Jared Dillian @jareddillian - Tumblr Blog

The Invisible Hand of Capitalism

The Fed is more or less doing modern monentary theory (MMT) as we speak.

But rather than giving printed dollars to the Treasury, it’s using the bond market as a conduit. Trillions in bond issuance, financed by trillions of dollars of printed money.

Don’t get me started on the pathetic levels of assistance we are offering American citizens in favor of financially irresponsible corporations.

What we are practicing here is not capitalism. In order for capitalism to work, we must allow corporations to fail. The bankruptcy process works just fine. Sure, shareholders and creditors would experience losses, and this would teach them to be more careful next time.

It is the down part of the cycle that is most instructive. Yet we never get to experience it.

The problem is bigger than just Trump, though. In times like this, there is huge societal momentum to do something. Thomas Massie, the one congressman who more or less favored doing nothing, was tarred and feathered. The word laissez-faire hasn’t been uttered in years.

Tough time to be a libertarian or a hard assets investor, though that may be changing soon.

The Great Experiment

MMT critics have said all along that if the Fed financed government expenditures, we’d end up with Zimbabwe-style hyperinflation. I guess we’re going to find out!

Gold’s performance has been underwhelming so far, though that may be starting to change.

I’ve had to remind many people over that past few weeks that gold typically outperforms after a crisis, not during.

In any case, if gold is going to work, now is the time. We’re looking at:

Unlimited quantitative easing (QE)

Negative interest rates (this is coming)

Unlimited deficits

Direct monetization

Plus, general COVID-19 pandemonium

I haven’t seen any takes on why gold would go down in this environment, except from the Elliott Wave guys. They think we are headed into a deflationary black hole and that gold is going to zero.

Meanwhile, the hyperinflation experienced in Weimar Germany, Venezuela, and Zimbabwe would tell us that we are not headed into a deflationary black hole.

One last point about gold. If you run correlations on gold with various stuff, it turns out that it has the highest correlation to budget deficits. Run the numbers yourself and see.

In recent history, gold skyrocketed to $1,900/ounce with the post-global financial crisis Obama deficits. And it tanked once the fiscally responsible Tea Party Republicans formed an effective opposition.

Of course, the Republicans aren’t fiscally responsible anymore.

The Silver Lining

Socialism is creeping back into the national conversation, so I thought I would comment on how well things are going. Really, they are.

IKEA is making masks. Hundreds of companies are making masks.

Trump is not directing this activity. There is no mask czar. There is no central planning. This is all happening spontaneously. Some might call this spontaneous order.

It is the invisible hand of capitalism. Each of us working for his own gain, benefiting us all.

If Trump really wanted to screw this up, he would appoint a mask czar, and attempt to dictate the activities of millions of people. But central planning doesn’t work. It doesn’t work in good times, and it doesn’t work in bad times. And emergencies are not a justification for it.

The doctors will get the supplies they need, in time, and in the right place. The invisible hand will ensure it happens.

Trump’s only job here is to provide inspiration. You can judge for yourself whether he is effective at that.

So while I am a natural-born pessimist, I do not believe that the worst-case scenario will be realized. In fact, I think that it is very, very hard to be short human ingenuity.

For some reason, most people are utterly convinced that our efforts to “flatten the curve” of coronavirus infections will fail. And for sure, there are parts of the country where people are taking the coronavirus less seriously.

But the track record of those who have bet against this country is very, very poor. I am old enough to have a pretty long memory of big failures in markets and governance.

I take to heart the old Winston Churchill quote, which he may or may not have actually said: “Americans can be relied upon to do the right thing after exhausting all other possibilities.”

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#the fed #The Federal Reserve #capitalism #mmt #coronavirus #socialism

The Stock Market Is Not a Magic Money Machine

I am writing from my home library since I’m no longer working in my office in downtown Myrtle Beach.

I’ve always resisted working from home because I don’t want to stress out in my own house. But it hasn’t been bad. I have a hot tub, a pool, cigars, and the cats.

Things are much worse for most other people. The virus and the protective measures have done untold economic damage. Some people are openly talking of a depression.

Already, this is one of the worst bear markets in stocks we have ever had—and it’s only been a little over a month. There was a lot of leverage in the system, and price-insensitive buying, like with stock buybacks, indexing, and short volatility trades.

Now, all that leverage is being unwound. The first 30%-plus drop was a result of that. Whether there’s any more downside is probably a question of economics.

I can tell you that, as someone who watches sentiment, this is perhaps one of the most difficult markets to trade in I’ve ever seen. For the past few weeks, sentiment has been max bearish, the CBOE Volatility Index (VIX) at record levels, and every sentiment indicator or oscillator pegged at zero.

Yet, the market has continued lower. Mean reversion simply has not worked.

Some people are comparing this to the crash of 1929, and the subsequent bear market that took stocks down 89%. They speak with certainty.

I don’t have that level of certainty, and I don’t see how anyone can.

The problem here is not economic. The problem is cultural: Americans are not well-equipped to deal with a crisis like this.

Culture of Disobedience

Americans disobey. They don’t follow rules. They don’t follow guidance. I had to pick up some medicine at the vet’s office for one of my cats the other day, and there were hundreds of cars on the road—just like any other day.

Where I live, in South Carolina, very few people are taking this seriously. People are individuals, and they follow their own judgment. There are few indications this will change, outside of tanks rolling down residential streets.

Because of our culture of disobedience, it’s very unlikely we will contain the spread of the virus. Some people will observe shelter-in-place orders, and others won’t. We’ll “flatten the curve” a little, but we’ll also lengthen the duration of the crisis, without clear resolution, which is actually the worst possible scenario.

Maybe some folks could also stand to do some social distancing from their portfolio. There could be more downside in stocks. Many people went into this with a large allocation to equities. If the market gives you a chance to rejigger your asset allocation, you should probably take it.

Things Were Risky All Along

I’ve been thinking a lot about safety.

Nobody cared about safety going into this. No one. I was reading articles about people investing their emergency funds in growth stocks. That kind of stuff.

For years, I was preaching safety. Bonds and cash. Gold. Huge allocations to this stuff. And there were millions of Baby Boomers who had giant allocations to stocks. Now they are selling—at a loss. It’s amazing.

And because markets are markets, when it’s time for people to take on risk again, nobody will want to. They’ll be interested in safe havens like bonds and cash and gold… at precisely the right moment to go into risk-on mode instead. But that is many years away.

With stocks down a little over 30% from their peak, even with the recent bear-market rally, this is already one of the worst bears of all time. And it happened in a blink.

For years, people have been focused on returns to the exclusion of all else—and not risk. Suddenly, the world seems like a much riskier place than it did a month ago.

Nothing has changed but the perception—it was risky all along.

The stock market is not, and never was, a magic money machine. The stock market has levels of volatility that make it unsuitable for many investors. No one should depend on the stock market for their retirement. It is unpredictable and capricious. And the vast majority of people are psychologically unequipped to handle it.

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#stock market #virus #economic damage #bonds #stocks #volatility

Yes, You Can Build a Portfolio That Gains from Disorder

As you have probably noticed, stocks are a wee bit more volatile these days. We’ve reached levels of volatility similar to what we experienced during the financial crisis, and before that, the Great Depression. It’s pretty intense.

I can tell you one thing: If you can handle this, you can handle anything. I would characterize any move over 2% in the stock market as large. 10% is, well, the largest since the crash of 1987.

In a plain vanilla sense, you are probably wondering how to mitigate the volatility in your portfolio, which is freaking out. You could step into your time machine, go back a few months, and buy some bonds. Except, even bonds are not helping now.

All kinds of wacky stuff is happening in the bond market, and bonds aren’t really providing any diversification benefits anymore, as risk parity strategies unwind.

Gold is supposed to provide some diversification benefits, but isn’t, because of liquidation. Commodities, no help. Real estate, no help.

The stark reality: In a crisis, correlation goes to 1 and everything moves in lockstep. And that is the problem with 95% of portfolios out there.

