9♠ – It’s never different this time

This post is part of the MoneyDeck series, a pack of 52 playing cards that describe 52 “golden rules” for Private Investors in the UK.

It’s never different this time – the more things change, the more they stay the same.

The four most expensive words in the English language are ‘This time it’s different – Sir John Templeton.

“This time it’s different” is a phrase wheeled out whenever markets are high on traditional valuation techniques.

• We are invited to believe that we are in a new paradigm, and that the old rules no longer apply.

It’s a pretty good indicator that we are in a bubble.

• Though not a reliable one that the bubble is about to burst.

Even within my investing lifetime, we’ve had:

• the “Western valuations don’t apply to Japan” in the late 1980s,
• “profits don’t matter, it’s clicks that count” in the dotcom boom in 1999-2000,
• the “chopped up crap isn’t crap any more” in the sub-prime crisis in 2007-08, and
• the “commodities supercycle” of 2012.

And here we are again, with US markets at valuations only seen before the depression or in 1999.

The first mention of “it’s different this time” that I could find for the current cycle dates back to 2015.

• Benedict Evans – tech analyst at Silicon Valley venture capital firm Andreessen Horowitz – concluded that tech was “not in a bubble” because lots of indicators were still below their 1999 dot-com peaks.

He avoided saying that we were in a “new paradigm”, but actually went further than the traditional phrase, saying “it’s always different” (albeit in a knowing way).

• More on this later.

Financial bubbles have a long history, the name dating back to the South Sea Bubble of 1711-1720.

• Prior to this they were known as “manias”, the most well-known being the tulip mania of 1637.
• This was made famous by Charles Mackay’s 1841 book “Extraordinary Popular Delusions and the Madness of Crowds”.

Even earlier than that, debasement of metal coins has sometimes taken on the features of a mania.

• An example is the Kipper-und Wipper Zeit (“Tipper and See-saw”) crisis of 1620–23,where states within the Holy Roman Empire reduced the precious metal content of coins from other states to raise revenue for the Thirty Year’s War.

Nowadays inflation has largely taken the place of debasement, and tulip bulbs and far-off projects have been replaced by equities and real estate.

Key features of bubbles (and then crashes) in developed economies include:

1. capital inflows
2. financial innovation and liberalisation
3. housing booms

Most economists and financial observers believe that bubbles can’t be identified in advance, and that deliberately bursting the bubble leads to a severe crisis.

• They prefer governments to deal with the after effects via monetary and fiscal policy.

Others such as GMO use a mathematical approach.

• For example defining a bubble as a two-standard move in the pricing of an asset (using some relationship to the real world, such as PE values) above the long term average or trend.
• They recommend steering clear of this asset – or at least underweighting it – while this condition persists.

An interesting point is that the GMO approach identifies many more bubbles than it should.

• Markets are more volatile than the maths used in mainstream models would suggest.

Of course, as Benedict said, in many ways things are different each time a bubble occurs – they are always different.

Things that constantly shifting include:

• Wars and conflicts, and therefore national boundaries (( After the first world war, bankers and economists predicted that no more wars would occur, and the future would be stable – these beliefs underpinned the Roaring Twenties and led to the Great Depression ))
• Terms of trade and economic blocs (the EU and globalisation, the rise of China, protectionism, international capital flows)
• Free movement of labour and immigration (or otherwise)
• Currencies and the underlying support for them (eg. the abandonment of the gold standard, sovereign defaults on debt)
• Fashionable economic policies (monetarism, declining inflation and interest rates, a 30-year bond market bull, a credit bubble, the Great Moderation / “the end of boom and bust”)
• The consequences of “the last war” (financial repression: low interest rates, QE, ballooning debt and zombie companies, increased regulation for banks, insurance companies and pension funds)
  Technology (not least the internet and smartphones)
• Demographics (ageing populations and falling worker to pensioner ratios)
• And last but not least, ceaseless financial innovation (easier and cheaper trading, securitization of all asset types, but even simple things like accounting standards, dividend policies and share buybacks)

There’s no doubting things are very different from when I was young.

But the real question is, do any of the changes make a material difference to how markets behave?

• Markets are driven by human psychology – fear and greed – and has that changed at all?
• I would argue that it hasn’t, and a bubble will always end in a crash.

So much for analysis, what about action?

The problem with high valuations is they aren’t very good short-term predictors of bubbles.

• Shares can carry on going up for two or three years after most people notice they are expensive.
• During this time you could easily miss out on 50% or more of upside.
• Bond markets can go up for 30 years or more, as we are seeing today.

You have two basic options:

1. ride out crashes, knowing that diversification, low costs and low taxes will work for you in the long run
2. perform some kind of systematic market timing, where you reduce your exposure to markets that are expensive, and increase exposure to markets that are cheap
   • how fast (and how far) you go in and out are up to you
   • you also need to work out a practical (cheap) way of modulating your exposure
   • and here you are relying on the signals of the past to work in the future
   • you need things not to be different this time

Whichever plan you choose – the key is to hold your nerve.

• Don’t decide to ride out the crash and then sell at the bottom.

That’s one strategy that is guaranteed not to work out differently this time.

So remember, it’s never different this time – the more things change, the more they stay the same.

Until next time.