1999 vs. 2018: Similarities, Differences, and Insights

1999 vs. 2018: The Similarities

  • Stock Market Overvaluation
    • Current US stock market more overvalued than at any time period over the past 100 years except for 1999
    • Growth stocks were on a scorching multi-year tear, trouncing the investment performance of value stocks
    • Index funds were generating significant increases in fund inflows
    • Warren Buffett warned against chasing performance by throwing money willy-nilly into the stock market at sky-high valuation levels
  • Long Duration Economic Expansion
    • In 1999, economy was in its 8th year of expansion since the previous recession
    • Job growth was rapid and inflation fears from an overheating economy were increasing
    • In 2018, economy is in its 9th year of expansion since the Financial Crisis
  • Rising Energy Prices and Interest Rates
    • In 1999, oil prices were rising quickly, albeit from a very low base, having tripled from the $11/bbl trough that occurred briefly in 1998
    • Fed tried to combat the inflationary pressures related to rising energy prices by steadily hiking interest rates
    • In 2018, WTI is trading above $60, more than double the $26/bbl trough
    • Relatedly, Fed is hiking interest rates
    • Importantly, interest rate hikes preceded not just the top of the US stock market in 2000, but also the stock market tops in 1928, 1987, and 2007
  • Technology Euphoria
    • In the late 1990s, investors were euphoric about technology stocks in general and dot-com stocks in particular. Internet economy was booming, and the share prices of new economy stocks were shooting to the moon even while old economy stocks languished
      • Companies which added “dot-com” to their names instantly experienced surges in their share prices
    • A generation later, investors are once again euphoric over technology stocks in general and especially any stocks which have added the term “blockchain” to their name
    • Technology-savvy cryptocurrency investors are investing in bitcoin, ethereum, and various initial coin offerings with abandon while poking fun at “no-coiners” who allegedly cannot comprehend the current revolution taking place in money
  • The Abandonment of Risk Aversion
    • During both eras, investors who stepped aside from the equity markets to own cash, high grade bonds, and other less risky assets were then and today mocked
    • Investors in gold were then and are today criticized for being excessively gloomy
    • Furthermore, the difference in investment returns between those who embraced risk and those who felt like it was the wrong time to be seeking risk were then and are today nothing short of remarkable

1999 vs. 2018: The Differences

  • Absolute Debt Levels
    • Absolute level of debt in the US today, relative to GDP, is 348% versus just 241% in 1999
    • Because so much of our national income is now being diverted to servicing these debts, GDP has been growing at an anemic rate since the GFC; it seems unlikely that debt could be expanded by a factor of 2x from current levels to boost the economy further
    • Federal Government boasted a budget surplus in 1999, unlike the fiscal situation today
  • Interest Rates
    • Interest rates are markedly lower today as compared to 1999
    • Back then, interest rates hovered around 6% for 10-year Treasuries, whereas today’s interest rates are just 2.6%
    • If long-term rates were to revert again to the 6% rate that existed in 1999, given the currently high level of debt to GDP, the inevitable result might be a painful economic recession
    • The Fed stands ready to buy Treasuries, if need be, to keep inflation-adjusted interest rates capped close to 0%; as long as interest rates remain at or below the inflation rate, policymakers hope that the economy will eventually outgrow its enormous debt
  • Inequality and Populism
    • Wealth and income inequality have risen dramatically during the past 20 years, resulting in a rise of political populism and the election of Donald Trump as President
    • In 1999, the wealth gains of the stock market boom were more widely distributed with significant participation from individual retail investors
    • In 2018, corporate buybacks and central bank asset purchases have driven stock market gains
    • Despite a record stock market, 42 million Americans today rely on food stamps to feed their families, while more than 42,000 Americans died in 2017 due to opioid-related drug overdoses
  • Demographics and Pensions
    • World’s population has aged since 1999, and so has the population of the US
    • Each day, 10,000 baby boomers retire and begin collecting Medicate and Social Security benefits, and that trend should continue until 2029
    • State and local pension plans across the US are finding themselves significantly underfunded, despite the remarkable stock market rally which has taken place since the GFC
    • In cities like Chicago, municipalities are cutting critical services like education and law enforcement to fund pension obligations and pay interest expenses
  • The Rise of China
    • China’s economic and military power has increased dramatically during the past 30 years and especially since the current millennium began
    • China has recently surpassed the US to become the top oil importer in the world; as a result, USD’s firm grip as the world’s reserve currency has been loosening
    • Growing number of countries such as Russia, Iran, Angola, and Pakistan are forming agreements to transact with China in Chinese Renminbi rather than in USD
    • Should this trend continue, this could materially reduce the foreign exchange reserves that foreign countries are currently holding in the form of US Treasuries, resulting in dollar depreciation and, in all likelihood, higher interest rates
  • The Funding of US Deficits
    • Foreign central banks were willing to fund US deficits by purchasing US Treasuries in 1999, but that no longer appears to be the case
    • Foreign official holdings of the US Treasuries have remained flat over the past 4 years, which means that foreign central banks are no longer funding US deficits
    • Not coincidentally, USD has finally started to weaken and, at the same time, interest rates have been increasing

1999 vs. 2018: Insights

  • US Stocks
    • Investing in a broad market index of US stocks was a poor decision in 1999, and it is likely to turn out to be a poor decision today
    • From the peak in September 2000, the annualized rate of return of investing in the S&P 500 index was -1.3% during the subsequent decade
    • Today, we expect the future real return of investing in a broad market index like the S&P 500 index to be disappointing for investors who are extrapolating the returns of recent years far out into the future
  • The Dollar
    • In 1999, the dollar was strong, attributable to a Federal budget surplus and a widespread belief that the US was the engine that powered the global economy
    • Today, the US budget deficit is deeply in the red and likely to worsen in future years due to the recently passed tax cuts and the fact that 10,000 baby boomers are entering retirement each and every day
    • Unlike 1999, foreign central banks are no longer financing US deficits by accumulating US Treasuries
  • Bonds
    • In 1999, with US 10-year Treasuries paying 6% and with inflation at just 2%, US Treasuries were an outstanding investment, generating a 4% real return for seemingly little risk
    • In 2017, faced with US 10-Year Treasuries paying 2.6%, a flattening yield curve, and economists urging the Federal Reserve to adopt an inflation target greater than 2%, long-term US Treasuries look much less attractive
    • In order to reflate the economy, central bank policy appears to be targeting negative real returns for US Treasuries; unlike 1999, 2018 does not appear to be a friendly environment for bond investors
  • Gold
    • During the 10 years beginning on 12/31/99, gold generated an annualized return of 14.1% despite central banks buying Treasuries and selling gold
    • Today, central banks, as a group, are no longer buying Treasuries, and they are buying gold aggressively
    • If we are correct in our call about the dollar and if we are correct in our expectation that real interest rates will remain negative as long as debt/GDP ratio remains unsustainably high, we expect gold will generate an attractive real return during the coming decade
  • Pockets of Investment Attraction
    • While the S&P 500 index was at its most overvalued level in history in 1999 by many metrics, value-seeking investors were able to find attractive investments by picking stocks in a disciplined and selective manner
    • In 1999, real estate investment trusts and small-cap stocks were incredibly cheap; both asset classes generated attractive returns even while the S&P 500 index languished for a decade
    • In 2018, we think that pockets of relative value exist in foreign stock markets, and we think pockets of relative value exist in companies whose earnings benefit from a weaker USD

Appleseed Fund 2017 Annual Letter, January 26, 2018

Image Source: S&P