The future is unwritten until it’s too late to do anything about it. This is also true on Wall Street, where we need to weigh every scenario as we figure out the best place to allocate our precious capital.
I think about these scenarios and the investment decisions around them in terms of game theory. Whenever we make a “move,” it needs to meaningfully shift the board in our favor . . . otherwise, it’s really just talk and pushing pieces around.
And unless a move takes us closer toward our strategic goals, there’s really no point in making it. That’s why I find all the anxiety around a looming recession so counterproductive. At best, letting a recession dictate your moves is a distraction.
At worst, the opportunity costs can really cut into your lifetime score. The Conference Board said last May there was a 50-50 chance of a recession coming in the next year. Made sense, right? The Fed was sucking money out of the economy as fast as possible and it was pretty clear that corporate earnings were starting to stall.
The COVID boom was ending fast. Smart people read the signs and started to brace for impact. Others let their minds run wild with doomsday scenarios: a housing crash, a 2008-style credit crunch, massive market turmoil.
No recession was called. The coin flip went the other way. And while the Fed and the rumor mill contributed to a lot of volatility, the S&P 500 actually went UP over the past 12 months. Wealth was created.
But you had to be in the game to get your slice of that wealth. If you were sitting on the sidelines waiting for that nasty recession that didn’t happen to blow over, you missed out.
Maybe you slept better, with your money safe in the bank getting eaten alive by inflation. That’s your choice. However, in terms of the game theory, what did you think your reward would have been if you were right?
Say for the sake of argument that the mother of all recessions started last summer, with all the worst aspects of the 2008 crash and the 2020 freeze. Those of us who stayed in the market would lose big, maybe even 40-50% of our liquid assets. Trillions of dollars in paper wealth would evaporate.
And because you already pulled all your money out, you’d suddenly be twice as rich in relative terms compared to the rest of us. That’s great. But it’s an extreme scenario that requires stocks go down and stay down . . . and in that scenario, I have a feeling the social and economic upheaval unleashed would basically end the game as we know it.
One of the best traders I ever worked with had a catch phrase: you never just cash out. You always cash out into something else, even if that “something else” is just dollars. And if you can’t cash out into anything, you can’t cash out.
Where would you have put your cash if you’d cashed out a year ago? Bonds? Bonds were poison last spring. You might’ve earned 2-3% in interest, enough to brunt the impact of inflation but not break even in real terms. The S&P 500 actually did better.
Stocks paying higher yields? That’s much more interesting. But you would’ve needed confidence in those companies and their ability to surf the economic tides well enough to keep those shareholder payouts coming. That confidence does not jibe with the doomsday scenario.
For that matter, was the doomsday scenario even compatible with dollars still being worth anything at all? I saw a lot of talk about hyperinflation and collapse. If you took it seriously, you’re probably sitting on a lot of canned meat and ammunition, which are useful but not exactly the kind of thing you can sell for more than you paid in the first place.
Gold didn’t outperform the S&P 500. It didn’t even keep up with inflation. In theory, hard assets become precious if confidence in paper money takes a big hit . . . but what happened was a lot less extreme. Dollars got a little less valuable. Bullion remained heavy.
That’s the joy of bullion. But it’s also the burden. You’re almost never going to earn extreme rewards there unless society collapses or you discover a nugget in your backyard.
Add it all up, there wasn’t a lot of incentive around betting on an economic downturn a year ago. Even if you’d been right, you just would’ve been sitting a little higher in a world where the rest of us are sitting a little lower.
That’s not how the market works. Wall Street is biased toward the upside. When a few of us really start winning, the gains become contagious. But when most of us are losing, it gets harder for even the hardcore short sellers to make money.
And it’s more than a zero-sum game. There’s no winner take all. Hot hands rotate as some people cash out and need to roll that cash into something else. We all need to keep the cash moving. That’s how the game works.
Sure, buying Big Tech a year ago was a gamble. At a few points, you’d be staring at a 15% loss. But the market recovered. Great companies kept expanding, innovating, improving. Generating wealth.
Now you’re already looking at a 15% year-over-year win. And these companies can generate infinite wealth over a long enough time period. Or they can stall. We just don’t know in advance.
Money on the sidelines will inevitably deteriorate under inflation’s weight. No risk there. No probability. It’s a guarantee.
You can lose 100% of your capital in the market unless you hedge your bets to control that downside. You can make much more than 100% if you’re patient. AMZN has doubled in the last five years. AAPL only needed three years.
That’s how long it takes to flip the game theory math. When you can win more than you lose, you make the move. That’s all it boils down to.
And as for a recession on the horizon . . . it’s never fun to sit through an economic down cycle, but for the last 150 years and more, Americans have rarely been more than 15 months from the next recession.
That doesn’t give any of us a lot of time in the market. It doesn’t give us a lot of time in the game.
Get in there! And remember, just like there’s always a recession somewhere, there’s always a relative boom. There will be good stocks and bad ones. Feel free to underweight the stocks that are in recession gear but overload the rest!