The world order of the past 32 years has been characterized by a buoyant economy and the spread of democracy under the protection of Pax Americana – a period of relative peace and stability that began with the fall of the Berlin wall in 1989 and arguably ended almost exactly one third of a century later with Russia’s invasion of Ukraine in 2022.
The tailwinds from this exceptional three-decade period have fostered a palpable sense of complacency and overconfidence among investors, which, if left unaddressed, could expose them to significant vulnerabilities in their investment plans.
This newsletter, among the most important that I have written, is designed to help address investor complacency and overconfidence in a way that will equip them for future success. Nothing in this newsletter is a forecast of gloom and doom ahead for the financial markets.
Thinking about the next big block of time (the next 30 years, or so), the new world order is likely to be meaningfully different. One cannot predict exactly what this new world order will be, but it will likely be much more challenging. International conflict, protectionism and bad economic ideas and trends seem to be on the rise. Looking at the developed economies in the world, and especially ours, we are in a pattern of running huge deficits and increasing debt at a greater rate than the economy is growing.
One major expected consequence is that inflation and interest rates, which had been close to zero for much of the past 32 years, will likely be meaningfully higher over the next few decades. The effects of this will show up in the financial markets.
I am not predicting that there will be more crises. The relatively benign old-world order had its own terrible shocks: the implosion of the dotcom bubble, 9/11, the global credit crisis and Covid 19, most recently. I am simply saying we are likely entering an era of different shocks. The number and nature of shocks has never mattered! It has always been the difference that the investor perceives -- relating to the current shock being experienced -- that has taken investors out of their plans and interrupted their compounding unnecessarily (potentially jeopardizing their wealth and even their retirement).
This is the origin of what I refer to as the four word death song of the American investor that is always sung when investors try to rationalize abandoning a plan in response to a perceived “unprecedented” event – “THIS TIME IS DIFFERENT!”
ANTIFRAGILITY IS THE KEY TO SUCCESS AHEAD
“Anything that has more upside than downside from random events (or certain shocks) is antifragile; the reverse is fragile.”
- Nassim Nicholas Taleb
After a long period of relative calm and very strong returns in the financial markets (marked by unusually low volatility), it is more important than ever for investors to become antifragile. The reality is that during such relative calm it is easy for complacency to cause investors to forget that (politically, geopolitically, economically and/or financially) the world breaks about every 5 to 10 years:
- 2020 – one-in-a-100-year global health pandemic, sending the S & P 500 down a record 34% in 33 days.
- 2008 – near collapse of the global financial system.
- 2001 – the first major terror attacks on US soil, leading to the financial markets shutting down for a week.
- 1991 – the fall of the Soviet Union.
- 1987 – the S & P 500 shed nearly a quarter of its value on a single day (an occurrence still without precedent).
- 1979 – end of a decade ushering in record rates of inflation, interest rates and unemployment, all nearing 20%.
- 1960s – the Cuban Missile Crisis and assassination of JFK early in the decade, followed by the Vietnam War and assassination of Martin Luther King Jr.
Historically, there is almost no exception to this pattern.
In the face of current relative investor complacency in a world that breaks so often and with many different crises likely ahead, today’s investor must become “unbreakable/antifragile!”
WE NEVER INVEST IN THE STOCK MARKET
In response to major crises, the “stock market” has historically declined an average of 33%. Each crisis is manifestly and inarguably different than previous ones. By the time the stock market -- which is where the craziest people in the world gather every day to do the craziest things they can think of – is down 30%, it has long since finished discounting the current crisis. Instead, it began discounting mass panic. As market declines deepen, the values of the great companies will separate from the prices of stocks, and they will go off in different directions. To succeed, investors must stay focused on the right variable (long-term enduring values of companies versus short-term stock prices). At market extremes, it is impossible to focus on both.
The S & P 500 companies enter crises not as victims, but as opportunists. They are among the most profitable, strongly financed, best managed, most innovative and transparent companies on the planet. They are the greatest companies because, for decades upon decades, they have demonstrated their ability to take in and absorb crises, work on, around and through the problems and emerge stronger on the other side. They are not simply resilient, which would indicate they were able to get through the crisis but came out, temperamentally, the same. They are antifragile, because they emerged stronger from the crisis and will not fear the next crisis. This is how investors must learn to respond to market crises. The ability to do this starts with accepting that they are invested in great companies -- NOT IN THE STOCK MARKET -- whose values are increasing when stock prices are declining. The increase in the long-term enduring value of companies is permanent, while the short-term declines in the prices of their stock is temporary!
The resilient investor will cringe as prices decline but they resist selling out. However, they will continue to view future crises as threats. The antifragile investor welcomes the opportunity to buy barrels full of shares while stock prices are declining, and the long-term enduring company values are increasing. They will view future crises as opportunities.
