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ChooseFI | Financial Independence Podcast
603 | Crash Proof: The Science Of Stock Market Resilience | Brian Feroldi
00:51:22
Stop betting on faith, start understanding the mechanics
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- [00:00]
A
Hello and welcome to Choose a vi. Today on the show we have Brian Feroldi back for another episode. This one was absolutely mind blowing. We're calling it the Science of Stock Market Resilience. Brian really goes through questions that a lot of us might ask in the back of our heads, but we never really have an outlet to find out the answers. Ultimately, the question that he's saying is most investors don't understand why markets recover. So we know if we listen to this show for long enough. You've seen J.L. collins talk about this. The stock market goes down all the time. It goes down 10% a year once or twice. It goes down 30% once every handful or 10 years, give or take. Seemingly, when you look at the chart, it always recovers. The question is why? This episode unpacks the mechanics of why these recoveries aren't just luck. And the takeaway is it helps you stay invested when times are the bleakest. I think you're really going to enjoy this episode. And with that, welcome to Choose Fi. Before we get started, I keep this podcast entirely ad free for two reasons. First, this is a five podcast and I don't want to promote products that I don't want you to buy in the first place. And second, I really like the clean listening experience of a show where you don't have to fast forward ads to keep it ad free. All I ask of you as a listener is the next time you open a travel rewards credit card, go to choosefi.com cards and with that onto the show. Brian, it is so good to have you back. Thanks for being here, Brad.
- [01:38]
B
Awesome to be back. Thank you for having me.
- [01:39]
A
You did a presentation that was extremely well received at economy this year 2026. The concept is crash proof the science of Stock Market resilience. Your contention is a lot of people intuitively understand whether they mechanically understand or not, but they intuitively understand why the stock market goes down. We can see all sorts of crazy things happening. All these exogenous shocks and Covid and fill in whatever blank you want. But why does the stock market actually recover?
- [02:08]
B
Yes, the general premise is exactly what you set up. About 100 million people in the US alone are essentially betting their financial future on the market going up. And any retirement calculator you have assumes some rate of return, which means that you're betting your financial future on the market, continuing to do what it has done to historically. Now, if you're like me, you've read a lot of the wonderful books out there that are about the market and they all show that wonderful image of the market going up and to the right over long periods of time. And all of them say, yes, the market crashes, but the market always recovers. You just have to have faith that it's going to come back. And it always has come back. All of that is true. But what always confused me is that nobody ever explained to me the actual mechanics of what causes the market to recover and what causes the market to kind of come back. And to your point, intuitively, at least to me, it makes sense. So the biggest crashes I've seen in my life were dotcom crash, economy terrible, everything way overinflated makes sense. The market decline, 2008, financial crisis, people are losing their jobs, housing prices are collapsing, credit default obligations. All that nonsense makes total sense why the market crashed. Covid. Huge, big negative thing makes total sense why the market crashed. To me, what made no sense to me was why did the market always bounce back from these big horrible things? That's what I hope it can help to illuminate for people.
- [03:38]
A
Yeah. And also sometimes the speed that it recovered. I'm not sure how much you've dove into that specifically, but I mean, I know with a couple of these more recent ones, Covid tariffs, et cetera, you feel like you blinked and it just came zooming back again. That's probably a side tangent, but maybe we'll put a pin in that and I suspect that'll be answered by you. But if not, I'd love to ask that later. So, yeah, when you said quote, unquote, faith, it recovers. My skin kind of crawled with that. Because you're right. We'll further the faith thing here and say we take it as gospel. You look at that chart over a long enough period of time, we could recite it as if we were elementary schoolers and it was just rote learning. Right. It's like, okay, yeah, you can zoom in on a certain time period and it might look really scary, but when you zoom out over a hundred plus years, it is up and to the right. But have we ever really dove into why? So where do we start on this journey?
- [04:31]
B
I'm the type of person that I don't take things on, quote, unquote, faith. Or at least I've always struggled with people saying trust me or this is how it works, and not getting a scientific explanation for why that thing happens. And again, many people that are listening to this are betting their financial independence on the market recovering from a crash. And you know, at economy there were signs that said like vtsax and chill. Great saying and totally true. But I'm the type of person that needs more information than that for me to actually feel comfortable. So the goal here is for people by the end of this podcast to understand the three fundamental forces that, that make the stock market. And specifically we're really going to be focusing on the US stock market, the S&P 500, why it always has recovered and in theory should always recover from future crashes.
