Blinded By Greed

Blinded By Greed?

Lately, I’ve been doing some research on the astounding returns of various investment classes over the decades.

• The S&P 500: How does a 9.92% annual return since 1928 sound?

• REITs: 9.77% per year since 1972.

• Large-cap value: Even better, at 11.13% annually since 1928!

• Small-cap value: An astonishing 13.15% annual return since 1928!!!

An extra 3% per year results in twice as much money at the end of 25 years! So keep that in mind when you compare the long-term returns of the various asset classes.

But these are long-term averages across some very different market and regulatory conditions. The fly in the ointment is that these conditions may very well be changed in the future, and returns might be lower than they have been in the past.

I’d love to average 10% per year (nominal) over the next 50 years, or about 7% real returns (after accounting for inflation). As noted above, the very-long-term historical data shows returns right around this level.

At 10% per year (nominal), an investment like an S&P 500 fund would turn $10,000 into almost $1.2 million over 50 years.

Alas, the ‘real’ (inflation-adjusted) returns of 7% per year make that $1.2 million into a much more modest $294,000 after 50 years, in terms of actual purchasing power. But still, turning $10k into $294k is no small feat!

But 7% nominal and 4% real returns, as some folks like John Bogle and Veeru Perianan writing for Charles Schwab have been predicting? Not so exciting.

Starting with $10,000, and assuming a 7% nominal yield and a 4% ‘real’ yield, I ran the same exercise described above. At 4% per year, $10k would turn into $294k (nominal), which would have the purchasing power of just $71k. After 50 years—yikes!

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I’m hoping returns aren’t that moribund over the next 50 years. But you never know. And it’s wise to consider not only best-case scenarios, but also worst-case scenarios. That’s why I’m continuing to read and reflect. And why I’m holding off on setting an early-retirement date.

In reading The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron by Bethany McLean and Peter Elkind, I came across a phenomenal explanation of the ugly side of investor psychology. Specifically, this passage illustrates the euphroric circumstances that can—and do—lead to people losing everything.

I’m talking about being blinded by greed.

From the beginning of Chapter 15, page 229:

At practically every employee meeting in the late 1990s, Ken Lay [Enron’s CEO] would trot out what he once described as “one of my most favorite slides.” The slide compared Enron’s stock performance against that of the S&P 500 during the 1990s…by May 1999, Enron had returned over 600 percent to its investors, one and a half times the return of the market’s most important index…by October 2000, Lay’s favorite slide showed that Enron had returned a stunning 1400 percent since 1990, more than three times the gain of the S&P 500.

Imagine putting your money into a single asset—say, Tesla stock, or Bitcoin—and beating the stock market’s gains three times over!!!

Imagine turning $100 into $1400!

Or having the $100,000 in your 401(k) grow to $1.4 million over the course of a decade—tax-free!!!

Is it any wonder that people turned a blind eye to Enron’s accounting irregularities? Faced with returns that astonishing, is there really any question why independent analysts routinely accepted the stories being spun by company leadership? Why Enron could do no wrong?

Indeed, on pages 229-230, McLean and Elkind go on to write:

Any remaining vestiges of skepticism were washed away in the torrent of praise that showered over the company and its top executives. Enron’s nearly incomprehensible financial statements? Nobody worried about them. The related-party transactions buried in the footnotes? Who bothered with footnotes?…All that mattered was that the stock was going up. Because the stock was rising, Enron’s executives were seen as brilliant. Because they were viewed as brilliant, all their new ideas had to be winners…Skilling [Enron’s president and COO] and Lay found themselves mentioned in the same breath as GE’s Jack Welch, Microsoft’s Bill Gates, Apple’s Steve Jobs, and the very small handful of other celebrity businessmen.”

Does this description remind you of anybody or anything in today’s market? I can think of a couple hype-fueled assets that have corrected in recent months, such as Tesla, GameStop, and Bitcoin. But I’m not sure they’ve finished correcting. And I’m worried that the entire stock market is overdue for another correction, despite the massive COVID dip in March-April of 2020.

I believe the post-COVID stock market recovery was too fast to be supported by economic fundamentals. In essence, we’re in a Fed-fueled bubble. Again.

On page 224, McLean and Elkind also note:

And it wasn’t just the industry that was lazy: in the glory years, regulators like the FERC and the CFTC did nothing to rein in Enron, either.

The current parallels to history have me a bit worried. As an indexer who has begun to spread money across global stocks and real estate, as well as U.S. stocks and bonds, I’m about as well-insulated as I can be from the actions of a few overhyped media manipulators like Enron was. But after seeing pretty sizable gains in my portfolio (55%!!!) over the course of about 14 months, I’m getting a definite Enron-style-bubble feeling in the pit of my stomach.

Given that I’m relatively young and have a relatively small amount invested, I can weather any financial storms that hit within the next couple of years. I’m continuing to invest fairly aggressively, while spreading my money across various asset classes in various parts of the world.

Call me a perma-bear if you want, but it certainly seems to me that U.S. federal policy—such as rock-bottom interest rates and pandemic-induced stimulus payments—have sent stock prices and cryptocurrency prices through the roof. And what goes up due to temporary conditions…well, they’ll come back down once those conditions change.

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The S&P 500 returned over 12.2% per year from 2009 through 2019. Compare that to the longer-term historical average of 9.92% mentioned above. An extra 2.25% per year, for a decade! Over the past decade, we’ve become accustomed to seeing that extra growth, but I’m not sure how much longer it’ll last.

And, given the growth we’ve seen in the stock market, I think the Fed is afraid to raise interest rates, because they realize that higher interest rates on bonds will trigger a sizable chunk of institutional money to move out of stocks and into bonds. This will cause a decline in stock values, which may well lead to a ‘vicious circle’ of declining share prices as people flee stocks and move to the safety of bonds.

At a time when the biggest chunk of the U.S. population is either retired, or on the doorstep of retirement, federal policymakers know that it’s political suicide to iniate an action that will cause a decline in stock prices. The very-active voting bloc of older Americans [along with the powerful AARP lobby] will howl if people’s retirement income is threatened by even a ~10% drop in the market.

Just like Enron executives who promised consistently rising earnings, Congress and the Fed have boxed themselves into a corner.

And ordinary people may end up paying the price.

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