“The irony of good times is that they breed complacency and skepticism of warnings.” – Morgan Housel
Morgan Housel is one of our favorite financial writers because of his ability to explain complex, macro investment lessons in simplified, anecdotal terms. He recently published a longer article entitled The Big Lessons From History in which he offered up four important lessons from history that repeat the same story again and again. One of the lessons entitled Calm Plants the Seeds of Crazy is the inspiration for this week’s post and was particularly apropos given the current COVID-19 pandemic and the record high valuations/complacency in the stock market.
COVID-19 has been a massive shock to our modern-day society. Governments and policy makers have taken extraordinary measures (lockdowns, quarantines, etc.) to slow down the spread of this highly contagious disease. People’s way of life has changed (social distancing, mask wearing, hoarding, etc.) which has created a long list of economic winners and losers that either benefit or are hampered by this new way of living. In response, the Federal Reserve and other global Central Banks have taken extreme measures to blunt the impact of COVID-19 on the global economy through stimulative measures to stave off a global depression.
But if COVID-19 would have manifested itself 100 years ago, it is highly likely that it would have been a non-event. Not because it would have been any less contagious or deadly, but simply because the collective societal psyche would have been much better prepared for it. Back in the early 1900’s infectious diseases were the norm (typhoid, measles, polio, scarlet fever, etc.) and were actually the most common cause of death. People living during this time simply saw the risk of dying from an infectious disease as a fact of life.
If we moderns lived for one year with the sort of death rates our pre–industrial age ancestors perpetually lived with, we’d be in societal shock. – “The End is Always Near” by Dan Carlin
Today, thanks to advances in modern medicine, death from infectious disease is extremely rare dropping by 94% from 1900 to 2010. Even though some epidemiologists have been warning of the risk of a global pandemic, public health budgets have been cut as we have been lulled into believing that this risk has been eliminated. As Morgan aptly stated in his article, “It’s hard to convince someone that they’re in danger of a risk they assume had been defeated.” Even though we know infinitely more about viruses today than we did 100 years ago, it is ironic to think that we are less equipped to handle them simply because we’ve convinced ourselves that this type of risk shouldn’t exist in our modern world or as Morgan puts it, “Calm plants the seeds of crazy.”
The famous Swiss psychiatrist Carl Jung developed a theory called enantiodromia, which is the idea that excess gives rise to the opposite. In the case of COVID-19, excess complacency to the risk of infectious disease due to advances in modern medicine created the fertile ground for COVID-19 to become a global pandemic. This same principal applies to investing and markets. Quoting directly from Morgan’s article:
When there are no recessions, people get confident. When they get confident they take risks. When they take risks, you get recessions.
When markets never crash, valuations go up. When valuations go up, markets are prone to crash.
We have been in a liquidity fueled bull market for over a decade now. Given what has transpired from the COVID induced sell-off and recovery, it is easy to be lulled into believing that fundamentals do not matter and it is all about liquidity from the Federal Reserve. Thus far, that mantra has proven to be true, but that does not mean that it will always be so. The biggest risks are always the ones that seem to appear out of nowhere, which can only be explained through the benefit of hindsight. Again quoting Morgan’s article:
Nothing too good or too bad stays that way forever, because great times plant the seeds of their own destruction through complacency and leverage, and bad times plant the seeds of their own turnaround through opportunity and panic-driven problem-solving.
Stocks and bonds both look extremely stretched from a historical valuation perspective. Belief in the almighty “Fed Put” has bread investor complacency and leverage/debt are at historically high levels. If we are to believe Morgan’s lesson from history that calm plants the seed of crazy, then one would have to conclude that we are currently planting the seeds of our own destruction. But that doesn’t mean that everything is all doom and gloom. As Morgan pointed out in the quote above, the process also works in reverse as bad times end up planting their own seeds of opportunity and turnaround through problem solving. And thus is the natural cycle of so many things in life.
Taking all of this into account and given the fact that we are hesitant to believe that the Fed has successfully figured out how to forever “tame the business cycle,” we are currently more prone to be cautious than opportunistic even if it means that we participate to a lesser extent in any further gains.
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
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