The Class of 2000 and 2008

There is a select group of investors who got the technology and housing bubbles right. I call them the class of 2000 and 2008. Although I was early and looked foolish near the peaks of both cycles, I was eventually vindicated and consider myself a member of this class. From the war stories many of you have shared with me, I know we have several readers who also not only survived the last two bubbles, but thrived in their aftermath.

Where are the members of the class of 2000 and 2008 today? It seems we’ve all gone our separate ways this market cycle. During the tech bubble most of us were singing the same tune, avoiding technology stocks and buying undervalued non-tech stocks. Again during the housing bubble, the message was clear and unified. We were in a bubble and it would not end well – avoid housing and mortgage related securities. While the message many members of the class of 2000 and 2008 are communicating today is similar, portfolio positioning seems less cohesive this cycle than past bubble cycles.

Most members of the class of 2000 and 2008 believe there is currently a central bank induced bubble in one form or another. Although there appears to be agreement that we’re in a bubble, class member responses vary considerably. Some are long bonds fearing deflation. Others are long gold fearing inflation. Some are short China. Others are short the yen and Japanese bonds. Some believe the central bank premium will be with us a long time and are long stocks and corporate bonds. Emerging markets appears to be an area where some believe you can stay invested and remain contrarian. There’s even a group of investors who say markets are inflated, but are riding the wave of asset inflation regardless, hoping to be the first ones off before it crashes. And then there’s a few who believe all asset classes are inflated and distorted. These investors are simply planning to wait for better opportunities and remain liquid.

With 100% cash in my absolute return portfolio, I’m in the patient camp (hedging cash with some form of hard assets makes sense to me as well). By remaining patient, I’m acknowledging I don’t know exactly how this cycle ends. Furthermore, and probably more important, I don’t know when it ends. I would have thought after QE3 ended markets would have encountered more turbulence. However, the determination by global central banks to do “whatever it takes” has been impressive. I didn’t expect central banks would actually drive bond yields negative and begin to nationalize stocks and bonds of private corporations. We really are in unprecedented times.

Considering investors have never lived through or even read about an environment similar to today’s, it’s not surprising opinions and positioning differ so much this cycle. It’s difficult to have a strong opinion on how things will unfold exactly when what’s happening has never occurred. To successfully navigate the current market cycle, I don’t believe it’s necessary to know the future with precision. While history doesn’t provide us with guidance on how globally orchestrated central bank asset bubbles end, history is very clear about the consequences of purchasing overvalued assets and assuming this time is different.

I’m not short stocks, I’m simply long liquidity. Therefore, unlike the participants in The Big Short, I don’t plan on making a large profit when the current market cycle ends and asset prices fall. Instead, my focus is on protecting capital and avoiding large losses. Once the cycle ends and market losses mount, I plan on investing the capital I protected decisively and aggressively. For my plan to work, I need to be prepared with my possible buy list and I need to remain flexible with abundant liquidity. Flexibility is essential near the end of bubble market cycles, as they can end quickly and with little warning. Some are able to get out before prices fall, but most don’t.

Investors who are playing the game and believe they’ll get out before everyone else reminds me of a book I read about D-Day. As soldiers were preparing to storm Nomandy’s beaches, they were told many of them would not make it back. The soldiers looked around at the other infantrymen and said to themselves “poor bastards” assuming it would be others who would fall. After eight years of a seemingly endless bull market, it’s not surprising that many investors are positioned as they too are bulletproof.

In my opinion, given the broadness of the asset inflation this market cycle, there are not many ways to remain invested and protect capital. In effect, there is significantly fewer pockets of value today versus the last two market cycles. In 1999-2000, there were actually a large number of unpopular non-tech stocks selling at large discounts to value. In 2006-2007, there weren’t as many values, but there were still some boring slow-growers that were attractively priced. This cycle, almost everything is inflated. As such, while I respect the opinions of many of my classmates who remain invested, I continue to believe patience remains the best option for absolute return investors.

Full market cycles are very effective in separating disciplined investors from the undisciplined. The last two cycles demonstrated this well, even if it didn’t become apparent until the cycles ended. Let’s assume the current market cycle ends next year. Who will be in the class of 2017? While I hope those in the class of 2000 and 2008 all make the grade, considering the broadness of overvaluation and the wide variety of portfolio positioning (we can’t all be right), the list of investors graduating with honors this cycle will likely be short. As such, once the current cycle ends, I suspect there will be a very limited number of investors that will be able to claim they successfully navigated through the tech bubble, the housing bubble, and the current global central bank bubble. It will be a very exclusive group. I’m looking forward to seeing who makes the cut and what positioning was most appropriate and most beneficial to capital.