The Hazards of Asset Allocation in a Late-Stage Major Bubble

https://www.gmo.com/asia/research-library/waiting-for-the-last-dance

by monsieurpng • 6 years ago

125 127 6 years ago

lixtra2• 6 years ago

Asset prices are just one parameter in a complex system. Inflation is another. For example commodity prices could inflate so fast that earnings of companies grow into their valuations.

Another parameter is whether you’re free to spend your money. Currently in lockdown, all my money doesn’t buy me a dinner with friends in a restaurant (okay, I could pay a hefty fine, so restaurant dinners have inflated 1000%s in price!).

It’s not clear to me how the future will unfold and therefore I spread my worth in various assets and consume what may be unavailable soon.

ethbr0• 6 years ago

Most of the stock market focused writing recently appear to be from one of two perspectives, with very little big picture that unifies both.

1) The monetary perspective, in which stock prices are what they are, but there's a broader game (the real economy) of primary concern

2) The stock market analyst perspective, in which stock prices ebb and flow within a given range according to somewhat understood patterns

The issue is that (1) has been taking monetary actions never before seen (not even to support WWII), and (2) is crying from the rooftops that nothing makes sense when analyzed under historical pricing standards.

Well, yes. Both of these are true.

dasudasu2• 6 years ago

You have the democrats calling for "trillions" in stimulus: https://www.bloomberg.com/news/articles/2021-01-08/biden-cal...

You have Jerome Powell telling you that "stocks are not that high" considering that the risk free rate just collapsed: https://www.cnbc.com/2020/12/16/powell-says-stock-prices-are...

If they want to go by history, they just have to look back at the last decade to see what this does to a stock market. There is no alternative.

mxschumacher• 6 years ago

Much higher commodity prices would eat into the margins of any company using those resources, thereby decreasing their value

lixtra2• 6 years ago

That depends on the pricing power of the company. But true, I rather meant broad inflation than commodities only.

freddie_mercury2• 6 years ago

GMO is a perfect example of HackerNews's cognitive bias towards cynical and pessimistic takes and thinking they signal intelligent commentary.

GMO's assets under management have collapsed by well over 50% over the years as they've been consistently wrong about, well essentially everything, in the markets for 10+ years now.

But they wrap up their pessimism in technocratic mumbo-jumbo so it sounds like an objective take and a certain kind of audience eats it up.

JohnJamesRambo2• 6 years ago

Well if you read the article they mention these things.

Far more typically, I was three years too early in the Japan bubble. We at GMO got entirely out of Japan in 1987, when it was over 40% of the EAFE benchmark and selling at over 40x earnings, against a previous all-time high of 25x. It seemed prudent to exit at the time, but for three years we underperformed painfully as the Japanese market went to 65x earnings on its way to becoming over 60% of the benchmark! But we also stayed completely out for three years after the top and ultimately made good money on the round trip.

It’s really really hard to call tops and bottoms but that doesn’t mean I just blindly invest no matter how irrational the market has become. Some of these things are just plain math, something Hacker News readers should be good at.

As a Model 3 owner, my personal favorite Tesla tidbit is that its market cap, now over $600 billion, amounts to over $1.25 million per car sold each year versus $9,000 per car for GM. What has 1929 got to equal that?

viktorcode2• 6 years ago

> As a Model 3 owner, my personal favorite Tesla tidbit is that its market cap, now over $600 billion, amounts to over $1.25 million per car sold each year versus $9,000 per car for GM. What has 1929 got to equal that?

This example shows how shallow this analysis is. They totally ignoring shift to green energy and that Tesla is a participant in this market. They are also considering Tesla as just another carmaker in the market, not paying enough attention to the many core differences. GM in my view is as far anti-Tesla as you can get.

bob33212• 6 years ago

In 2000 AMZN was worth $500 per book sold each year and Enron was worth $.01 megawatt hour traded each year.

nabla9• 6 years ago

They are right about high valuations in general. Their conclusion is just looking back and assuming future is same as before, with little to no reasining.

What very high valuations mean is lower ROI in the future, only that. I'm 99% certain that Total Return (TR) from stock markets 2010-2020 >> 2021-2030. SP500 TR is 13.97% annualized for last 10 years (price return 11.64%). I'm surprised if it's above 5% annualized for next 10 years.

