We’ve Seen These Cycles Before, Here’s Playbook For Those Revolutionary Profits
“There is an old investing adage – often mistakenly attributed to Nathan Mayer Rothschild – that one should “buy to the sound of cannons, sell to the sound of trumpets”. Most of all, don’t be greedy by getting levered up in the summer of 2007 when the credit cycle is working against you. The endless multi-billion dollar private equity deals, dotcom parties in Silicon Valley and long waiting list for micro jets sound like trumpets blaring.” Me, 2007
I’m always amazed at how the economy and the markets actually do go through cycles. The cycles, like history, rhyme, but never completely repeat because each cycle is unique in its own right even though the ups and downs/bubbles and crashes look much the same.
One of the main reasons, really the main one, that I write about the markets is so that I can keep a track record of my analysis over the years and even decades. Indeed, here’s something I wrote for the Financial Times back in 2007 in an article called “Boom times are here but cheap capital is not” that looks quite similar to the analysis I was writing last year:
“The only thing we know for sure in the summer of 2007 is that it is a great time for the economy and the broader market. Whether you take a 25-year or five-year view of the economy, we are in boom times. But if the idea is to buy low and sell high, then it’s important to recognise we’re certainly in the “high” part of the spectrum. And, given how good the economy is and how far the world’s financial markets have run, it would be prudent to pay attention to the turn in the world’s ability to access capital.
Stocks go up when companies increase earnings and earnings can only rise in a credit-driven world when capital is cheap and easily accessible. The great bull market and economic expansion of the last quarter century have coincided with two events; a decline in US interest rates and the personal computer/ internet-fuelled explosion in capital distribution outlets.
While the direction and impact of interest rates have been clear-cut (a lowering of the cost of capital), PCs and access to the internet have made it easier for individuals to access and deploy capital. But the credit cycle has turned. We’ve undoubtedly seen an inflection point come and go in the longer-term credit cycle during the past couple of years, as the Federal Reserve took real rates back up above zero and ended its steady rate cuts.
The US cut real interest rates – interest rates less the inflation rate – to below zero and was flooding the world with money. But the rate at which that money flooded the world was greater than the rate of US economic growth. And that means access to capital got about as “good as it could get” during this cycle. Put another way, capital can only get more expensive and harder to come by. The fact is that earnings growth has been slowing for the past couple years, and that hasn’t stopped the ongoing bull market. Earnings are still rising, right? And stocks go up when earnings increase, right? You can ignore conventional wisdom that focuses on the “slowing of earnings growth”. But you cannot ignore the changed credit cycle.
Corporate and consumer access to capital peaked when the long-term direction of interest rates turned, as rates clearly bottomed out during the past couple of years. I’d like to think that the capital cycle could turn positive again, and it’s possible. In the past couple of years, the former strength of the US dollar relative to the developed world’s other centrally controlled currencies meant the Fed could cut or raise rates as it wanted to, depending on the domestic economy.
That the dollar remains weak in spite of the Fed jawboning inflation and hinting about raising rates leaves the Fed with a tough choice: stimulate the economy with lower rates and see the dollar collapse or let the credit cycle play out, entailing real economic and stock market pain. Unfortunately, the culmination of that 25-year boom of economic expansion and reduced barriers to capital didn’t end until it had flowed all the way down to the low-income consumer segment of the US economy. Yes, the subprime excesses that are now unwinding were the top of the multi-decade credit cycle that’s now turned.
There is an old investing adage – often mistakenly attributed to Nathan Mayer Rothschild – that one should “buy to the sound of cannons, sell to the sound of trumpets”. When I launched my hedge fund in October 2002, cannons could be heard in the form of 30 per cent unemployment in telecommunications. It is five years since these cannons were audible, and investors should heed the possibility of their return. Stick with long-dated calls and puts while the premiums are still cheap. Most of all, don’t be greedy by getting levered up in the summer of 2007 when the credit cycle is working against you. The endless multi-billion dollar private equity deals, dotcom parties in Silicon Valley and long waiting list for micro jets sound like trumpets blaring.”
Here’s what I wrote in February 2021 in an article literally called “Strategies For This Blow-Off Top Market” when the speculative stocks topped and started their now year-and-a-half long crash:
“There’s too much speculation, euphoria and greed running rampant in the market and society right now. There’s no fear. That doesn’t mean it will all come crashing down tomorrow, but I’m getting increasingly uncomfortable with the ongoing Blow-Off Top Phase of The Bubble-Blowing Bull Market that we’ve been very successfully riding for the past eleven years now.
