Via Wolf Street

It just looks so tempting.

By Wolf Richter. This is the transcript of my podcast last Sunday, THE WOLF STREET REPORT. You can listen to it on YouTube or download it at Apple Podcasts and others.

We are in the miraculous process of borrowing and printing ourselves to prosperity or whatever. Short-term interest rates on essentially risk-free money, such as US Treasury bills or insured bank deposits, are near zero. For folks in many countries in Europe, they’re below zero. Long term risk-free interest rates are below 1% in the US and below zero in some other countries.

With the Federal Reserve leading the charge, central banks have jumped with both feet into the “let-inflation-run-hot” dogma. Inflation means the destruction of purchasing power of the currency, and thereby the destruction of purchasing power of labor paid in that currency.

This is no biggie at the top, where folks get raises to the tunes of millions of dollars. But it’s a biggie for the lower 50% on the income scale. For them, the dogma of letting inflation run hot is going to be very tough. And as inflation saps the purchasing power of their incomes, they’ll cut back.

And for investors, the thin income streams from low-risk investments are not nearly enough to compensate for the loss of purchasing power of that investment due to inflation.

So, to dodge these issues, let’s put or keep our hard-earned nest egg in the stock market?

The US stock market is ridiculously overvalued, though it has recently been through a little bit of a selloff, particularly among the biggest names in tech, or so-called tech, that are down between 8% and 13%, and in Tesla’s case by about 25%, from their peaks just a few days ago. They’re very fragile – after the enormous run-up they’ve had. Many of those stocks, if they dropped 50%, would still be enormously overvalued. If Tesla dropped 90% from its all-time peak, it would still be overvalued.

The idea that stocks can only go up is nonsense.

The US stock market has been the target of global buyers that have pushed US stocks higher because people around the globe believed that it can only go up, after their own stock markets have never gotten anywhere near their highs of many years or even decades ago.

In fact, the US stock market has been the exception among major stock markets.

Let’s look what other stock markets have done, right now, even after the blistering run-up in share prices since March. These are the biggest global stock markets, and every single one of them is down by a big margin from the peak many years ago. So let’s see…

  • The Japanese Nikkei is still down 40% from 1989. That was 31 years ago.
  • The Shanghai Composite index is down 45% from 2007. That was 13 years ago.
  • Hong Kong’s Hang Seng Index is down 10% from the peak in 2007
  • The German DAX is a “total return” index that includes dividends. So it cannot be compared to the other indices here, or to the S&P 500. The German index that is not a total return index and therefore can be compared to the S&P 500 is the DAXK. Despite its red-hot surge in recent months, it’s still down 8% from the peak in the year 2000. That was twenty years ago.
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The early months of the year 2000 in Europe was the peak of the combined euro bubble and tech bubble. You see that year cropping up a lot here.

  • The London stock exchange index FTSE is down 13% from 1999. 21 years ago.
  • The Italian stock index, the FTSE MIB, is down about 60% from the year 2000. 20 years ago.
  • The French stock index, the CAC40, is down 24% from its peak in the year 2000. 20 years ago.
  • The Spanish stock index IBEX 35 is down 58% from its peak in 2007, which was the peak of the Spanish housing bubble that collapsed with devastating results. 12 years ago.

So yes, the hopes that stock markets always go up has proven to be a very bad deal for believers in those markets. Buy-and-hold has been costly for these investors – unless they got the market timing right, buying low and selling high, but that’s trading not buy-and-hold. And the other traders that didn’t get the timing right got run over by an endless freight train.

Those markets dove after a huge ridiculous bubble, and they never recovered.

The US markets are now in the same kind of huge ridiculous bubble. And as we want to put money into the stock market, or keep our nest egg in the stock market, we need to keep in mind what happened in the other big stock markets around the world after huge ridiculous bubbles.

And yes, in all those countries, with the exception of China, central banks have repressed interest rates to zero or even below zero.

And in all those countries, including in China, central banks have engaged in money-printing policies, such as asset purchases or similar strategies. As you can see, whatever those policies did, we know one thing they didn’t do: take stocks back to their old highs.

