The sky is falling!
The market is about to crash!
The youth of today are corrupted!
Every innocuous thing you love is Bad, Actually!
Doomsaying is the grift that keeps on giving. Spread fear and doubt about some looming crisis—real or imagined—and you instantly take on a mantle of wisdom and moral authority.
Best of all, you don’t need to have any special knowledge or insight. No-one will call you on your bullshit. You can be wrong over and over and over again, and everyone will still gather around, spellbound, to listen to your wise counsel.1
Humans are wired up to take a potential threat much more seriously than an equivalent opportunity. We can’t help but prick our ears up at this kind of thing. Or as we say in the news business: if it bleeds, it leads.
And so, we end up with headlines like this:
2013: THE NEXT STOCK MARKET CRASH: Why Many Pros Think It Has Already Begun — Business Insider
2014: Has the Stock Market Crash of 2014 Begun? — The Motley Fool
2015: The Stock Market Crash Of 2015 Is Just Getting Started — ETF Daily News
2016: Stock-market crash of 2016: The countdown begins — MarketWatch
2017: Is The Stock Market A Bubble Waiting To Burst? — NPR
2018: We are now in a bear market — here’s what that means — CNBC
2019: Don’t Be Fooled By The Latest Stock Market Rally — Forbes
These are not trashy clickbait merchants. They’re some of the most prestigious titles in the financial press. I’m pretty sure I’ve written articles of this nature before. There’s nothing malicious about it—everyone is following their incentives, and this is what the public wants. I like reading these kind of stories as much as anyone. Too bad they’re not worth the paper they’re printed on.
The headlines look especially silly when you overlay them on a graph showing what actually happened to the stock market over the last 10 years:
Of course, the prophets of doom will get their satisfaction one day. They’re constantly calling for a market crash, which means they’ll eventually be proven right, entirely by accident. On that fateful day, they’ll level a trembling finger at the charts, and pronounce the most satisfying words in the English language: I told you so!
(no-one will remember that they’ve been saying this literally every single year, and that taking their advice at any other point in time would have been a really bad idea.)
When we zoom out to look at the past 90 years of stock market history, we can see several cycles of booms and busts. And so, it’s not a question of if there will be another crash, so much as when.
We’re currently experiencing the longest bull market in history, with 10 years of sweet, sweet gains:
If you look at the graph, it kind of looks like we’re due for a downturn. Note the vertical grey bars, which mark a recession in the economy. Hmm. Haven’t had one of those in a while.
Except this is not how markets work! There is no cosmic overseer who eyeballs the charts and introduces a crash when we’re ‘due’. There’s just seven billion people trading and saving for the future and inventing new things and declaring wars and learning and having children and dying and passing laws and exchanging information and creating companies and generally going about the project of human existence.
The market is a collective intelligence that emerges, bottom-up, from this stupendously complex web of constant interactions. To claim to be able to predict it is a claim of omniscience.
Maybe there will be a stock market crash today. Maybe it will be next month. Maybe it won’t happen for another 10 years. I don’t have a clue, and neither does anyone else.
I say all of this as a prelude to the fact that I, too, am kind of worried about what happens when the market crashes. I’m not trying to spread fear and doubt to make myself look wise. I’m a dum-dum. But at least I know I’m a dum-dum.
So, there are no predictions in this post. They’d inevitably be wrong, and if they were right, it would only be by coincidence. Instead, I want to explain why my views have changed in recent years.
I never used to worry about the market crashing, because the conventional advice is that it doesn’t matter. I’m still not losing any sleep over it. But I do want to push back just a little on that advice, and add a bit more nuance to my previous writings on this topic.
Hold the Line
The standard line is that for long-term investors, market crashes just don’t matter a damn. You pay no attention to the headlines, and calmly ride out the volatility. After all, you’re buying productive businesses: their prices at any given point in time are of no consequence when you’re holding onto them for 20, 30, 40, or 50 years.
The real money is made when you not only hold the line, but keep buying during the downturn. That way, you get to pick up stocks in a discount sale that only comes around once every decade or two.
Here’s the section on timing from the Beginner’s Guide to Investing:
I have repeated the standard line many times. It is, as far as I know, technically the best advice. But lately I’m getting more of an appreciation for the difference between technical models—tested under sterile laboratory conditions—and what actually works out in the messy real world.