- [05:27]
A
Okay, that makes perfect sense. And now can I assume so you wrote the book why does the stock market go up? Right. So can we zoom out and say that this is not just in relation to crashes, but just general why does the stock market go up? Is that a fair assumption?
- [05:44]
B
We're definitely going to cover that because the same force that causes the market to go up over time is also the same force that causes markets to recover from crashes. And the good news here is nothing we're about to cover is like super complicated. It's really just understanding the processes that are in place that allow markets to recover. So the hope is that the next time the market crashes, and I guarantee you it will crash at some point that you're not betting the market recovering just on faith or I hope this happens, you actually understand scientifically the forces that cause it to recover.
- [06:21]
A
Okay, so three fundamental forces. We're going to get to the first one in a second. But real quick, you said essentially the market is going to crash. For people who are new to stock market investing, whether that's individual stocks or hopefully for most people here, the fundamental basis is broad based index funds. But they might not know that this is essentially guaranteed that the stock market is going to crash at some point over their investing lives. And I know you don't have info in front of you, but I suspect this is something you have memorized. Like over a 40 to 50 year investing lifetime, what can someone expect in terms of hey, the market went down 10% this year or 20% or 30%?
- [07:00]
B
Yep. So roughly speaking, on average the market falls 10% from its recent high about once every 11 months. So every year you can expect, or you should expect, the market from its recent peak will fall about 10% every two years on average. That peak to trough is about 15%. And then once every three years on average it's it drops 20% about once a decade, once every 10 years, that fall is 30%. And then two to three times a century the fall is 40% or more. So over a, let's just call it a 50 year investing with that kind of time horizon, you should expect one effectively depression like crash, about 40 or 50, 10% drops, about 10 or so 15% drops and about 7 or so 20% drops. So and that's what like the historic data indicates. And I think that's just a good baseline to have in mind.
- [08:10]
A
Yeah, that's really the critical part here is just to understand that this is part of investing in the stock market. Like Brian said, this is happening once every 11 months, a 10% peak to trough job. So if you freak out when that happens, that's going to be a tough go. It's going to be a tough 40 to 50 year investing lifetime. It just is. So Brian, a lot of what we try to do here at choose of I, as you know, is arm people psychologically for these things that are essentially going to happen. I keep coming up with the word preordained, but that's a bit of a stretch. But it's almost a certainty obviously that you're going to have a 10% drop in a given two year period, three year period, whatever. Especially if on average it's happening once every 11 months. So to everybody listening, this is part of the process. And I think what having a brilliant expert like Brian on to talk about is, okay, look, that's part of the deal. But yet there are these fundamental forces that the stock market always recovers because of them. And I think, Brian, that is the perfect launching point. So all right, let's start with fundamental force number one.
- [09:12]
B
So fundamental force that you need to just drill into your psyche when it comes to the stock market is that stocks follow earnings. Let me say that again. Stocks follow earnings. As go the earnings of a company or an index also goes the price or the market value of that same index. So if a company generates a billion dollars in profit and then 10 years later that same company is generating $10 billion in profit, all things held equally, you can assume that that company will have 10 times the market value 10 years later because the profits of that company grew by tenfold. Conversely, if a company is generating $10 billion in profits and then 10 years later it's generating $5 billion in profits, all things held equally, that same company would roughly have half the market value as it did before. So this is a truth when it comes to investing in stocks, stocks follow earnings. Where earnings go, the stock price will eventually follow.
- [10:31]
A
Eventually. That's an interesting word. I'm glad you tacked that on there. I'm curious on your theory on how efficient the stock market is and such Because I think a lot of people see oddities and this is where they find it hard to wrap their mind around. Is it really tethered to reality? Is it really tethered to earnings? Or is it based on meme stocks or these random icons that they seem to love? Eventually is the critical word there. And how do you think through short term versus eventually when it comes to stock price following earnings?
