The American bull market can’t last forever

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The American bull market can't last forever
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The gap between valuations and reality is even greater than before the Crac of 1929

The numbers do not give the winning investment formula. Success in creating money involves what Alexander Ineichen, a Swiss analyst, calls “applied wisdom.” Financial assets appear potentially vulnerable with rates at their lowest in five millennia, US stocks at record valuations, and not lacking in irrational exuberance. According to Ineichen, the smart investor should be aware of the risks, but it is not reason enough to run away.

Ineichen’s shiny new book, Applied Wisdom: 700 Witticisms to Save Your Ass (ets) (Applied Wisdom: 700 Occurrences to Save Your Butt / Assets, offers everything there is to know about investment. The first rule, as Barack Obama concisely put it, is “don’t be silly.” Many investors are choosing to ignore it, piling into SPACs, sky-high-priced cloud deals, dubious cryptocurrencies, NFTs, and the like. His actions violate another key rule, articulated by George Soros: “Good investment is boring.”

Although some of today’s high-flying investments may be successful, it is difficult to separate the winners and losers of tomorrow. When they first appeared, many technologies that later became popular were discarded. In the 1920s, an RCA employee scrapped the wireless music box as having “no imaginable commercial value.” Thomas Watson, the brilliant head of IBM, thought in 1943 that the world did not need more than five computers. Paul Krugman predicted in 1998 that the internet would have no greater impact than the fax. And even when the technologies take off, speculators often suffer, be it buying shares in RCA in 1929 or in dot-coms.

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The bull market for public debt has lasted four decades. Falling returns have pushed the stock market higher and higher. At some point, markets will run into Stein’s Law: “If something can’t go on forever, it will stop.” But that evidence tells us nothing about the timing. In the late 1990s, returns on Japanese debt fell to what seemed impossibly low levels at the time. Yet Japan’s bond sellers, waiting for increased returns, have been losing money for 25 years.

The problem is that markets are complex systems, unpredictable by nature. “Only fools, liars and charlatans predict earthquakes,” said seismologist Charles Richter. Ineichen invokes (Forrest) Gump’s Law: Life is a box of chocolates, you don’t know what you’re going to get. That doesn’t stop people from trying to forecast. But studies show that forecasters with the highest media profile are especially bad. Nassim Nicholas Taleb jokes that Wall Street hires economists to “provide stories to its less sophisticated clients.” In short, as Peter Drucker, the management consultant, wrote, “Forecasting is not a respectable human activity.”

None of this comforts investors. There is no question that US stocks are extremely expensive by historical standards. And applied wisdom, according to Ineichen, involves paying attention to history. (As music journalist Steve Turner puts it, “History repeats itself; it has to; no one listens.”) Experience suggests that buying stocks at inflated valuations carries the risk of a permanent loss of capital. On the other hand, there is the danger of leaving the party too early, since, as John Maynard Keynes said, “markets can remain irrational longer than one can remain solvent.”

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It’s not just irrationality: US stocks have been trading above their long-term median valuation for at least 25 years. Ineichen cites Martin Zweig’s two cardinal investment rules: “Don’t fight the trend” and, more pertinently now, “don’t fight the Fed.” The wisdom lies in watching the markets. Wait for the facts to change, and then change your mind. Ineichen is an exponent of the Nowcasting. It involves following real-time indicators – derived from market trends, company earnings forecasts and various metrics – to gauge whether the trend is intact or is going to reverse.

Ineichen’s firm IR&M offers weekly economic and market data updates. Its latest report indicates that the US economy continues to surprise to the upside. Confidence remains very positive, although it has declined slightly from the hugely high levels reached after the end of the closings. The Philadelphia Business Outlook Survey is also very positive. Earnings estimates continue to improve across all sectors, with energy performing the best. Of the 23 US indicators that Ineichen tracks, there are only three red flags (consumer confidence, homebuilding, and the National Association of Home Builders survey).

These metrics do not indicate that the ceiling of the stock market will collapse anytime soon. But Ineichen goes too far when he claims that the nowcasting it is to forecasting what astronomy is to astrology. Markets do not perform as well as planets: as Isaac Newton, unfortunate investor in the South Sea bubble of 1720, said, he could predict the movement of heavenly bodies, but not the madness of people. And as Ineichen acknowledges, markets are driven by opinion rather than fact. Forecasts can help, but they are still only a model and are therefore subject to Box’s Law: “All models are wrong. Some are useful ”.

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In 1928, the banker Felix Somary received Keynes. The world’s best-known economist was optimistic about Wall Street, arguing that thanks to the Fed there would be no more crashes. Somary, known as the “crow of Zurich” for his bleak forecasts, disagreed. He predicted that a crash was coming: “It will come from the gap between appearances and reality. I’ve never seen such stormy weather accumulate. ” Today, the gap is even greater than before the Great Crac. It is an opinion, not a forecast. Still, as naturalist David Attenborough wisely observes, “walking on thin ice is always risky.”