[7 min read]

Vern Gowdie

Due to ill health, Vern has not been able to write today’s Rum Rebellion.

Instead, we are publishing an edited extract of a letter Vern wrote to himself and shared recently with readers of The Gowdie Advisory and The Gowdie Letter.

A long-time reader described it as…‘Your latest article is one of the best you’ve done’ and another as ‘an excellent read’.

Here’s Vern’s letter to himself…

Recognise you are a square peg in a round hole.

Seeing the world differently does not necessarily make you right.

And, even if you are right, it could take an awfully long time for that to be proven.

In the interim, you will be plagued with doubts.

Am I missing something?

What am I not seeing that others are…or think they are?

Are they ignorant of history or am I too confident in thinking my version of history will prevail?

Do the lessons learned from the market experiences of 1987, 2000 and 2008 no longer apply?

I’m pretty sure they still do.

But where’s the teacher of those lessons disappeared to?

On an extended sabbatical or permanently retired?

Hopefully, it’s the former.

You are betwixt and between your father’s generation and that of your children

On one side there is the Great Depression-era’s frugality and on the other, the ‘buy now, pay later’ mindset of the millennials.

Such a contrast in attitudes.

Dad’s generation is gradually dying and with them goes the mindset of austerity.

We now inhabit a world where ‘living within your means’ is an outdated concept.

Politicians talk about it, but never practice it.

Household and corporate debt continues to rise…without any obvious repercussions.

Can this continue indefinitely?

History says ‘no’.

But, on the results to date, is it possible that history is being rewritten?

Possible…yes.

Probable…unlikely.

If I was Dad’s age these thoughts would not be entertained.

At 91, Dad’s financial race has been (more or less) run.

Getting 0.5% on his term deposits is ‘neither here nor there’ to him.

His part age pension payment is enough to make his world go round.

The movement of markets is of no real concern to Dad.

Whether house price rise or fall or if Wall Street hits a new high or collapses or cryptocurrencies are the new money frontier or not, he could care less.

Whereas I don’t have the luxury of not caring.

There’s still a few decades (hopefully) of market activity left for me to navigate.

Making it successfully across the (health and wealth) divide from age 61–91 (or even 101) is the goal, but it’s far from an assured outcome.

What if this really is a new paradigm?

What if the Fed can continually aid in the recovery of an ailing market?

And as much as you scoff at the notion of ‘this time is different’, what if it is different?

Are cryptos the dawning of a new era in money and you just don’t get it?

Are your previous personal and professional experiences holding you back and limiting your ability to embrace a different future?

If I’m wrong and markets somehow manage to defy cyclical rotation, then I’ve made a terrible error of judgement. One that will have cost me and those who’ve listened to me dearly. The prospect of that weighs heavily.

To date, logic has NOT prevailed.

There are others who are also watching, waiting, and wondering.

While I am not alone in my thinking, it can get lonely.

I know my time in this business has made me sceptical of claims about the new and improved world ahead.

While things change, the basics remain.

• 1+1 still equals 2.
• Through the ages, excessive debt has always been the downfall of individuals, businesses and nations.
• There are no free lunches…pipers eventually get paid.
• Market movements — especially when moving to an extreme — can be heavily influenced by emotions.

Yet, I see what’s happening with property values and ask why are property prices booming?

Logically it makes no sense.

You read news articles like this…

‘Australia’s near-stagnant wage growth has persisted long before the COVID-19 crisis began. Now, the tide is unlikely to turn even in the next five years, data from Deloitte Access Economics showed.

‘With wage growth practically flatlining for more than a decade now, workers in Australia have grown accustomed to the trend of stagnant pay increases.’

Human Resource Director magazine, 21 January 2021

And, then there’s this from The Sydney Morning Herald a few days ago…

‘Over the eight years to last December [2020], however, wages rose by 19 per cent, not much more than the 15 per cent rise in consumer prices. That’s what the fuss is about: since 2012, wages have barely risen faster than prices.’

If on average, wages are barely keeping up with cost of living pressures, how is it possible for households to borrow even larger sums of money to push up home prices?

It’s different to the 2007 housing bubble. That one was driven by poor quality borrowers being shoehorned into adjustable rate mortgages they had no chance of affording in the longer term.

This boom in prices is being driven by government and RBA intervention.

Low rates. Mortgage relief schemes. First homeowner grant. Home builder grant. Stamp duty exemptions and concessions.

Government is determined to keep a floor under property values.

Unless there is wages growth and/or a further reduction in borrowing rates, surely prices must be close to bumping up against the ceiling of affordability?

You’d think so.

However, after speaking with Catherine Cashmore, I’m forming the view that property prices could remain elevated (or even steadily appreciate) for a few more years yet.

The X factor in all this is an unexpected global event that undermines confidence.

Should this happen, I’m certain governments and central banks will pull out all stops to maintain confidence.

Will it work?

Maybe.

It really does depend on the type of ‘event’ and its severity.