- [11:06]
B
The best analogy that I've ever heard with thinking through this is a man walking a dog on a leash that's made out of elastic band. The man represents the profits of, let's just call it the economy. And the dog represents the price of the stock market. So the man is walking up a very slowly gradual hill. Profits of all corporations are gradually growing over time, but the dog is reacting wildly to the environment around him. Sometime the dog is really excited, jumps way ahead of the man, trying to go up to sniff things and smell things. But the dog is attached to the man by this leash. Eventually something scary comes along and the dog darts way behind the man. And the man is now leading the dog. That is how you have to think of stock earnings versus stock prices. The two of them can be wildly detached from each other over the short term, but over the long term, you need to watch where the man goes, not where the dog goes. The problem is the dog is so much more interesting than the man. Everybody in the news is focused on what is the dog looking at. What caught the dog's attention? Is the dog really excited or not? That is the price that gets quoted in the news, that gets thrown at you all the time. What that is is just a dog reacting to its immediate environment. And I would even protest. Most people that invest in the stock market don't even know the man exists. I would challenge everybody as soon as you have a free moment. If you're driving ever Google these words S&P 500 earnings and pull up a chart that shows you the earnings, aka the profits of the S& over the last 100 years. I bet this is a chart that you've never seen before. That chart shows you the man. What is happening to the actual profits of the S&P 500. Spoiler alert. It's a chart that is squiggly but goes up into the right. And that is the thing that you need to truly pay attention to if you're an investor. What are the profits of the S&P 500? Then overlay that same chart with the price. And while they are wildly detached from each other in the short Term, in the long term, there's essentially a 100% correlation between those two things.
- [13:41]
A
I love that. The dog, the leash, the man. That's something people can really grab hold of. It's keep your eye on the man. That is really interesting. You can hear me think through it as we're talking here because like you said, it's sexy because you see that number, people talk about it, it's on cable news. And also, frankly, that's the number that shows up multiplied by the number of shares you have when you log into your brokerage account. That is a visceral number because, oh, my net worth went up. Oh, my net worth went down. As opposed to this earnings, which sure, that sounds good in theory, but when it's detached from the near term, hey, earnings went up, but oh damn, the stock price went down. Like that doesn't make any sense is what people think. So how could it be as inextricably linked as you're saying? But, and I'm not trying to harp on this, but eventually is the part, and I know you do in depth analysis of stocks and also I know you're now doing this with the help of AI, which I heard you on Paula's Afford Anything, which is really cool. How do you think about eventually? What type of timeframe is that for you, Brian, the individual stock investor?
- [14:47]
B
It depends on if you're talking about investing in an individual stock or if you're talking about investing in index. My personal strategy is my retirement funds, my 401k, my Roth IRA, all that kind of stuff. It's just indexed dollar cost averaging. I look at that maybe once a year. Like I truly don't care about the price or the net worth of those assets because I know internally I'm betting on the man and the man will eventually do his thing. And if I'm correct about the man, the price will totally take care of itself over the long, which I think is a very psychologically healthy way for most people to invest. With individual companies it's a little bit different because the man moves at a way faster speed than he does for the economy in general. And the leash between the man and the dog can be wildly longer and it can snap back way, way shorter. So generally speaking, if I'm buying an index that I believe in for the long term, I just set it up on autopilot once and check it on it once a year. If I'm buying an individual company, it requires more frequent check ins. But as a general statement, I like to give companies at Least three years from when I purchase them before I would make another decision about I was right or I was wrong about that company.
- [16:02]
A
Okay, so three years, I like that. Again, not going on faith. I think that's going to be a through line here. So my question for you, you just talked about all of these retirement accounts, long term accounts that are in broad based index funds, probably s and P500 or total stock market. So I guess my question to you is, are there possibly periods where the price of the market, the price of stocks, let's say, is wildly outpacing earnings? And you might say, as Brian Feraldi, Intelligent Investor, look at it and say, hey, I know this is on autopilot, but something isn't right here. Maybe it's time for me to make a shift again. It's like the fundamental underpinning of FI is we$, cost, average, all these things. Right. But again, we're not taking it on faith here. How would you think through that again it gets into active investing. And that's another thing that maybe we want to shy away from. But realistically, there must be periods where stock prices are far outpacing earnings for some reason over that short term. Do you ever think about changing your strategy in these retirement accounts?
