When the Next Crash Comes...

Oct 21, 2015

- By Bill Bonner

Bill Bonner
Zurich, Switzerland

"We don't pay any attention to 'the stock market.' We buy good companies at good prices.

An old friend was explaining how his private fund operates.

"We aim for 12% per year," he continued. "And that's what we get, more or less."

US stock market investors gained nothing but lost nothing yesterday. Between the bulls and bears, fear and greed, profit and loss -- it was a draw.

But our friend - who started his fund in 2008 - is neither bull nor bear:

"When you invest in stocks you know there will be periods when stock market returns go negative. But we don't worry about it. When you buy stocks, you accept the risk of occasional bear markets. But you get paid for it. About 5% per year by my calculation. It's called the 'risk premium' that you earn in return for being willing to endure periods of loss."

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On display was a second opinion. Here at the Diary, we've given you ours: it is a brave investor - or a reckless one -- who is in US stocks now. They are expensive>. The risk of loss is great. And it could be a long, long time before they recover. Our friend has a different point of view.

"Look, what's the worst that could happen? In the Great Depression, stocks went down 90%. I buy stocks that wouldn't mind holding through a Depression. I make more money than most investors because I get paid for being willing to suffer through downturns. If you earn the risk premium, you've got to take the risk.

"Even if the market were to go down 90% it wouldn't affect my lifestyle. I can only sleep on one mattress at night and eat one bowl of cereal in the morning."

He has a point. He believes that investing in the stock market is a little like working on an oil rig in the North Atlantic. You get paid better. But you have to be willing to be separated from your family and friends. Not always. But sometimes. Likewise, the returns given by the stock market are greater> - over time - than those in bonds because there are times when the stock market investor has to bid adieu to his beloved capital. It comes back...but it could take a while before he sees it again. While the bond investor is cozy in his own bed, night after night, the stock market investor is, from time to time, forced to spend long dark nights far from hearth and home.

He doesn't mind, of course. He's paid to do it. That is the 'risk premium' he earns.

But there are times, we believe, when the 'risk premium' disappears. There are times when investors see only premium but are blind to the risk. Seeing no hazard, they need no hazard pay.

Besides, the feds have their back, or so they think.

Since Alan Greenspan took over the Fed in 1987, they were largely right. He, and his successors, rushed in where fools feared to tread - taking the 'risk' out of the stock market. Of course, they could not eliminate it completely. Occasionally, markets fall. Investors take losses. They are still forced to pack their bags and leave home from time to time. But by following a stock market break with more and easier credit, the Fed substantially reduced the time of exile. In the most recent event, for example, US stocks lost half their value. But thanks to herculean efforts from the feds investors were reunited with their money only three years later.

But as faith in the Fed's willingness to backstop the market has grown, the risk premium has declined. At least, that is our hypothesis. People don't need to be paid to take a risk they don't think is real. So, they bid up stocks to a level where there is not likely to be much return ...and no 'premium' at all.

Here is what could happen: When the next crash comes, the feds will come to the rescue>, as expected. But with rates already near zero, what can they do? Maybe they will have no more success than the Japanese, where stocks fell 80% after 1990...and have never recovered...despite interest rates near zero for the last 20 years!

"I've got time," says our friend. (In the interest of full disclosure...we have money invested in his fund.)

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "When the Next Crash Comes..."

Arul Thareja

Oct 23, 2015

Hi Bill, why do you have money invested in his fund, if you are recommending being out of the stock market to every one :)

2. New photo looks nice

Regards,
Arul

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