Correlation is the risk that nobody sees. Correlation is the risk that nobody saw in 2008, which was precisely the cause of CDOs and such blowing up. Correlation is always lurking. It’s the relationship between currencies and bonds and stocks and banks and people that you don’t see until it’s too late.

Correlation causes weird stuff to happen. I heard about a high-yield muni bond fund that sank 16% in a day. No way in a million universes should that happen. Correlation. Someone is losing money over there, so he has to sell a winner over here. That is happening times a thousand in the markets right now.

Stocks, bonds, FX, gold, everything is moving like a marching band—but in ways that you would not expect. You have no idea where the weaknesses are until it’s too late.

Fragility

I will borrow a little Nassim Taleb for a paragraph—it’s about the difference between building portfolios that are fragile versus those that are antifragile. As most people have found out in the past few weeks, they had fragile portfolios. Most people did.

You want to build a portfolio that gains from disorder. Not many people did that, outside of some vol funds and the tail risk guys, who do that sort of thing for a living.

You can’t be a tail risk fund, so don’t even think about it.

The reality is that we are all more or less long-only investors, and once every 12 years we are going to get clubbed over the head with a baton. You can take steps to mitigate this (like the 35/65 portfolio), but the tradeoff is lower returns. So, is there no hope?

Let me speak briefly about sentiment trading and asymmetry. One of the cool things about being a sentiment trader is that you are always betting against the crowd. If people are excessively bearish, you’re bullish, and vice versa.

The nice thing about this is that it frequently puts you in low-risk trades where there is significant asymmetry—you can make more than you can lose.

Of course, none of us know what the real probability distribution is, but if you have some experience and a nose for crowd psychology, you will be risking a little to make a lot, rather than risking a lot to make a little.

Whenever I trade, I think about this asymmetry (which some people might call optionality). It’s one of the reasons I’ve been short Canadian banks all these years—even in the best-case scenario for the Canadian banks, I never perceived a lot of upside. And that was the right call.

Value investors do this, too—they invest in things with a margin of safety. Sentiment trading is a distant cousin of value investing.

When you invest this way, you tend to be less exposed to large shocks. Oftentimes you will have built a portfolio that gains from disorder. And it always helps to have a hedge—buying a few deep out-of-the-money puts is never a bad idea, as long as you remember to sell them.

If you didn’t get it right this time, for the killer virus, make sure you get it right for next time, when the asteroid hits.

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#portfolio #investment portfolio #balanced portfolio

Your Portfolio for the Next Decade—Fix It with the “Anti-Stock”

For months—years—I’ve been extolling the virtues of portfolios that are primarily comprised of bonds. Especially in retirement.

Bonds provide necessary diversification. They may end up reducing returns, but you are more than compensated by the reduction in risk.

A few months ago, people were giving me a lot of grief about this. I heard all about how irresponsible it was to promote bonds in a low interest rate environment. Then interest rates went even lower, as stocks went down a lot.

So people with a bond-heavy portfolio would have been… happy. Or at least, they would have slept well at night.

Never mind the fact that because of convexity effects, when interest rates are low and go even lower, bond prices go up a lot. When the Fed cut rates 50 basis points in early March, at one point the long bond was up more than five points in a day.

And people say that bonds are boring!

Anyway, the point of holding bonds is for the diversification benefits. But when interest rates are very low (close to zero), some of those benefits start to disappear.

This makes things very hard. If stocks are volatile, and bonds are no help, where do you put your money to mitigate volatility? There aren’t many options.

Your Options

Here are your options:

Commodities (especially gold)

Real estate (either physical real estate or REITs)

Cash

Misc., like collectibles and art

Generally, art and collectibles do a pretty poor job of diversifying a portfolio. They’re cyclical and tend to move with stocks.

I always like cash, and everyone should have 10–20% cash in their portfolio at all times. The good thing about cash now is that, with interest rates at such low levels—perhaps even negative—the opportunity cost of holding cash is low.

It’s kind of dumb to hold cash when interest rates are 8%. Makes more sense when rates are at 1%.

The big diversifiers are really commodities and real estate. Commodities are a tough sell right now, though. They have a negative cost of carry, and they’ve been going down for a long time.

We’re currently experiencing a deflationary shock with coronavirus, but my suspicion is that the deflation is a head fake.

Within commodities, though, gold has a special role. Its whole purpose is to provide diversification, because it’s the anti-stock and anti-bond. It’s the alternative to traditional finance. And the correlation is typically zero, or negative (or it used to be).

I think that it makes sense to move away from bonds as a diversifier and toward gold.

That’s hard for people to swallow. I proposed this to my mom who thinks gold is risky. It is certainly “riskier” than the bonds she is holding, if you define risk as volatility. But again, you add something with low correlation to stocks and bonds to the portfolio, and it is going to improve the risk characteristics.

The same is true for real estate, although less so. The nice thing about real estate is that it also provides income, which gold doesn’t. Although again—in a low rate environment, the opportunity cost of holding gold is practically nonexistent.

Real estate should perform well in an inflationary environment, and it should also provide decent diversification benefits.

The Portfolio

People have very practical concerns about how to 1) save for retirement and 2) protect against inflation in a low interest rate environment.

To do that, you want a portfolio with less stocks, less bonds, some cash, some gold, and some real estate. What does that look like?

The 20/20/20/20/20 portfolio.

20% stocks

20% bonds

20% cash

20% gold

20% real estate

This is the benchmark we should be using for the next 10 years and beyond.

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#investment portfolio #stocks #bonds #realestate

The 3 Cs of Trading Markets in Turmoil

Whenever CNBC breaks out its “Markets in Turmoil“ chyron, markets tend to rally.

Not this time!

This is my 21st year in the capital markets. I have seen some crazy stuff. Actually, 99% of the stuff I have seen is boring stuff, but it’s the crazy stuff that I remember.

Some of you have the ability to short things, trade derivatives and do all kinds of other fancy stuff. Most others just buy things. For the latter group, it often comes down to very brief moments where you have to decide to buy something cheap. Those decisions are hard because they often feel terrible.

Here’s something to take some of the sting out of those hard investing decisions. I call it the 3 Cs of trading in a crisis. I published this for my paid-up subscribers last week. And this short list can help you in any market, and especially in times like these.

The 3 Cs of trading in a crisis are:

Capital

Conviction

Courage

Capital

In order to buy stuff, you need cash.

If you have cash, it means you weren’t fully invested on the highs.

This time around, like most times, everyone was fully invested on the highs.

Cash yields nothing, so people were very scornful of cash, considering it a drag on performance. But people forget about the option value of cash, the idea that cash is a big pile of possibilities, and it allows you to buy things cheaper in the future.

This is why you always keep cash around.

People never, ever learn this lesson, no matter how many times they get burned. Again and again, markets go up, people chase performance, and feel the need to be fully invested… on the highs.

Don’t be one of these people.

Conviction

Conviction is how sure you are on a trade.

There is one easy way to get more conviction on something: do a lot of research on it. The more you know about something, the better you feel about it, and the more comfortable you are. Although there is such a thing as knowing too much.

Just because you have conviction on a trade doesn’t mean you are right. You can have conviction and be wrong. But conviction is necessary to get comfortable with a trade, which will help you size it appropriately.

When I have conviction on a trade, I feel like I must act. And I can’t do it fast enough.

Courage

Oftentimes, these opportunities happen when things look really bad. And even if you have the capital, and you have the conviction, working up the courage can be tough.

We had some 1,000-point down days in the Dow in the past two weeks. Takes some courage to buy the market down 1,000 points. Never feels good when you push the buy button. If it does, then you could be a psychopath.

I have never had a shortage of courage in my career, which some people confuse with bravado. I’m a trader, and it’s in my DNA. I’m always up for taking a risk. I’ve done some big, big trades in my career, and I’ve never had any fear.