- [17:08]
B
The answer to your question is yes, there are absolutely periods when those two things become fundamentally detached from each other. The media shorthand for those periods are bubble. Right. All as a bubble means is that the price has become wildly detached from the fundamentals of that same asset. At the end of 1999, there's no doubt, looking backwards with the benefit of hindsight, that we were in a Internet stock bubble. Right. Companies weren't even reporting earnings, they were reporting eyeballs or users, and that's what their stocks were actually trading against. There was no man. The man, there was a hope to potentially build a man. Right, exactly. So the leash was attached to nothing, did absolutely nothing. The leash kept going forward and forward and forward. Yeah, there are periods in time like that. If you look at the market as a whole, there are some indicators that you can use to figure out are the prices detached from fundamentals. There's things like the cyclically adjusted PE ratio, also called the CAPE ratio. You can look at the PE ratio of the market in general, you can look at the Warren Buffett indicator, which measures the gross domestic product of a country to the market value of the country. So there are things that you can look at kind of at the macro level. But to answer your question, does that change what I think is the best advice for what you should do. The answer there is no. I don't change anything about my contributions to my retirement accounts when even if I thought prices were high. So that part of my portfolio is on autopilot and I think that that's the correct thing for people to do. Don't stop contributing to your 401k. Don't stop contributing to your whatever system you have in place that's on BTS X and chill. I wouldn't touch anything about that. I do make more tactical decisions with the individual stock portion of my portfolio. I'm not trying to time the price of those positions. I'm trying to time the valuation of those positions and I'm trying to invest when the leash is a favorable distance between the dog and the man. So I hope that that answers the question as to what I do.
- [19:16]
A
Brian, one last thing on this. I'm kind of playing devil's advocate, as you can tell, because this is my strategy as well. But for somebody out there who's saying, all right, look, maybe there are some times where there's a bubble and it seems that historical earnings and prices are out of whack and maybe they're only a couple years from fi. I think it's easy for you and I in our 40s to say, all right, look, there's a real likelihood for our retirement accounts. We're not going to need them for 20, 30 or maybe more years, especially if we have a significant amount in our taxable brokerages. So over 20, 30, 40 plus years, we're both pretty happy that this is going to go up and to the right. But what if the timeframe was different? What if you were 58 and you were relying on that money at 59 and a half? Again, you, Brian, and you saw a bubble forming. And I'm not asking you to tell us precisely tactically what you do, but like, would you consider or is this still like a, hey, this is the best strategy. I've done all the research that satisfies me. Like, how would you think about that particular instance?
- [20:13]
B
What you're effectively asking is portfolio strategy and allocation, decision making frameworks. And this is where I would call on people that are smarter than me about this topic, like Frank Vasquez, for example. What is the proper asset allocation for you? 10 years from retirement, 5 years from retirement, in using the word retirement, financial independence and post that, how much of a cash position should you have? Should you focus more on fixed income, like bonds and stuff like that? Should you have a bond ladder that pays for your Lifestyle. I'm a fan of all that kind of thinking. It just depends on how complicated you want to get to it. For me personally, once I am truly dependent on my portfolio, I will absolutely dial back the risk profile, generate more income for myself, have a big cash cushion to pay for a year plus of expenses. That's absolutely something that I'm going to do and to consider. So to me, that's almost a separate question about what is the proper asset allocation. If you are nearing retirement and you think that prices are elevated, there's all kinds of things that you can do to protect yourself from higher valuations.
- [21:18]
A
Yeah, I agree. Frank Vasquez, he's someone who I'm going to get on to talk about that very specifically, before we move on to fundamental force two, is there anything else that we should talk about with force one? Are there examples? Can we talk about specifically how S&P 500 earnings have grown consistently? Anything else you want to dive into before we move on?
