Transcription
There's an old saying: history doesn't repeat itself, but it often rhymes. And what if I told you that some of the most prolific super investors, like Warren Buffett and Monish Pabrai, are quietly preparing for a rerun of previous times? Times that made countless investors quit, but also made the smart money a fuckload of profit in the long run, guys. I truly believe that the rhyming over the next 10 years is going to replicate many secular bear markets in the past. It's not going to be pleasant, and I'm going to break down the secular bear market right now.
I want to take you guys back to the late '90s. It's the peak of the dot-com bubble, and everyone thinks that they're a genius. Stocks are doubling; stocks are tripling. I had a friend in college who didn't go to college to go take advantage and be a broker, and he once said to me, "Paul, you know how crazy it was? If we had a stock that only went up 200% or 300% that day, we were pissed." Back then, also, your cab drivers were giving you ticker symbols. Does that sound familiar now? Back then, Warren Buffett—the Warren Buffett—he was sitting there watching this all unfold. In 1999, when the party's in full swing, he came out and basically said, "Guys, you might want to take your chips off the table, or be ready; expectations are getting way out of control." And boy, was he right. But ironically—and this was, I think, the first chapter of his book *Snowball*—he was at an investment seminar with all these billionaires, and so many people were like, "This guy is out of whack; he has no idea; he's such a dinosaur." Well, guys, he's 94 now. He wasn't 94 back then.
Warren Buffett has expressed concerns in the past about periods of low stock market returns—a lot of people would call those "loss decades." In his 1999 shareholder letter, Buffett cautioned that investors' expectations had become unrealistic and that a market adjustment was likely, especially in sectors where speculation was rampant. Guys, do me a favor: go back, re-watch that last sentence, and change it to 2025. Does it sound the same? Absolutely. Munger, before his death 15 months ago, was found saying this now. Buffett noted that while Berkshire would eventually find opportunities to invest significant cash in equity markets, the timing of those investments was uncertain. Buffett's warning proved ever so prescient. From 2000 to 2012, the S&P 500 experienced an annualized return of approximately 3%—a period referred to as a loss decade for stocks. And during this time, income-focused investments like bonds and dividend-paying stocks vastly outperformed the broader market. Small caps vastly outperformed the broader market from 2000 to 2012. The S&P barely moved. Buffett even used this awesome analogy: he said, "Being in a hot market like that is like being Cinderella at the ball. You know the clock's going to strike midnight, but you don't want to leave; the music's playing; everyone's having fun, so you stick around. And then boom—pumpkin time."
Now, I will say one thing: I don't think people realize the clock is going to run out. There are people out there who truly believe that this will keep on going. So why does that matter now? For exactly that; it's looking awfully familiar. High valuations, tons of hype, and people paying crazy prices for average companies, or paying insanely crazy prices for phenomenal companies. And what happens when you pay too much for something? Your returns will get crushed, just like back then. The fifth tenant of our principal-driven investing is one of the most—is probably the most important one: a great story becomes a bad investment if you pay the wrong price.
So let's take a look at this chart of the S&P 500 going back to the Great Depression. This was the Great Depression right here. You had the start of it. Look how long it took—it took over 20 years to get back to the same spot. Now, dividends were a lot higher back then, so you got some return from here, but then you look at the time—1966 or so—when Warren Buffett closed his partnership down. He closed his partnership down because he wanted to secure his track record, and he said there were no good buys out there. Guys, our valuation today is several times worse than it was back here. Now, is the market different than it was back then? Absolutely. But look at this: from essentially right here until right here—16 years of nothing. This is a secular bear market. This is a secular bear market. A secular bear means it's a long-term bear market; they tend to last 15 to 20 years. Okay, then we have a huge bull market. Look at valuations here in 2000; boom—2012 or so before it finally broke even again, and you have a massive run-up. This is the Great Financial Crisis. So where do we stand now?
