Tuesday, October 25, 2022

The Biggest Prediction of My Career

By Dan Ferris (View Archive)

Editor's note: Regular Empire Financial Daily readers know we believe we're closer to a market bottom than a top, and that for investors with a long-term view, stocks are setting up for a historic buying opportunity. But getting the timing right can be tricky.

That's why we're sharing an update from our friend and regarded value investor Dan Ferris over at our corporate affiliate Stansberry Research. In today's essay, he says what he thinks you should be doing right now...

We humans can't help but think about the future...

It's impossible to avoid such thoughts. I doubt you can be a functioning human being without thinking about the future and trying to make some guess about how it might look.

The process of valuing a business, which I've spent most of my career studying, is based on guesses about the future. I'll go even further... It is impossible to value any asset without making assumptions about the future.

So when I say, "Prepare, don't predict," I'm referring to the moment when you put your hard-earned capital at risk. My mantra is about not betting 100% of your capital on any (especially macro) prediction or forecast.

A longer way of saying my three-word mantra might be, "Never bet your whole portfolio on any single prediction or forecast. You don't know the future and neither does anybody else. A good investor must prepare his portfolio for a wide variety of outcomes."

The truth is often unsatisfying...

For example, it's as unsatisfying as it is true that nobody wants to be told it's easy to get rich slowly. All you have to do is commit to the discipline of saving and investing for several decades.

Investors need to learn to think about the future the way historians do. They need to learn about the past and think about whether the future might resemble it. The future won't repeat the past, but as the saying goes, it'll rhyme.

That's why I believe that history is about to rhyme with specific episodes in the past, and those episodes were some of the most difficult times investors have lived through over the past century or more.

Past mega-bubbles all started out like the current one started, and every one of them ended with a steep bear market followed by a sideways market. I simply find it far too difficult to believe that this mega-bubble will turn out differently.

You've probably heard it said that "this time is different" are the four most dangerous words in finance. I couldn't agree more. That phrase is the title of a famous financial book by Carmen Reinhart and Kenneth Rogoff. The book covers eight centuries of financial crises in 66 rich and poor countries across five continents.

Something that keeps happening over and over again for 800 years is not a coincidence...

It's human nature in action... and proof that groups of human beings in markets behave certain ways under certain conditions...

For example, what's the difference between people getting caught up in the frenzy to pay any price for tulip bulbs in Holland in 1637 and the frenzy to pay any price to buy non-fungible tokens ("NFTs") in 2021?

Tulips and NFTs sure are different. One is essentially a giant flower seed and the other is a digital widget. But the human behavior in both episodes looks pretty much identical to me. People saw the price of something increasing and lost all relationship with what they knew – if anything – about its value. They behaved desperately, trying to make a fortune overnight. Many of them eventually lost everything and lived to regret such a vain effort.

Before every speculative frenzy fell into a crisis, some expert said, "this time is different." But it never was. And it's never different this time. This is not just an old market adage. It's some of the most profound, time-honored, proven wisdom available to humanity. The Book of Ecclesiastes says, "There is no new thing under the sun."

That doesn't mean you can't invent new ways to do everything from cooking your dinner to moving between two points on the globe. History tells us you can do those things. The Bible passage means something else. It means human nature never changes.

Financial crises – including mega-bubbles, bear markets, and multidecade sideways markets – are as old as markets and will happen as long as human beings are the primary actors in markets.

The biggest mega-bubble in all of recorded history started peaking in March 2020...

The 10-year Treasury bond dipped to its all-time low yield of 0.499%. That December, the amount of negative-yield debt in the world hit $18.4 trillion.

That period, from March 2020 to December 2020, was the top of the biggest bubble of all time in any single asset: bonds. But it was just one part of the mega-bubble...

The stock market started peaking in February 2021, when bubbles in unprofitable speculative tech stocks, special-purpose acquisition companies ("SPACs"), cannabis stocks, and clean-energy stocks all peaked. In November 2021, the Russell 2000 Small-Cap and Nasdaq Composite indices both peaked. And on January 3, 2022, the S&P 500 topped out.

It took roughly two years for the biggest mega-bubble in all of recorded history to peak, but it has done so. We're still at the beginning of what I fear will be the most epic bear market in history.

No mega-bubble has ever ended without a brutal bear market, followed by a decades-plus-long sideways market...

For example...