- [21:35]
B
Yeah, just one thing to think in mind. I think analogies and real world examples are just so helpful. Anybody here that watches Shane Shark Tank knows this point kind of intuitively. If somebody walks into the shark tank with an idea and the sharks are like, how much revenue are you doing? And they're like, zero, what is the valuation that the sharks are going to assign to that company? They're going to do a very, very low valuation because the sharks know that the risk here is enormous. This hasn't been proven out in the world at all. It's just an idea at this point. So they're going to want a very low valuation. They're going to want to give a little bit of money and get a huge equity stake if they decide to invest. Conversely, if somebody walks into the shark tank and they say, how much revenue did you do? They said, we did $10 million in revenue in the last year and we did $2 million in profit. The sharks are gonna give that company a way bigger valuation and they're gonna be much more comfortable giving that company money and taking a smaller ownership stake because that model is proven out and the company may have lots of sales or even, best case scenario, lots of profits that they need. So you've seen this valuation thing and the fact that stocks follow earnings and kind of play out in shark tank companies that come in with no sales and no profits. Low valuation, high sales, high earnings, big valuation. Same exact concept applies to stocks and the stock market.
- [22:56]
A
Let's move on to force number two here, Brian.
- [22:59]
B
Okay, so now that we accept And I really hope that you accept force number one, stocks follow earnings. The answer to the question, why does the stock market recover? Is very simply earnings, profits always recover from crashes. The reason that this happens is not a mystery. It is not magic. There is a predictable process that happens during any economic recession or any economic downturn that causes profits first to plunge and then to recover and bounce back. And as long as earnings bounce back, remember, stocks follow earnings, so too will the price of the index. So again, if you pull up a chart showing the s and P500 earnings over the last 100 years, it's a squiggly line. And every time the line crashes, so every time profits crash, they almost immediately bounce back and return to their former highs and then eclipse their former highs. So that's what I hope to talk about with force number two. Why, after they decline, do they bounce back? If you understand why they bounce back, you will understand why the market bounces back.
- [24:15]
A
Okay, well, I definitely am quite, quite curious on this because, yeah, again, not taking things on faith and also things that aren't intuitive. Right. Like if there's some outside shock that actually made a material difference in the world, it's not a hundred percent intuitive that earnings are always going to recover. And that's why we're going to get into the forces here. So I'm just going to let you run with this.
- [24:36]
B
Sure. I want you to think of a economic recession or a depression, kind of like a forest fire. Like, think of it like an economic forest fire. So a spark gets lit by something bad going on and all this brush that's kind of out there is. Gets burned away. So that's the mental model I want you to have as we go through this. Okay, so what happens as a fire is raging in the economy? Well, step one is that businesses lose revenue. Demand for their products and services goes down. So how do companies react when demand for their products and services go down? Well, they have a fire alarm go off. The, the management team jumps in and says, oh, crap, I do not have demand. We're not selling our products anymore. We need to tighten our belt. We need to cut hourly workers for shifts. We need to lay off people. We need to get our financial house in order. It's an extremely painful period for the company, for the employees that are affected. But this is understandable. Companies must lower their costs and to align the business expenses with the new levels of demand that they're seeing. So they have to get more lean, if you will. And this is why when recessions first Start, you see headline after headline, thousands of jobs cut, Microsoft cuts jobs, this company cuts job. And the unemployment rate kind of skyrockets. This is the worst part of the process. No doubt it's painful for everybody, but it has to be done because companies need to right size their expenses to their new levels of revenue.
- [26:18]
A
All right, that makes sense. I'm thinking in terms of what are ramifications again, it's like this is a process. And I know you're going to walk us through this because I'm thinking, okay, obviously high unemployment, not wonderful. That doesn't automatically suggest that we're going to have this wonderful unicorns and rainbows recovery and earnings are going to come back. But this isn't your first rodeo, right? You've studied a bunch of these. So let's go.
