Weekend Reading: Who What When

Mar 01, 2021 | Andrew Dunn


Hi everybody,


          Who, What, When, Where, Why, and How. The six important questions any journalist knows to ask when investigating a story. Recent financial news media has been selling papers and clicks talking about bubbles, or the potential bubbles, forming in the market. Day trading, Bitcoin, Tesla, SPACS, GameStop, COVID19, short squeezes, IPOs, commodity prices, all-time highs, vaccines, low rates, trillions of stimulus…. Are these problems? Is this a bubble? Are we at the top? How long can it go? Are things about to get even better, or are they primed to get a lot worse?


You may be wondering some or all of the same, but here’s the good news. You don’t need to worry. This week I’m going to show you that not only does no one hold the answers to these questions, but in fact you can invest very successfully without even having need of those answers. To do that, we only need to ask the first three questions from Journalism 101. Who, What, and When.




          In 1995 Ray Dalio called the tech bubble. That same year, Peter Lynch joined him and said “not enough investors are worried”.


In 1996 the S&P rose 23%.


Then Howard Marks joined the bears, noting I’m 1996 that every cab driver just wanted to tell him about the hot stock he should look into. At the end of ‘96 Seth Klarman wrote about his concern with internet stocks in his year end letter, saying the mania will end badly. To Klarman’s credit, he did also say that he did not know when.


In 1997 the S&P rose 33%.


          Next was George Soros. He actually put a short trade on US technology stocks and by the end of 1998 had lost $700 million.


          In 1999 Warren Buffet was forced to answer why he didn’t hold AOL, Yahoo or the other hot tech names. Berkshire had lagged the NASDAQ by 15% per year since 1994. The NASDAQ had returned 40% per year from 1994-1999, while the large cap value index returned 24% each year over that same time. Not bad on its own, but a large gap below the dot com darlings.


In 1999 the NASDAQ rose 86% and then another 15% in the first few months of 2000. I’m not really sure what happened after that…. Just kidding, the NASDAQ had fallen 75% by October 2002 effectively giving up all of its gains and returning to its 1996 level (where it was the year after Dalio was the first to make the bubble call).


All of those named investors are world famous. They are so because of their exceptional long term returns and accurate foresight. But here you can see the problem with prediction… being too early is a lot like being wrong. Through the dot com bubble burst, and for years after, these investors had spectacular returns and somewhat cemented their god like status in the industry, but for the 5 years before they were bums. They were “Old Wall”, stuck in their ways and missing out on the feast of returns that would surely never end. Making money was easy and all the day traders were smarter than they were. Until they weren’t. The accident of timing shouldn’t be confused with intelligence. Imagine if Dalio had waited 4 years to make his comments. Or if Buffet had said, in his 1999 interview, that AOL et al were “a bubble that was going to pop soon”. They would look like true oracles, but that would be no more an accident than the losses sustained by the people whose names we do not know that finally “got into this day trading thing” in Feb of 2000. Extreme valuations can get more extreme, and they can continue to do so until they stop. Few, if any, who make or lose money in a bubble or a mania do so from intelligence or foresight. They have good luck at the beginning equal to the bad luck of those who joined at the end. No one ever mentions it, but even the early investors in “to the moon” assets rarely make a “to the moon” call until the stock is basically already there. And they never have a rational reason for the valuation. I imagine it’s akin to how most people gamble…they may have some notion of basic strategy, but no more or less than the other’s at the table. Most of it comes down to the luck of the cards, and in fact their lack of sophistication may actually cause them to make bets that are too big or too small relative to the statistical outcomes of the wager. When those statistically irrational bets pay off we think them savvy. When they flop, we think them fools. The gap between the savvy and the fools is often explained by no more than luck, and the outcome was decided when they chose their seats and the dealer shuffled the deck.


I’ll drive this point home with a name you likely do not know…. George Vanderheiden. George managed a large fund at Fidelity and called the tech bubble as well. He was massively underweight tech and overweight value stocks, and in late 1999 he wrote “Tulip bulbs for sale” on a whiteboard outside his office and left a package of them underneath it, referencing Tulip Mania. All through 1999 he had relentless questioning from management, consultants, the press, and investors who were selling his fund on mass. George chose to retire in early 2000, no doubt run down by the brow beating, and he left behind a fund that was perfectly positioned for the next half decade. His timing was more accurate than almost anyone, but he didn’t have the megaphone the other’s did and his retirement timing was perhaps worse than most, and so again we see the role that luck plays in all of this, even for the smart folks.


Today, we have a growing number of respected names pointing out bubbles. We also have them calling for outcomes like higher inflation while it remains low or higher gold prices while the price sags. I read and listen to them all, and greatly respect their opinions and intelligence, but I realize that, as in the above examples, they may be wrong for a long time before they are right. Other far less savvy investors may be right for a long time more before they are wrong, and they may get a lot of air time in the media because of it. Wrong for the right reasons, vs right for the wrong reasons. A strange Mexican standoff of sorts. And so, we have reached our next question… If no one is reliable over the short term, what do we do about it?




            In our Dot Com bubble example it may be interesting to learn that if you measured the period from the first warning in 1995 to the trough of the crash in 2002, 10 year US Treasury Bills outperformed the Nasdaq (9.7% total return vs 5.9% total return). Over that same period T-Bills had a max loss of -9.6%, vs the Nasdaq with its aforementioned -75% crash. I know this because Verdad Research did measure it, and I copied that info from their report to this email J . Other investment styles or asset classes had more return with less risk over that period as well, compared to the Nasdaq, and therein lies the solution to our bubble question. In investing, there is always a level of risk that is unhealthy for everyone involved, from the investor to the fund manager. This is the risk level we must avoid, but that doesn’t mean we must avoid risk all together. We can take a page from Greek mythology here.


