The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (14 page)

The current denial of future inflation reminds us of the denial about the real estate bubble before it popped. In 2003, people believed that housing prices would keep going up at 10 percent per year for at least another decade, maybe longer. They were wrong, terribly wrong, but they admitted that only after the bubble popped. Until then, it was all perfectly reasonable and risk free, just like they say all this money printing is now. One of the proponents of believing that real estate was not in a bubble was then Federal Reserve chairman Alan Greenspan (who famously said we had “just a bit of froth on the coasts”). Come to think of it, one of the proponents of the thinking that money printing won’t cause future inflation is the current Federal Reserve chairman, Ben Bernanke. It seems that denying economic reality is one of the key job requirements for a Federal Reserve chairman. But denying reality won’t change reality as much as Alan or Ben or many others would like to think. It helps people to justify bad investments, but it doesn’t turn those bad investments into good investments. As much fun as it is in the short term, denial is not reality. Never has been and never will be.

Because they have so much to lose. The bubbles have brought us the greatest flow of easy money in our history. There is nothing better than easy money—it is
much
more fun than hard money; it’s absolutely intoxicating.

The Internet bubble was a great example of how people can deny reality when there is so much easy money to be had. Even the most sophisticated investors—venture capitalists and investment bankers—fell victim to the siren song of easy money. Even today, how good is it when you can sell a firm, only a few years after starting it, and with no revenues and no profits, for $1 billion, as was the case when Instagram was sold to Facebook in March 2012. That’s pretty good. John D. Rockefeller may have made a lot of money, but he never made so much money so fast as did Instagram.

Real estate has had similar tales. Seaside cottages purchased for $10,000 a few decades ago are now worth over $1 million. San Francisco, Boston, and New York have probably benefited the most from the combined real estate and stock bubbles. But there are lots of incredible tales of fast, big wealth in Los Angeles, Las Vegas, Phoenix, and Florida. The bubbles have been very, very good to us. Even if you weren’t lucky enough to get a huge windfall and become a millionaire or billionaire from stocks or real estate, many people also benefited from businesses that prospered along with this enormous explosion of fast, enormous wealth.

Many of those people worked hard for their money, but they made a whole lot more money because of the bubbles than they would have otherwise. There was a lot of easy-money icing on top of the hard-money cake.

And finally, many, many more participated in the general increase of easy money in the form of a dartboard stock market that increased more than 1,000 percent no matter where you threw the darts at the stock page, or housing that doubled or tripled in value with little or no improvements.

It is good, very good. Admit it—easy money is a lot of fun. And, we might add, since it is a world bubble economy, there are lots of easy-money millionaires and billionaires around the world, and that has a big impact on Wall Street’s thinking as well. They don’t want to lose any easy money, whether it comes from the United States or some other country. Fast, big money from China, Russia, or the Middle East will do just fine to keep them happy. Right now in London, the best homes are selling for over $100 million, which is up from just a few million dollars several decades ago. And many are being bought by foreigners, not the Brits, with fast, big money, from Russia, the Middle East, and elsewhere.

How many Wall Street analysts or economists predicted the recent financial collapse or even the Internet collapse? They can’t and won’t see the next—and much bigger—one coming either.

Remember, these are the same firms that, in a period of low interest rates, low unemployment, and low inflation, basically went bankrupt during the financial crisis. In fact, almost
all
of the
best
and
biggest
investment banking firms would have failed without massive government assistance.

This
did not
happen in the Great Depression, despite record high unemployment and a devastated economy. Many firms survived the Depression without government bailouts. The reason for the incompetence today is that they have been blinded by easy money. They have more advanced degrees from top schools than in the past and the same basic genetic intelligence, but they are blinded by easy money.

So don’t look to them to shine a spotlight on the problem—they are trying desperately to turn off the spotlight to save that easy money. Frankly, so are many of the rest of us who have stock and real estate investments. This willingness to overlook reality doesn’t affect just the financially sophisticated, but the financially unsophisticated as well. We all want easy money.

Those who keep hoping the easy money will return will say stocks and bonds have done well in the past 30 years and gold hasn’t—and that is true!! Look at those charts at the start of this chapter. But, as we have said many times,
it is different this time
. We are in a bubble economy, and it will eventually pop. It’s already started to pop in stocks and real estate, so the past 10 years are more indicative of their future performance than were the 20 years prior to that. Although the past 10 years have been good for bonds, that bubble is likely about to pop soon, too.

The bottom line is that the easy money is coming to an end and the cheerleaders on Wall Street and those outside the Street who cheer on the cheerleaders won’t see this simply because they don’t want to. Rather than face the decline and even demise of easy money, CW investors want to still believe in the magical powers of the mythical “natural growth rate” to bring us back to what we had before. The desire to hang on to CW investing, despite all evidence that it is no longer useful, is rooted in the basic human desire to avoid change and to believe in the past—especially when that past was so very, very good to us.

On some level, many CW investment experts know that something feels “different” this time, but they don’t let themselves think about that too much and they don’t radically change course. They may get very worked up over political debates about how the government is handling the economy, depending on which side they support, but they don’t let themselves get too worked up about what will actually make a big difference in their future: their own willingness to see the bubbles and prepare for the pop.