- [26:39]
B
At least this makes sense. I hope this makes sense. When things go down, companies lay off people and they cut projects that have low hope and they cut back on their marketing. It's no surprise. The same way that if you got laid off, you would immediately look to your expenses and say, how can we cut this down so we can survive this tough period? Companies do the exact same thing. Okay? That's phase one. Phase two is the cleansing period. So when demand for products and services fall, all companies are hurt. But the ones that are hurt the most are the ones that were struggling when times were good. So this is when the Circuit Cities of the world, the Radio Shacks of the world, the Bed Bath and Beyonds of the world, the Blockbusters of the world, companies that were struggling during good times, they were barely keeping afloat during good times. When bad times hit, it's too much, they break. This is when companies start to go under. Businesses absolutely get closed down. So Sears, Polaroid, Woolsworth, they go bankrupt. And the indexes see this happening and the indexes are self cleansing. So they kick out the companies that are weak and they bring in the newer companies. Now the interesting part about periods of economic stress is that market share shifts drastically. So the demand for companies, products and services doesn't necessarily disappear. But if the company you were buying from goes out of business, well, you now have to buy from the companies that are left. So when Blockbuster went under, people didn't stop watching movies, they were just forced to change their viewing habits to become Netflix subscribers. So downturns actually caused the weaker companies to die and the stronger companies that are remaining actually pick up market share.
- [28:32]
A
You could tie that back to your forest fire analogy as well. Right. In terms of they talk about forest fires Being cleansing in some sense.
- [28:41]
B
That's why the analogy works. The deadwood gets cleared out and it makes way for the things that are emerging to actually emerge stronger. So anyway, that's something that you have to understand. And at the index level, at the S&P 500 level, if you've ever heard of them, cleansing, where bad companies get kicked out, new ones get entered. It happens continuously, but especially during this period. Now, that gives ways to phase three, which is no government wants to be in charge when things are going horrible in the economy. So this is when the government tends to step in. And they can step in in a couple of ways. The first way that they step in is by lowering interest rates. Right. This is when the Federal Reserve comes in and they cut interest rates. And cut interest rates actually spurs demand. People that were debating whether they should do something or not with a lowering of interest rate that actually spurs people to take on projects and to do things the same way that the demand for housing is. At one level, when interest rates are 6%, but if interest rates go to 4%, suddenly the number of people that can buy a house jumps because the monthly payment that they have to Ford actually increases the pool of buyers. So governments step in by lowering interest rates, or sometimes with direct support. Remember during 2008, the auto companies and the banks were actually injected hundreds of billions of dollars. Or during COVID how many times were checks actually sent to consumers and businesses? So the government injects money back into the economy because people are hurting.
- [30:13]
A
Yeah, PPP loans was another one during COVID for sure. I'm glad that you explained that about the mortgage. I think that's something everybody can understand because again, it's not altogether intuitive. Okay. Interest rates go down because some savers might be saying, oh, but that's terrible, I didn't want that. Why is that a good thing for the economy? Well, the mortgage is a better personal finance example that people can understand. But writ large, okay. Projects or expansions for business, it's dramatically cheaper when interest rates are lower. So that's. Yet that's really the more systemic reason why this is going to be a positive thing. When government steps in and lowers interest rates.
- [30:52]
B
Yeah. And think about when you're buying a house. Let's just say you're spending $500,000. You know what an extra percentage point of interest does to your monthly payment? Well, imagine if you're a business thinking about a project that costs $500 million. Right. A teeny tiny change in the interest rate can literally result in millions or tens of millions of dollars of change of interest, which is the equivalent amount of money that could hire a couple hundred or a couple thousand people. So small changes in interest rates times the economy is actually a really big
- [31:24]
A
deal without a doubt. All right, so that was phase three.
- [31:26]
B
Now that brings up phase four. So remember, we've gone down, companies have cut weak, companies are dead or dying, the government is stepping in. Here's the most exciting part about downturns. Innovation accelerates when times are tough. This is so counterintuitive, but innovation and new business formation goes up when markets are very stressed. The best example I can give is during COVID in the fall of 2019. What percentage of companies offered remote work? Almost zero single digits in April of 2020. So four months later, what percentage of companies offered remote work?
- [32:10]
A
Probably 90% plus.
- [32:11]
B
Would it be fair to say that innovation accelerated during COVID Do you remember operation warp speed? Or how many rules and regulations were just thrown out the window? I mean companies, restaurants in my town could sell beer to go. Think about how many rules were just thrown out the window and how many new business models were started because of a crisis that was happening. Innovation goes up when times are tough, when you're fat and happy, when things are going well, you are less willing to give new business models a try to try new things. But when you are out of work, boy, will you try new things. Will you try new products and services to save money again, multiply that by the economy and all kinds of good things can happen.