That does not necessarily mean rapid decline in valuations (as bursting or crash). It can be stagnated stock market. It can be market boom that continues next 5 years and then fall back little above 2020 levels.

peterlk• 6 years ago

and thinking they signal intelligent commentary

Can you point out where in the writing their commentary is not intelligent?

You seem to be attacking the author of this article but make no commentary about the weakness of their arguments. This makes me more inclined to believe them over you. I'm not saying you're wrong, but as someone who doesn't know much about the market, I do not see the implicit/obvious points that would prove the article wrong. Furthermore, being wrong in the past does not preclude someone from being right about the future, and vice versa.

freddie_mercury2• 6 years ago

GMO's forecasts, and really the backbone of their entire investing philosophy, is that valuations will revert to historical averages.

Valuations are a non-stationary process with no defined mathematical mean, so the entire concept of "mean reverting valuations" is nonsensical.

Their entire investing philosophy isn't based on some deep understanding of the market but is simply an "end of history illusion" that the past (in this case the era in which the principals of GMO came of age) will continue unchanged indefinitely into the future.

It isn't just they they've been wrong about US valuations and US returns. They've also been wrong about Emerging Market valuations and those returns. It can't just be handwaved away as "US investors went crazy for FANG and Tesla" because that only addresses half their failure.

fractionalhare3• 6 years ago

GMO's assets under management have collapsed by well over 50% over the years

Do you have a source for this? It looks like they've been hovering at $64B discretionary AUM since 2014, and that hasn't changed through 2020. [1][2]

All I could find was this article, which I think might be misleading. [3] It seems like it might be conflating GMO's total AUM with the AUM of its asset allocation business, but I'm not sure.

1. https://web.archive.org/web/20150408043537/http://www.gmo.co...

2. https://www.gmo.com/globalassets/documents---manually-loaded...

3. https://www.google.com/amp/s/www.marketwatch.com/amp/story/i...

viktorcode2• 6 years ago

Thankfully, there's a measure of how correct a financial strategist is: fund performance.

You believe Epic Bubble is nigh? Then you know how to make the most of it. Don't just preach, lead by example.

ProjectArcturis5• 6 years ago

No, these only happen once or twice in a career. The sample size is too small. They are hard for anyone to get exactly right. Someone who nails the top this time around is much more likely to have been lucky than skillful.

jokethrowaway2• 6 years ago

I'm not following. Let's assume there's a big bubble. What do you recommend?

Currency kept getting printed by idiotic governments and distributed to mainly rich people which invest in stock, crypto and gold, overinflating their value.

Shorting the market is risky, how long can you keep shorting until you run out of money?

I don't see a slam dunk anywhere even if you think there's a epic bubble

pembrook6• 6 years ago

Word of caution to anybody reading this, GMO has been saying this for years...and they will be right eventually of course...but it doesn’t mean you should do anything different with your money.

A tale of the worlds worst market timer: https://awealthofcommonsense.com/2014/02/worlds-worst-market...

dash2• 6 years ago

The problem with the story is it works if you invest in stocks and don't use margin. Lots of people are playing options and using margin. They risk getting called, and at that point they don't have the ability to buy-and-hold.

pembrook6• 6 years ago

So maybe don’t buy speculative zero-sum option contracts on margin then?

Play stupid games, win stupid prizes.

DennisP6• 6 years ago

The article actually talks about their record:

in late 1997, as the S&P 500 passed its previous 1929 peak of 21x earnings, we rapidly sold down our discretionary U.S. equity positions then watched in horror as the market went to 35x on rising earnings. We lost half our Asset Allocation book of business but in the ensuing decline we much more than made up our losses.

For the average investor it might be overly bold to step out of the stock market entirely in times like these. However, there's nothing wrong with moving to a more conservative allocation that will do better in crashes, but still perform reasonably well if you hold it that way forever. A great place to start is the sample portfolios at portfoliocharts.com.

If you're 25 and saving to retire at 65 then maybe don't worry about it, but if you're 50 that's another matter.

throw0101a2• 6 years ago

However, there's nothing wrong with moving to a more conservative allocation that will do better in crashes, but still perform reasonably well if you hold it that way forever.

Rates of return are not the only reason to hold an particular type of asset, which is why bonds may be worth having even if yields are low:

* https://awealthofcommonsense.com/2020/08/why-would-anyone-ow...