I’m unusual—don’t confuse courage with fearlessness—it’s normal to experience fear—even healthy. You shouldn’t be a kamikaze like me.

It’s good to deliberate about a trade, and really think about what you are doing. But don’t take too long — sometimes it comes down to a matter of seconds.

But let me tell you: It’s not enough for you to hear me say all of this. If you truly want to learn about the 3Cs — Capital, Conviction, and Courage — and have this knowledge seep straight into your bone marrow and completely live it ... you should hear this every day of your life as an investor. Because it takes that much reinforcement to live, breathe, and feel comfortable with the 3 Cs and to follow through on those high-conviction trades.

That’s why I want you to subscribe to my free weekly e-letter, The 10th Man, today. You’ll be happy you did.

#crisis #investing #trade market #how to invest

The End of College Is Near

I predict that 20% of colleges and universities will shut down or merge in the next 10 years, and probably more.

It was a good run.

Most people fail to understand that higher education is in itself countercyclical. When the economy is bad, and people lose jobs, many of them will go back to school.

You have probably heard about the for-profit education boom and bust. That is old news. You might not have heard that total enrollment has been declining for the last eight years as the economy has improved.

What comes next will pulverize nearly every institution of higher learning in the country, private and public.

The reason: demographics. Basically, an echo of the baby bust of the early seventies.

I was born at the bottom of that baby bust in 1974. My small generation hatched a small generation, which is now making its way through college.

Enrollment will drop 15% on average, on top of the eight-year correction that schools have already experienced.

This may not seem like much, but finances at colleges and universities have deteriorated sharply, and many of them will not even be able to withstand a drop of a few percent.

A Bull Market in Higher Education

There have been bull markets in dot-com stocks, homebuilder stocks, energy stocks, and FANG stocks. There can be a bull market in anything, even higher education.

Unless you have been trapped under something heavy, you probably know that college is expensive.

It is expensive because it is implicitly subsidized by the federal government, which will lend any amount of money to any student without regard for willingness or ability to repay.

The demand for higher education has been relatively inelastic, but demand elasticity is starting to set in.

Today, 45% fewer 18- to 29-year-olds say going to college is “very important” than in 2013. A 45% drop in just seven years.

I talk about it incessantly on my radio show. Higher education has become so expensive that it makes practically no sense for anyone, except as a luxury purchase for the idle rich.

Not even a Wall Street job is going to be any help in paying off $200,000 to $300,000 in debt. So we have fewer students going to college and fewer students wanting to go to college. Right.

The Bull Market Was Awesome

New academic buildings, new athletic facilities, new residence halls with swimming pools, climbing walls, and recreation facilities. Lots of administration and diversity staff.

Ironically, the one cohort that utterly failed to benefit from the boom times was the professors, who are really the only people adding value and remain vastly underpaid.

When the cuts come, they won’t come for the administration or the diversity staff. Academic programs will be the first to go, which raises some interesting questions about what the purpose of a university is.

A discussion on higher education would not be complete without a discussion of college football, which is a drain on resources in 99% of cases.

Yes, Alabama is wildly profitable. Only a handful of football programs are, and hundreds of schools have tried to replicate what Alabama is doing.

The economics of college athletics is widely misunderstood. Some people complain that football is a source of alumni support, but it really isn’t.

It’s popular among alumni, yes, but financially speaking, the vast majority of schools would be better off without it.

A Race to the Bottom

Some schools are thinking outside the box and trying to recruit folks outside the rapidly shrinking pool of high school seniors.

There are millions of people in the US who have “some college” on their resumes, all of whom are potential customers, depending on how much debt they have left over from the last time around.

Schools will also be recruiting foreign students heavily. But it won’t be enough to plug the gap.

Smaller liberal arts colleges are already closing, and many more will close their doors for good, or merge with larger schools to stay afloat.

But state schools will suffer too, and many of them will require explicit taxpayer assistance, which will be politically distasteful to say the least.

Schools will resort to lowering standards to keep enrollment up, but that is a race to the bottom, and the value of every student’s degree will decrease correspondingly, setting off a vicious cycle that makes college even less attractive.

My suspicion is that universities—allegedly with very smart people in charge—have done pretty much zero to prepare for the coming bust. Many schools have lots of debt, not much cash, and a lot of fixed costs.

Almost nobody has prepared for what is about to come next. And this is operating under the assumption that the Department of Education continues to be as willing to lend money as it has been in the past.

As an investor who came of age in a bear market, I tend to look for bear markets. We have had some wingdingers in the last 20 years. This one will be up there, with pretty profound economic effects.

Colleges and universities employ a lot of people and in many cases are the lifeblood of a single town. You’ve probably noticed that the nicest buildings in your town are the academic buildings. Wait until they are all empty.

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#higher education #university #school #expensive education #bull market

Stocks Are the Opiate of the Masses

The stock market is the opiate of the masses.

Oh sure, the days of watching Jim Cramer mash buttons on his console with his sleeves rolled up to his armpits are pretty much over.

And nobody really day trades anymore, except for masochists. And, despite a 10,000-point rise in the Dow since the election, nobody seems all that happy.

But the stock market is still the opiate of the masses.

I know this because anytime I go on Twitter, the financial pundits are tweeting about stocks. They usually don’t tweet about bonds or commodities or FX. I follow one or two oddballs that tweet about volatility.

But it’s usually wall-to-wall stocks. Mostly Farmers’ Almanac stuff about how “9 of the last 11 Decembers have been positive,” and “60% of the time it works every time.” Not a lot of value added. So I spend less time on Twitter.

But I will say that the ratio of stock market tweets to tweets about other asset classes is about 10 to 1. And most of the non-stock market tweets are from a coterie of macro doom guys. That is another genre altogether.

And even though people aren’t whipping and driving stocks, they’re whipping and driving index funds. The obsession with the stock market is still there; it’s just morphed into something entirely different. Vanguard, by the way, is now showing television commercials. I take this as a sign.

People are still enthralled by the stock market. Index funds might not be as exciting as dot-com stocks to talk about at cocktail parties. But people still go home and feel a thrill up their legs when they log into their Vanguard accounts and see a big fat number.

Bonds Are Not the Opiate of the Masses

I was a noisy bond bull earlier in the year, and I pissed a lot of people off. It was the right call, but not a popular one.

I am still bullish.

There are virtually no bond market tweets, aside from me doing a sack dance every once in a while. Which is interesting, because the rally in bonds has been just as historic and unprecedented as the rally in stocks, and perhaps more so—but nobody is interested. Not only is nobody interested, everyone hates it. Every time bonds sell off ten basis points, the internet erupts in cheers.

Interest rates will stop going down when a full-fledged bond mania develops. It might take a while.

Just in the past few weeks, we’ve had a blowout payroll number, a Boris Johnson victory in the UK, and a bunch of other bond-torching news. And the bond market has steadfastly refused to sell off. Not a lot to hang onto, if you’re a bond bear.

Sure, a lot of things could pop the bubble if you think it’s a bubble. Inflation fears could do it, lots more Treasury supply, etc. And the flows just keep on coming. High-yield spreads have dropped to historic lows.

Popular Delusions

If people are this unhappy when all financial assets are shooting off into space, what will happen when we actually get a bear market?

I think about this all the time.

Investors believe that financial markets are supposed to behave a certain way. They believe they’re supposed to reliably produce 8 percent returns every year. Or more, in the case of 2019. When they don’t, people get a bit indignant.

Two salient points:

People think the stock market returns 8 percent a year, because it has historically returned 8 percent a year

People think that past performance does not indicate future results

They hold these two conflicting ideas in their heads simultaneously. It’s a feat of mental gymnastics that I cannot replicate. The fact is we don’t know what the stock market will return in the future. It could return 4 percent, or 0 percent, or -4 percent, or 16 percent. We just have no idea.

Now, the problem is that people have done all this actuarial science around the 8 percent number to plan for retirement. There is a good chance that we might not hit that 8 percent number for a bunch of reasons, not the least of which is politics. If Bernie Sanders is elected president, I assure you we’ll be off to a pretty poor start.