So maybe we don’t want to lose 20% or 50% or 60% of our nest egg. So we think we might put it in secure instruments, such as insured bank deposits or Treasury bills or high-grade corporate bonds or similar.

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So we might be earning 0.5% or 0.8% at the bank if we’re lucky. Short-term Treasury bill yields are near 0% now. If we buy a 10-year Treasury note, we’ll only get 0.7% in interest for the next 10 years. So-called risk-free investments – they’re called risk free because you have essentially no risk of losing your principal – just don’t pay much in interest.

This wouldn’t be a huge issue, if inflation were 0%. But that’s not the case. The Fed has promised to let inflation run hot. Inflation has been rising for the past few months, and the Fed has given us to understand that it won’t even think about thinking about doing anything about inflation when it begins to overshoot its target.

The Fed’s target is another thing. The Fed’s inflation target is 2% as measured by the core PCE inflation indicator. This core PCE indicator nearly always runs lower than the core Consumer Price Index. So 2% core PCE might be 2.7% CPI inflation. And if the Fed lets it run hot and it gets to 4% based on core PCE, inflation as measured by CPI will be over 5%.

Meanwhile, we’re sitting on our just-bought 10-year Treasury securities that will pay 0.7% for the next ten years. And short-term interest rates will still be near 0%. High-grade corporate bonds are not much better. So if that sounds like a rip-off, it’s because that’s precisely what it is – designed and executed by the Federal Reserve.

So we say, OK, I’m not going for that rip-off. And the riskier assets beckon. We want to get the 4% dividend yield that a company offers on its stock. We buy the shares to earn that yield, and two months later, the company eliminates its dividend, and our yield is now zero, and the shares plunge. We got whacked twice. That’s the risk.

If you invest in a stock index fund, your nest egg might drop 20% or 50%.

Nearly all asset prices rose in lockstep over the past few years — stocks, bonds, housing, commercial real estate, and the like. There was no diversification possible because they all did the same thing. And now they threaten to remain in lockstep, but in the other direction. In this environment, diversification has proven to not exist.

Even precious metals have surged recently has stocks and bonds and real estate surged. For a diversified portfolio, part of it must go down while another part goes up. If everything goes up together, we’re not diversified. We’re just fooling ourselves.

Then there’s real estate as an investment.

So let me say this first: if you’re ready to buy a home that you want to live in, and you have your reasons to buy it, and you understand that a home is an expense, and you can afford to buy that home, by all means buy it. Don’t put your life on hold, waiting for the right moment.

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But it’s important to understand that a home is an investment only during housing bubbles. And they cannot go on forever. The other times, a home is an expense. But if you’re comfortable with the mortgage payments, and you love your home, and you’ll intend to stay there over the long term, by all means, buy it.

But if you’re looking at housing as an investment, because you don’t want to lose money fast in the stock market, and because you don’t want to lose money slowly to inflation with low-risk investments, well then, good luck, because you may need luck. Housing bubbles when they blow up are really rough because housing as an investment is highly leveraged. And housing bubbles have blown up plenty of times before.

We can also try to put our money to work day-trading stocks and options. And that’s a lot of fun and excitement. A real adrenaline trip. But during the past stock market downturns, most day traders took huge hits, day after day, and it turned into the most frustrating nerve-wracking activity ever, and very expensive, until they finally threw in the towel and tried to get their old jobs back.

Anyone can day-trade a relentless bull market. But when it turns on us, it gets really rough. And before we know it, much of our play-money is gone.

So I’ve listed some of the choices and possible outcomes that investors have to struggle with. And there are no simple answers.

This is the most treacherous investment environment I’ve ever seen. There is a good chance that the US stock market ten years from now will look like some of the stock markets I listed earlier, meaning way down from its peak in 2020. There is nothing easier, in this environment, than turning your hard-earned nest egg into scrambled eggs. You can listen and subscribe to THE WOLF STREET REPORT on YouTube or download it at Apple Podcasts and others.

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