Transcription
The market had never sold above 21 times earnings on the S&P, which it hit in 1929 at the peak. It never got back there until that bubble, really in '97 December, it finally reached 21. So, since that was the highest PE in history, GMO and I became officially bearish, and we watched the PE rise from 21 steadily to 35 on rising earnings.
This was a very painful experience. It lasted for two and a quarter years, and we started out bearish. We became by '99 extremely bearish. You can't possibly call a bubble or a bust to the right day, except once every several lifetimes by sheer luck. What you can do, though, is identify bubbles that will eventually burst. And that turns out, in the past, to have been intellectually pretty straightforward. You can measure them. Some of them went their way very high, and all of them eventually go back to trend. And that movement from very high to back to trend has always made cash look very much better for quite a few years. And yes, we got that right. It always paid, even though we lost a lot of business. '98, '99, and early 2000, we averaged about 6, 6 1/2% annualized underperformance. People think that you don't want to underperform in a bare market, but that's nonsense. In a bare market, everyone freezes. They don't fire you until they've had time to regroup at the bottom and think about it. But in a bull market, everyone's on edge. Talking to the people who are doing well, and they get awfully excited, and they're itching to fire you. And our ability to time the breaking of a bubble was by no means tight enough to avoid serious commercial pain.
It's guaranteed that any large commercial investment firm will not attempt to emphatically call the end of a bubble. It's lousy business. The odds are not in your favor. The client's impatience will make you regret it. So, it guarantees that the average investor will never hear that the market is dreadfully dangerous and overpriced when it is, in fact, dreadfully dangerous and overpriced.
Let's make the point, every bare market is temporary. We've lived in a world that has been growing quite nicely. That means, however enthusiastic markets get, bare markets will be temporary. What the listener will not realize is that we have spent half the time since 1925 getting back to the old high and half the time basically moving forward. So, from 1929, you don't get back in real terms. The index doesn't recover until about 1958. And then, when the oil crisis of '72 breaks, you don't get back until the mid-90s. When the tech bubble of 2000 breaks, you haven't made any money by 2011. These are not insignificantly long periods of time, and they add up to half of all the time. And everyone thinks, after having had a wonderful 17-year run of basically new high ground most of the time, the average investor thinks that this is normal. This is how we spend our time. Well, we this is how we spend half our time, and the other half licking our wounds and waiting to get back.
In Japan, of course, the mother and father of all bubbles broke in '89, and adjusted for very little inflation. Incidentally, adjusted for inflation, they hit a new high two or three, four years ago. That was a rather long wait from '89, 30 years.
It's hard to know how much the introduction of ChatGPT played. It was an introduction to the average investor, the average person, that a lot of important changes were going on in the world of AI. And most of us tried ChatGPT out in a week or two and realized it was, in its own way, amazing. And most of us decided that it was going to be a game-changer sooner or later. And what happened is the broad market stayed weak, but the MAG 7 made a huge gain. And all the way through '23, until very late in the fourth quarter, the rest of the S&P had not gone up. So, it was very reluctantly leaving its bare market mindset. But those seven doubled and better and dragged the market kicking and screaming with it. And finally, they threw in the towel and decided that, after all, they would also go up. So, maybe without ChatGPT, that bare market would have continued on its way and finished what it started. It was about 60% of what I would have needed to feel that it it was a reasonable bare market in those circumstances.
People have the feeling that if something comes in that's new and brilliant, that you don't have to worry about a bubble. It's only if it's hype and it's underneath the surface, not serious, then you have to worry. And that's absolutely not the case. The more serious a new technology is, the more obvious it is that it's serious, the more guaranteed you are to have a bubble. So, just think about it. You're dealing with the railroads. Everyone who isn't brain dead looks at the consequences of railroads expanding rapidly and sees that it will change everything, increase productivity, and be an enormous boost to the long-run well-being of the economy. And therefore, the ordinary person would love to invest because anything that important is bound to make them money, they think. And of course, that is absolutely true in the very long term, absolutely untrue in the short term. So, what happens? They don't build one railroad track between Leeds and Manchester, two of the great industrial centers of the industrial revolution. They build six tracks, four at least of which are redundant. And the fifth one isn't that much good. And the sixth one, of course, is brilliant. And everybody loses their shirt. It was precisely the fact that it was obvious and hugely beneficial that guaranteed everyone would invest and everyone would lose money.