It may turn out that actual returns are lower, and people may find they should have saved a lot more. That is almost always the case—people’s realized returns are lower than theoretical returns because they can’t help but engage in market timing.

To fix this, try the 35/65 portfolio. But the 35/65 portfolio doesn’t protect you against situations where stocks and bonds both decline.

In that case, try the 20/20/20/20/20 portfolio:

20% stocks

20% bonds

20% commodities

20% real estate

20% cash

Someday, I’ll get around to figuring out historical returns on that.

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#stocks #stock market #bonds #investing in bonds #investment portfolio

After 20 Years of Trading, You Learn That You Actually Know Nothing

You ever notice—

That some memories tend to be stronger than others?

What sort of things do you remember?

You remember events in your life that had a lot of feelings associated with them.

You remember the death of your pet like it was yesterday. All the nights spent sitting on the couch watching Wheel Of Fortune—it’s just a blur.

Researchers have studied this in rats. They found that rats remembered things better if they experienced a rush of adrenaline.

In those moments with strong memories, it feels like time slows down. Time doesn’t actually slow down—time is linear. But human beings experience time as flexible. Time also speeds up when things are boring.

I’m fond of saying that all of finance, or at least the interesting part, is about human behavior. I find the daily fluctuations of stocks and credit spreads less interesting the older I get. And I think finance is more depraved the older I get. But the human behavior part fascinates me.

Miller’s Planet

The fact that time stretches and compresses isn’t news to anyone who’s traded options.

In the world of options, time and volatility work in opposite directions. As time passes, options decay. As volatility increases, options increase in value. All stuff you learned in class.

But if you think about it, volatility increasing is another way of saying that there’s a lot of s--- going on. Things are crazy. Options increase in value—which is really like saying that time is slowing down.

Which is exactly how we experience it. Of all my days trading on Wall Street, what are the times that I remember most? The financial crisis, naturally. There was a lot of adrenaline associated with that.

We all have strong memories of it. And while we experienced it, it seemed like time was slowing down—which was reflected in options prices. They were the highest in recorded history.

Finance is simply human behavior.

If I think back over the last 10 years, what do I remember?

The European crisis

The US debt downgrade

The Ebola scare

The yuan devaluation

The vol-splosion

All the crazy times. Nobody remembers the stuff in between. Old-timers like me remember all the way back to 1997 and 1998, with the Asian Financial Crisis and LTCM and the Russian debt default. It’s the accidents that help us mark our time in the markets.

Perspective

We all perceive things differently. As I just demonstrated, we all perceive time differently.

We also might perceive color differently—we just don’t know. There is no way to know that the red I see is the red you see.

We all have different perspectives, especially when it comes to financial markets. I might find a stock attractive that you find unattractive. Happens all the time.

A lot of financial analysis is searching for some objective truth in the markets. This is what the value people try to do. They try to identify the correct value of a security and then buy it if it’s underpriced.

But there really is no objective truth in finance—just a set of ever-changing perspectives. Some examples:

Target is up over 90%, year to date:

Is Target’s business 90% better? Is it earning 90% more revenue? Of course not—more people find the stock attractive and fewer find it unattractive.

Pharmaceutical giant Bristol-Myers is up 48% in the last couple of months:

Again, is their business 50% better? No.

People have created several models to explain stock market behavior. Keynes’s beauty pageant is at the top of the list. I will always catch a beauty pageant if it’s on TV. The goal isn’t picking the most attractive contestant. It’s picking the contestant that the judges will find most attractive. It’s a great exercise.

But I don’t think that’s the right model.

I came up with my own model and gave it to the world on the Bloomberg Opinion page. You can read about it here. But I feel like it’s incomplete, too.

Sentiment also plays a role—big turning points are always at sentiment extremes.

I’m not sure what the answer is—or if there even is an answer. I think about it all the time. People smarter than me spend even more time thinking about it.

Maybe there is no Grand Unified Theory—maybe there are regimes in the financial markets, and sometimes some things work and sometimes other things work.

Maybe the rules change all the time and there is nothing we can do about it.

I am not even sure buy-and-hold and dollar-cost averaging will work going forward.

And that’s what you learn when you have 20 years of experience—that you actually know nothing.

That said, one thing I do know is that the adrenaline rush reckless traders get throwing money at “hot stocks” is not something to aspire to. It’s much better to even out your odds with a diversified, balanced portfolio and a long-term view.

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Why Every Investor Should Go on an Information Diet

I spend a lot of time thinking about the information that I consume. Do you?

We all consume exabytes of information. Have you ever noticed that people spend way more time thinking about the food they consume than the information they consume?

I have family members who are health nuts—watching every bite they eat and augmenting it with supplements—but think nothing of spending 10 minutes cruising around The Drudge Report, which will make you feel like the world is coming to an end pretty much any time you load the page. Some people have read Drudge for twenty years. Imagine how that would make you feel.

I gave up Drudge about six or seven years ago. I keep track of politics on Twitter—but I don’t follow people who are toxic waste. I don’t watch cable news. Before I started the radio show, I watched NBC Nightly News, but I’m glad to be rid of that. I’ve Marie Kondo-ed my information intake, getting rid of anything that doesn’t bring me joy.

Monitoring your information intake is crucial to your mental health. It is also crucial to your investment decision-making.

The Bulls and the Bears

If you want to read bearish information, there are places to do that. If you want to read bullish information, there are places to do that.

Funny—most people spend all their time either reading just the bearish or bullish information. They don’t get both sides of the story.

People like to point out that if you consumed nothing but bearish information since 2009, you would have missed out on a historic stock market rally and you would have drastically underperformed. This is true.

But if you’re consuming nothing but bullish information, about how index funds are king and stocks for the long run and dollar cost averaging, you’ll probably get fricasseed when the bear market begins. We will get one eventually.

Polarization

Political polarization has happened for a lot of reasons, but chief among them is the advent of social media. Go look at charts of polarization—it didn’t really start happening until Facebook and Twitter came on the scene.

It is not particularly difficult to see why. Ever spend 5-10 minutes on Facebook and feel… unsettled?

People spend a lot of time on Facebook. I spend some time on Facebook. It’s pretty rare that Facebook makes me feel good.

There is a lot of crap, memes and such. But there are also people’s terrible political opinions. Funny thing about political opinions on Facebook. I don’t really care to read any of them, even the ones that I agree with. Facebook is full of user-generated content, and the problem with the user-generated content is that it is uninformed, hysterical garbage.

I hide opinionated people on Facebook, but not because the opinions bother me. It is really for my emotional health. I don’t want to log on and feel worse. I have been curating my feed for years, and I finally have it where I want it. As for me, I basically post pictures of my cats, which always make people feel good.

You may find this hard to believe, but there are lots of people out there whose purpose in life seems to be arguing on the internet. I blundered into communist Twitter the other day—not fun.

There are armies of trolls out there. The internet facilitates polarization because we are not dealing with each other face to face. It’s easy to dehumanize “the other side” online. If we were all sitting in the same room, we’d probably just have a normal conversation.

I hope that someday we get bored of arguing on the internet. But it seems to be getting worse, not better.

Politics < Ethics < Philosophy

It is easy to drown in the noise. Politics is noise. Above politics is ethics, and above ethics is philosophy.

If you’ve been following all the tit-for-tat and the drama of the impeachment hearings, if the names McGahn and Strzok mean anything to you, if you can actually recite the timeline of all the China trade negotiations, then you are spending time in politics, in the noise.

Imagine what you could have done with your time instead of learning about this nonsense. If you think this helps you have an opinion on the direction of the stock market, all I have to say to that is LMAO.

If you eat Big Macs and fries and fast food and other junk, you will get fat and feel terrible. I know this from experience. If you read toxic, opinionated trash, you will go crazy, and feel terrible.