So when Warren Buffett warned of a lost decade, he wasn't trying to scare anyone; it's just math. He was doing what smart investors do: looking at the fundamentals and saying, "Hey, this doesn't make sense." And it didn't make sense then; it certainly doesn't make sense now, right now. So I should say this: back here, stocks were 55% overpriced based on two metrics: the 10-year cyclically adjusted P/E ratio, which takes the last 10 years of earnings and brings it to today, and the stock market to GDP ratio—the Warren Buffett indicator. Both of them were at 55%. Today, we're at 100% plus for both of them. Guys, look at this chart right here: whenever we're 50% overvaluation or more, the next 10-year returns have been negative 0.9%. This is going back to 1928. We've had 26 incidences of that—26 quarters where that actually was the case—and the returns were negative 0.9% on average for the next 10 years. So, as I said, there's going to be a lot of choppiness. Look at this market; it was sideways for a long time, but you had two crashes in there. Look at this market; it was sideways for a long time; you had two big drawdowns here. Guys, the point is: if you have a long-term outlook, you're going to do very, very well. If you have a short-term outlook, it's going to suck.
Now, fast forward a couple of decades from 1999, and who else saw the writing on the wall before his death? Charlie Munger. Before he passed, Munger gave a talk at Caltech where he essentially echoed the same concerns. He didn't use flashy language, but his message was very, very clear: with valuations this high and competition for returns fiercer than ever, we might be staring down another decade of underwhelming performance. Remember, guys, this was before his death; he died 15 months ago, and he said it's going to be harder for the next generation of investors. Why? Because the easy money's already been made; the market's not cheap, and that means future returns might not look like the past. Now, Munger wasn't saying to sell everything; he was just saying, "Be realistic."
So, uh, my next set of questions are more on the finance side. So Paul Goodson, who was a Bachelor of Science in 1975, asked: "You expect the next 10 years to have lower returns in the equity markets than the last 10? It doesn't give us an idea why." The answer is yes. And could you give us a hint as to why that might come? Yes, because so many people are in it, and the frenzy is so great, and the systems of management—the reward systems—are so foolish that I don't think it's going to work at all. I don't think—I think the returns will go down. Yes, in real terms, the returns will be lower. He was saying what we echo in our videos time and time again: don't expect the last five or ten years to repeat itself for the next 5, 10, 15 years. There will be a time in everyone's lifetime here that's watching this video where they'll see another booming bull market, but they have to start when valuations are low, not when they're at all-time highs. If I can't get that to you—if you can't believe that it takes low valuations to get higher returns—then I really encourage you to start with the basics and start watching our videos over again from the very beginning. You've got to remember: the less you pay for something—the less you pay for a dollar of cash flow—the better your returns will be.
So we've already talked about Warren Buffett warning of a lost decade back in '99, when everyone thought stocks could only go up. And I do realize a lot of our viewers here might not even be alive in 1999; that sounds like a lifetime ago for you. It was for us; that was the year I graduated high school. I still feel like I'm like a 25-year-old. But what followed? Twelve years of flat returns. That wasn't luck; that was valuation; that was math. Now, fast forward to today, and the good friend of the channel, Monish Pabrai, joins the chorus. In a recent clip, Monish said something that should really make you sit up: "If you're buying the S&P today, your chance of making more than 5% a year over the next decade are zero. I think the odds that the S&P delivers over 5% returns a year for the next 10 or 15 years approximates zero." Let that sink in. This isn't some YouTube influencer chasing clicks; Monish is a student and friend of Buffett, and he was a very close friend of Munger, playing bridge with him very religiously. He's been on our channel; he sat down with us, and he shares the same core principle we preach here at Everything Money: valuation matters, and it matters a lot. What he's saying is very simple: when you buy the market at inflated valuations, you're locking in low future returns. It's not emotion; it's not a hunch; it's math. And if Buffett, Munger, Pabrai—all these other investors—are all singing the same tune, shouldn't we take a listen?
So, guys, this is where we stand with valuations currently, right now. This is the stock market GDP ratio; we're 98.16% overvalued. Hasn't included the last couple of days of bull market, but so you add that in there, we're over 100% now. What could make that fall? Two things: GDP going up very quickly, or prices falling very quickly. Which one is more likely to happen? I don't know. So, 10-year cyclically adjusted P/E ratio—this is where we go for earnings on the S&P, brought to today's value, not caring where the money was made—whether it was locally, internationally, it didn't matter—we're 101% overvalued, and at a 30—almost a 35—10-year P/E. Let's use an example: let's say I give you a dollar a year every year for the rest of your life, and you want a 10% return. Simple math here, right? $1 divided by 10% equals $10. You basically got to pay $10 to get that stream of income. That's a normal, rational market—9 or 10%. Now let's look at where we are today. If you remember in my ratio, we're currently at 100% higher—100% overvalued. That means instead of $10, we're now paying $20 for the exact same dollar of earnings.
