Clickbait vs. Reality

Don't Listen to Doomer Forecasters

Photo by Benjamin Wedemeyer on Unsplash

Predicting Doom

One of the most lucrative investing niches is predictions of doom.

When browsing through the top investing newsletters and YouTube channels, you'll often find predictions of catastrophe. The image accompanying the YouTube video typically features a concerned face, often set against a backdrop of fire or explosions with a bold prediction that the stock market is about to crash, USD is about to collapse, we’re going to have hyperinflation, or another Great Depression.

Crafting these narratives is easy.

You could cite constantly rising debt levels in nominal terms and not take inflation or the size of the economy into account. Ever-increasing debt looks scary.

You could pick out a scary looking valuation indicator. The Shiller P/E has made the market look overvalued for the past 25 years - only showing it as 'fairly valued' in 2009. You could turn to more sophisticated measures like market cap to GDP, which have shown the market to be overvalued for the last decade.

You could look at the Fed's unusual activity over the last 15 years. Taking interest rates to zero is foolish and will have dire consequences for the US economy, correct?

You could cite the fact that M2 money supply has been constantly increasing, and surely, that will result in dire consequences, as well.

There are a variety of macro indicators that can appear alarming. It’s easy to string together a few of them and convince people that doom is on the horizon.

While these narratives are often logical, they’re often wrong. I have been hearing them since I first got interested in investing 25 years ago as a teenager.

The Fear Hustle

What’s striking about most of these predictions is that there is never a precise time frame for when the doom will arrive.

If the Great Crash doesn't arrive immediately, don't worry. You can always say you're early. The Great Depression part 2 will come, eventually, and your predictions will bear fruit.

That's a critical way to tell if you're dealing with someone who is giving a reliable forecast. If they aren't willing to put an actual time frame on the prediction, they're probably just bloviating. A forecast without timing is useless.

Philip Tetlock did some great work on this in his book Superforecasting. He outlined some critical criteria for good forecasters. Key among them is that they are willing to change their mind and don't stick to a specific prediction or narrative. They also exercise some humility and acknowledge the difficulty in predicting these things. Additionally, they're willing to put a time frame on it. Not “The Soviet Union will collapse” – more like 'The Soviet Union will collapse in the next five years.”

Most financial forecasters do not meet these criteria. They stick to a narrative and script and peddle it, usually based on extreme fear. They don’t give specific time frames. They stick to a script and are often unwavering.

Why It Resonates

Bearish forecasts always have intellectual underpinnings such as valuations, debt levels, and unprecedented Fed policy, etc.

The intellectual arguments are not the reason that they resonate with people and drive large numbers for newsletters and YouTube channels.

Human beings are not primarily swayed by logical arguments alone; they require an emotional underpinning.

Typically, people begin with an emotion and then seek evidence to validate their emotional beliefs.

We human beings are prone to be fearful. All living things have a deep-seated sense of fear. It’s what kept our ancestors alive. If your ancestor saw something dangerous looking around the corner, it’s better to be safe than sorry. The person sitting around and waiting for the danger to come to them is eventually wrong and dies. We’ve evolved from the people that stayed alive. As a result, we’re hard wired to be fearful.

The same emotions are preyed upon by bearish forecasts of doom. They’re appealing to your intellect on the surface, but what they’re really appealing to are your base instincts of fear.

A Crash Is Coming

Predictions of crashes can be intriguing because crashes are inevitable.

Unfortunately, the forecasts are still useless. Saying there is going to be a stock market crash “at some point” is kind of like saying it’s going to snow in Boston “at some point” in the winter.

The complexity of “predicting” crashes lies in the fact that the market's peak, bottom, and timing of the crash are often elusive.

When we consider the performance of the US stock market, we often focus on its remarkable long-term growth. For instance, an investment of $10,000 in a market-cap-weighted index of US stocks in 1972 would have grown to approximately $1.9 million today.

However, while we tend to fixate on the returns, it’s important to realize that drawdowns are a constant feature of markets. Since 1972, three notable drawdowns have exceeded 40%: a 45% decline during 1973-74 amidst the oil crisis and inflation concerns, a 44% decline following the tech bubble burst, and a 50% decline during the financial crisis.

Each time, compelling narratives emerged suggesting that the downturn would last longer. In 1973-74, there was a prevailing sense that the postwar economic boom was over, ushering in an era of diminished expectations for America. Post-tech bubble, there was a widespread belief that the prosperous decades of the 1980s and 1990s had concluded, foretelling a period of extensive hardship. During the financial crisis, fears of a systemic collapse permeated the markets.

Even more moderate drawdowns in the 15-25% range can be terrifying, particularly when experienced firsthand. For instance, in 1987, the market experienced a 29% drawdown, and in 2020, amid the COVID-19 pandemic, we saw another 25% drawdown.