And you will think all kinds of things, like, the stock market will crash, or the stock market will go up forever.

As it is with everything in life, the truth is somewhere in between.

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Why Every Investor Should Be Politically Flexible

Things used to be so simple.

You buy a stock, the government cuts taxes, the stock goes up.

Actually, things still are that simple.

And yet vastly more complex. We cut taxes in 2017, but future tax increases—large ones—are likely.

The Federal Reserve is lowering interest rates because it is told to by the president.

There are tariffs, things we haven’t seen in a while. Deficits are rising with zero collective will to contain them.

And we’ve seen a sharp rise in authoritarian behavior from elected leaders of all stripes, globally, which is a source of consternation.

There have been many articles written about how you should not mix your politics with your investing. Many. Except… occasionally, you should.

From 2009 to 2011, it paid to be a far-right gold bug. The liberals were left in the dust.

Since 2011, it has paid to be a liberal growth stock indexer.

Maybe going forward, it will pay to be an MMT-er. Who knows.

My point here is that the stock market goes through political regimes, much like it goes through volatility regimes.

It took me years to understand this. My early investing years were spent thinking that center-right policies were good for the stock market. In general, that is true.

And it is always and everywhere true that cutting taxes, especially corporate taxes and investment taxes, results in higher stock prices.

Aside from that, things get a little hazy. Tariffs are supposed to be bad for stocks, but on a long-term basis, they haven’t been.

As for deficits, the record is a bit mixed. Stocks have gone up when debt is both rising and falling.

Now that the debt issue is becoming a bit hard to handle, you might think that stocks would begin to care. Clearly, they don’t.

Crazy Town

You can’t say anything for certain anymore.

There are some folks out there—like Leon Cooperman—who say the stock market might not even open if Elizabeth Warren is elected president.

I tend to agree. But maybe not!

Maybe Elizabeth Warren gets elected—and stocks go up!

Sometimes stock markets go up when bad things are happening. This was true in Weimar Germany, Zimbabwe, and Venezuela.

There isn’t a person alive who can say with 100% certainty what stocks are going to do. After all, the conventional wisdom was wrong about Trump. The only thing you can say with 100% certainty is that it is going to be a surprise.

I try not to make normative statements about the stock market anymore.

I try not to say what the stock market should do.

I try to predict what the stock market will do.

One of the things I have been writing about is that supply and demand ultimately drives stock prices, and right now stock supply is down because of all the buybacks.

I’m not saying the market can’t go down, I’m saying it’s hard for it to go down.

Basically, nothing would surprise me about 2020. Nothing at all.

Political Investing

One of the hardest things about investing is to be intellectually malleable. To think one thing one day, and then think another thing the next.

Even harder is to be politically malleable. To have one political belief one day, and the opposite belief the next. Impossible.

I do not know one person who got it right from 2009 to 2011 and also got it right from 2011 to today. People take sides, they put on a jersey, and they play for that team. Which means you get to be right every so often, but not all the time.

I can sort of switch sides, but not really.

If it isn’t obvious by now, I am a libertarian-slash-classical liberal. Which means I have missed out on the stock market rally from about 2015 onwards.

I have run into a few people in my career who have actually told me that they would rather lose money than buy a stock like Alphabet. Or whatever. That gets into a central thesis of mine—the vast majority of people would rather be right than make money.

Ideally, you get to do both. But that is pretty rare. I remember buying fluffy tech stocks in 2013. It felt terrible, but I did it because it was the right trade. The trade worked. I was never comfortable with it. It was an unnatural act.

If you want to be right, put it on your tombstone. In this life, we make money.

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Conspiracy Theories Are Killing This Nation

There is a burgeoning conspiracy theory that Jeffrey Epstein was murdered in his jail cell.

Although it’s not really burgeoning, is it? Most people really believe this. I think once a majority of people believe a conspiracy theory, it becomes fact.

Out of all conspiracy theories, this one is certainly plausible—Epstein potentially had a lot of damaging information on a lot of rich, powerful people.

But it is also plausible that Epstein lived a life of saturnalian excess and was not looking forward to the sparse and potentially brutal conditions in prison.

And it is also worth pointing out that corrections officers are not known for their empathy—or their grasp of social psychology and the broad political implications if Epstein was permitted to end his life. Never, ever bet against government incompetence.

I like that theory better than the theory where Spiderman parachutes into Epstein’s prison cell and gives him hemlock. That’s the thing with conspiracy theories—they assume there is a conspiracy, and conspiracies are difficult to hold together.

Do rich and powerful people conspire? If they do, how do they keep it secret?

I don’t know, but I do know this—the people who believe that rich and powerful people conspire tend not to be very successful people, because they are always blaming others for their problems.

The Mainstreaming of Conspiracy Theories

One thing I’ve banged on lately is the mainstreaming of conspiracy theories. I mean, even Trump himself tweets them out.

You would be surprised at how deeply conspiracy theories have been mainstreamed into the discourse of the financial industry.

Like, lots of people believe that the government buys stocks. That there is this thing called the Plunge Protection Team where there is a guy sitting in a closet in the Treasury building buying e-minis on a Dell computer whenever the market goes down.

There is a theory that JP Morgan, the bank, is short literally all the silver in the world to suppress silver prices. And so on.

You don’t find these things in the corners of the dark web. They are right out in the open. The biggest financial media outlets give these people a platform to share their beliefs.

The most disturbing thing about my industry, hands down, is that the vast majority of people working in the capital markets believe things that are simply not true.

On a micro level, there is no money to be made in conspiracy theories. If there really was a PPT (and yes, I know about the President’s Working Group on Financial Markets), then you should be able to make money off it in a systematic way.

But you can’t, so it’s just somebody to blame when things don’t go your way when you’re short. If you’re long a bunch of silver and it won’t go up, blame someone else for your problems.

If It Feels Like the Country is Falling Apart

On a macro level, belief in conspiracies is a direct result of loss of trust in institutions.

In Epstein’s case, the corrections officers failed at their job, the judicial system failed at its job, and the media failed at its job.

These are institutions, and the health of this country is based on the strength of its institutions. What makes extreme political beliefs possible anywhere in the world is a loss of trust in institutions.

The internet also tends to amplify fringe beliefs, which everyone knows by now.

I see Epstein memes in my own Facebook feed, from people who, up until this point, had been apolitical. Their first foray into politics is in the form of a conspiracy theory.

If I were a psychiatrist and I were presented with a patient who believed things that simply were not true, I would call that person delusional and I would prescribe an atypical antipsychotic. I take great interest in mental health—when the human mind malfunctions, what do you do? We have tools to deal with that.

What do you do when the country, collectively, believes things that aren’t true? Take a pill? Turn it off and turn it on again?

Sure, there has always been a fringe element in the US. But they were confined to the fringe, and that’s not so true anymore. The fringe is now the center.

Bernie Sanders—nobody else seems to have the courage to say this—is a large-C Communist. He is very popular. On the other side, there is a faction of Trump supporters called QAnon who do nothing but traffic in conspiracies.

If it feels like the country is coming apart, it’s because it is.

Like I said, there is no money to be made in this stuff. The money is made by staying in the sane center—and profiting off of the craziness. Negative interest rates would be crazy. The S&P 500 at 5,000 would be crazy. The VIX at 8 (or 80) would be crazy.

If volatility increases in politics and social psychology, it stands to reason that it might increase in financial markets. I haven’t been too high on tail risk in the last several years, but I am starting to come around.

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#government conspiracy #conspiracy theory #jeffrey epstein

Don’t Look for Investing Advice in the Media

When I was a trader at Lehman Brothers, I was told not to talk to the media under any circumstances. If a reporter calls and says, “I’m so-and-so, and I’m from The Wall Street Journal,” you hang up. Click.

There doesn’t seem to be a good relationship between the traders and the reporters who cover them! I wonder why that is?

You might have heard about the incident at the Des Moines Register a month or two ago. A young man went to a football game and held up a sign on camera, asking for money for beer, as a joke. He got $1 million. He donated it—to a children’s hospital.