ProjectArcturis5• 6 years ago

The article that GMO wrote puts the best spin on their record. The actual performance can be seen here: https://finance.yahoo.com/quote/GMWAX?p=GMWAX Going back to its inception in 1996, their global allocation mutual fund has returned roughly 15%. Not annualized, 15% TOTAL during a period when the S&P tripled. GMO are worthless as advisors.

staticman2• 6 years ago

The average investor has little money to save and can't afford more conservative investments with lower expectes returns to meet their goals.

itsoktocry7• 6 years ago

A tale of the worlds worst market timer: https://awealthofcommonsense.com/2014/02/worlds-worst-market...

I see this posted from time to time, but the assumptions are kind of silly. A huge portion of the "miraculous" returns come from the fact that this fictional person was able to put an entire year's worth of salary into the market in one go, 50 years ago. In 1970 the average salary was about $6,000, but he managed to save one third each year to invest?

So, sure it demonstrates the power of compounding. But, to me, an alternative lesson is that you can be an incredibly diligent saver and, through sheer bad luck, have barely enough to retire. I mean, it's not like $1MM in retirement money means "set for life" anymore.

Closi10• 6 years ago

It's not like $1MM in retirement money means "set for life" anymore.

It absolutely does, unless you are planning on living in a mansion eating nothing but caviar.

pembrook6• 6 years ago

What's your better, alternative option?

You're saying that $1MM in retirement isn't as much as you'd like...so...it'd be better to have nothing and have saved zero?

valuearb4• 6 years ago

He never saved more than $6,000 a year, which is likely less than 10% of his income at terminus.

And you missed the point that this is the worst you could do. If “Bob” had simply invested every year, his end result is likely 2-3x.

heipei• 6 years ago

It's not about the absolute numbers so much as the fact how that fictional saver behaved after having a huge chunk of his investment wiped out by each following market downturn: He never sold anything, and that's the key lesson here. For me reading about this worst market timer was actually quite comforting because it's assuming the unrealistic worst-case scenario in terms of timing coupled with level-headed behaviour afterwards.

There was also a study done by Vanguard which showed that historically, dollar-cost averaging underperforms lump-sum investments which was just as interesting to me.

throw0101a2• 6 years ago

The best thing to do, given that most people's largest saving goal in life is retirement, is to put away a little away every month. Sitting on the sidelines will give you absolutely abysmal long-term returns, even if you were omniscient and knew ahead of time when the crash(es) would come:

* https://ofdollarsanddata.com/even-god-couldnt-beat-dollar-co...

If you know when the peak and the trough will be, then you can jump in an out. The thing is by missing the worst days you tend to miss the best days:

* https://theirrelevantinvestor.com/2019/02/08/miss-the-worst-...

jgalt2123• 6 years ago

It pretty much comes down to how long can Fed keep printing $100B+ a month of money. Nothing else matters.

https://www.goodreads.com/book/show/27191691-the-only-game-i...

kruxigt• 6 years ago

Correct answer!

lumpy283• 6 years ago

I think he is right to mention the unprecendent gap between the economic fundamentals and their financial representations.

Plus > The single most dependable feature of the late stages of the great bubbles of history has been really crazy investor behavior, especially on the part of individuals.

That trend is even "truer" today, fostered by Robinhood and Co (eToro, Revolut, etc.). The access to markets was not as easy in 2008, limiting the role individuals could play in a bubble.

lotsofpulp3• 6 years ago

unprecendent gap between the economic fundamentals and their financial representations.

The fundamental fundamental is the house always wins, and the leaders of the US have indicated they will do whatever it takes to maintain broad market asset prices.

lumpy283• 6 years ago

So who is going to lose? There are always winners and losers in markets.

lordnacho• 6 years ago

As a former fund manager, I think this is a well written essay by a well respected guy. He gives a lot of pointers to evidence as to why it's a bubble. He tells us why it's hard to time, but remarkably he gives a relatively tight timeframe (weeks to months) as well as a trigger: widespread vaccination.

Of course it's just a summary of conventional thought about bubbles, but it's a good summary.

CapriciousCptl• 6 years ago

In 2021, everything's a bubble.

