“The White Witch? Who is she?”, said Lucy.
“Why, it is she that has got all Narnia under her thumb. It’s she that makes it always winter. Always winter, but never Christmas.” replied Mr. Tumnus.
In C.S. Lewis’ fantastical adventure, Lucy wanders into the land of Narnia through a wardrobe, where she meets a faun named Mr. Tumnus. After developing a friendship, Mr. Tumnus betrays Lucy into the hands of the evil White Witch who, as he explains, has made Narnia a most miserable place. A place where the days are short and cold, but Christmas never comes. “How awful!” exclaims Lucy.
The thought of living in such a world evokes a sense of despondency. It is one of the reasons that C.S. Lewis is viewed so favorably as a writer – he knew how to make people think and feel more deeply about life through stories, analogies, and images.
If Lewis had created the land of Narnia to describe the US stock market over the past 13 years, the portrayal would be quite the contrast to the introduction in The Lion, The Witch, and The Wardrobe. In fact, Lewis might well have described investing in the land of Narnia as always Christmas, but never winter. “How wonderful!” I can almost hear Lucy (and all children everywhere) say.
Always Christmas, But Never Winter
There is a saying in the financial industry that everybody is a long-term investor until the markets go down. It’s a pithy statement that gains a lot of traction when stock prices are falling because, well, everybody wants to sell everything and sell it 10 minutes ago. But what if the market never goes down? What if when it does go down, it doesn’t stay down for very long? What if month after month, year after year, the stock market grinds higher despite obscenely expensive prices amidst a deteriorating economic situation?
The fact of the matter is that the past 13 years have been a fantastic time to be invested in the US stock market. Some foreign stock markets have done well, too. Japanese and European stocks, for instance, benefited from all the free money their governments provided to the financial system during the COVID panic. The Nikkei 225 is up 112% over the past 10 years, with most of that coming the past 2 ½ years. Not too shabby. Of course, it’s still down 15% from its all-time high in 1990! But nobody cares anymore what happened 10 minutes ago, let alone 30 years in the past.
Compared to US stocks, however, the Nikkei’s returns look docile. The S&P 500 is up over 158% in the past 10 years, and over 420% since the bottom of the last bear market in March of 2009. It truly has been a remarkable run during which everyone remains a “long-term investor” and Christmas never ends.
A Cautionary Tale
Lewis’ fantasy world was written to convey the significance of the Gospel, which was central to his Christian faith. But like any good storyteller, it conveyed much more than that. Cautionary tales abound, such as the danger of gluttony exemplified in Edmond’s weakness for Turkish Delight.
Similarly, there may be a cautionary tale for investors delighting in the never-ending Christmas of the US stock market today. As indicated below, a more normal value of the S&P 500 (at least based on things like earnings) is somewhere in the range of 1600-1800. That would require a 60% decline from the 4700 level it currently hovers around.
Whether due to naivete, ignorance, or a love for gambling (or perhaps a combination of the three), those who have heavily invested in US stocks over the past 13 years have been rewarded with seemingly endless boxes of Turkish Delight. But there were similar time periods of ostensibly endless Christmas from 1920-1930, 1952-1969, and most recently from 1994-2008. All these periods saw massive stock market appreciation without corresponding increases in profitability to sustain it. Not surprisingly, each period ended with US stock prices at or below more normal values, which is approximately 60% below current prices.
This time IS different.
Now I am aware of and understand many of the arguments for why “this time is different”, and thus stocks are unlikely to fall any time soon. And, I have to say, some of them are quite convincing. There are those that think US stocks have reached a “permanently high plateau”, which is exactly what the famed economist Irving Fisher said in 1929…right before stocks crashed over 80%. Others have an unwavering confidence in the strength of the US economy and believe that if it continues to grow, stocks simply cannot or will not fall. And while I share their optimism regarding the relative (and I stress that word) strength of the US economy, saying that stocks cannot fall if the US economy grows is a fundamental category error. It’s like attending a Kansas City Chiefs’ game because you heard Taylor Swift is performing. You’re likely to get a performance, just not the one you’re expecting.
Still, others believe in US stocks because they think that the rise of passive investing has permanently changed the structure of stock market prices. This view suggests that indexes like the S&P 500 no longer reflect real economic information but instead respond merely to the almost mechanistic flows of retirement savings into market-cap-weighted index funds. I am most sympathetic to this view, as it does explain some interesting and relatively unique market phenomena over the past 15 years or so.
The thing is, it’s always different and it’s always the same. Or as someone once said, “History doesn’t repeat but it does rhyme.” Anyone who cares about what happened more than 10 minutes ago, or what will happen more than 10 minutes in the future, will nevertheless be cautious in today’s economic environment.
Regardless of how one feels about the US stock market, one bright red warning sign is the inverted yield curve, which has preceded all recessions and many of the major bear markets in stocks in the past. In fact, the inversion is so extreme that it is quite capable of guiding Santa’s sleigh.
One could also look at the LEI index, the oil futures market, and bank lending activity to see problems on the horizon. These are all warning signs that should make investors cautious about the stability of the stock market in 2024. In contrast, the above metrics are very good signs for bonds, suggesting that whereas winter may be coming in stocks, Christmas time in the bond market may be on its way.
The Time Is at Hand
Later in the Lewis’ story, Father Christmas arrives in Narnia and brings presents to Lucy and the rest of the children. However, he clarifies that “they are tools not toys. The time to use them is perhaps at hand. Bear them well.” Tools such as the inverted yield curve are very useful, but they are not to be used as toys, tossed around without sound analysis or used inappropriately to predict an imminent economic collapse. If misused, such tools can cause more damage than good.
The narrative in the financial media seems to be that since a recession has not shown up in the past 12-15 months since the yield curve inverted, then we must be heading for a “soft landing”. Economists now predict economic growth will continue to be decent, and the stock market can continue rallying higher.
Thus, many believe the yield curve inversion was a false positive, and that for the first time in history, it will not be followed by a recession.
Unfortunately, this is what happens when tools are treated like toys. On average, recessions occur 12-24 months after the yield curve first inverts. Since the yield curve didn’t invert until late last summer, then a lack of a recession so far is not at all surprising. And its absence proves nothing.
The time may well be at hand for the yield curve to once again be proven right. But even if a recession is not imminent, the history of the yield curve provides a cautionary tale for those who are under the gluttonous pull of the stock market’s Turkish Delight.
Regardless of our view on stocks or bonds and where things go from here, if the history of financial markets has taught us anything, it’s that asset values are fickle and fleeting. The price of assets we buy may go higher or lower over short periods of time. And while they do typically go higher over longer time periods, we have no guarantees.
But Christmas time is a celebration of more than quantifiable values on a profit and loss statement or balance sheet. Christmas is a celebration of more than candy canes and presents, of hot cocoa and cookies, of snowmen and bright lights. Christmas is a celebration of the one that literally divides our timelines.
“For unto us a child is born, to us a son is given; and the government shall be upon his shoulder, and his name shall be called Wonderful Counselor, Mighty God, Everlasting Father, Prince of Peace” Isaiah 9:6-7.
This world is big, and predicting the future of asset prices is challenging due to the innumerable variables involved. Stability is something we all seek but often find illusive. But as a much older and wiser Lucy declared in the Narnian finale, The Last Battle, “In our world, a stable once had something inside it that was bigger than our whole world.”
If you’re looking for something stable to find shelter in this Christmas season, then I would encourage you to look no further than that one.