And fast forward to the dot-coms. The dot-coms again, you had to be brain dead to not realize it was changing the world. You could go click, click, click and find the cheapest item in the world of the kind that you wanted and have it delivered in a week. It was going to be amazing in many ways, and it was. But from the peak of 2000, one of the more amazing companies, Amazon, went down 92%. Okay? Yes, it had just gone up eight or nine times in a couple of years. And yes, it inherited the world after that, but I assure you, it is no fun going down 92%. And most of the others simply went out of business. The pet.coms all vaporized in 3 months to 6 months. It was precisely that people could see that .com was a brilliant idea that guaranteed everyone would overinvest. Everyone would start too many VCs, too many startups, and we'd get the six railroad tracks in every little area.
This time, AI, well, it's at least as important, isn't it, as the .com. It's clearly important. It's going to be on a heck of a ride. And pretty well everyone can tell it's important. Everyone is putting their money behind it. And some of the greatest believers are the richest companies who can't buy enough of the chips from Nvidia. The spending programs of the seven great companies. Each company is like a a medium-sized country. You know, $70 billion, $105 billion in a year, $40 billion, most of it ending up in the coffers of Nvidia.
The employment market suffers from very unreliable data here. There, you have to know each of the series, what their strengths and weaknesses are, and look for mistakes that occur. But net net, I'm led to believe that the employment market has been weakening for some time. The GDP has been weakening for some time. International relationships have seldom, if ever, been worse. Global trade, which has led us to glory since 1945, has obviously ended. A future historian will look back and say, "My God, look at all the obvious signs of impending doom." And I am going to add a whole lot more to those from the fundamentals like resource problems, climate change damage, which is multiplying much faster than anyone feared, toxicity, and its effect on many things, including baby production, which is plummeting. Population growth is slowing all over the world. This has a truly profound economic effect, which has already been taking place for 10 or 15 years. You add this all up and you say, "Holy moly." And they were still optimistic.
The average investor is not worried until the hammer lands on the head clearly and squarely. And he goes out. Then he wakes up. If you add it together with my lesson about preference for good news, it means you extrapolate good conditions. You look to interpret all the data as good. You extrapolate that, and only when hit on the head every few years does the market go down. And once in a blue moon, you get hit from different directions, not only on the head but here, there, and everywhere. And for a second or two, for a few months every 20 years, we exaggerate the bad news. We are capable, because we live in the present. We are actually capable, when things go really bad and really obvious, of exaggerating the downside.
Let me point out 1974, been there, done that. The market was 7 and 12 times very depressed earnings. 1982, eight times very depressed earnings. 2000, 35 times very inflated earnings. This is not an organism trying to normalize. If it did that, it would multiply depressed earnings by high PEs and multiply inflated earnings by low PEs, wouldn't it? Tending to give you price to book, give or take. It does the exact opposite. It double counts given half a chance. So, when things are bad, it'll put a low multiple on. When things are good, it will always look to put a high multiple on. So, things look superficially good. The latest data is not bad. So, put a very high multiple on it. Serious measures of value say that this is the highest price market in the history of the stock market of the US. This is not a good sign for long-term returns.
By the way, if you go back and look at the second, third, and fourth most overpriced markets, you're looking at 1929, 2000, 1972, and the housing bubble of '07. This is an incredible bubble, but it is nothing like Japan. You know, Japan had never sold over 25 times earnings, and then it went to 65. So, the consequence was, every bear got washed out in Japan. Only a few bears in Europe and America survived, including us. We got out 100% 3 years too soon. That did not cost us six points a year. That cost us over 10 points a year for 3 years, all of which we got back with a lot of interest. We went into the collapse zero. Japan stayed there for 5 years, and Japan, as we know, spent 20 years before it hit a low and 30 years plus before it hit a new high. Uh, so the moral of the story was, we have done this in spades. The same result. It's killing to get the timing right, but the consequences are never different. Yet, it always goes back to reasonably priced eventually.
It turns out in 2000 and today that the rest of the world in equity markets were not that expensive. Sometimes everything goes together. 2000, real estate was very cheap. Bonds were very cheap. Inflation-protected TIPS yielded 4.3%, can you believe it? Right at the market peak. And foreign stocks were not that expensive. The same is true today. You could buy a portfolio of European, Canadian, Australian, and so on, and the rest of the world, and you will do okay. If the US market would drop 50% in the next 2 or 3 years, it might go down a while in sympathy. Might go down 20%, but it will bounce very quickly. If you're feeling up for taking risk, I would put a lot of money outside the US in equities. If you're feeling very nervous, I would have cash or some blend of those two.
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