Investing in the late 1990s was a lot of fun. It wasn't about making or losing money, but about how much or how little you were going to make. The greatest frustration was jumping into a stock that moved up too slowly, as you watched other ones climb at a more rapid rate. I rolled an ever-increasing number of call options on several different telecommunications and technology stocks from one expiration month to the next, accumulating a tremendous amount of paper wealth. Looking back on that period, it was way too easy, but I didn't recognize it, because I was relatively inexperienced. The period that followed was not easy at all, as from 2000 to 2002, the S&P 500 (SPY) declined three years in a row.
Investing in the mid-2000s was also exciting and profitable, but in a very different way. The stock market did well, but it was investing in real estate that became a no-lose proposition. It wasn't about which property you owned, but how many you owned. As the home I owned and lived in doubled in value over a five-year period, I watched others purchase investment properties at extraordinary low borrowing costs with the intentions of selling at ever-higher prices down the road. Looking back on that period, it was way too easy. The period that followed was horrific, as the S&P 500 lost half its value during what is now known as the Great Recession.
There are many similarities between these two periods, but they are also very different. This is why it has been said that history doesn't repeat itself, but it often rhymes. The most obvious similarity was the misuse of leverage and the malinvestment that occurred as a result.
While the investment landscape today is very different from that in the late 1990s or mid-2000s, there are some factors that clearly rhyme. Leverage is being employed at unprecedented levels, but it is not concentrated within one segment of the economy or market. It permeates everywhere.
If there is an obsession today, like the ones we saw in technology stocks and real estate, I would say it is in the hunt for yield. Many high-yielding investments are promoted today as no-lose propositions, the same way the consensus viewed real estate during the build-up to the housing bubble. This was part of the Federal Reserve's design as it lowered the interest rate earned on the safest investments to near zero. Now investors can earn yields of 7-10% on a variety of different investment vehicles with seemingly no end in sight. This seems too easy to me.
Our views are largely shaped by our experiences, and I have plenty when it comes to investing. Something that disturbs me a great deal is how one mountain chart after another, regardless of what it is measuring, reminds me of the previous two very difficult periods that I lived through. As a result, it is hard for me to believe that this time will be different.
Everything runs in cycles. The present condition of consumer confidence has only been this high when I was trading tech stocks in 1999. I can assure you that those were some excellent present conditions. Perhaps conditions today will continue to improve to unprecedented levels, but that is a bet I am not willing to make.
Regardless of the methodology behind stock market valuation, we are at levels only seen in late 1999 and 1929. This doesn't mean that valuations can't go higher, and it doesn't mean that they have to decline, but it does strongly suggest that returns moving forward will be substantially below historical averages.
What is alarming about the chart below is that companies do a horrible job of timing their stock buybacks, as shown from the previous peak in 2007, which was just prior to the stock market losing half its value. In 2018 we surpassed the 2007 peak.
The mountain chart below shows the staggering increase in debt relative to net earnings (EBITDA) for the 2,000 small-cap companies that populate the Russell 2000 index (IWM). This was instigated by the Federal Reserve's near-zero interest rate policy that followed the financial crisis in 2009. This reminds me of the leverage employed in the late 1990s and mid-2000s. It is only sustainable if earnings continue to grow and borrowing costs do not rise.
When these concerns are raised, they are summarily dismissed, based on the belief that the Federal Reserve, in concert with other major central banks, will indefinitely support financial asset prices with liquidity measures. Despite global central banks moving towards the gradual withdrawal of liquidity, the consensus of investors remains undeterred. It assumes that if asset prices fall, central banks will simply reverse course. We have already seen this happen to a certain extent when Chairman Powell softened his hawkish tone following the stock market decline in the fourth quarter of last year. Stock prices have already recovered the majority of their losses. Again, this is too easy.
I think the Federal Reserve will be faced with a situation that it is not currently anticipating. It will be one that makes its job far more difficult than it has been in the past. While it has met its dual mandate of full employment and stable prices, it can't withdraw its crisis-induced liquidity measures without undermining the wealth effect that underpins the expansion. At the same time, inflationary pressures are building that could lead to a rise in long-term interest rates. All of this is occurring at the late stage of what will soon be the longest expansion on record. Everything seems too easy for a guy that has been navigating markets for nearly 30 years. I expect things to get far more difficult moving forward.
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Disclaimer: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.