“It’s Like Treasuries On Steroids”

The REIT we’ll introduce today offers an extra degree of safety. It avoids physical real estate properties entirely, and instead invests primarily in mortgage securities that are effectively backed by the government. And they’re a better buy than government bonds.

Poor People Have Welfare, Social Security and Medicare: This Is The Dole for Rich People

Everyone thinks they know the story about the Dutch tulip mania.

You know, everyone in Europe from prime ministers to chimney sweeps sold everything to lay hands on prized “broken” flowers, striped by a mosaic virus. At the height of the madness, buyers traded mansions for a single bulb. Once, a hapless sailor mistook a tulip bulb for an onion, sliced it up and ate it on a sandwich, and went to jail… for destroying a million dollars’ worth of property.

When the bubble burst – as all bubbles must – ruined speculators committed suicide and Holland’s economy sank into depression.

There’s just one problem with the narrative: none of it is true.

Most of the legends about tulip mania – which was actually a fad confined to a few wealthy merchants, and in reality didn’t disrupt Holland’s economy in any meaningful way – sprang from the fertile imagination of a Scottish poet and journalist named Charles Mackay.

Mackay is most famous for the 1840s investment psychology classic Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, where he fabricated most of the details of “Tulipomania” as a warning to traders. The fable has since burrowed so deeply into our investment and cultural zeitgeist that we accept it as fact.

Mackay was a master storyteller. He was also deeply steeped in denial.

At the same time that he was spinning cautionary tales about the non-existent tulip bubble, Mackay was in the thick of a real-life bubble of his own: the British railway mania.

On September 15, 1830, the launch of the Liverpool and Manchester railway gave birth to the modern railroad industry. For the first time in history, cheap and fast movement of goods and people between distant cities became possible.

As rail transport exploded across Britain, the public became swept up by the promises of this revolutionary new technology. Speculators and promoters seized on the frenzy to raise capital and peddle increasingly dubious investment prospects to the unsuspecting public (and to many household names, like Charles Darwin and the Brontë sisters). Share prices of publicly traded railway companies surged across the board, regardless of the viability of their underlying businesses… with all of the predictable consequences.

The boom reached its zenith in 1846, with the British parliament approving a record 236 listings of new railway corporations, which together promised to lay 9,500 miles of track.

The bust followed shortly thereafter, as a broad index of railway share prices was cut in half during the “Panic of 1847.” Many shareholders were wiped out completely as bankruptcies swept across the industry. Roughly two-thirds of the publicly listed stocks were delisted from the exchange or bought out at pennies on the dollar.

Charles Mackay somehow didn’t see this pattern. Or he outright ignored it.

During the peak years of railway mania, 1844 through 1846, Mackay served as editor of a paper called the Glasgow Argus – where he wrote puff pieces encouraging railway speculation and soothing the fears of investors.

“We think that those who sound the alarm of an approaching railway crisis have somewhat exaggerated the danger,” he wrote in 1845. “We think the alarmists are in error and that there is no reason whatever to fear for any legitimate railway speculation.”

At the same time, he resolutely refuted the suggestion that earlier bubbles – like the ones he himself examined in Extraordinary Popular Delusions – had anything in common with the railway craze:

“It may appear wise to the careless or to the ignorant to trace resemblances. Those, however, who look more deeply into the matter and think for themselves cannot discover sufficient resemblance of cause to anticipate a ­similarity of effect.”

After the disastrous Panic of 1847, though, Mackay’s silence spoke volumes.

Although Delusions became a perennial bestseller, with many updated editions…at no time did he ever mention the railway bubble, except once in an oblique footnote.

Why did Charles Mackay, the bubble expert, have such a blind spot?

Simply put, the tale of speculative mania going bust is as old as time itself. And denial prior to the bust is equally time-honored. It is historically hard for speculators to accept the end of a bull market.

Take October 29, 1929, “Black Tuesday” – the stock market crash that started the Great Depression. Plunging stock prices decimated customer positions, leaving brokerage firms on the hook for the unpayable margin debts of millions of speculators.

The next day, denial hit the front page of the New York Times in full force.

There’s no mention of real estate investor C. Fred Stewart, who gassed himself to death in his kitchen… or Wellington Lytle, who died with just four cents to his name… or John Schwitzgebel, who shot himself and was found lying under the stock pages of the newspaper.

Ah, no. In this upbeat world, “Rally at close cheers brokers.” And optimistic bankers stand by to “aid” the market with buying orders.

Throughout the article, the author cited numerous high-profile industrialists and market leaders of the day, assuring the panicked public that the worst was over:

“The market has now passed through three days of collapse, and so violent has it been that most authorities believe that the end is not far away… The smashing decline has brought stocks down to a level where, in the opinion of leading bankers and industrialists, they are a buy on their merits and prospects, and brokers have so advised their customers.”

In the short term, the “experts” were right. The market found a bottom in November 1929, and surged by nearly 50% over the next months. But it was a short-lived reprieve…

By April 1930, the U.S. stock market had recovered to 80% of its prior 1929 peak. Many believed the worst had passed…but when the selling resumed, the market plunged by another 85%.

