How do you stay a millionaire?

After one of the longest bull markets in history, the question on everyone’s mind is: Do I get to keep it all?

April 17, 2018 | Bogumil Baranowski
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“How do I keep what I have?” is the query we hear much more often than, “How much will the market rise this year?” Those who are familiar with our long-term value contrarian mindset know better than to pose the latter question seriously. If we hear it, we know they’re teasing rather than expecting a serious answer.

We believe our strength lies in evaluating businesses and buying them cheaply in order to sell them at a higher price later.

Still it’s remarkable how conversations — even with those who know us well — have recently focused almost exclusively on how much higher this market can go. Until early February, many observers seem to have forgotten that a down market is even possible. The recent increase in volatility and a worldwide sell-off in major indices has broadened the discussion. Investors started to focus more on keeping what they’ve made in this market. Some wisely realize that they might not have the time to make their money back if they were to lose it. What can be done about that?

These are the kinds of questions we are happy to answer.

The wealth preservation dilemma

Wealth preservation is at the core of what we do. We constantly remind ourselves of Warren Buffett’s Rule Number 1: “Never lose money.” It’s followed by Rule Number 2: “Never Forget Rule Number 1.”
This is easier said than done. We are all up against a major dilemma, for the following reasons:

We are sitting on inflated assets, and we’ve gotten into the habit of watching their values rise without our doing a thing.


What we do now may define our standard of living for decades to come.

Individuals who are just launching careers and investment strategies have a major advantage here. If they can spread their purchases out over the next few decades, they will do just fine. However, those who are fully invested and sitting on a big nest egg have a reason for concern. Investment strategy is more important now than ever.

Looking at the numbers: are financial assets really inflated?


The S&P 500, a broad US market equity index, rose from 666 (March 2008) to 2,870 (as of January 2018). As of early April 2018, it’s dropped to 2,650. Overall that’s an average gain of 2,000 points in a decade. In other words, the market value of US equities almost quadrupled in ten years. Here’s some context: the S&P 500 peaked near 1,500 at the top of the internet bubble in 2000, and again at the top of housing bubble in 2007. Today, we are 70% over those two peaks.

The US GDP, though, has risen only about 30% since the 2007 market peak, and about the same 30% since the 2008 market low.

Another measure is CAPE: cyclically adjusted 10-year price-to-earnings. It currently sits over 30x, exactly where it was on Black Tuesday in 1929 (though still below the near-45x recorded during the internet bubble). The historical range over the last 120 years is 5x to 45x, with 15-25x being the most common level.

We’ve witnessed a growing disconnect between the price, and value, and major inflation in stock prices.


The Case-Shiller Home Price Index just reached 197.5 (still below the 220 recorded during the housing bubble). Home prices have risen 35% since the depths of the last financial crisis, and hover around 50% above pre-housing bubble levels. Some homes in desirable urban areas have increased even more in value.

Usually demographics and income share responsibility for sustainable growth in home values. But an aging population on one hand, and youth burdened with student loans on the other, don’t bode well for the supply-demand dynamics. What’s more, the big house in the suburbs has lost some of its appeal to younger home buyers, thus putting further pressure on home prices.

Are all asset prices up?

Curiously, only financial assets have exhibited this meteoric rise we’re discussing. If you consider a car, a motorcycle or a boat an asset, you’ll see that their apples-to-apples comparable prices have remained constant. Although car dealers have convinced us to treat ourselves to ever bigger, pricier cars over the last few decades, the price of comparable new vehicles remained the same. The Federal Reserve diligently tracks consumer price index for all new vehicles, and the index is flat since 1997.

Bottom-line: It costs about the same to buy a car, a motorcycle, or a boat as it did 20 years ago.  Real median household income hasn’t changed much in those two decades. Then why does it cost 50% more to buy a home? Or twice as much to buy a dollar of S&P 500 earnings?

Low interest rates + much more leverage = BUBBLE

Prolonged periods of low interest rates accompanied by ever-rising debt (public, corporate, and private) have helped inflate financial assets. In the last 40 years, the US has seen the 10-year Treasury rate fall from 15% to 1.88%, providing an unprecedented tailwind to all financial asset prices.

With dropping rates, as investors we’ve been willing to accept ever-lower income. The dividend yield for the S&P 500 fell from over 6% in early 1980s to 1.89% today. Earnings yield for the same index fell from 16% to 3%. When the yield falls, the asset prices go up.

There is no secret to it. Is it a one-way street though? You might ask. It is a dead end eventually, and you need to back up, and reverse the process with rising yield, and dropping prices…

Buy and hold, bonds versus equities

It’s not just that we’ve become accustomed to this one-way investment trajectory. We’re also used to passive if not complacent investment practices. The “buy and hold” approach has been hugely effective over the last few decades. In an environment with more unreliable movement in interest rates, “buy and hold” may lose its charm.

We also tend to think of equities as being “risky” and bonds as “less risky.” It’s true that equities could be more vulnerable to a sell-off, but bonds should also be treated with caution. Bonds with long-term maturities will undergo a lot of volatility in a world resetting interest rates from current all-time lows. A 30-year US treasury can move up or down as much as 30% or so with every point move in interest rates. That’s a major swing for a security that pays 3%.

Where to next?

The world economy goes through short-term and long-term cycles. Students of financial history are familiar with the many ways fortunes appear and disappear. Still, the extent of the current easy money experiment might be the biggest in history. Its consequences will correspond in scale.

What to do, then?

If you are just starting out investing, you will dollar-average your investments over many decades with a variety of economic backdrops. There will be many buying opportunities ahead.

However, if you expect your current portfolio of stocks and bonds to provide you with financial security, that is a different story.

If you are holding highly inflated financial assets, you may consider what we’ve been doing for a while now:

  1. Raising your cash position and being less than fully invested
  2. Holding the strongest, highest conviction stocks
  3. Holding only very short-maturity fixed income (bonds), and only of the highest quality
  4. Adding some market protection. We have opted for precious metals (gold), and certain inverse ETFs that go up when particular assets go down

As much as it is very enjoyable to make money, and see your wealth grow, let’s not forget Buffett’s Rule 1 – “Never lose money!”

Happy investing!

Bogumil Baranowski




This article is not intended to be a clientspecific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.