  Bonds... 10-year treasury after tax amounts to less than inflation.
  Holding cash... The USG keeps giving out money for nothing, meaning more money chasing the same amount of goods, services and investments.
  Index funds... Earnings yields are at all time lows, about 3%.

kyleblarson• 6 years ago

If pundits like this guy are so wise, why are they 1) Always on CNBC talking about stuff like this rather than trading it and making a killing 2) Still working when they are as old as the author of this article?

wcoenen• 6 years ago

This man was recently in the news for having made $200M on Quantumscape by accident, obviously he doesn't need to work. He's said to work "primarily in environmental philanthropy".

https://www.ft.com/content/faedd2a1-2008-4f1e-9198-7694fba79...

mensetmanusman2• 6 years ago

It’s possible to mistake a bubble forming for intentional inflation.

The Fed has pumped a few trillion dollars into the global economy. This will inflate some prices somewhere.

The inflation has hit equities and real estate but kept consumer prices mostly intact.

The trillions aren’t going anywhere for a long time...

godzillabrennus• 6 years ago

Real estate prices always go up... same mentality as 2007/2008 housing crisis...

paulmendoza3• 6 years ago

Yes, 24% of all US dollars ever created were created last year. Very little went to poor people.

mensetmanusman2• 6 years ago

Yes, the US printed like $20k per citizen.

Our world would be a lot more interesting if that had went directly into the hands of citizens instead of the hands of real estate and Wall St.

midhhhthrow2• 6 years ago

Absolutely.

Money has to go somewhere. The feds and gov of the world have ensured that no one can be in cash for long. So, money must go into equities, gold or bitcoin

lamontcg• 6 years ago

Money can go under the mattress.

Monetary velocity is collapsing.

Literally everyone seems to have turned into an Austrian economist lately.

Nobody remembers "pushing on a string" these days and the "Fed Put" is so accepted that it isn't even discussed, it is just assumed the world works that way.

jokethrowaway2• 6 years ago

This is just the last one...

Keynesian policies have been all the rage in the western world in the last decades - we'll pay the price at some point.

hacker_9• 6 years ago

People forget the stock market is just a device to turn money into more money, which creates (and requires) sustained bubbles. There will be a blow off the top from time to time, but this just gives you a chance to buy at lower prices and so get better returns when it ticks up.

akkartik• 6 years ago

The most useful part of this for me:

"my definition of success for a bear market call.. It is simply that sooner or later there will come a time when an investor is pleased to have been out of the market.. requiring that you get the timing right is overreach. If the hurdle for calling a bubble is set too high, so that you must call the top precisely, you will never try. And that condemns you to ride over the cliff every cycle, along with the great majority of investors and managers."

eloff4• 6 years ago

GMO has pounding this drum for years[1][2]. Eventually, they'll be right, but not because they were able to call it correctly. In fact given the run-up since they started calling for the bubble to burst you'd likely still be ahead if the bubble burst tomorrow and stocks halved in value.

Now a lot of what they say has some truth to it, and they might actually be right. But they might also continue being wrong for years to come. Timing the market is a fools errand. Good advice is invest mostly by value or underestimated growth stocks, invest continuously, and only with money you don't need for at least 10 years. And finally, when the inevitable plunge does come, don't sell no matter how bad it gets. You only lose or make money when you sell, before that it's just points on paper.

[1] 2018 https://www.institutionalinvestor.com/article/b1743d0x0ms3yx... [2] 2017 https://www.gmo.com/americas/research-library/is-the-u.s.-st...

segmondy• 6 years ago

I agree with the article that we are in a bubble, but what it doesn't talk about is about inflation and also that the dollar could be rapidly declining in value, which will cause the price of things to rise. I have witnessed and experienced in my lifetime in under a decade country that had a currency value of 1:1 with USD have their currency lose value and end up at a ratio of 100:1USD. Meaning price of everything goes up 100x. If dollar is falling compared to yuan and say EU, let's even say it only falls 5x. That means price of milk can go up to $10, $100k houses can go up to $500k, and $100 stocks $500. Of course the price in commodities are often slower than stocks, but as the stocks go up and "everyone" get's reach and some gains are coming out, those gains turn into actually cash that also drive up price of commodities. So as the market melts up, if you stay out, you are going to get very poor. You want to melt up with it, in the future tho, all that money will be worth very less or near the same of what it was worth. Frankly it's a big casino, and all one can do is hedge. I see folks beating the article up, but the title captures the environment. "The hazard of asset allocation in a late-state major bubble". You can do the right thing and completely lose. I suppose one key thing he's pointing out is that you don't want to get wiped out, have enough to get back in the game.

The Hazards of Asset Allocation in a Late-Stage Major Bubble

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