The whiplash roller coaster wiped out scores more traders, including legendary speculator Jesse Livermore, who cleared a $100 million windfall from shorting stocks in the initial 1929 crash. But he ultimately ended up penniless, as he doubled down on his massive short position in the face of the powerful bear market rally through April 1930. (Livermore also eventually committed suicide.)

Source: Dow Jones – 1929 Crash and Bear Market

The moral of the story is really the same as the moral of Extraordinary Popular Delusions: Don’t be seduced by speculative mania. And don’t assume that you’ll be the one happy exception to the rule.

Today’s market is no different. After a devastating 2022 that rewarded bears, the market consensus has flipped in favor of the bulls to start the year, punishing short sellers with $81 billion in losses in January alone:


Consider the case of the Noble Absolute Return Fund (NOPE), launched in September of last year under the guise of “raging against the Everything Bubble”. The fund had a stellar run out of the gate as stocks plummeted in the final months of 2022, including a 54% return in December alone. These returns were driven primarily by a massive short position in the shares of electric vehicle maker Tesla (TSLA), which paid off big as shares plunged.

NOPE’s fortunes have since faded, as 2022’s beaten-down stocks enjoyed a massive surge in 2023. (Tesla rallied 80%, and “meme stocks” like BBBY rose sharply in hopes of a short squeeze.) Over the past month, NOPE is down more than 50%.

Not surprisingly, the bulls are out in full force. High-profile social media influencer Jason DeBolt, who broadcasts his Tesla investing journey on Twitter, announced last week that he had sold his $2.8 million house, and used the proceeds to double down on his all-in Tesla gamble:

We won’t venture a prediction about the future of Tesla (or Jason DeBolt), but one thing is clear: Speculative excess does not mean the end of a bear market. It just means speculators are likely to get caught with their pants down in the inevitable vicious reversal.

Latest Recession Red Flag: Negative PMI

Despite last year’s decline in share prices, valuations in U.S. markets today are still close to all-time highs. The following chart from hedge fund manager John Hussman gauges whether markets are closer to a top or bottom. This ratio divides the total market capitalization of U.S. businesses by their “gross value-added,” a measure of profitability. When this ratio is high, it means U.S. businesses are expensive relative to their earnings, and vice versa.

The chart below shows that this valuation metric remains near all-time highs, despite a modest decline from the record levels. So if the lows are in for the U.S. stock market, it would be the most expensive bear market bottom of all time:

Source: https://www.hussmanfunds.com/

Meanwhile, the consensus narrative also tells us that the worst of the economic slowdown is now behind us, and we can expect a “soft landing” – a mild contraction that avoids a recession.

But the history of bear markets is littered with similarly false “all clear” signals, from 1929 to 2007. (The New York Times is responsible for a great deal of misinformation, it seems.)

We prefer to take a data-informed view. Prior to every sharp recession of the past many decades, the yield curve has inverted – that is, long duration Treasury yields fall below those of short duration yields. And that’s what’s happening now, with a record yield curve inversion pointing towards serious economic trouble ahead, as Porter recently explained on Twitter:

We’ve also spotted another major recession red flag: persistent declines in a key leading indicator for economic activity, the S&P Global Purchasing Managers Index (PMI).

Every month, the PMI surveys supply chain managers across the U.S. to determine whether their business is expanding, contracting, or staying flat – then sums up the results. When that total falls below 50, it indicates a broad economic contraction.

The latest data released in January showed the U.S. manufacturing sector has now contracted for seven consecutive months, while the services sector has contracted for the last three months. (Giving the lie to another popular bullish narrative, consumer spending hasn’t “moved from goods to services” – it’s just evaporated altogether.)

A one- or two-month blip below 50 can happen at any time. But when PMIs register a series of consecutive negative numbers in goods and services – that’s a giant red warning flag. These readings telegraph a persistent, broad-based decline in activity across the entire economy.

As the chart below shows, sharp and persistent contractions in PMI readings provided a warning signal leading into the 2008 Great Financial Crisis. And the latest PMI data is eroding in a similar fashion today:

And this time, the pace of the deterioration is quick. According to S&P Global, “the rate of [PMI] decline is among the steepest seen since the global financial crisis.”

Deceptive whipsaw rallies aside, we remain firmly in Camp Recession (and, we’d like to think, Camp Common Sense) at Porter & Co. And that means adding defensive names to the portfolio.

Better Than Treasuries – Believe It Or Not

Today’s “safety” play (which we’ve added to our “Battleship” portfolio section) is a real estate investment trust (REIT). These mutual-fund-style vehicles pool capital and invest it across a diversified portfolio of real estate assets. They’re required by law to pay out 90% of their profits to investors, which means they offer exceptionally high dividend yields.

And because of the recent spike in mortgage rates (more on this later), there’s rarely been a better time to invest in REITs than right now.

The REIT we’ll introduce today offers an extra degree of safety. It avoids physical real estate properties entirely, and instead invests primarily in mortgage securities that are effectively backed by the government. These securities have zero default risk – they’re as good as Treasury bonds, since they’re backed by the full faith and credit of Uncle Sam.

And they’re a better buy than government bonds. Today, Treasuries will generate a yield of around 4%, while this REIT’s government-backed mortgage portfolio offers a staggering 15% yield.