I asked back in the midst of the crash and economic shut down last spring several times that perhaps the biggest question for the markets was if tens of trillions of dollars in monetary and fiscal pumping from every major economy in the world would be enough to overcome the near-term collapse in earnings and economic activity. The answer has been a resounding YES.
It’s clear now that there are trillions of dollars chasing speculative gains in the stock market, in the crypto markets, in the real estate markets and in just about every market on the planet except for gold and silver (they are probably next?).
I am here to tell you that it’s not a great time to be investing for the long-term. That doesn’t mean that you sell everything and in fact, many individual stocks, will go up in value for many years to come even from these levels (maybe SpaceX and Starlink for example). I also think that inflation could be coming back to the economy for several years here. Higher interest rates (perhaps look at shorting and/or buying puts on the TLT again?) and commodity inflation looks likely to kick in this year and for years to come (perhaps the DBA ETF might be interesting here?).”
But
And here’s something else I wrote in the FT back then called “Waiting for the noise pollution to die down” in which I talked further about the economic cycle at the time and why, even though, I saw so much potential for the future, I was staying cautious:
“Is a US recession already a foregone conclusion? Is that really what the markets, the fundamentals and the Federal Reserve are telling us? I’d argue that the set-up at the moment is more “binary”. Two starkly different outcomes look possible.
Certainly, the US economy has cooled from the torrid pace that had surprised all those economists that shoot off their guesses about the future of this $13,000bn economy in the first few months of the year. Now, after they all chased the strength by upping their estimates for the rest of the year, the economy is beginning to surprise them on the downside. But just because the economy is cooling (or has already cooled) and is weaker than most traders and economists expected, we cannot necessarily extrapolate a Snoopy-like Joe Coolness out for the next few quarters or years.
Though I have been a rather vocal bull for most of the past three and a half years of running my fund, on May 10 I pulled my horns in, moving almost entirely into cash and Microsoft except for my long-held Apple and Google positions. It was one of the luckiest timing calls of my life. The reasons for the move were threefold and I think we should look for a reverse of those factors to help guide us as to when (or whether) to get back into the market: 1. The chatter on the technology conference calls turned from “we can’t stay up with demand” to “we are comfortable with our inventory levels”. It is now at the stage of “we’ve got to work through some inventory.” 2. Most commodity stocks went parabolic and their customers were scrambling to secure five, seven or 10-year supply deals. 3. The world’s central banks seemed to have crossed the fine line between “please take this money” and “if you want capital, it’s gonna cost you”.
The good news is that the tech markets – especially the volatile and often-leading semi-conductor sector – have tried already to price in the inventory problems, as the decline of more than 30 per cent in the SOXX index indicates. Many former high-flyers and the fastest growers, from Broadcom to Qualcomm, warned about the second half of the year. Also good news is the decline of more than 30 per cent in many commodity indices, which in May blew the top off their parabolic charts. Parabolic no longer describes that action. Then there are the central banks, which have continued to use the tools at their disposal, including interest rate increases, to sap liquidity from the world’s markets.
Housing in the US has all but collapsed and the inventory situation in that sector is far from being worked through. And that leads me to what is really on most traders’ minds. Just how binary is this set-up? On the one hand, if the US heads into recession and housing really collapses, can we avoid an outright depression? If the economy continues to cool and those housing and tech inventories continue to pile up, things could get really ugly really fast. The markets would probably continue to falter, reducing multiples and taking growth stocks to yet lower lows.
Of course, it’s not as if the Fed and the markets will just stand still. At some point we have to figure that the politically motivated Fed (yes, the Fed is politically motivated) and many other central banks will have to step in and work to reliquefy the world’s economies – and markets. And then, of course, we’d be back off to the races. I use the term “techo bubble” to refer to the possibility that such a reliquefication would fuel another speculative fervour in the market. Tech would probably lead once again as growth became the mantra and all that liquidity would boost the fundamentals and the markets in a fantastic reflexive manner that fed on itself in a virtuous cycle.
I think that, not unusually, the economists’ timing was wrong. It is now that the conundrum is headed the Fed’s way. Is the set-up really so binary that the Fed has to choose between another bubble or another collapse? Of course, maybe things will all work out smoothly and the Fed’s actions, the inventory issues, the action in commodities and the rest of it are just noise. Then again, as AC/DC might tell us, ‘Rock ’n’ roll ain’t noise pollution’ – and I don’t think this set-up, which is likely really to rock or just roll over, is noise. I’m anxious to get back to trading and investing and being my usual bullish self. But not until the noise dies down.”