  • A negative 89% bear market and a 25-year sideways market followed the September 1929 Dow Jones Industrial Average mega-bubble peak.
  • A negative 78% bear market and a 15-year sideways market followed the March 2000 Nasdaq mega-bubble peak.
  • A negative 76% bear market and a still ongoing 33-year sideways market has followed the December 1989 mega-bubble peak in the Japanese stock market.

I consider repeating all this once again to be a valuable service. It's too hard to remember every day that part of what you need to prepare for is the worst thing that will ever happen to you as an investor. Human nature again.

But keeping it in your awareness is more urgent than you may imagine.

The mega-bubble + bear market + sideways-market phenomenon is like a convicted serial killer who has escaped from prison...

Would that scare you? Of course! It would be a nightmare for anybody near that prison. Even if you lived thousands of miles away, you'd fear for those nearby.

Well, bursting mega-bubbles are like serial killers on the loose. They've killed millions of folks' retirements before, and they'll do it again. And they're slashing away at them as you read this. Just look at stocks and bonds this year...

It's the worst start to the year for stocks since 1970, and the worst U.S. Treasury bond performance since 1788. Inflation is at 40-year highs. Mortgage rates are above 7%. Inflation is above 8%.

There's no way we'll get out of this with a "soft landing." We're going to experience a very hard landing, likely featuring stagflation, recession... and a sovereign debt crisis whose magnitude is difficult to fathom.

I've identified something which the market's actions – unpleasant as they've been – suggest will get a lot worse... and which most folks aren't prepared for at all...

If you want to know where we are right now, check out economist/portfolio manager John Hussman's latest market comment titled, "Estimating Downside Market Risk," in which he quoted the classic 1932 finance book, The Dow Theory, by Robert Rhea:

There are three principal phases of a bear market: the first represents the abandonment of the hopes upon which stocks were purchased at inflated prices; the second reflects selling due to decreased business and earnings, and the third is caused by distress selling of sound securities, regardless of their value, by those who must find a cash market for at least a portion of their assets.

If you want to know where we are right now, just ask yourself...

Does it seem like investors have abandoned the hopes upon which stocks were purchased at inflated prices?

It seems to me like they can't wait for any reason to pour their money back in. They're still in denial and desperately trying to win back what they've lost. That never ends well.

I've devoted myself to warning folks about what the market's action of the last couple years likely means for the next several years. I hope I'm wrong, but like I said, it seems foolish to believe that this time is different, since it never has been different in past mega-bubbles.

Even if I'm 50% right, we're talking 50% of the worst calamity U.S. investors have faced since the Great Depression.

Add to that the disturbing fact that most investors today have never really dealt with the combination of high inflation, rising interest rates, and a bear market. We haven't seen inflation this high for 40 years. A 50- or 60-year-old investor probably wasn't buying stocks back then. If they were, they were just getting started and got lucky to come in at the tail end of the brutal 1970s inflationary period.

Investors are facing the worst calamity ever... and they're totally unprepared...

Most investors today are more likely to deny what's happening and what it means than they are to study up on their market history and prepare their portfolios.

It all sounds terrible, I know, but honestly, it's not all bad news. There are strategies which are perfect for the type of market that's unfolding today, and which I believe will dominate the scene for at least a decade, maybe two.

The stocks we've found aren't just about preserving wealth, though that's a key consideration. We've also studied the kind of businesses that do well in bad times, and which we expect will do well under a variety of scenarios that could play out over the next several years, including high inflation, stagflation, recession, war, currency crises... and many others I can't fathom right now.

We've created a "done for you" 10-stock portfolio that should help you survive and thrive during the difficult times ahead.

I can't give away the stock recommendations from my Extreme Value newsletter, but my recent presentation – during which I share two stocks I think you ought to sell right away – is free of charge. They're two of the most popular stocks in the world right now, so you'll want to hear what they are and why I think you should sell them now.

It's not short... but please watch the whole thing. Do it so you can tell yourself you gave my warning a chance. If you disagree with my conclusions, no harm. Along the way, you'll learn some interesting market history during the presentation. So you'll still be glad you watched the whole thing.

I hate to think of all the folks who'll be blindsided by what's coming. I hate to think I didn't do everything to convince everybody I could possibly convince to wake up and prepare.

I hope you'll take a look at my presentation. To watch it, click here.


Dan Ferris
October 25, 2022