“Every past decline looks like an opportunity; Every future decline looks like a risk”
- ~Morgan Housel
STEPS TO ATTAINING ANTIFRAGILITY
Since surprise is the mother of panic, embrace and engage with history so as not to be surprised by different or seemingly unprecedented shocks. Understand and embrace the difference between investing in “the stock market” and investing in “great companies.” The stock market has nothing to do with goal-focused, planning-driven, long-term investors!
Understand some key facts about the history of stocks:
- Since 1980, they’ve experienced average intra-year declines of about 15% (for any or no reason).
- One year in five or six, the declines have averaged twice that amount, about 33% (the average bear market decline).
- All major declines are catalyzed by an event that is different than past events, but what all the declines historically have in common is that they are TEMPORARY!
- We have never known and can never know, in advance, how when or why the crises will be resolved, as there are no facts about the future. We simply must accept that they will get resolved. Since certainty does not exist anywhere as a condition in nature, we must learn to consistently practice rationality under conditions of uncertainty.
- We must NEVER change our portfolio or plan in response to political, geopolitical, economic, financial market or current events. The only time a plan should change is in response to a change in our goals or a life-event change.
- We must remember that our investment success is never to be measured relative to a random market benchmark (i.e., S & P 500 performance) but always to the only relevant benchmarks we have -- our plan and goals.
- The steeper and faster the decline, the steeper, longer and stronger the increase. The S & P 500 declined from roughly 3,300 to 2,200 in one month (March 2020). Today it stands at 6,000 –having tripled in less than 5 years (a return of 13% annually). The credit crisis-driven market decline from roughly 1,500 to 650 caused an historic 60% plunge in the 1.5 years ending in March 2009. What followed was one of the longest and strongest secular bull markets in history, increasing 9-fold and annualizing at about 17% through December 2024. THIS IS HOW IT WORKS AND HOW IT HAS ALWAYS WORKED!
In the short term, it is easy to be a pessimist given the constant stream of never-ending bad news. But it is impossible not to be a long-term optimist, even in the face of the many short-term breakages. The S & P 500 has had an average annual decline of 15% since 1980 and has experienced six bear markets (including two halvings -- in 2000 to 2002 and 2007 to 2009). During this period, it also increased 60-fold, from 100 to 6,000, returning about 10.3% annually. AS THE ECONOMY CANNOT BE CONSISTENTLY FORECAST NOR THE MARKET CONSISTENTLY TIMED, THE ONLY WAY TO HAVE CAPTURED THE FULL 10.3% RETURN WAS TO BE WILLING TO RIDE OUT EVERY OUNCE OF THE VOLATILITY AND REMAIN INVESTED THROUGH EVERY CRISIS (EVEN TAKING ADVANTAGE OF THEM OPPORTUNISTICALLY).
“Long term optimism is the only world view that squares with the entire historical record”
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~Nick Murray
CONCLUSION
Increasing international conflict, along with much higher interest rates and inflation will likely be characteristic of the new world order of the next several decades. This contrasts with the past few decades which were characterized by the globalization of democracy, along with very low interest rates and inflation. As a result, the political, geopolitical, economic and financial shocks will likely be very different.
The purpose of this newsletter is in no way to encourage anyone to make any changes to their portfolio or plan in anticipation of future shocks. Rather, the message is to make sure you are prepared, both financially and emotionally, to be able to adhere steadfastly to your plan regardless of the real or imagined crises ahead (unprecedented or not). Keeping two to three years’ worth of spending outside of stocks (in short term bonds or money markets) during retirement prepares you financially. Emotionally, adopting the principles in this essay should help you to remain calm during all different crises (real or imagined) and adjust your temperament (not your portfolio) to move along the spectrum from merely being resilient in the face of crises to becoming antifragile.
Remember, the steeper and faster the declines, the steeper, longer and stronger the move to new all-time highs. Especially in crises, focus on the PERMANENTLY increasing, long-term enduring values of what you own – great companies. Focus away from the short-term TEMPORARY declines in stock prices and what you don’t own – the stock market. Always believing in the former instead of the latter will make all the difference between success and failure.
We are still likely in a secular (long-term) bull market that will continue through the end of this decade. Investing in bonds to reduce the illusory risk of volatility always leads to the real risk of killing our money’s buying power in the face of historical 3% average annualized compound inflation. In a likely period ahead of sustained higher inflation, bonds should be even more destructive to wealth and appropriate allocations to stock ownership even more critical to preserving it.
“The real key to making money in stocks is not to get scared out of them.”
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~Peter Lynch
Wishing everyone and their family a happy holiday and a happy and healthy New Year!