- [33:01]
A
Yeah, necessity is the mother of invention is a quote that readily comes to mind. And yeah, you saw that all over businesses, not just selling beer to go. But how many restaurants completely overhauled their entire business model to be just to go almost overnight? They had to. Because what are your options at that point? You go out of business or you adjust. And also frankly, right in a time like that, people are trying to come up with new ways you can save and you can lower costs. Right, like that's what you mentioned earlier. Like, hey, what happens when you lose your job? Okay, well yeah, you batten down the hatches and you cut some random things that you might have in good times spent on. But also frankly, I've done this before. I suspect you have and again, writ large over 350/million people in America alone. People are going to try new businesses, especially in this day and age. Brian, you and I know how easy it is to start a business and low cost it is. That doesn't mean of course every business is going to Succeed, it doesn't work that way. But when the barrier to entry to starting a new business, especially in America, is so low, why wouldn't you test things out again, like you said 2019, is everybody doing remote work? Is anybody caring about what their employees think? Well, no, but it's similar to this. It's like when times are good and you're rolling, are you looking for that next thing? I think only it's tiny select few are. So that was phase four of force number two. But I think there is a fifth phase, correct?
- [34:33]
B
Yeah. So this is my favorite one. This is my phase. And phase five. So we've had cut, cleanse, intervention, innovation, and phase five is emergence. This is when new companies and businesses start to recover from all of the factors that came before them. So again, think of a forest fire. The fire is now completely through the forest. What you're left with is quite literally the best possible environment for growing again. All the dead wood has been cleared away. There's been fertilizer sprinkled in everywhere from the government. There's no competition above you, there's just pure sunshine. It is the best possible growing conditions for a new forest. You have to think of the economy and as the exact same way. So all those new businesses and new ideas that we're getting off the ground, well, one big thing that holds those companies back is talent. A lot of the talent that is out there to get those ideas off the ground is trapped inside other companies. Again, people are fat and happy and they don't want to change. Well, if they're laid off, if that talent is suddenly available for hire, they're more willing to join smaller companies and, and to put their skills and resources behind those companies. And they're entering a company, a smaller company, in the best possible environment for growth because competition is at its lowest and talent availability is at its highest. So that is why that sets the stage for profits to eventually recover. And remember, all the competition that was hobbling is now completely wiped out. They're off the table. The market share shifted from the weak players to the strong players. All these forces combine to set the stage for profits to start to rebound.
- [36:31]
A
Okay, I didn't mention this earlier, but that cleansing portion, Anybody that's ever heard J.L. collins talk on this podcast or others about his book the Simple Path to Wealth has heard him talk about the self cleansing nature of an index fund. And I think that has provided great solace to a lot of people in that like this makes sense. There's a limited downside right in the sense that they can only go to zero. And then I know we've talked many times, somewhat contentiously between the two of us about companies like Tesla. Palantir is another one that I know you've highlighted where the potential upside of these companies, it's literally unlimited. And you can see many thousands x return on these companies. They're fledgling and they grow into something enormous. They grow into a, a top 10 or 20 biggest company in the S&P 500. And that's the interesting nature of this cleansing. And this might be unanswerable, Brian, but this process, again it's earnings always recover, this always recovers, yada, yada, yada. Is there like a rough timeline in looking at, at history? When things are bad, human nature is such that like we're scared, we can't imagine we're going to see the end of this. But yet you describe this process and it makes perfect sense. You're going through it, it's like, hey, the town's available, people have to take chances, government intervenes. Like all of these things make sense. We've seen it, I mean just in your and mine investing lifetimes, we've seen this multiple times. But yet it's still not intuitive to me that there's some like amount of time where this would happen. Like is there some rough, Again, you cannot predict this for the next one, but where you've seen is it, does this happen in a year? 2, 5, 10? Do you have any sense?