Now, I want you guys to keep in mind something else on individual companies: it is okay to overpay. What might appear to be overpaying is just paying more for a better-quality company that has more staying power and can increase its profit and free cash flow faster than other companies. They absolutely deserve a premium. We're talking about the market in general; we're talking about the entire US economy. Paying a 100% premium probably doesn't make much sense for an entire economy. For a couple of companies here and there, absolutely. And even those companies should be smaller, with lots of runway and lots of opportunities for reinvesting the money in the business. But if you're a company like Apple, who generates $100 billion a year in free cash flow, where can you invest that to really move the needle? It's very difficult. It's what Warren Buffett and Charlie Munger always warned about Berkshire: we're becoming so big that our reinvestment opportunities are becoming smaller and smaller. And Buffett said time and again, "If I had a million dollars, I guarantee I'd make 50% returns." For the record, the reason he says he can guarantee is he has a separate brokerage account that he runs of his own money, and I guarantee he has gotten those kinds of returns. Then now, with all this said, this doesn't mean the market's going to crash tomorrow. Markets don't go in straight lines; they zigzag. I've shown this a thousand times. This is the value of the S&P over a long period of time. This is how the price goes more realistically; it goes like this, like this, like this. That's what it does. That's why we talk about dollar-cost averaging. This is why valuations matter. When you start from a point of high valuation, over the next 10 years it'll rhyme to lower returns and higher volatility. This is not doom and gloom; it's just math; it's logic. And if you understand that, you can sleep well at night knowing that the logic will make sense on both the upside and the downside.
I've said it before: there'll be a time on this channel when I say companies are so fairly valued and so incredible a deal, people say, "Paul, we're not getting these huge returns that you think is going to be possible." It's like, I don't know when things are going to change, just like I don't know when the market's going to hit a bear market or a crash, just—and I won't know when the market will finally recover and say it's a new bull market. The market will probably not repeat itself, but it sure as heck will rhyme. Now, this last decade you're probably looking at and saying, "Oh, that's so scary." Remember what Morgan Housel says: every past bear market and crash looks like an opportunity; every future one looks like a risk. I want you to remember that they're all opportunities. This will give you a chance to load up on stocks at low valuations, because another Munger quote is: when they finally—when value finally finds itself—it springs, and it springs very hard up. So when people finally care about it, it will go crazy. You need to stick to your principles; you need to stick to your dollar-cost averaging to meet your goals. For any money above and beyond that, if you want to buy individual companies, be very, very process-driven in there; make sure you understand what you're buying, why you're buying it, and know that the market price is not determining if you're right or wrong. I'm not endorsing Tesla as a value play at all, but the stock is lower than it was in 2021, yet revenue and profit are two times greater. Does that make sense? Again, if they were overvalued then, doesn't mean they could still be overvalued now. Just because something is cheaper does not make it cheap; there is a big difference there.
Now, guys, if you do want to understand our five tenants of our principal-driven investing, do me a favor: click the link below, sign up for a free PDF to get emailed to you right away. It's really important to understand these five tenants of principal-driven investing. I truly believe in all these, and it allows you to stay calm during crazy times. It'll also encourage you to make the bets you need to make when opportunities are there, because they will be there eventually. We discussed a lot in this video: Buffett's warning in '99, Munger's caution before he passed, Pabrai literally saying your odds of getting more than 5% are zero. The message is getting louder, and the higher stocks go, and the faster they go high, the louder the message will be. And just when you think you've heard it all, Warren Buffett recently dropped a powerful message in one of his most recent letters, and not many people are talking about it, but we are, because we don't mind sitting there and going against the market. We break it down on our channel in a recent video. This isn't some recycled Buffett quote from 20 years ago that's overused; this is fresh; it's relevant, and it speaks directly to where we are right now in this overvalued market. So click the video that is linked on the screen right now to watch it. And when Buffett speaks, you better believe that we are going to listen. Thank you for your time.