<July 26, 2024>
It’s that time of the market cycle—when sensible advice and positioning is tossed aside for the chance of making a killing in risk assets. Of course, it doesn’t feel like risk. It feels like bliss. Pure exhilaration and satisfaction. Coming into work and seeing your large caps, small caps, and whatever else floats your boat, go up and up—there’s nothing better.
Memories of 1999 are still fresh in my mind. Instead of coming into work to watch my stocks go up, I’d sit down, turn on Bloomberg, and watch tech stocks soar while my small cap value stocks declined day after day. Small cap value stocks were extremely out of favor in 1999 and, unlike today’s valuations, were dirt cheap. But it didn’t matter. Valuations were the last thing driving markets. It was all about momentum and how much you could make in months, weeks, or even days. Day trading was the rage with clever television commercials convincing investors that they too could become rich without effort.
Before 1999, I was convinced I knew everything about the financial markets. An extended earnings cycle and bull market contributed to my overconfidence. That all changed in 1999—I had much to learn! Nothing can prepare you for navigating through an asset bubble. Trying to maintain your investment discipline and sanity is extremely difficult. And I suppose you don’t have to do both. While I believe I maintained my discipline throughout the tech bubble, I’m less certain about my sanity!
Here we are again. Stock prices are soaring, testing investment processes and disciplines. Valuations are near or above past bubble peaks. Meanwhile, the Federal Reserve is on the verge of cutting rates, neglecting the destabilizing risks of runaway asset inflation. In such an environment, some professional investors will fold, some will hold, and some will dabble “just a little” to try to keep their jobs.
It’s not hard to see who is playing along and who isn’t. Just open the hood of any portfolio and take a peek—the holdings will tell the story. For those participating, dismissing risk is often rewarded with near-term returns, accolades, and higher compensation. For many, the rewards and seductiveness of asset bubbles are irresistible.
In the 1999 bubble, many professional investors deviated from their investment disciplines. Career risk was elevated, and not keeping up with the crowd could cost you your job in addition to your pride. I personally knew several talented value managers who were let go and replaced with managers eager to join the party. The pressure to conform was intense, especially for younger analysts and managers who had never been exposed to the temptations of seemingly free money.
I recently had the fortune to speak with several young analysts and portfolio managers. These were very smart investors. We discussed the macro, the micro, and many of our favorite ideas. If I could describe the group in three words, it would be young, bright, and confident. What a great combination! And if I could describe their reaction to how I explained our positioning, and the fact we were 80% invested in T-bills, it would be bewildered. While I’m a generation X’er, I’m certain in the back of their minds they were thinking, “Ok, Boomer”!
Sometimes it’s hard remembering how it was being a young analyst and manager. The desire to prove yourself is very powerful early in an investment career. When I was an analyst in New York in the 1990s, I wanted to prove to my manager that hiring a young kid from Louisville, Kentucky wasn’t a mistake. I worked long hours and went through my buy recommendations carefully to make sure I didn’t make my manager look foolish. I was very concerned about the risk of losing money and protecting my manager’s reputation.
Today things are very different. Looking foolish has been redefined from losing money to not making enough. For analysts working for relative return strategies, should they recommend a second-derivative artificial intelligence investment that floods its press releases with future sales potential, or should they buy a beaten down cyclical with few near-term catalysts? Or even worse, recommend investing patiently and waiting for better opportunities!
We’re at the stage of the market cycle where careers are made or destroyed. In 1999, I thought my investment career was over. I enrolled in graduate school and was prepared to move on from an industry that I no longer understood. The tech bubble and willingness of market participants to play along was beyond my comprehension. Why would investors pay these prices? As I eventually learned, it wasn’t just greed, it was survival. Survival for professionals trying to keep their jobs and survival for individuals trying to keep up with their peers. The risk of being left behind and feeling alone far exceeded the risk of meaningful losses.
For those still left debating whether to jump in or sit out the boom in stock prices, we believe thinking objectively and keeping your emotions out of the driver’s seat is worth considering. While such advice often sounds like “blah, blah, blah” at this stage of the cycle, it’s advice that many in the aftermath of asset bubbles wished they considered. And perhaps we’re wrong, and we should be the ones capitulating. Maybe, but when we consider valuations and the drivers of this cycle, sustainability is not a word that comes to mind. Instead of a healthy economy and invincible bull market, we see conformity, the extrapolation of the unsustainable, and a top-heavy market risking losing control on the upside. We see 1999.
Eric Cinnamond
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Definitions:
Nasdaq: a stock market index that includes almost all stocks listed on the Nasdaq stock exchange.. The composition of the NASDAQ Composite is heavily weighted towards companies in the information technology sector.
Wilshire 5000: a market-capitalization-weighted index of the market value of all American stocks actively traded in the United States. As of December 31, 2023, the index contained 3,403 components.
Russell 2000 Value: a small cap index that measures the performance of the small cap value segment of the US equity universe.
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