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Lessons Learned The Hard Way
"There's nothing in this world, which will so violently distort a man's judgement more than the sight of his neighbor getting rich." – J.P. Morgan, 1907
The amount of disgust among retail investors in this market is apparent.
Most friends and family don’t even look at their brokerage account statements anymore. They’re tired of seeing a sea of red. They’re tired of watching their accounts go down.
The reactions are all the same. Negative.
That doesn’t mean we’re near a bottom. Far from it. Actually… maybe we already hit the bottom. But our advice is — and has been for months — that the knife is still falling. Don’t be a hero trying to catch it. So much so it sounds like our warning has been falling on deaf ears.
Bear markets are a time for introspection. A time to understand how us humans make the same mistakes over and over. Throughout history.
Every. Single. Time.
Long enough bull markets lull you into thinking the market can never go down. That this time is different. That paradigms change and can’t go back.
This bull market was predicated on quantitative easing and zero interest rates.
The financial world was built on top of it. We wouldn’t fault you if you thought the ’08-’09 Great Recession was a time the world would deleverage itself. But the opposite happened.
Global debt increased by over $72 trillion from 2007-2017. The world continued to take on trillions in debt the following years, too.
Why not if the cost of capital was free. There were literally no repercussions to borrowing money. For companies and countries alike.
Here’s what we said on November 23rd, 2021 in our note Why Corporate Debt Is At All Time Highs:
“When money is free, there’s no financial risk for companies to acquire others.
Let’s say Apple wants to buy another company for example. It could pay for the company with cash in the bank. Issue debt. Or issue equity and dilute shareholders.
How does Apple choose? It’s got around $200 billion in cash on its books. And it produces around $80 billion in free cash flow each year.
So it could acquire a company with cash in the bank plus the profits it makes selling its products. So it doesn’t need to issue equity and dilute shareholders.
But what about debt? Earlier this year, it issued $14 billion worth of bonds. Included were $2.5 billion worth of 5-year bonds with 0.7% interest. And $1.75 billion worth of 50-year bonds at 2.8%.
That means it’s paying just $175 million per year in interest on those five year bonds.
Apple makes $200+ million in free cash every day.
Meaning the cost to borrow $2 billion is worth one day's operating free cash flow to Apple... Aka there’s literally no consequence to Apple borrowing money.
It’s why if you take a look at Apple’s balance sheet, they’ve gone from $0 in long term debt to $110 billion over the past 8 years.
Apple never needed to borrow a single dollar. They did because they could. Why not borrow money if it’s practically free?
Expand this across the globe and you can see why corporate debt is at all-time highs. With companies still borrowing record amounts of money… and using it to acquire others. Easy formula. Borrow money for free. And acquire fast-growing companies.
Should that acquisition not work out… no biggie. It won’t cost you. You practically borrowed money for free.
This is how 0% interest rates are distorting the free market.
There should be a risk to borrowing money. But that’s not the case anymore. Not since 2009 when the Federal Reserve dropped rates to 0%.”
Then COVID-19 happened. Governments and central banks kept interest rates at zero. But printed trillions of dollars.
So much so that 40% of all US currency in existence was printed in the past 2 1/2 years.
This is what led to the blowoff top in all assets.
Everyone was making money hand over fist.
It was so easy making money, Barstool Founder, Dave Portnoy, was literally picking ticker symbols out of a hat and making money.
A banana taped to a wall sold for over $120,000. Random crypto coins went up 10,000% in a year.
There was a bubble in everything.
Stocks. Cryptos. Art. Real estate. New and used cars. Collectibles. You name it.
Everyone got sucked in. The fear of missing out (FOMO) was real.
We felt the irrational exuberance. We nailed the market peak in November 2021. The Nasdaq peaked the day before we wrote our weekly missive.
Here’s what we said in our November 16th, 2021 missive Don’t Fall For The Trap:
“Everyone’s getting rich right now.
Everyone’s got cash ready to spend and invest.
Every asset is at or near all-time highs.
Stocks. Bonds. Crypto. Real Estate. Art. New and Used Cars. Watches. Collectibles.
My guess is you’ve heard or read about some average Joe making millions, by getting lucky. Or maybe your friends and family are telling you how much money they’re making from some stock or cryptocurrency…
This is what happens towards the end of a bull market. The mania phase.
It’s probably making you want to dabble in certain asset classes you wouldn’t have ever gotten into…
Mania phases like these suck you in like a blackhole. Making you want to invest more and more of your money into speculative ideas.
Don’t succumb to the temptation.
Times like these are not normal. Getting caught up in this market will slaughter the average investor.
When the mania will end is anyone’s guess. And you won’t get a prediction out of us.
I just know the music will stop eventually. I don’t want you or anyone you know being the one left holding the bag when things turn.
Investing isn't about keeping up with the Joneses. It's about making sure you have enough money to live the life you want, when you want.
So make sure you don't fall for the ‘investing is easy’ trap from the mania phase that we're in.”
The following week we said:
“Eventually things will end badly. Interest rates will go up. Companies won't be able to refinance their debt.”
We’ve been raising cash ever since. We hold about 30-40% cash in our portfolio right now. And that’s in addition to a couple of hedges.
Unfortunately, that hasn’t been enough. We’ve taken just as many cuts as the next investor. But the data says to hold your highest conviction positions despite what’s going on in macro-land. Especially when it comes to Trophy Assets and the math behind compounding.
Morgan Housel said it best in his recent blog post Little Rules About Big Things:
“Most financial mistakes come when you try to force things to happen faster than is required. Compounding doesn’t like when you try to use a cheat code.”
So the internal struggles Mike and I have had to manage portfolios has been extraordinarily challenging.
This is the hardest investing environment we’ve seen in our collective tenure as investors… And it’s not going to get easier for a very long time.
Mania phases force investors to throw rationale out the window. To go lax on due diligence or underwriting. To give management a break about excess spending. To pay exorbitant prices because this time is different.
But it never is.
Like we said before: “Investing isn't about keeping up with the Joneses. It's about making sure you have enough money to live the life you want, when you want.”
The pendulum is swinging the other way. The Federal Reserve has stated they want you to lose money.
But inevitably the pendulum will swing back into a mania phase. Whether that’s a year, five years, or ten years from now. It makes no difference.
Our human intuition is to follow the herd.
Don’t lose sight of that. Stick with your investing plan. And don’t let FOMO pressure you into speculative assets like your peers.
Sure you won’t get rich overnight. But you won’t lose everything either. You’ll preserve your wealth better than 99% of investors. And sleep well at night knowing you protected your capital.
Good investing,
Lance
P.S. You’ve done the hard work earning the money. It’s our job to help grow it safely. Our portfolio is built on Three Pillars to help avoid markets like these. So if you’re interested in understanding our portfolio and/or strategy, reply back and let us know. We’d love to set up a call.