One thing is now an absolute given, blatant intervention in the functioning of markets is official policy. 

Which brings me to a market where the Fed has been active in putting its heavy hand on the valuation scale.

Wall Street.

Without the Fed’s props, this market should have collapsed long ago.

But it hasn’t.

Will it?

Gees, how I ponder that question.

I’m a fan of Hussman’s logic.

Should I be?

I think so.

His reasoning in sound.

Mathematically based.

Historically referenced.

Let’s face it, man hasn’t changed.

We are still the same greedy, gullible, fearful, and remorseful beings as our ancestors.

I look at this chart of Hussman’s — five different valuation metrics — and there is an obvious overlay.

Each one tends to move in the same direction as the others.

To me it looks like a pretty compelling picture.

But are looks deceiving?

If they are, then you have to buy into the premise of ‘this time is different’.

That’s a big call. This is 75 years of data…from good, bad and indifferent times.

Low interest rates. High interest rates.

Single- to double-figure inflation.

Stagflation.

The US market has traversed a lot of different terrain since the Second World War.

Yet, the under- to overvaluation pattern is constant.

The range of overvaluation has changed markedly since the late 1980s…when Greenspan started playing God.

Looking back, when Greenspan gave his ‘irrational exuberance’ speech in late 1996, the valuation metrics were in line with the peak in the mid-1960s…the start of a 16-year secular bear market. Perhaps, this is what prompted Greenspan to sound a note of caution.

His warning was ignored.

The S&P 500 continued on its merry way for another three-plus years.

Eventually, the rubber bands of valuation were stretched too far and there was a snapback.

But the lesson from this period is…valuations count for nought when speculative fever is running high.

Greenspan (and others like Buffett and Grantham) were right in calling the dotcom era a bubble. However, it took time for that to be proven.

The 2007 valuation peak was more like K2 to the dotcom’s Everest.

While it never scaled the same heights as 2000, the bursting of the US housing bubble took it down to greater depths…but nowhere near as low as the late 1940s and early 1980s.

The Fed’s rescue efforts created a sharp V-shaped recovery.

Whereas, recoveries from previous lows, were more gradual.

This demonstrates the power of the Fed.

What’s been both amazing (and baffling) is the valuation metrics for this current market have surpassed the 2007 peak (in 2012) and the dotcom peak (in 2017/18).

The only rational explanation for this is ‘irrational exuberance’.

Belief in the Fed is so, so strong.

Can it be maintained?

I can think of plenty of reasons why it won’t…mostly based on mathematics and history.

However, there is no getting away from the Fed’s ability — since the 1990s — to elevate valuation metrics into a range of higher highs and higher lows.

What do you do?

Oh, how I’ve agonised over this question.

If you stay the course, is that being stubborn or sensible?

Everything I’ve learnt from almost 35 years in this business tells me the preferred course of action is to remain resolute…something, somewhere, sometime will take this market by surprise.

When it does, it could be a repeat of what happened in March 2020…short and swift.

My gut tells me we won’t see it coming.

It’ll be an off-the-radar risk event.

When? I wish I knew.

That’s what makes this so hard.

Could we be making more money — which let’s face it, wouldn’t be all that hard with TDs at 0.6% — in the interim.

But what capital cost does that extra 3, 4 or 5% come with.

Will it be a 20% or 30% downside followed by a Fed-funded rapid recovery OR could it be steeper, and absent any great speculate fervour, the recovery is more gradual or not at all?

Questions lead to more questions.

Can you live without an extra 3, 4 or 5%?

For the foreseeable future, yes.

The only caveat is if inflation takes off.

That could pose a problem.

Can you afford to drop 20%, 30% or more in pursuit of that extra return?

That would be painful.

Here we are back to where we started.

After all the toing and froing, the least hurt for Linda and I is, less income.

Therefore, we stay the course and trust that history and mathematics prevail…preferably sooner rather than later.

In the event there’s an unexpected shock to markets, then the Fed will respond with an expected oversized stimulus package. That’s a given.

Are we then going to be in for a series of wild down and equally wild up rides?

I think this is more likely than the market being on a never-ending path to higher highs. That prospect is just a bridge too far for me.

This investment environment is different from what we’ve experienced previously.

Intervention will be on a scale unlike anything before.

This is going to make it tricky to determine when enough risk is out of the market to begin the process of investing on a dollar-cost-average basis.

I’m not sure what this exercise has accomplished…well, maybe that we continue erring on the side of caution.

More questions tend to lead to more questions and fewer answers.

Time to call it quits. For now, find comfort in knowing history, logic and mathematics are on your side…and dig deep into those reserves of patience.

Please be assured I am constantly thinking about our situation…yours and mine.

Regards,

Vern Gowdie,
Editor, The Rum Rebellion

Vern is also the Editor of The Gowdie Letter and The Gowdie Advisory — investment services designed to help everyday Australians avoid the financial pitfalls of a volatile economy and make informed decisions to grow their wealth for generations to come.

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