When the market crashes, it falls for more than a year on average, and loses over 30 per cent of its value. And that’s the average. Sometimes, it’s a lot worse. When crashes happen, we know for a fact that many otherwise smart people panic and sell out, with the worst possible timing.
If you wake up one morning and see tens of thousands of dollars missing from your precious retirement fund, all rational thought tends to fly out the window. You have to know yourself: when the crash comes, can you brave a 30 per cent decline without flinching? What if it happens in the space of a couple of days? How will you sleep at night? Do you have an ulcer? No? Do you want one?
I think it’s a good idea to visualise these kinds of scenarios in as much detail as you can, and really try to ‘feel’ it. Be honest with yourself about how you might respond in a crisis. Maybe it makes sense to take some money off the table, or have a portfolio that isn’t 100 per cent in stocks, even if it’s technically not the best strategy.
Crying ‘Uncle!’
Even if you know you have the intestinal fortitude to hold the line through the bad times, the universe has a way of messing with your best-laid plans.
Traders talk about their ‘uncle points’. When someone is twisting your arm out of its socket, there will come a point you’re in so much pain that you have no choice but to cry ‘Uncle!’ and close out the position, no matter how much it humiliates you, or ruins all your plans.
Maybe you don’t plan to cash out your investments any time soon. But life comes at you fast. What if you lose your job, or your marriage, or your house burns down, or a loved one gets sick? If you can provide solid answers to these kinds of questions, which ought to involve words like “insurance” and “emergency funds”, that’s great. But you can’t eliminate every uncertainty.
The new orthodoxy of the financial independence and early retirement (FIRE) movement is built around the belief that buying-and-holding index funds is a guaranteed way to get rich:
- Thou shalt not try to pick stocks.
- Thou shalt not time the market.
- Thou shalt not trade in and out.
- Thou shalt set up an automated drip-feed, and hold the faith through good times and bad.
- Once thou hast saved ~25x your annual expenses, thou shalt retire early.
I still think this is very good advice. But FIRE hasn’t really been tested under fire yet.2 It assumes we’re capable of behaving like Mr Spock during a crisis, even when all our instincts are screaming at us to panic. And it doesn’t account for uncle points.
There’s one more assumption that deserves some closer scrutiny, so this post is gonna have to be a two-parter. Next up: just how safe are index funds, really?
Notes:
- e.g. professional doomsayer and New York Times columnist Paul Krugman (sample quote: “By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine”), or Paul Ehrlich, who was showered with awards and honours for likening humans to cancer and being persistently wrong about everything, and the long line of fellow Malthusians promoting the kind of policies that make Thanos look sane.
- The FIRE movement began in the 90s, but it really only started becoming a cultural force in the 2010s, through the writings of Jacob Fisker (Early Retirement Extreme) and Pete Adeney (Mr Money Mustache). Coincidentally, the property market and the share market have been on a hot streak ever since.
Not Sure What the Future Holds? Get Your Copy of Optionality Now.
If anyone is interested in further reading, I recommend the book What I Learned Losing a Million Dollars by Jim Paul and Brendan Moynihan. Some of it is repetitive, but it really helped me understand herd mentality.
(Since you always tends to think “I’m not following the herd!” about your own actions, how can you protect yourself from foolish buying/selling? Answer: by assuming you stop being impartial the moment you’ve invested money, and therefore you need to write down a plan IN ADVANCE—before you’ve got any skin in the game—and stick to it no matter what. And also assume that if you have ever panicked and sold when you shouldn’t have in the past, you will do so again, unless you set up a system now to prevent it.)
Thanks Kate, that’s a great insight. I am super curious if people manage to actually stick with their ironclad pre-commitment, or still end up losing their head. I feel pretty confident I’ll be able to obey my past self’s instructions, but I’d rather have some kind of ‘Ulysses contract’ in place to bind my hands!
I’m curious to get your further perspective – the change from a linear looking gradient pre mid nineties to a exponential looking gradient (or a very different linear gradient .. who know?) correlates to the rise of digital products – fixed cost of production, very low/no cost replication and the ability to essentially get an exponential return on investment (Kim K e-moji’s anyone?).