A reporter at the Des Moines Register decided to do a story on the young man. He dug up some old racist tweets from this guy—the guy that donated $1 million to a children’s hospital—and published them, in an attempt to “cancel” him.

The internet responded in fine fashion, and used the same search box to dig up racist tweets from the reporter.

This was a good opportunity for the management of the Des Moines Register to set the record straight and apologize to the young man for canceling him, but instead they canceled the reporter, firing him.

Can you imagine what kind of psychology it takes to want to ruin a man who donates a million dollars to a children’s hospital? I can’t.

The reporter said that the tweet-digging was part of a routine background check, but he would have had to search for specific words to find those tweets, so it was not routine at all.

This is where we are.

It’s Actually Worse

I don’t get wound up about this much anymore, but do you remember that incident in 2017 where a deranged Bernie Sanders supporter shot up a softball field full of Republicans, almost mortally wounding Steve Scalise?

That night I came home and was watching NBC Nightly News. The internet moves faster than TV, so by this point, we already knew from the shooter’s social media posts what his motivations were. In fact, Bernie had already been out earlier in the day disavowing his supporter.

At the end of the NBC News segment, the reporter said: “We may never know what his motives were.”

It is the 80/20 problem. Eighty percent of journalists are curious and empathetic. There are some bad apples. I have journalists who are friends. I also know journalists who are not friends. The ones who are not friends fall into two distinct categories:

They engage in the politics of personal destruction. Lots of journalists make it a mission to “takedown” the “rich and powerful.” Except the rich and powerful are people, too.

They are activists, not reporters. My suspicion is that a lot of journalists view their role as “changing the world,” rather than “telling the truth.” They try to shape opinion in subtle and not-so-subtle ways.

It’s hard to be critical of the media these days because Trump has poisoned the well. It’s more nuanced than “fake news” or “enemies of the people.” Though Trump has a point, however inartfully he makes it—most of the people who cover him have lost objectivity in one way or another.

How to Consume Information

I try to teach this to my students, or, I did when I was teaching.

When I read an article, I take into account several pieces of information:

What is the media outlet?

Who is the reporter?

What other pieces has the reporter published?

What is the structure of the story?

What is the slant?

What pictures are being used to accompany the story?

Most people do not read news critically—they just read the words, without putting any thought into who wrote them and why. This is what the journalists are counting on.

I will consume left-wing as well as right-wing media. But not uncritically! I always know the source and the motivations. In fact, it is good to see the other side.

Fox News has a reputation for being biased, but my experience with Fox News is that they have a wide variety of voices on that network, from Trumpian (Hannity) to champagne populist (Carlson) to libertarian (Timpf) and everyone in between. The opinion shows are dumb, but the news is worthwhile if you view it critically.

Journalism is always most compelling at the extremes. You should know this intuitively, but you might not—by the time the journalists get around to writing a story on something, the trend has already passed. Journalists don’t predict things, they write about the now.

The bull case is always most compelling at the highs and the bear case is always most compelling at the lows. Remember Chipotle from last year? Exactly.

In my career, I have seen people make investing errors, large and small, because of their biases. I have made some myself.

If you have a particular political bias, which you probably do, you might want to let go of it for investing purposes, if you want to stay solvent.

The conservative gold bugs cleaned up from 2009–2011, but since then, it’s been a liberal indexing/growth trade. Intellectual flexibility is the key.

So much more to say, but we’ll stop here… for now.

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Why Fractional Shares Don’t Make Sense

Charles Schwab wants to offer investors the ability to trade fractional shares of stock. You know, in case you don’t have enough money for one share of stock.

I oppose this, because as you all know, I am the Grinch who wants to take Christmas from all the Whos down in Whoville.

I’m sure some people will say that about me. I am accustomed to it. Let’s rationalize this.

The average stock is about $30.

If you don’t have $30…

You probably lack the sophistication and the risk tolerance to be investing in the stock market.

Like, if the only money you have is $5, maybe you should put that in the bank?

And besides, the first $10,000 you save should be in the bank, anyway, as an emergency fund.

And even if you do have more than $10,000, my suggestion to you is that you invest in open-end mutual funds, instead. Load or no-load, I don’t care.

You really should only be investing in individual stocks if you have $100,000, and you can build a portfolio of 20 stocks, with $5,000 positions in each of them.

If you don’t have a portfolio of 20 stocks, I would not call that investing. I would characterize that as “screwing around” in stocks.

Ok—there is a need to screw around in stocks from time to time. It’s good for people to experiment and learn how the market works. But don’t call it investing. Call it what it is—screwing around.

Investing Is Hard and Should Be Hard

The push over the last 20 years, going back to the early days of online discount brokerages, in the late ‘90s, has been to make investing cheaper and easier.

I think investing should be harder and more expensive.

And I have a bit of a problem with the “do-it-yourself” revolution, where someone can pick stocks and funds from a laptop in their bedroom.

At some point in their investing career, everyone gets tested, and it’s good to have help, a calm voice of reason to keep you from doing stupid things.

Most people have exceptionally poor ideas about risk. This is why the stock market returns eight percent, on average, but lots of folks are lucky to make zero.

As for the expensive part, I have written before that high fees should not be the enemy of investors, because high fees discourage overtrading. People in the brokerage industry have made public statements about how they hope zero commissions will not lead to overtrading.

Belief in the upward-sloping demand curve persists.

Of course, people will overtrade. The goal here is to buy and hold. High commissions encourage people to hold…for long periods of time.

I sincerely believe this—that about half the country should not be involved in the stock market at all. They should save, in a bank account. Maybe I would change their mind if, once invested, they were denied access to their brokerage account until age 70.

But there is an irresistible temptation to sell the winners and let the losers run. It is human nature. People got Nobel Prizes over this.

I Am Not the Enemy of Investors

Au contraire, I am the friend of investors. People are beginning to think about the behavioral aspects of investing, which is good.

We should all be thinking about what kind of systems we want to put in place that encourage people to buy and hold forever. Zero commissions and fractional shares ain’t gonna do it. I see this as a step backward.

Yes, fees eat into returns—but only if you trade a lot. And the higher the fees are, the less you trade. I like loads on mutual funds the best. Ain’t nobody going to whip around load mutual funds. When you invest in a fund with a 3% load, you are making at least a 10-year decision.

Some people approach fees with the indignation of Bernie Sanders, thinking that financial services employees are overpaid. Maybe. Probably not. It has nothing to do with that. Transactions costs are not the enemy.

I also think it wouldn’t be the worst thing in the world if we ditched decimalization and went back to fractions—for a whole bunch of reasons.

Anyway, enjoy your zero commissions. Wait until you day trade Snapchat 600 times in a year, make $12 in profit, and then have to type in 600 trades into TurboTax off your 1099-B.

And look:

If you can invest for basically no cost…

And buy and hold forever, without ever being tempted to sell…

Then congratulations, you are a steely-eyed missile man. And you were able to take full advantage of the low costs produced by competitive forces in the brokerage industry.

Lots of people want to own the next AMZN. But they won’t, if they sell it after it goes up 40%. Which they will be tempted to do if there is no cost to doing so. Dead horse is dead.

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When the Market Gets Expensive, Invest in Yourself

The Federal Reserve has embarked on QE4—sort of. They are buying Treasury bills.

Here we go again.

There is a genus of financial commentary that revolves solely around the Fed and its relentless pursuit of credit expansion, and how it will result in inflation. I know, because I used to do this.

This made for a good trade, from 2009-2011. Now it is mostly people being angry. But there is still a pretty huge appetite for this angry, anti-Fed commentary, so I will indulge in it, a little.

The Fed should not be doing QE4.

Something I used to say—quantitative easing is not debt monetization. Debt monetization is a matter of intent. If the intent is to keep interest rates low to finance the government, then it is debt monetization.

We are getting close.