Interestingly, when the bubbles do begin to fully burst, CW investors will instantly change their minds about “natural growth” and all the rest, and will completely understand that they need to get out of the popping bubbles as fast as they possibly can. There will be a stampede to sell, not buy, when the bubbles fall. If anyone really believed what they say they believe, wouldn’t they want to stay in and buy up the so-called “bargains”? Some will do that, but most will not. At that point, most investors will be sellers, not buyers, and CW investing will be no more. Unfortunately, a whole lot of their money will have gone to Money Heaven. Until then, most CW investors just cannot let themselves see the falling bubble economy and the dangerous Aftershock ahead.

We have come down hard on conventional wisdom, but we do not want to be so hard on CW investors. To be fair, most CW investors simply do not know what else to do. There are not a lot of sensible alternative views of the markets and economy available, or wise advice as to what to do about it. If you have been a CW investor up to now, and most investors have been, then the first step is to allow yourself to consider the possibility that CW is not going to work for you forever. Most likely, you have already seen it fail you at least once, in 2008. That is just a small taste of what is to come.

If you are starting to think we may be onto something and you want to explore your options for changing your investment approach, please be prepared for your current CW financial advisers and others to shoot you down or at least not show too much interest in hearing about our macro view. Many CW advisers will go so far as to tell you to stop reading scary books because it’s not good for you or your portfolio. Please remember that while these folks may know more than you about many investing details, only you can decide what overall big picture of the investment environment that you believe is correct. Your point of view is not trivial; it is essential to your investment decisions. Don’t let others take the wheel. They are working for you, not the other way around.

While we don’t like CW cheerleaders because they are working to keep people in denial, we do understand why they do it. For financial analysts, they’re just doing their job in being cheerleaders. That’s what they are paid to do, whether they are stock and bond salespeople or the financial analysts who support them. There is a reason that financial analysts give a buy or a hold recommendation over 90 percent of the time. They are paid by and are supported by stock and bond salespeople. They are paid based on selling people stocks and bonds, not for pointing out the bubbles and telling you to go away. If they did that, they would be out of a job very quickly, and nobody wants to be out of a job, especially in this market.

But it is important for the rest of us to understand that financial analysts have that bias. We should not count on them to help us figure out what is really occurring or help us prepare for future protection. Never going to happen.

Like financial analysts and stock and bond salesmen, many cheerleading money managers want to keep their jobs. And they don’t keep their jobs by investing their money in money market funds. They need to invest their money in stocks—whether or not the risks are worth it. No one will hire a money manager just to invest in money market funds. Almost no one will hire a money manager just to invest in bonds. They have to invest in stocks to get the hope of a return to justify their high pay.

Even if the risks are far higher than the meager return from stocks justifies, it’s absolutely critical that they invest in stocks to keep their jobs. There are certainly exceptions to this rule, but generally stocks are the stock-in-trade of money managers. When stocks are in a long-term bull market, being so focused on stocks is fine. But if they are in a bubble that is popping and turns into a long-term bear market, that’s not so good.

Keep in mind that money managers are investing other people’s money. Even if they lose money, as long as they are doing as well as other stock-oriented money managers, they will likely keep their jobs.

Of course, there are a minority of money managers who are not primarily salespeople. They are willing to manage money without a focus on stocks and it certainly isn’t easy. So, not all money managers are cheerleaders and salespeople. But an awful lot of them are.

An individual investor is very different from a money manager. An individual investor is investing his or her own money. His or her job is not dependent on investing in stocks. This is not “other people’s money.” If individual investors lose, they lose big—not just their bonuses at work but money that their families depend on.

Many CW advisers call individual investors “stupid money,” and they call money managers “smart money.” At this point we couldn’t disagree more. The way we see it, they just have different goals. The people who play with other people’s money are working to keep their jobs; the people who invest their own money are working to protect their assets. And the people who are investing their own money are voting with their feet. Even during the rebound of 2011 and early 2012, investors were moving their money out of stock mutual funds. The outflows since the 2008 crash have been enormous, despite the rebound, as
Figure 3.8
shows.

Figure 3.7
Outflows from Domestic Stock Mutual Funds Since 2008 Crash

Despite the big rebound in the stock market since the financial crisis of 2008, individual investors remain highly skeptical and have been pulling their money out of stock mutual funds every year since.

Source
: Investment Company Institute.

Now you might say that means these people are being too cautious and the money managers are right. If the stock market bubble is rising, that is correct. But, if the stock market bubble is popping, reducing your stock market exposure is absolutely the right thing to do.

People who manage other people’s money are biased to think the stock market bubble of the 1980s and 1990s will return. People who are risking their own money are more willing to see the reality that this market has not produced good returns for over a decade and the risks far outweigh the benefits. And they are reacting accordingly. It’s not stupid money at all. It’s people focused on protecting their own money rather than people playing with other people’s money who are simply, and understandably, trying to keep their jobs.