“People always ask me what is going on in the markets. It is simple. Greatest speculative bubble of all time in all things. By two orders of magnitude.”
-Michael Burry (investor starred in the Big Short)
The debt, equity, and crypto markets are red-hot. The market’s looming collapse will serve as a regression to the mean, and as a lesson for WallStreetBets gamblers who believe investing is fun. It’s not.
Here’s a summary of past market crashes:
- 1929: stocks crash 90%
- 2000: dot-com stocks collapse 80%
- 2008: real estate drops 50%
- 2018: crypto dives 80%
The long-term (10+ years) and conservative investor shouldn’t worry about crashes. He can weather the drop and enjoy the next bull run. It is the Robinhood traders buying crypto options on margin that should worry — it’s almost wipeout o’clock.
I’m not predicting doomsday, advising you to sell anything, or saying that the successful stock-picker cannot find bargains. What I am saying is: don’t be swimming naked when the tide goes out.
Risky bonds offer rock-bottom yields
There’s a country I call Desperado. By overspending and collecting few taxes, its debt is rated as “junk”. And rightly so — Desperado defaulted almost 10 times in 200 years.
In 2017, Desperado asks investors for a $3 billion loan at 8% interest, with a catch: repayment is in 100 years. Given Desperado’s bankruptcy history, sane investors reply “no way, Jose.” But to think that all investors are rational profit-maximizing machines is, in one word, nuts.
Foolish investors say “okay, Jose”, and lend billions to Desperado. Two years later, Desperado goes bankrupt, and unsuspicious investors wave adiós to their savings.
This is a real story, and Desperado is Argentina.
Before throwing money at risky bonds, check out the following graph. The higher the spread between junk and government bond yields, the higher the reward for the extra risk.
Why is the risk spread so depressed today? Because government bond yields are at 0%, investors are forced to assume risk if they want a positive return. In high demand, today’s junk is selling for the price of yesterday’s roses.
Safe bonds guarantee losses
“Bonds are not the place to be these days. In Germany and Japan, investors earn a negative return on trillions of dollars of sovereign debt. Fixed-income investors worldwide — whether pension funds, insurance companies or retirees — face a bleak future.”
-Warren Buffett, in February 2021
Germany’s 10-year bonds currently yield -0.1%. With triple-A bonds, you are the one paying interest. Add the 1% management fee and 4% yearly inflation, and voilà—you are guaranteed to lose purchasing power with “safe” bonds.
Bondholders made excellent returns in the last 10 years, as interest rates dropped and prices rose, thanks to central banks printing gazillions of Monopoly money. But soon it’s midnight, and Cinderella must stop partying.
Central banks pulverized investment opportunities
The US Fed is printing $120 billion each month, and the European Central Bank a similar amount. By buying bonds with new money, the Fed is increasing bond prices, thus lowering yields available to you and me.
Negative bond yields and rising inflation leave you cornered with stocks, real estate, and alternative investments as the only options. Let’s look at stocks first.
“Nowadays people know the price of everything and the value of nothing.”
Stock multiples are near historical records
The NASDAQ surged more than tenfold since the 2008 financial crisis. This measure is useless—when assessing stocks, we should not judge the price (what you pay), but the value (what you get).
A traditional measure of value is the price-earnings ratio. To factor in economic booms & busts, I prefer the cyclically adjusted price-earnings ratio (CAPE), which is a measure of price divided by the average of ten years of earnings.
As you can see, the CAPE ratio is at the 2nd highest point in the last 150 years, after the dot-com bubble. Due to negative bond yields and emerging tech, bulls argue “this time it’s different”—the 4 most expensive words in history.
Examples of irrational exuberance
- Hometown International owns one deli store with $35,000 in sales, its shares delisted from an over-the-counter exchange for disclosure irregularities. So the market valued the deli at $100 million.