But ostensibly, there are some reasons to be conducting quantitative easing in T-bills. It will steepen the yield curve. Minneapolis Fed President Neel Kashkari went a step further and said that we should be doing yield curve control like Japan, to ensure the yield curve remains steep.

Maybe we should let the market determine interest rates? Unfashionable idea, I know.

To answer your question, yes, we are all going to hell. It will be because of the Keynesians. Their sack dance continues, because relentless credit expansion has so far ensured that recessions are in short supply.

My guess is that we’ve lengthened the cycle and increased the amplitude.

If you think inequality (and the political angst that goes with it) is bad now, you ain’t seen nothing yet.

This Is Not an Article About Finance

No fun being a finance junkie these days. All bad news. And yes, stocks going up is bad news, if they’re going up for the wrong reasons.

We live in an economy full of distortions caused by interventions of varying magnitudes. And it is definitely going to get worse.

If you sat around and worried about this stuff all the time, you would make yourself miserable.

But if you sat around passively and didn’t take any action to protect your assets, that wouldn’t be very smart, either.

I suspect many of you fall into the same camp as me—you have enough wealth to get totally screwed by the authorities, but not enough that you can really protect yourself. You’re not a billionaire.

You do things where you can—buy gold or bitcoin—but I can think of a hundred different ways that won’t work out, either.

My recommendation is simple. Do not spend too much time thinking about this stuff. Of course, if you were really paranoid, you’d be on the first plane to Singapore with a tube of toothpaste full of diamonds. I really do not want to get to that level of paranoia. It isn’t healthy.

Then again, there have been times in history where the people with that level of paranoia were the ones who survived.

Things You Should Invest In

So let’s talk about things you should invest in. I will preface this with the fair warning that the following applies to people who have already accumulated wealth.

Experiences: Concerts, clubs, hiking trips, winery tours, etc. You should spend money on memorable experiences, then treasure the memories. Fly to Paris for a weekend. Have you ever done that? I have done that. Will never forget it. When your favorite band comes to town, go see them. I know it is past your bedtime. You only get one shot at this.

Luxury: Suits, shirts, casual clothes, watches, shoes, cars. I know the 2005 Corolla helps you save money. We do not know what’s going to happen over the next ten years. You might as well enjoy your money now. I’m not kidding.

Food and Drink: Nice dinners, fine wines. Nothing like the tactile sensation, however fleeting, of eating really good food.

Things you should not invest in:

Stocks And Bonds: They give you no enjoyment. Soon, they will be taxed out the wazoo.

(Please take me seriously, but not literally. Of course, you will have stocks and bonds. The point here is to think about consumption as an asset class, of sorts.)

A lot of people, myself included, spend time trying to think up the optimal asset allocation. Honestly, most assets look bad, and I’m pessimistic enough about the future that it makes me want to enjoy the present. Especially if you’re of an age where you should be decumulating assets anyway.

He who dies with the most toys does not win.

So my investment “advice” these days is kind of like anti-investment advice. Everything is unattractive, and we’re all going to get hosed by wealth taxes and negative interest rates, so you might as well enjoy yourselves.

Start today. If you’re not in the habit of going out to dinner on a Thursday night, do it. And stop by the jewelry store on the way home. I doubt there will be a wealth tax on that.

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Baby Boomers Are the Worst Investors in the World

Baby boomers, man.

Before I begin, a good rule of thumb for anything I write: don’t take anything personally.

Baby Boomers are the worst investors in the world.

I have seen it with my own two eyes. They got gorked up on dot-com stocks in 1999, then got rinsed. They got gorked up on stocks again in 2007, then got rinsed.

They are gorked up on stocks again.

Have you ever tried talking to a Baby Boomer about their asset allocation?

Hey Dad… uh, you’re getting close to retirement. Don’t you think you should lighten up on stocks?

We all know how that conversation goes. Not well. Especially with cable news turned up to 11 in the background.

The Rule of Thumb

In the old days, they had this rule of thumb that your age should be your percentage allocation to bonds. So if you were 70 years old, you should have a 70% allocation to bonds.

The reason is simple.

When you’re close to retirement, you don’t want to risk losing it all. You want something safe, that spits out some income.

In my travels, I would say that the average Baby Boomer has an 80%-90% allocation to stocks. When the sane, sober Generation Xers try to have a conversation about de-risking, they get told to beat it.

For whatever reason, Baby Boomers have an insane tolerance for risk. And it has not served them well. They are wealthy, but they could have been wealthier.

They are credulous. If a bubble pops up, they believe in it, and dive in headfirst, whether it’s cannabis or dot com or security stocks. Not bitcoin—that posed a technological hurdle they could not overcome.

Ironically, the one bull market they have not been sucked into is bonds. Which is the one thing they should have been investing in all along.

Boomers and Bonds

Bonds are for old people—although not just for old people—and yet old people don’t want them.

A little louder, for the Tommy Bahama shirts in the back:

If the stock market crashes, you are all screwed.

Pretend you have $2,000,000 saved for retirement. In 2008, the stock market went down nearly 60%.

If the stock market goes down 60% again, you will have $800,000, which will drastically reduce your standard of living in retirement.

Theoretically this would get your attention, but it probably doesn’t because you don’t think it’s possible that the stock market would go down 60 percent again.

You’re right. It might go down more than 60%. There is precedent for that, too.

This is why stocks are unsuitable for all different kinds of people—they make sense for people in their 20s and 30s, and also 40s, but as you get older you have to cut risk dramatically.

This used to be the conventional wisdom. Not anymore. What happened?

What happened was an 11-year bull market. There are lots of investors whose investing career has not spanned a full cycle. Only the first half of the cycle, which is less instructive than the second half.

Boomers have been through a bunch of cycles and, as a cohort, have learned precisely zero lessons from them.

But What About Low Rates?

I get asked this all the time, so I will answer this question one more time…

“Why invest in bonds when interest rates are so low—when it’s clearly a bubble?”

Stocks are a bubble, and yet you invest in those.

Believe it or not, interest rates can go lower, and probably will.

But most of all…

Bonds provide diversification.

Stocks may have gone down almost 60% from 2007-2009, but a 35/65 portfolio of stocks and bonds only went down 24%.

That fact remains relevant whether you believe bonds are “in a bubble” or not. I have a bit more to say on this, which I will send to you tomorrow.

Here’s the thing—financial markets simply aren’t fair. They’re not fair to normal human beings with normal human emotions, people who get excited by high prices and demoralized by low prices.

A humblebrag: whether because of genetics or study or whatever, I have been blessed with the ability to do the opposite: I get excited by low prices and demoralized by high prices.

Financial Advisors

Many financial advisors (lots of them CFAs and CFPs) are motivated by one thing and one thing only—retaining assets. Before any financial advisors get angry here, I'll refer you back to my earlier rule of thumb: don't take anything I write personally

Anyway, the worst-case scenario for these advisors is that you pull your account. Most people don’t pull their accounts when they lose money—it is easy for the advisor to shift blame to the market. They pull their accounts when they don’t make as much money as everyone else.

If you went to your advisor and asked to shift your asset allocation to bonds, he or she is going to put up a massive fight. Because your expected return will drop, and you won’t make as much money as “everyone else.” If you’re all in stocks, and you lose money, well, so will everyone else.

That is a fight you might not win. If you told him about this guy on the internet yammering on about bonds, he would probably tell you that I am a crank.

Financial advisors are many things—relationship managers, mainly—but the majority of them are not market experts. His opinion is no better or worse than the person on CNBC.

I have a strong suspicion that very few Baby Boomers will take my advice. Because, you know, Baby Boomers.

It’s not about my giant ego. I try to prevent unnecessary misery. How am I doing?

I give myself a D+.

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How to Build Your Own Bond Portfolio

Most investors seem to fall into two camps when it comes to bonds.

On one side, there are people who remain anti-bonds. Or at least, anti-investing-more-in-bonds.