Doesn’t that sound a lot like me right now when I keep saying that I’m staying mostly defensive here but am anxious to get back to trading and investing and being my usual bullish self. But not until the noise dies down (and/or until we get another crash-ish leg down).
And finally, here’s something else I wrote in the FT back then called “Invest in technology and live la dolce vita” in which I predicted the (at the time) upcoming Smartphone Revolution future as I explained why Apple and Google were must owns for that future:
“I sometimes argue that the best things in life come from Italy: Armani, Lamborghini, lasagne – even coffee had to go there to become a delicacy. So I went to Italy to find me a good woman. Don’t laugh, I’m serious.
But my iPhone, proudly designed in California, wouldn’t work in Italy. Lost in some back alley at 11pm in the middle of downtown Rome on a rented motorcycle – not having eaten for hours and having narrowly escaped a ticket for not wearing my helmet – I turned right into oncoming traffic, putting the bike on its side. (I don’t know why – the belle donne had told me to turn left). I hopped back on to the bike, body and ego sore and bruised, and decided I wasn’t supposed to be in Italy.
Even though AT&T had told me otherwise, I couldn’t make a call on my iPhone. I couldn’t get it to work on the local WiFi networks, either. So I schlepped to a hotel to access the internet – and book a seat on the next flight to New York City. But American Airlines wouldn’t let me change my international flight using the internet, so I had to find a phone that would let me dial the US, which meant booking a room at the hotel. Convergence has come a long way since the BlackBerry first added voice capabilities, but as my experience in Italy underscores, convergence still has a long way to go.
Having said that, the iPhone and its competitors will soon usher in the golden age of converged communications. As Apple rolls out new WiFi-based iPods and, more to the point, as next generation handsets become technology-agnostic (in other words, they’ll connect you to the internet over 3G wireless, WiFi and WiMax), we’ll all be able to call, e-mail and Facebook each other at any time.
Heck, in another year or so, I’ll be able to pull out my Windows-based Samsung “Double Black Diamond” (I made up that name) in Milan and access my Vonage account. I’ll be able to call my assistant and ask her to call American Airlines and change my flight – and she can call me back when it’s done. Another year or two after that, I’ll be able to pull up, and watch, any video that’s ever been published. It’s this idea of riding the internet “platform” that is so crucial to investing in technology. In coming years, your mobile phone will become increasingly like your laptop.
You’ll have the same programs running on each of them. VoIP software, YouTube and other video sites and browser-based applications will work on any high-end phone just as they work on your laptop. There will even be iChat-like real-time video chat applications on your mobile phone – riding the browser-platform that rides the internet-protocol platform. Google and Apple remain the best plays on this converged platform concept.”
Back in 2007, Google and Apple were just about the only the ways to get in front of upcoming The Smart Revolution because it hadn’t developed quite yet but there were trillions of dollars in market valuation created in The Smart Revolution in addition to both Apple and Google attaining trillion dollar valuations in their own rights.
When I wrote that article back in 2007, Google was at $180 or so. It’s up like 1500% since then. Apple was at about a split-adjusted $2 or so. It’s up about 7300% since then. Both were down 30% or more from their recent highs when that article was published in the FT in August 2007.
The takeaway here is that we’ve been through cycles like this before and we navigated them similarly which turned out to be incredibly successful way of navigating that most recent similar cycle. Back in 2007, the most obvious next multi-trillion dollar Revolution to get in front of was smart phones. In 2022, it’s probably The Space Revolution or maybe The Biotech Revolution or maybe The Virtual Reality Revolution or maybe all three of those and a few other Revolutions will become trillion dollar market places fifteen years from now the way that The Smartphone Revolution and The Cloud Revolution and other tech Revolutions did in the last fifteen years. It won’t be smooth and we won’t just blindly buy great sounding stories. But if we stick with out playbook, as we did fifteen years ago, I do believe we will have an equal or even a bigger amount of returns when we look back fifteen years from now.
Patience, diligence, and getting in front of trillion dollar Revolutions is what we do. Let’s proceed.
Two housekeeping notes, I’m closing our my KD and my TLT positions. Neither one worked out and I want to continue to be ready to build up our portfolio for the next cycle as it sets itself up in coming days, weeks and months.
