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Come on, guys!

YTD…S&P 500 down 20%. NASDAQ down 30%. Bitcoin down 55%. ARKK down 60%.

How did we not see this coming? When the good times are rolling, it is hard to believe they’ll ever end. But they always do. And the signs were everywhere. It almost feels obvious now. Not the exact timing, that’s close to impossible to call. No, knowing that the good times were going to end. We had extreme valuations – no, not justified by the fundamentals or low interest rates – and frenzied investor psychology…the two key ingredients.

What were some of the warning signs over the last 18-24 months (not a complete list!):

1) Companies with no revenue and no product going public with valuations in the tens of billions.

2) Cryptocurrencies spawning by the thousands (despite their supposed advantage of “fixed” supply).

3) Venture capital valuations skyrocketing and fundraising eclipsing the prior record set in 2000.

4) GameStop, AMC, and other meme-stocks soaring to breathtaking levels.

5) 2-3 SPACS launching EACH DAY in late 2020 and early 2021.

Anyone older than 45 or with the faintest sense of market history knew this would end. Yet many seem surprised by the recent market sell off. Some, of course, now claim to have seen it coming all along.* Others have turned cautious after years of proclaiming “this time is different.” But most, I think, are genuinely surprised.

We’ve been through a decade when the riskiest activities have been rewarded with the best returns. But that cannot continue forever as Howard Marks noted in Risk (2006): …riskier investments absolutely cannot be counted on to deliver higher returns. Why not? It’s simple: if riskier investments reliably produced higher returns, they wouldn’t be riskier!

Paraphrasing John Hussman, the good times end when risk aversion meets an over-valued market. It still feels early but risk aversion is returning. Unfortunately, valuations are still undeniably high, especially in the U.S.

We rarely know what causes investor psychology to change. Even after the fact. And those that look for single causes or simple explanations are usually wrong. You could manufacture a narrative today – unexpected inflation, higher interest rates, Ukraine. But, if not them, it would have been something else.** We didn’t know when and whether it would be with a bang or with a whimper. But we knew this was coming. We also knew for sure that the longer the party, the bigger the hangover. And the last decade or so has been one hell of a party…


*there were a few that did but they tended, as if often the case, to be early.

**plus, investor psychology seems to have peaked in the first half of 2021 when inflation was still “transitory,” etc.

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