On the other side, there are the “yes, but” folks. They get why it’s important but don’t take action because they don’t know where to start.

If you are in the latter camp, let me tell you how you should build a bond portfolio.

Know Your Risks

The best way to build a bond portfolio is to start by thinking about the risks.

A portfolio of bonds can go down, you know.

Yes, I know that US Treasuries cannot technically default (or at least, they haven’t so far). But their price can go down, and substantially.

For example, if long-term interest rates go up a lot—say 2% or so—the price of a 30-year Treasury bond could drop by as much as 40%. That’s a scary number.

Most people aren’t worried about that right now. They may be someday.

So the first consideration is the direction of interest rates, known as duration risk. For US Treasury bonds, that is pretty much the only risk.

For other types of bonds, there are other risks.

Corporate bonds can and do default. They haven’t in a while, but they will someday. More important, the price of these bonds will decline as the market perceives companies to be less credit worthy.

This is known as spread widening. The spread between corporate interest rates and Treasury interest rates will widen.

In the last credit meltdown in 2015, led by energy credits, high-yield spreads widened to about 700 basis points over Treasuries.

That’s a bunch of gobbledygook to many people. What does that mean to me as an investor in a bond mutual fund?

Well, if you own a high-quality, investment-grade corporate bond fund, the most it can probably go down because of credit concerns is about 5–7%. If it is a fund that is concentrated in BBB credits, perhaps a bit more.

If you own a high-yield bond fund that focuses on BBB credits, your downside is probably capped at around 20%. If it owns mostly speculative CCC credits, you could lose 30% or more. This is also true for convertible bond funds.

With international bonds, it is very much dependent on the situation, but emerging market bonds tend to be very economically sensitive and the downside could be large if we have a global recession.

Mortgage-backed securities are pretty boring most of the time, except in 2008, or if interest rates rise rapidly.

One day, municipal bonds will be very, very exciting. Although people have been saying that for 15 years or more.

Now that we know the risks, let’s build a portfolio.

Reach for Safety

What is your income?

If it is north of $300K–$400K, you will want to consider owning lots of municipal bonds.

Yes, I’ve heard all the arguments against munis—unfunded public pensions leading to muni bond defaults, blah, blah, blah. Maybe that is an issue in the next recession. Maybe not.

For the rest of the portfolio, you will want a mix of Treasury and corporate bonds. With yields this low, people are tempted to massively overweight corporates. I understand that sentiment.

By the way, one thing that is poorly understood about investment-grade corporate bonds is that they are also very sensitive to interest rates.

When Apple issued their first bonds back in 2013, people were surprised to see 10% of the value evaporate in a month—all on duration.

High-yield bonds have a little exposure to interest rates (especially with the low coupons these days), but not much. Mostly, they are correlated with stocks.

So:

Treasury—all interest rate risk.

Investment-grade corporates—some credit risk, some interest rate risk.

High-yield corporates—mostly credit risk (they behave like stocks).

I don’t have a rubric here for what you should do, but your instincts on this—to overweight corporates to get more yield—are probably bad. This is actually the wrong time to be reaching for yield.

It’s the right time to be reaching for safety. Had you done so eight months ago, you would be pretty happy today. Treasury bonds are up over 20% this year.

Maturity Matching

The other thing you need to consider when building a bond portfolio is the length of maturity you want.

Short-term bonds = less interest rate risk and less credit risk.

Long-term bonds = more interest rate risk and more credit risk.

You could just do it naively and pick a range of maturities. I’m not going to talk about it here, but you might want to do some research on bond laddering. The idea is to spread your risk along the interest rate curve.

The school of thought is that you want to match your bond maturities with your liabilities.

If you are going to retire in 30 years, you probably want 30-year bonds. If you are going to send a child to college in 10 years, you probably want 10-year bonds.

If you have a view on interest rates, that can help. For example, I think that the Fed is likely to cut rates to zero and beyond. This would make shorter maturities more attractive.

Once you put together your portfolio, you can figure out the weighted average maturity. A typical bond portfolio has a weighted average maturity of 5–7 years. If you are worried about interest rates or credit, you can make it shorter, or vice versa.

More Art than Science

The key here is diversification.

A portfolio full of municipal bonds will expose you to, well, the idiosyncratic risk that muni credit blows up.

And yes, this is more art than science.

And I know it’s not straightforward. One of my readers said this recently: “I went into bonds hoping to ease up on time needed on my portfolio, but now I think shares are simpler!”

He’s not wrong.

But the bond market is much larger than the stock market. For many reasons, it is not clever to avoid it altogether.

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When Most Investors Believe Something, It’s Usually Wrong

You have probably heard that $15 trillion of bonds are trading with negative yields. That’s 25% of all sovereign bonds outstanding.

Lots of people are furious about this—but it’s no use getting mad at the market.

Lots of people say it doesn’t make sense.

It makes sense to me, and to a few other people.

If you see something in the market that doesn’t make sense, it’s usually best to stay away, rather than picking a fight with it.

We’re not in uncharted territory here.

Let’s Do a Market Psychology Exercise

Back in 2012, 10-year yields were actually lower:

And again in 2016:

Both of those times (and I remember this quite clearly), people were bullish on bonds and said that yields were going lower. Instead, they rocketed higher.

They said that the deflation/disinflation that we were experiencing was unstoppable, and a whole bunch of other stuff, that turned out not to happen.

In 2016, I presented a short bond thesis at a conference, and I practically got hounded off the stage. Nobody remembers this, but everyone was really bullish on bonds back then.

It was actually kind of a weird situation. The organizers of the conference avoided me after that, like I was radioactive.

Now, practically nobody is bullish! Why is that? I suppose the inflation picture is markedly different—we have tariffs and there are wage pressures and such—but I don’t think that’s what this is about.

My thesis, which I have carried around for 20 years: When everyone believes something, it is usually wrong.

What does everyone believe right now? That negative yields are unsustainable.

Maybe that is true. Maybe not.

Bubbles in Everything

You can have a bubble in any asset class, from little stuffed animals to lines of computer code. Why not bonds?

The bitcoin bubble burst when there were more Coinbase accounts than Schwab accounts, and there was a bitcoin rapper in the New York Times. We don’t have any bond rappers yet, so I’d say the bull market has a ways to go.

George Soros always said that if he saw a bubble forming, he would get in there and try to make it bigger—which is pretty much the opposite of what everyone does.

What everyone does, is go on Twitter to complain about it.

I can’t do one scroll through Twitter without someone freaking out about negative interest rates. Turn on the internet and see.

But what if negative interest rates… are normal? What if they make sense?

Ask this question around certain people and they completely lose their minds. The last time I saw people get this indignant about a trade, it was… Beyond Meat. See how that turned out.

I have experience with this sentiment thing.

When something makes people angry, I have confidence that the trend in question will continue for a very long time. I think negative rates are not an aberration and could become a semi-permanent feature of finance.

When people start to believe in negative rates, they will probably come to an end.

Stupid Things Get More Stupid

Lehman Brothers was a “bond house.” It was really good at fixed income—not so good at equities. Though equities did pretty well toward the end.

It was kind of hard not to be exposed to bonds at Lehman, even if you did work in equities. If you recall, the Barclays bond indices that we have today used to be Lehman bond indices.

I got a lot of customer flow in the 20+ Year Treasury Bond ETF, TLT, and it was because Lehman had the index.

I also took six weeks of bond math when I joined the firm in the summer of 2001, and most of it stuck with me.

A lot has changed since then. Most of the trading activity in US Treasuries is electronic. Back then, it was all high-touch—carried out by actual humans.

A lot has remained the same. It’s still fundamentally the same market that it was 20 years ago.

There’s a lot more debt, but one thing that has remained constant is how difficult it is to trade off of supply—the idea that more bonds make rates go higher.

And, people believe strange things about the bond market these days—they think more supply makes interest rates go down.

If you think things are stupid, they will probably get more stupid. You can put that on my tombstone.

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