Investors need a Noah’s Ark to weather next storm
The danger of being too comfortable with good times has Larry Sarbit fearing déjà vu.
In the fall of 1987, while preparing to embark on a new phase of my career, my wife and I took an extended, month-long vacation. The timing was just dumb lucky.
While I was off, on Oct. 19, 1987, the Dow Jones Industrial Average crashed, cutting the value of that index by an incredible 22.6 per cent in a single trading session. To put that in perspective, on Oct. 28, 1929 — generally considered the beginning of the Great Depression — the decline had been a paltry 12.8 per cent.
Most investors, myself included, didn’t see the 1987 collapse coming. But I remember how absolutely terrifying it was for anyone who managed money or invested in the stock market, with many wondering if a new depression was at hand.
The truth is that no one knows the timing of events such as these. But we know they happen every few decades. Most importantly, I think that they are likely to happen again and again.
These days, we face many challenges in the investment field. An inverted yield curve, numerous indicators of a slowing economy, tariff wars, geopolitical tensions associated with Iran, etc. I’m not an economist but it is hard to ignore these factors, especially in the face of a very expensive market. The Shiller P/E Ratio, which compares current stock prices to a 10-year average of inflation-adjusted earnings, now sits at 30, about the same as it was at the market top in 1929. So is it any wonder that we are worried?
Why has the stock market remained at historically inflated valuations, despite negative indicators? Interest rates continue to remain at very low levels, historically speaking. The Fed Funds rate is currently under 2.4 per cent while 10-year treasuries are just above two per cent. If you are starved for return as most investors are, rates at these levels can spark a desperate search.
And this forces many to “stretch” for that return. One of my favourite quotes: “More money has been lost reaching for yield than at the point of a gun.”
And with the stock market having delivered positive returns for over 10 years, investors continue to pile in, viewing it as one of the last resorts for what they believe is a never-ending upward trajectory. Never mind that just 10 years earlier, a 17-month bear market that lasted from Oct. 9, 2007 to March 9, 2009, saw The S&P 500 lose approximately 50 per cent of its value.
I fear the market is now overwhelmed with investors who have no memory of this, never mind the bursting of the end-of-century, dot-com bubble where at its trough on Oct. 9, 2002, the Nasdaq-100 had dropped 78 per cent from its peak. To me, this incredible ease with overvalued markets is dangerous. Investors have grown comfortable with hefty stock market valuations, much as I witnessed back in the late 1990s and 2007. And with interest rates at such low levels, people are able to justify paying big premiums for stocks.
I haven’t a clue as to when the markets will drop again. But to hear people express such a dismissive attitude toward current valuations is something I’ve witnessed before.
Now, there is a big difference between knowing something is going to happen and actually be prepared when it does.
Warren Buffett referenced this idea in his 1982 Letter to Berkshire Hathaway shareholders, in which he cited the Noah Principle, which holds that “predicting rain doesn’t count, building arks does.”
If you are familiar with the story of Noah and his ark from the Book of Genesis in the Bible, the world had been overtaken by evil, violence and corruption, with Noah being the last virtuous man and the only follower of God left on Earth.
We all know how the story ends: God destroys all life on Earth except for Noah and his family and a host of Earth’s lifeforms, which survive on the ark to repopulate the planet.
Noah is what I would call a contrarian in the extreme form. He hears God’s voice tell him to build the ark to prepare for the coming storm, gets to work, and about 120 years later he is ready to survive the calamity at hand. Now, to say Noah had patience is the most extreme of understatements.
Today, investors face pressure over much shorter time frames, with demands for returns on an annual, quarterly or even monthly basis. Short-term performance trumps long-term preparedness, in the minds of many.
But are those drops of water coming from the sky just another shower or is it the start of something a little more sinister? We don’t know when the market will return to a rational or cheap level. We do know that huge rains have occurred in the past and markets can and will decline again. So, my recommendation: Build yourself a financial ark just in case a big rain is on its way. Financial Post
Larry Sarbit is the CEO and CIO at Winnipeg-based Sarbit Advisory Services.