Two questions – a/ what is your view of the impact of digitisation on the market and the likely future direction of the market?
b/ what would this graph look like if you separated analogue (physical products and distribution), hybrid companies (physical products, digital consumer facing sales e.g. amazon) and digital (production of digital product, digital replication and distribution) and how would that inform your choices?
My personal pick is – producers of physical products with reliable market demand (e.g. toilet paper) who have good business fundamentals aren’t really gonna go up and down *as long as they have good distribution channels* until there is a major technical innovation (reusable toilet paper?). Meat producers right now are probably getting a bit worried about the fake meat innovation for example.
Producers of more time sensitive products whose channel to consumption is at risk from digitisation are likely to fail (e.g. trendy clothing retailers who didn’t perceive the risk of substitution of online shopping portal for bricks and mortar/have poor supply chain management and get ‘stuck’ with physical product they can’t move, newspaper producers who didn’t innovate etc), and/or be at the beck and call of the digital sales channel owner.
Pure digital producers who hit the mark with consumers will generate unbelievable revenue … and the other 90% or so will drown. E.g. Entertainment superstars – Taylor Swift etc.
These aren’t my ideas – I’m thinking about this based on the work MIT CISR have done on looking at the impact of digitisation on business, and the different roles a business can have in a digital economy.
So I’d be aiming my investment strategy at a mix of basics and possible digital rockstar/failure options and avoiding the producers of products whose relevance is time sensitive and emotionally driven in favour of punts on pure digital products. If I could invest in a pure digital fund, I’d put in about 20-30% of my available funds …. and chuck the rest in basics.
Hi Jasmin, thanks for the thoughtful comment! Sorry to disappoint, but I don’t have any special insight as to whether your thesis is correct or not. It strays into the realm of trying to predict something incredibly complex, and to the extent that it is true, that should already be priced in by the market.
As a general rule, boring old utilities and things people need in good times and bad (waste management, electricity, defence, healthcare etc) do pretty well during a downturn. But that still relies on being able to predict when a downturn is coming.
A lot of the best-performing stocks of all time are really boring and pedestrian. Warren Buffett has done extremely well by refusing to invest in things he doesn’t understand. He missed out some huge upside (Berkshire didn’t buy into FAANG until ~2016 I think) but also didn’t lose any money in e.g. the dotcom bubble. So I think you’re wise to keep at least some of your allocation in ‘the basics’, rather than going purely digital.
I think of the market as a gigantic info-sucking machine that performs all this hard work and research for me, so I can just kick back and copy the aggregate prediction. I respect people who choose to do otherwise, in that you’re helping to calibrate the market by actually staking out a position. So I wish you all the best with the strategy!
Sensible reasoning. Gotta be honest ,I like stock picking I know it goes against better judgment but I feel like money is only energy and if it goes somewhere positive I’ll get positive energy back (hopefully). In response to your fairfax article I have to admit buying into CBD when it hit its low last week , I probably was always going to and if I’d had the chance to buy for 0.086 I probably would’ve been tempted to cash out at ipo too that’s just capitalism. Stocks don’t make up a big percent for me though.
Yeah man for sure. I don’t really regret my stock-picking days, in the sense that it was fun, low-stakes, and I learned a lot (albeit the hard way). Good luck with CBD! I know of a few people who were happy to have a flutter once it came down from the ridiculous IPO price, although I would personally treat it as play money.
Good article. At the end of 2017 I was 89 per cent invested in shares. Over the last few months, I’ve reduced my holding to just over 60 per cent and have a lot of cash. I sleep better now and no longer obsessively check my investments. If it crashes, fine, I have a lot of cash on hand to invest. If it doesn’t, that’s ok too.
I did this because Jack Bogle said in an interview just before he died in December that trees don’t grow to the sky and things are now officially crazy out there, especially with the insane levels of corporate debt. He said if you are comfortable with 70 per cent in shares then you might want to reduce this down to 60 percent. Good enough for me.
I FIRED in 2017 and invested everything I earned in the markets over the previous decade. No need to try to hit it out of the park again. Better to take some profits and chill out. I know what it is to lose more than 50 per cent of my investments.
Thanks for weighing in Richard, and congratulations on reaching FIRE! Good to know I’m not crazy with this line of thinking. I’m gonna look for that Bogle interview now.