At a recent conference I was asked why ACM so often has a rosy outlook on both the economy and the stock market. After all, both go up and down and if we could simply get ahead of just a few of the declines it would be enormously valuable. While this is obviously true, finding those dips before they happen is a tremendously difficult task. It is far more common for market declines to be a gross overreaction to what turns out to be an insignificant piece of news. Not surprisingly, our outlook today remains rosy for 2019. What does it take for ACM to become bearish?
Some of the most well-known investors who successfully called the 2008 economic crisis include John Paulson, Meredith Whitney, and Nouriel Roubini. All were heralded as brilliant investors for having correctly called the Great Recession. John Paulson’s performance was so strong that his flagship Advantage fund had assets that peaked at over $30B by early 2011. Just 8 years later, it now has only $4B. What happened?
In the year that John Paulson’s assets peaked, the flagship Advantage fund’s performance declined by 36%, a year in which the S&P was up about nearly 2%. This was actually the third year of underperformance in a row, a stretch in which it underperformed the market by over 60%. Inflows had continued because of all of the publicity from calling 2008 correctly. But in 2012, it lost another 14% and marked its 4th consecutive year of substantial underperformance. In 2013, it finally had a good year, but the next few years were even more disastrous and Paulson himself called 2016 “the most challenging year since inception,” which is pretty remarkable considering the nearly 40% underperformance in 2011. Paulson’s collective performance since calling 2008 correctly has been catastrophic.
Meredith Whitney, a graduate of Brown, also called the economic collapse in 2008 and was instantly heralded as an investing guru. She left Oppenheimer & Co. in 2009 to start her own consulting firm and by 2010 was making another major call. On an interview aired on “60 Minutes” she called for a massive amount of municipal bond defaults.
“There is not a doubt in my mind that we will see a spate of municipal bond defaults. We could see 50…we could see 50-100 sizeable defaults… more. This will amount to hundreds of billions of dollars’ worth of defaults.” (The full televised interview is included as a link at the end of this commentary)
The defaults never happened, and by 2013 Whitney was forced to close down her consulting business. She then started a hedge fund, but that closed only 2 years later.
Finally, Dr. Doom himself, Nouriel Roubini, also correctly called the housing crisis. Roubini is also a “perma bear,” known for his persistently negative views of the market and of the economy. In 2011, he again vocally anticipated another recession, a global recession which never manifested. He remained bearish for years and would have missed most of the recovery. He had also been bearish for years prior to the 2008 recession. Roubini was and remains a professor at NYU and his ambitions appear to have been more to create a public persona. More than anything, he seems to be selling himself in the media to help promote his “Dr. Doom” brand (which more recently he has been trying to modify).
There are many perma bears who can claim credit for getting 2008 right. But even a stopped clock is right twice a day. Anybody who is perpetually negative will always be able to claim he is right when a recession happens. The one thing that all perma bears appear to have in common is that they don’t manage money. They tend to sell newsletters and books.
All three of these well-educated, qualified experts correctly predicted 2008. But all of them also performed poorly since their correct call of the 2008 Recession. Getting the timing right for a market decline is incredibly difficult. In ACM’s history we’ve had one discussion about going to all cash and that conversation happened in 2007. In fact, we did end up increasing our cash position to 15%. The reason that we have such a high bar to move towards cash is because the stock market’s average annual total return has been about 9% for the past 90 years. This means that in an average month, the market has risen nearly 1%, so missing a single average month of performance is significant. By moving to cash, you are betting against the market. Even if the market is up only 0.5% in a month that would actually be below its historical average. This history creates a very high bar for us to want to be out of the market.
An analogy that I often use compares investing in the market to operating a casino. A casino has odds that are obviously tilted in its favor. On average, it makes money even though on any given night it might lose money. But I always want to bet on the casino making money. By being out of the market or short the market, I am actively making a choice to bet against the casino. The more time that you are out of the market or the more time that you spend at a casino, the more likely you are to underperform. Players at the casino might win on a given night, but on average they don’t.
This is further supported by the average retail investor’s performance, which as noted in my recent commentary, is under 3% per year because he tries to time the market. This was most recently evident in December 2018 when many investors pulled out of the market right after the market had already sharply declined. Inflows resumed only after the market climbed in January. Selling low and buying high is a sure-fire way to lock in poor performance. Retail investors aren’t the only group to get caught by the allure of trying to time the market. Many professionals have as well, and the overwhelming majority fare very poorly.
So what does it take for ACM to become bearish? A lot. As a firm, we look at scores of economic data on a daily basis. In fact, we have created an algorithm that tracks economic data to help us forecast whether any material risk might be coming down the road. We have tremendous resources, experts, and PhDs, including research from an ex-Federal Reserve Chairman, who all have insight into the market and the economy. But a call for outright cash should be highly unusual and reserved only for the most extreme of situations where the market is clearly missing a large risk. Gaining this insight before it happens is very rare for the overwhelming majority of investors and so this bar must remain extremely high.
Meredith Whitney “60 Minutes” Interview: https://www.dailymotion.com/video/x2o569g