At every decade’s start we become conditioned to keep investing in the sectors that created the largest profits in the previous 10 years
At every decade’s start we become conditioned to keep investing in the sectors that created the largest profits in the previous 10 years
At every decade’s start we become conditioned to keep investing in the sectors that created the largest profits in the previous 10 years
The conditioning is so strong that becomes unfathomable to envision how the dominant sectors and countries of the previous decade will not continue to dominate in the future.
And yet the top performing companies of one decade never continue to outperform in the following decade. They usually end up entering a prolonged multi-year bear market, resulting in flat to negative returns 10 years later.
This is where we are now, where the gains from high-growth technology companies have been so strong over the previous decade that it seems impossible to see how Apple, Google, Microsoft and Amazon cannot continue to do well.
We are currently at a global turning point in many established trends that will have significant ramifications for world economies, and investors’ portfolios. Many investors will continue to cling to a portfolio built for the previous decade, until it becomes clear years later that this positioning is outdated.
In the last four decades, we had four major bubbles, all of which burst spectacularly:
- 1980s – Japan’s economic miracle. Investors were convinced that Japan’s economy would eclipse the US, and every company board of directors was busy emulating the Japanese management style. The bubble suffered an epic bursting, and the country still hasn’t recovered thirty years later.
- 1990s – the US technology bubble, as typified by the Nasdaq 100. Young people (and some middle aged ones too) quit their jobs in droves to day trade tech stocks. Most of these companies had no profits, so analysts invented valuation metrics based on ‘eyeball views’ to justify ever higher stock prices. The mantra of this decade was ‘.com’. A company that added this to their name would see an instantaneous doubling of its share price. Two years after the peak the majority of these companies went bankrupt. Eight years later the whole sector was still -80% from its peak.
- 2000s – the previous decade’s bubble was squarely centred around US markets given the country’s high level of innovation. The last bubble’s focus on high growth companies with little in the way of tangible assets created a decade of chronic underinvestment in all commodities. This set the stage for a new bubble in commodities like iron ore and gold, and a related boom in Emerging Markets where many of the commodity companies are located. The place to be was summarised in the acronym BRIC: Brazil Russia India China. The 2008 GFC brought all of this to a halt, with Emerging Market equities currently still below their 2007 peaks.
- 2010s – Last decade’s bubble was similar to the 1990s, though with stronger fundamentals. The bubble was in the FANMAG acronym. So far this bubble hasn’t fully deflated, as only the ‘F’ and the ‘N’ have suffered large losses.
Each of these manias fit neatly into decade-long periods, as this is how long it takes for investors to become convinced that these trends will continue forever. Spotting which sectors are in a bubble isn’t too difficult, all we need to do is look at the strongest performing stocks of the last 10 years (FANMAG, along with the Asian equivalents of BAT: Baidu Alibaba and Tencent clearly fit this bill). Be careful when acronyms are created to identify investment themes.
While some investors end up with almost 100% allocation to these sectors at the peak, wise investors instead actively rebalance and diversify as the bubble progresses. More active contrarian investors can even go underweight anticipating the top. This top occurs when the most speculative stocks in the sector have already crashed. We only need to look at the speculative ‘COVID beneficiaries’ that have all lost -70% of their value: Zoom, Peloton, Pinterest, Beyond Meat, Robinhood. Netflix is not quite there yet, having only fallen by half so far.
Spotting the bubble in progress is not too difficult. Anticipating the next bubble is far more arduous.
In doing this, it’s important to assess the big changes that are happening now that will impact the investing landscape. The last thirty years have been driven by global disinflation as China entered the WTO in 2001, ushering a ‘just-in-time’ inventory management system for companies. Globalisation supercharged this, where companies created efficient supply chains to find the most efficient way to manufacture their goods.
China exported deflation via a cheap labour force that produced large quantities of goods of better quality than other Asian manufacturing hubs.
The globalisation was accelerated by the USSR’s implosion in 1991. Global trade increase significantly, and military spending by governments collapsed, releasing money to be spent elsewhere.
Every single one of these trends has now ended. Global capital flows are decreasing. The size of China’s labour force has peaked and is less competitive. Tariffs and increasing geopolitical tensions mean that companies are focusing on securing their supply chains, instead of optimising them for cost. Countries will do the same, focusing on self-sufficiency and protectionism. Defense spending will increase significantly, putting a strain on many countries’ finances, on top of debt levels that are already perilous.
The Russia Ukraine war is not an isolated case, but a symptom of all the above. The resulting spike in food prices is not transitory as it is driven by global forces that go beyond Russia’s recent actions. We will soon see the first casualities of all these forces in the default and toppling of governments in Sri Lanka, followed by other Emerging Market countries like Egypt.
To top off this list, we have just witnessed the weaponization of fiat currencies. The ability of the US and Europe to deny Russia’s access to its cash reserves is the biggest game changer that is currently under-appreciated by markets. We are witnessing the end of the Bretton Woods II monetary system that started in 1971 by terminating convertibility to gold, ushering in global fiat money. This change will have massive ramifications to every part of the global economy. Every government in the world will be assessing the implications on how they hold their financial reserves, and their actions will impact investments markets to a similar in magnitude to China’s entry into the WTO.
Given all these changes, do you still think this decade’s economic environment and investment winners will be the same as the last decade?
By LEONARDO DRAGO
Co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund management services to endowments and family offices, and wealth-advisory services to accredited individual investors.