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Winter is Coming
In A Clash of Kings, the second book of George R. R. Martin’s A Song of Ice and Fire1 saga, Catelyn Stark travels to Renly Baratheon’s camp in an attempt to broker an alliance between the Starks and the warring Baratheon brothers. But what Catelyn saw shocked her: Renly and his army treated the War of the Five Kings like it was all just a big game.
To his arrogant and vainglorious knights, waging war meant dreamy songs sung about the victors and riches and titles to be won — not the potential death and destruction of reality. Renly’s crew had never experienced real hardship or serious setback. They had never been tested by loss or fear. This stood in stark2 relief to her son’s grizzled Northern Army and its stoic acceptance of the life-and-death stakes of war.
After Catelyn remarks that she pities Renly’s nonchalant knights, she drops this absolute banger on one of the startled lords when he asks why she feels that way.
“Because it will not last,” Catelyn answered, sadly. “Because they are the knights of summer, and winter is coming.”
Unfortunately, the knights of summer have leapt off the page and into today’s stock market. It’s not hard to recognize them: those exuberant investors with no experience or memory of the Dotcom Crash or Great Recession. Still unscarred from the terror of seeing their retirement accounts nosedive 30% in one afternoon. No hard lessons learned that bubbles exist, panic moves the market, and valuations always matter.
In other words, our knights believe that stocks only go up.
Only, they don’t.
Stocks can go down. Sometimes by a lot. It has been known to happen from time to time.3
The Dow Jones Industrial Average suffered an annual loss 31 times in the last 100 years. That’s almost a 1-in-3 chance of losing money in any given year. Never make the mistake of believing that 20% annual returns are normal. They’re not. Not even a new normal. This time will not be different.
Market downturns are an inevitable part of investing — and everyone needs to accept that and prepare4 for the coming winter. Our knights, though, disagree.
Over the past decade of obscene returns, they’ve crowded into growth stocks with nose-bleed valuations — or, worse, meme stocks — seeing only dollar signs and clout on the horizon. Unfortunately, such a strategy only works as long as everyone else stays in a buying mood. When a stock’s price becomes divorced from its underlying fundamentals, the fun can only last for so long. Eventually, there will be a bump in the road — and, for our knights, probably a margin call to wash them out to sea.
George Goodman, writing under the pseudonym Adam Smith, colorfully describes this phenomena in The Money Game:
We are all at a wonderful party, and by the rules of the game we know that at some point in time the Black Horsemen will burst through the great terrace doors to cut down the revelers; those who leave early may be saved, but the music and wines are so seductive that we do not want to leave, but we do ask, “What time is it? What time is it?” Only none of the clocks have any hands.
Da Vinci couldn’t paint a better picture of a late-stage bull market.
If you’ve spent the last few years YOLOing your money with the Cathie Woods of the world, it’s probably time to say your party goodbyes and head home. Consider poor old Netflix and its fall from grace over the past week. The premiere streaming service, a high-flying growth stock popular with our knights, admitted that competition from other streamers might hurt its future growth potential.
For a company trading at almost 40x earnings, that’s a big no-no. Practically overnight, $NFLX dropped 25% and has slowly sunk further since. Even the smallest signs of weakness get brutally punished when your valuation is out of whack.
Don’t overpay for growth and future earnings. Be cautious when everyone else is hyped. An ahistorical market should scare smart investors, not encourage them.
In short, be a value investor. Use market downturns to plant the seeds that will one day blossom into generational wealth. Fight the FOMO and invest in stodgy blue-chip stocks with strong earnings and cash flows. Get rich slow.
No one can time the market. No one knows whether tomorrow will be up or down.
But winter is coming — whether in 2022, 2023, or beyond. That’s why studying history (or fiction like ASOIAF) is essential. We can learn lessons vicariously from the people who lived through it, without having to suffer any of the actual consequences. It’s a pretty sweet deal.
And, by the way, Catelyn was right. It will not last. And no one should fear the winds of winter more than the knights of summer.
The inspiration for HBO’s Game of Thrones.
Corrections and bear markets happen, too.
Mentally, more than anything. This is not a call to retreat to cash.