienced and experienced alike) ‘hang on tight and enjoy the ride’. Everyone is happy. Rarely is the sustainability of the boom questioned. Don’t jinx the market. Enjoy it. But we know from history, the party always ends.

In my experience, investors are not mentally prepared for the bust...especially one that wipes 60%-plus off market values. There is rarely a Plan B. No one told you this could happen, which explains why the mob’s default position is panic followed by fear...and plenty of it.

A sound strategy is firmly focused on understanding the downside...what can go wrong, and if it does, what is the likely cost? Is this an acceptable or unacceptable cost? If these factors have been accurately assessed, you can make a reasoned decision on where to allocate your capital, and the upside can take care of itself.

Knowing your tolerance for loss is far more important than dreaming about the riches that await you.

Also, experience tells us it’s better (and a lot less costly) to learn the lessons BEFORE rather than AFTER the event.

Regards,

Vern Gowdie,
Editor, The Rum Rebellion

Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory — investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.

Last week, Federal Reserve chairman Jerome Powell admitted that ‘inflation could be higher and more persistent than we expected.’

Also last week, new inflation readings suggested that this time he is right.

The Daily Mail reports:

‘The Federal Reserve’s preferred measure of inflation has registered another jump, hitting its highest level in three decades.

‘Federal data on Friday showed the core personal consumption expenditures (PCE) price index, excluding volatile food and energy, increased 0.4 percent in June for an annual gain of 3.5 percent, the largest gain since December 1991.

‘The overall PCE price index, with food and energy included, rose 0.5 percent in May for an annual gain of 4 percent, the fastest rate since the Great Recession in 2008.’

Already, over the last 12 months, inflation has cut into wages. According to the National Review, the average loss is 1.9%.

Of course, that’s the whole idea. Inflation is a tax. It takes money from wage earners and savers and moves it along to a great assortment of people…through the feds’ various boondoggles, pet projects, and transfer schemes.

There is no mystery about what causes inflation…nor what the purpose of it is. But there are plenty of surprises in the inflation story. We never know exactly how it will develop…or how bad it will be.

Inflation on the pampas

Our own understanding of inflation has been greatly helped by being locked down for nine months last year in Argentina. There, inflation has been ‘higher and more persistent than expected’ since the 1950s. And today, the gauchos know all there is to know about inflation — except the important parts.

In the news last week, was this item in the English-language Buenos Aires Times:

‘Argentina’s government speeds up money printing ahead of election’

‘Argentina’s Central Bank is printing money for the Treasury in July at the fastest pace so far this year, potentially fueling even faster inflation as it helps to finance government spending ahead of midterm elections in November.’

With 50% inflation already, you’d think the gauchos would lean back in the saddle, stick out their heels, and pull back on the reins. Instead, they’re digging in the spurs.

But that’s the beauty of the inflation tax. People never seem to catch on. The ruling party will pass out the money to ‘the people’. In thanks, the people are supposed to vote for another four-year term, in which they will be ruthlessly robbed by the ruling party.

Not ‘just another tax’

And Americans? Are they any smarter? Not as far as we can tell.

While we were exploring the idea of a ‘mission economy’ last week, the feds were up to more Argentine-style mischief. The Senate came to terms on a US$1.2 trillion ‘infrastructure’ bill. A senate panel added US$25 billion to Biden’s already-inflated defence budget. And then the Democrats said they were getting close to another US$3.5 trillion in spending, focused on ‘human infrastructure’.

It sounds sinister…like using men’s and women’s bodies for bridge girders and railway sleepers. But of course, it is just another grab bag of giveaways and boondoggles…designed to encourage dependence, helplessness, and gratitude.

But so what, you ask? Government is always going to waste money…it might as well get it from ‘the inflation tax’, right?

But describing inflation as ‘just another tax’ is like saying an intentional famine is ‘just another diet program’. Like other taxes, inflation takes wealth from some and gives it to others. But it is often fatal to the civil society that produces it.

How can you run a business when your costs change almost daily…and you have no idea what your receipts will be worth? How can you plan for retirement? How can you save money or make wealth-creating, long-term investments?

You can’t. As it runs its course, inflation staggers and discombobulates an economy. Eventually, though still not understanding how they are being ripped off, people get sick of it…and they welcome scoundrels in uniform who promise stability.

Fatal to civil society

That’s another thing we’ve learned from living in Argentina; inflation brings financial, social, and political chaos. That country has had four different currencies since 1970.

The peso ley replaced the gold-backed peso at the rate of 100-to-1.

In 1983, the peso Argentina replaced the peso ley at the rate of 10,000-to-1.

In 1985, the austral replaced the peso Argentina at the rate of 1,000-to-1.

In 1991, the peso convertible replaced the austral at the rate of 10,000-to-1.

When the peso convertible was introduced, it was meant to be fixed to the US dollar, one-to-one. Now, it is trading on the black market (the blue US dollar exchange rate) at 180-to-1.

And talk about the way inflation cuts into wages! Bloomberg reports:

‘Of all the numbers that lay bare the pandemic plight of blue-collar workers, few are as jarring as the pay cut suffered by the millions of Argentines who toil in off-the-book jobs.

‘The decline for people like waiters, construction workers and candy-vendors was 36% on average last year, considering inflation. That staggering number is almost four times the average pay cut that Argentines in the formal economy had to absorb.’

Is it any wonder? Argentina has also had two military dictatorships since the 1950s.

We don’t know what surprises lie ahead for the US. But get ready to salute.

Regards,

Bill Bonner,
For The Rum Rebellion