- After Trump’s blog had to close due to the absence of readers, Trump announces he will launch a new social media, Truth Social. Shortly after a SPAC reveals the purchase of Trump’s Truth Social, the SPAC’s shares decuple from $10 to $100. I write the Truth.
- Tesla is leading the EV, battery, and AI revolutions. But with only a 1% global market share, Tesla is valued more than the next 9 biggest carmakers by market cap. Would you rather own Toyota, Volkswagen, BYD, Daimler, Great Wall Motors, NIO, BMW, and General Motors, or Tesla?
One day, Hertz—which was recently bankrupt—announces a deal purchasing 100,000 Teslas (which Elon Musk then tweeted isn’t signed). By how much does this $4 billion deal increase Tesla’s worth? $120 billion.
“The stock is not the company and the company is not the stock.”
“Stay away from the crowd.”
Copy of Bitcoin: Litecoin
Litecoin launches in 2011 to solve Bitcoin’s slow transaction speed of 10 minutes. Litecoin copy-pastes Bitcoin’s code and reduces transaction speed to 2.5 minutes, becoming worth tens of billion in 2021.
Copy of a copy: Dogecoin
In 2013, a pair of software engineers make Dogecoin as a joke, copy-pasting the code of Litecoin, itself a copy of Bitcoin. The copy-of-a-copy meme coin becomes worth $85 billion (larger than General Motors) at its peak in May of 2021, the day before Elon Musk hosts a Saturday Night Live show as “the Dogefather”. Welcome to Alice in Wonderland, where there is no limit to craziness.
Copy³: Shiba Inu
“Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”
Shiba Inu is crypto’s maddest Mad Hatter. In 2020, an anonymous coder creates Shiba Inu as a new token on Ethereum, publishing a woofpaper. The creator donates 50% of the meme coins to Vitalik Buterin—who has no involvement with Shiba Inu. In 2021, Vitalik finds himself with $7 billion of Shiba coins. He donates $1 billion to charity for Covid relief in India, and destroys the remaining $6 billion stake.
Biggest NFT artist: “NFTs are a bubble”
Today, artists can sell digital art as crypto NFTs and receive a cut from future re-sales. Consider Van Gogh, who only sold 1 painting in his lifetime—The Red Vineyard—for $2,000. Imagine how rich his family would be if they made 1% of every re-sale of a Van Gogh painting.
Beeple is a digital artist who created art every day for 5,000 consecutive days. One day, he sells a JPG collage of his 5,000 pieces of art through a Christie’s auction, fetching $69 million from a crypto millionaire who overpaid for bragging rights.
As a comparison, Leonardo da Vinci’s Salvator Mundi was the most expensive painting ever sold at $450 million. Beeple’s $69 million NFT sale signals that digital art is now as important as physical art, but also that it’s a bubble.
“I absolutely think it’s a bubble. I go back to the analogy of the beginning of the internet. There was a bubble. And the bubble burst”
When everyone is buying crypto
“Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day’s financial news as he worked with rag and polish. An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market. My cook had a brokerage account and followed the ticker closely.”
-Bernard Baruch, before the big Crash of 1929
This summer on a Ukrainian train, I see a physical ad on crypto, it says “Sell crypto with one hand only”. You don’t have to go to Europe’s poorest country to see the crypto pervasiveness for yourself. Just like in 1929, take a taxi ride— the driver might be a crypto hodler.
“Everything popular is wrong.”
Short-term greed, fueled by low-interest rates, has led to sky-high valuations in almost all asset classes.
If you don’t want to get burnt when the party stops, avoid:
- High leverage
- Bonds (both safe and high-yield)
- Hot stocks (e.g., Tesla, Rivian, IPOs)
- Shitcoins (Dogecoin, Shiba Inu)
- Expensive asset managers (1–2% annual fees)
Even after my advice, I know most people will act as the CEO of Citibank before the 2008 crash.
“As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”
-Former CEO of Citibank, in 2007
Don’t be foolish. Be fearful.