Behavior, Bubbles, and Inflation

November 30, 2021

I get asked a lot if I'm worried about the market. With occasional exceptions, the answer is no. It's not possible to control it, so worry has no advantage, and a well-structured portfolio should have downside protections built in regardless of market direction. I do worry about behavioral error. Behavioral error leads to incredible loss of wealth, and it is endemic in the investing population.

Right now, the biggest behavioral error I see is that people have too much cash sitting around. Cash does nothing for you as an investor, except almost guarantee that you are going to lose. It almost certainly will not have the long-term returns of the stock and real estate markets, and it does not afford the protection of certain types of bonds.

A secondary worry is inflation. Inflation is enemy number one for the investor, even though most people don't perceive it as such. It's quiet, but it erodes real returns. Some asset classes tend to do well in inflationary periods. For example, real estate investment trusts. Over the past year, REITs, like homeowners, have been able to refinance much of their debt into lower cost obligations. And then inflation sets in, and they can raise rents at a faster pace, and at the same time, their cheaper debt becomes doubly cheap, because the debt is a fixed contract, and it's easier to pay back with more plentiful dollars that are now worth less.

Are we in a bubble? I don't know. Maybe. But if we are, I'm going to go out on a limb here and say we're not at the end of it. You know I've said many times that no one can predict the market short term, and that's still true, but experience does give insight into patterns. Bubbles generally end when investors don't think they can lose money, when people wonder why they are going to work when their neighbor is day-trading, and when Jim Cramer swings the chicken so wildly things break on the set. To some degree, because rising markets fuel consumption, the cycle can spiral upward for some time.

Keep in mind this graph. I would guess we're in the Excitement stage:

Finally, quote of the week. Logistics humor:

“Amazon had space on ships and I couldn’t say no to anyone,” says David Knopfler, whose Brooklyn-based Lights.com sells home décor and lighting fixtures. “If Kim Jong Un had a container, I might take it, too. I can’t be idealistic.”

I hope you had a nice Thanksgiving and are enjoying the leftovers.

Dan Cunningham