Drawdowns are the norm. Not the exception.

The drawdowns are scary in the heat of the moment. These events are often accompanied by convincing narratives suggesting the worst is still to come. People likened the 1987 crash to the 1929 crash, noting that exuberant bull markets preceded both. Many thought the booming 1980s would usher in a decade reminiscent of the 1930s in the 1990s.

Doubts arose about the economy's ability to recover from a complete shutdown during the COVID-19 pandemic. In 2011, during the debt ceiling debate, fears mounted that the consequences of the bailouts and spending to address the financial crisis, coupled with political dysfunction, would exact a severe toll.

How To Insulate Yourself

How should investors navigate this reality?

The key step is to acknowledge that no one can accurately predict the market. If these forecasters truly had the ability to foresee crashes or booms, they would be billionaires exploiting their predictions in the markets.

Even then, the billionaires get it wrong.

For example, Ray Dalio has been predicting a scenario similar to 1937 for the past decade. Dalio isn’t the only one. Similar patterns can be seen with other successful billionaire speculators, whose public forecasts are often marred by incorrect predictions. A year ago, Stanley Druckenmiller called for a ‘hard landing’ recession. It didn’t happen.

When encountering perpetual bearish sentiment, I recommend stepping back, going for a walk, and recognizing that your emotions are being manipulated.

It's important to critically assess what these forecasters are selling. Often, it's products like physical gold (at a significant markup) or exclusive investment strategies that only they can provide. Their predictions of market doom are often linked to selling a solution to save you from it. The market is going to crash, so you need them to help you.

Understand that these forecasters have vested interests that may not align with yours, and it's wise to move on without succumbing to their sales pitch.

However, simply recognizing these tactics may not be sufficient. It’s often not enough to intellectually understand that the forecast is probably wrong.

Extreme fear can override logical decision-making. To protect yourself from making impulsive decisions based on scary forecasts, consider adding protections to your portfolio to protect from severe bear markets.

The key is to design a portfolio that can weather severe crashes and economic downturns.

In terms of asset allocation, I prefer uncorrelated assets (like treasuries & gold) and lower volatility portfolios. One effective approach is Harry Browne's Permanent Portfolio. This strategy allows you to remain unfazed by extreme bearish forecasts when your portfolio is only down a modest amount during turbulent times, like 2008 when it was down by only 2%. Another alternative is the Golden Butterfly, by Tyler at Portfolio Charts, which lost only 8% in 2008.

If you're interested in learning more about such portfolios, I recommend checking out my podcast episodes where I discuss these strategies in detail with experts like Craig Rowland and Tyler from Portfolio Charts.

Recession Resilience for the Stock Picker

If you prefer individual stock picking, there are also effective strategies to build a recession-resistant stock portfolio.

When selecting stocks, I prioritize companies that demonstrated resilience during the last major crisis from 2007 to 2011. I focus on firms that maintained profitability without reporting losses during that challenging period.

Another critical strategy is to favor companies with low debt levels and strong interest coverage ratios. Companies entering a crisis with minimal debt that are generating free cash flow can probably survive the crisis.

Additionally, I consider competitive moats essential. Is the company highly cyclical and vulnerable to economic disruptions? If so, they will probably face difficulty during the next major recession. To prevent this, I seek out companies with sustainable competitive advantages (moats) that resist competitive pressures.

It's essential to recognize that these factors won't entirely shield a portfolio from downturns like those seen in 2008. A 100% stock portfolio is going down in a year like that no matter what you do. However, a diversified portfolio composed of these resilient characteristics can help mitigate the impact of market downturns, potentially limiting losses to less than the overall market decline.

In contrast, investors heavily concentrated in highly leveraged, cyclical companies with weak competitive positions may experience much more significant drawdowns, potentially exceeding the market’s drawdown.

Accept Reality & Develop a Plan

Regardless of how you choose to approach the inevitability of crashes and recessions, the most crucial aspect of your strategy is to avoid the temptation to believe that you can predict them. No one truly possesses the ability to predict market downturns accurately.

I wish that there were a way to predict an impending market crash. Ideally, you could exit the market before the decline and re-enter at the bottom. However, this feat is impossible to achieve. It would result in an outstanding track record that no one possesses.

There is no reliable method for perfectly timing the market.

The most effective approach is to delve into historical data and draw insights from past major crashes and recessions to develop a plan. Understand the severity and impact of previous downturns and how different portfolios behave. This will help you develop a plan for navigating these situations when they occur - because they will occur.

Focus on being well-prepared. Don’t try to predict. Most importantly, ignore the forecasters who claim that they can.

In an uncertain and unpredictable world, that’s the best that we can do.

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