The S&P index has been extremely normal on all time horizons over the last 5 years. Extremely normal:

• 1 month 3%
• 3 months 4%
• So far this year 14.5% (that’s actually a bit extreme in its own right, at least annualized: +31.5%)
• 1 year: 22.8% (quite good, really good actually compared to the long time average of 10% total returns including dividends, but not great enough to be remarkable)
• 5 years (85.7%; i.e., 13% annualized. Again, good, not great)
• 15.5 years (+13% annualized, since the bottom of the 2008-2009 crash)

Just looking at stock market statistics it’s as if nothing interesting has happened the last five years. Or the last 15 years for that matter.

In a way it’s true. Nothing has probably happened that is likely to significantly change 50-year projections of value creation in terms of productivity, innovation, profits, cash flows, interest rates etc.

On the other hand, that’s not how stock markets typically behave. They experience bull and bear markets and wild swings based on temporary external events. Not so much this period, despite a pandemic, crazy interventions (lock-downs plus unprecedented stimulus packages) and an AI-revolution.

Sure, there were significant corrections in Q1 2020 and H1 2022, but so short-lived that if you blinked you missed them. And although the rallies in Q2-Q4 2020 (doubling) and Q4’23-Q2’24 (+50%) were quite significant, they mainly just made up for the correction right before.

Nothing to see here. Circulate!

OK, 13% annualized for 15+ years is actually kind of great. On the other hand, the market halved the year before, so the 17-year CAGR was actually just 7.5%. That in turn gives an overly and unnecessarily negative impression by calculating from an epic bull market peak. Rather, overall, nothing remarkable has been happening the last 20-30 years.

As it should be, since the long future doesn’t change very much.

No matter a hedge fund (LTCM 1998) or venerable investment bank (Lehman 2008) almost crashed the global financial system, no matter the internet came alive (Netscape 1995) or Amazon, Cisco, Ericsson, Microsoft and many more were incinerated after the internet peak of 2000, no matter the advent of the smartphone (Apple 2007), the BRICs rising to global power, various wars and acts of terror (9/11, 2001 for example), or the current AI-boom. No matter interest rates being cut from 5% to zero and raised right back up again. No matter an unprecedented lock-down of the global economy, or a sudden bout of inflation.

No matter whatever you throw at the economy or the financial markets, the long term trajectory for humankind’s value creation remains untouched.

It is that way because population growth and their productivity are very stable factors. And the stock market on average reflects the value creation over the coming long term future.

More precisely, the value of a stock is the sum of the coming 50 years of cash flows it produces, ultimately stemming from the company’s profit generation. And that future, and sum of cash flows, just doesn’t change very much. It might for individual stocks, especially the perception of their future, but not for the economy as a whole.

The economy moves like a supertanker, slowly and steadily, growing by 2% in employment, 2% productivity, and 2% prices, for a total of 6% per year. The largest listed stocks are 2%-points better than the average economy in terms of results, thus growing profits by 8% per year on average. Then add an additional 2% dividend yield for a total return of 10% per year, to holders of a broad stock market index. On average. Over very long periods of time. 25 years, 50 years, 100 years, 150 years.

Some ten to twenty year periods are awful, and some 10-20 year periods are wonderful, but typically you’ll get your 10% average total return over most decade-long time horizons. And if not, you’ll usually be fairly compensated over the ensuing decade.

So normal it hurts

The returns have been so normal it hurts. And yet, valuations are nothing close to normal. Rather, they are the most extreme in history. Even worse, they have been trending higher since their nadir 45 years ago. Valuations trending! Trending valuation metrics are a worse abomination than even the Kwisatz Haderach in Dune.

Measured as Price/Sales or MC/GVA, MC/GDP or similar ratios, the S&P index is currently about 2-3 times as expensive as its historical norm! Not 20-30% overvalued, but 100-200% overvalued! Based on those metrics, a quick halving, as after the 2000 and 2007 peaks, looks very reasonable, and wouldn’t even make the average stock cheap, just kind of fairly valued — exactly as around the 2009 epic great financial crash bottom. And such a huge correction would only serve to lower the 2-decade annual average to around 8% — also very normal. In retrospect it would seem as if nothing interesting had happened, about the same as when we today look back at the last 30 years.

Hurt incoming?

A 50% correction would hurt, of course, but would also be perfectly “normal”. But is such a drop likely in the short term? Not even the pandemic and lock-down, or the Ukrainian war, managed to bring markets down more than 35%. And now central bankers are ready to counter any perceived systemic risks with more stimulus than ever, perhaps $5T QE packages at a time rather than $1T, and an annual $5T budget deficit in the US rather than timid ones of trillions. Not to mention The Fed having room to lower interest rates by at least 550 points.

Currency is simply being created ever faster over time, and in times of panic extremely fast. Combined with an increasing market share for passive, index-hugging, and momentum funds, the largest stocks keep pulling in more money faster than other stocks. That creates a self-perpetuating tailwind for the stock market index.

Outflows could in theory reverse the “indexation disease” effect and cause the mother of all bear markets (worse than the 1930s), but it’s not very likely in the era of modern central banking. Any sharp downturn for stocks, and in particular any disruption of the corporate bond market, will be met by hugantic stimulus efforts that completely disregards the risk of inflation. Anything with perceived real value (gold, Bitcoin, and stocks) will be in great demand as holders of currency try to keep their portfolio weights of cash steady, or lower than usual. That means higher prices for real assets since the amount of cash doesn’t fall when buying assets (the cash of course just changes hands).

The bull isn’t necessarily close to a turning point

Speculation is running hot, but it could just as well go on for quite some time yet

(charts from Thomas Callum’s chart storm)

Every decade has its own winners

Bridgewater:

“Throughout history, certain companies have dominated the equity market, but the process of creative destruction makes staying on top for long periods of time very difficult”

I’m not saying a crash is imminent. I’m not even saying one has to occur at all. I’m actually rather saying that a continued strong bull market, and a halving, or just a kind of sideways market would all be pretty normal.

I’m reducing my exposure to stocks and growth

Money printing and index-hugging make for a continued melt-up. Valuations, growth speculation and top-ten dominance make for a crash. It’s more or less a coin-toss at this point, at least with a time horizon of a year or two.

I think we’ll see a mini-crash, almost a flash crash, reminiscent of Q4 2018, Q1 2020 or H1 2022. It should occur right about now, and could be triggered by just about anything. Election results, pandemic, wars, natural disasters, a Ponzi scheme bursting, terror, fraud being exposed… I think the plunge will be abruptly aborted by rate cuts, QE and fiscal stimulus programs and send asset prices soaring, followed by rising inflation.

I prefer to play that scenario by holding value stocks and gold (including some gold stocks like Canagold and EMX), and be ready to buy Bitcoin, Ether and growth stocks after a 30% correction or so. I’m actually already reducing my overall allocation to listed stocks, including Kaspi. Just so you know.

However, I haven’t yet adjusted my pension fund holdings which include Brock Milton Capital’s “the 25 best companies in the world” which is a sort of Magnificent-25 type of fund (strategy: buy the best companies, like LVMH and GOOG, at any price, and keep forever). Maybe I’ll do that this week.

I’m apparently becoming a bit bearish after all, despite setting out to write a bullish story about how indexation and QE would just produce more of the same of what we’ve seen the last 15 years. /Karl-Mikael Syding, 1 July, 2024