            Odysseus, on his adventures, had to sail past the Sirens who in our case will represent whatever bubble asset you would like. Odysseus wanted to hear their enchanting song but knew doing so would drive him mad. He provided his men with beeswax to plug their ears, so that they wouldn’t be driven insane as they sailed the ship, and then had them lash him to the mast so that he could listen to the song but be incapable of hurling himself into the sea in an effort to join the Sirens. From time to time we may want to listen to a Siren song investment or two, but we have to ensure the same two things Odysseus did. 1) that our ship will continue to sail safely thanks to a protected crew and 2) that we take precautions to avoid being driven to our investment deaths in our attempt to flirt with known danger for potential great reward.


            One way we can do this is to always ask ourselves how could we be wrong, and how could we lose a lot of money. When you get too excited about making money you tend to ignore the risks of losing it. If we try to minimize our mistakes and eliminate those that could cost us the most money then we are more likely to realize when we are approaching an unhealthy level of risk. In baseball you can reach the hall of fame by striking out 60-70% of the time. Investing is similar, as long as you minimize the impact of your strikeouts via proper risk management. And it’s risk management that deals with the question of When.




            When will a bubble bust? When will inflation hit a certain target? When is the best time to buy or sell in our portfolio? Allow me to join the ranks of some of the greatest investment sages to ever walk this earth by answering these, and all other timing questions, with three powerful words.


I don’t know.


            As mentioned before, luckily I, and we, don’t have to know. In fact, it’s best that we acknowledge we don’t know rather than try very hard to pretend we do. Therein lies the skill. All of the investors who did very well through the dot come crash did so because they acknowledged this reality. Warren Buffet actually literally said those words in response to why he didn’t own tech stocks… he didn’t know how to value what they would be worth in the future. Buffet is perhaps the best example of our “When” question in action. When we take big bets or try to market time we run the risk of being very wrong This is because the discomfort caused by excessive greed or fear can cause us to act in a way that forces us out of the game at the wrong time. Imagine for example the investor who takes on too much risk and sustains a massive permanent loss, or the investor who is so fearful that they cash out and then is incapable of getting back in because either they were right and so now are terrified of a bad market or, more commonly, they were wrong and now the market is even higher than before, leaving them in the dust. Buffet, and his long term investors, have done exceedingly well because they know what the plan is. Buffet (and his partner Charlie Munger) are great communicators and have always stuck to their discipline, which their believers can recite like scripture. Everyone knows what Buffet is about, and so they don’t cash out to chase tech stocks when he doesn’t own them in 1999, and they don’t sell their Berkshire in any of the market crashes since then because they trust in the process. Buffet gives his investors what they need to stay in, and that allows them to benefit from his ability to be right “over time”, but not necessarily “on time”. Let’s wrap this up by taking a page from Buffet’s book and giving you some actionable advice on the current market.


            Depending on when this makes it out, the market is at or near all-time highs. You may have also recently made a TFSA or RRSP deposit, given the time of year. So, should we invest that cash into our portfolio now, or should we wait? And if we wait, does that mean we should sell some of our holdings for more cash, or should we leave what is already invested alone. I’ll bail you out here and answer for you…. My gut tells me you should wait. The problem is, my gut is wrong. It’s forgotten that I don’t know.


          Investing at all-time highs feels wrong because we interpret it as paying more for something than anyone else…we’re the sucker. The problem is, all-time highs are not a precursor for a correction. In fact, they are more common than you may think. The S&P has reached an all-time high 1,170 times since 1950, or an average of 16 times a year, more than once per month. If you had invested only at the all-time highs from 1950 to 2020, your returns would be just barely below the average returns of investing on any other date, as shown on this chart.

         Ok but this time is different. We are at an all-time high AND there is all sorts of issues with bubbles and Covid and debt levels. Surely some cash is good to hold for a significant correction? Well, again, we don’t know. And statistically, that move would be the wrong one. The S&P has been down by more than 10% only 6.5% of the time one year after an all-time high. Over 3 years, only 1.6% of the time.  And it has never been down by more than 10% five years after an all-time high. I don’t have the stats for how often the market corrects more than 10% from an all-time high in under a year, but if you are investing in the market for less than a year best of luck to you. That doesn’t describe anyone I know.


            Now I have been as guilty as anyone of trying to “know” what’s going to happen. I’ll admit to that, and this email list is a bit of a glimpse into my attempts to keep getting better at investing and, hopefully, bring you along with me on that journey. I do not think the stats above mean that we just plow every dollar into the markets all the time, but instead I think they speak to the importance of looking out beyond the end of our noses when me make investment decisions. If you have a sound strategy, proper risk management, a long term focus and you do your best to minimize mistakes by owning quality assets, the you don’t actually need to worry too much about the level of the broad market. You may not want to buy a massively overvalued individual stock, but you certainly can buy good companies in markets that are considered “expensive” and still do very well.


          Who do we believe? Nobody.


          What do we do about it? Manage our risk.


          When will that thing we are waiting for happen? I don’t know.



No further questions.


Thanks to Verdad, RBC, and Patrick O’Shaughnessy for the data behind this email.


Have a great weekend everybody!