What Got You Here, Won’t Get You There

I was reading a recently released book by Morgan Housel, a venture capitalist who writes one of my favorite blogs. I read this quote and it struck me as particularly timely:

“Your personal experiences with money make up maybe 0.0000001% of what’s happened in the world, but maybe 80% of how you think the world works.”

I share this because there are powerful secular trends that have allowed us to “sail downwind” since the early 1980s, including:

1. Interest rates: This biggest influence I can think of is chronically falling interest rates. While we don’t know the exact limits of negative rates, I think it’s fair to say we’re near the end of this cycle (probably at the end in Europe and Japan). It’s a very high probability to say this tailwind will turn into neutral or a headwind over the next decade.
2. Debt: We’ve increased debt virtually everywhere all over the world. Living on credit is fun/easy while you’re spending but is a headwind when you’re paying it down. The limits of debt levels are a lot more uncertain then the end of interest rate decreases, but I think it’s fair to say we’re much closer to the end than the beginning.
3. Labor: We’ve seen labor’s power in the U.S. deteriorate consistently for 40 years. While great for corporate earnings, it sows the seeds of social unrest. We have inequality ratios in the U.S. that rival the late 1920s. Once again, the exact limit is unknown, but it’s easy to assume we’re much closer to the end than the beginning.
4. Taxes: We’ve lowered taxes on corporations to a point that exacerbates the debt problem and is arguably unsustainable. Even before COVID-19, the U.S. government was running a deficit that was unheard of during economic expansions.

Despite stock valuations rising the last five years, we can see the effects of this less-friendly environment by looking at NIPA profits (a broad measure of U.S. corporate profits), which are virtually flat since 2015, even before COVID-19 hit us.

Hedge fund manager Chris Cole reminds us that, “A remarkable 91% of the price appreciation for a classic equity and bond portfolio (60/40) over the past 90 years come from just 22 years between 1984 and 2007.”

My point here is if you’re looking to your personal experience of the last couple of decades to draw investment lessons to guide your future, you’re likely to come up with sub-optimal lessons, and in some cases, the opposite conclusions that will be useful over the next 10 to 20 years.

Like a ship shifting from sailing downwind to into a headwind, the fundamentals of sailing don’t change but the optimal strategy does (tacking.)

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