- [38:11]
B
So the speed of the recovery depends greatly on the factors that went into the downturn. And the worse the downturn, the longer it is for the recovery to happen. Now let's be clear. Let's go back to our man and dog analogy. What I just described is the man. Earnings are the man. And I'm talking about the man getting back on his feet and continuing to walk. If you're actually talking about the dog prices, what's so fascinating about stock markets is that markets tend to predict what the man is going to do about six to nine months before the man does it. So if you look at the 2008 financial crisis, for example, do you know by chance off the top of your head when, when the stock market peaked prior to the crisis?
- [39:01]
A
Oh, I have no idea.
- [39:03]
B
July of 2007. And when did the crisis really get bad? Like when did prices really drop? It wasn't until the fall of 2008 and prices didn't bottom until March 9th of 2009. So you're essentially talking about an 18 month period, almost a two year period between the peak and the bottom of that crisis, which was like essentially the worst since the Great Depression. So the market bottomed March of 2009. If you looked at any economic headline in March of 2009, horrible. It was horrible. GDP was down, layoffs were up, the government was stepping in. It was just pure crisis. And yet that was the bottom. That was actually the best time possible to buy, because the price typically predicts what's going to happen to earnings about six to nine months ahead of time. This is why trying to quote unquote, time, the bottom is so unbelievably challenging, because if you're just looking at the headline and the news, the bottom typically happens when the news is the worst. It's like there's nothing but bleakness ahead of you and all the headlines are terrible, and yet that's when it's the optimal time to buy. So to answer your question, how long does it take the man to recover? Totally depends on the period in Covid. I think the economy recovered after six months. It was like three to six months. It was an extremely fast recovery from the 2008 crisis. I think it was like two years before the economy took back and profits started to truly rise again. So every crisis is unique. It can be as short as a few months to as long as a few years. But the bigger point is, while the timing isn't predictable, the process is.
- [40:48]
A
Yes, and that is the critical part that hopefully everybody takes away. Because In March of 2020, when the world was literally shutting down, it was entirely unforeseeable that this would come back six months later, especially when for many of us, it was fresh in our minds, even though it was a decade plus since the great financial crisis that lasted, like you just said, a couple years. Like literally the world shut down. How could you have possibly foreseen that six months later everything would be unicorns and rainbows? Like, I think that's. That is a cautionary tale for or yet another piece of information for man, timing the market is almost impossible. No matter how intelligent you think you are, no matter how much you think you know. That to me has always seemed like a fool's errand.
- [41:35]
B
Yeah, the absolute time to buy is at the period of maximum pessimism. And the period of maximum pessimism is precisely when you absolutely do not want to buy because there's no good news anywhere and prices have fallen so much and you feel like you almost want to throw up when you're hitting the buy button. But that is the Absolute time to buy. Conversely, the best time to sell is the exact inverse is when everybody is excited, the news is rosy, everybody's getting rich, and you see mass euphoria. This is why trying to do the opposite of what you see the market doing is so unbelievably challenging.
- [42:12]
A
Agreed. All right, so force number three, I think we're up to now.
- [42:16]
B
Yep. So let's review them. Force number one, stocks follow earnings. Force number two, earnings always recover. And we went through the reasons why. Force number three is profits rise over time. Earnings always go up eventually. Now, I literally wrote a whole book about why that happens, but I'll give you the Cliff Note versions. Essentially, the reasons that profits rise over time is that there are several sub factors that are working for all companies or all companies around the globe that cause their profits to rise. I'll just tick through a couple of them here for the sake of time. So there's productivity. Companies get better at making more and more stuff with fewer and fewer inputs. There's inflation. Companies are raising prices just by a little bit each year, but that compounds over time. There's innovation. New products and new services are launched each and every year. For example, what was your spending on AI three years ago? Mine was zero. What's my spending on AI now? I spend $200 a month on AI. A brand new market that opened. And you can do that with market after market after market. Reason number four, geographic expansion. So companies don't just sell in the US they sell around the globe. And the global middle class continues to grow. Force number five is population growth. So the population of the Earth continues to increase. So productivity, inflation, innovation, geographic expansion, and population. Any of those is almost imperceptible in any given year, maybe 1% to 2%. But you add them up and then you compound them over time. And as long as those forces are in place, profits will rise over time. And as long as profits rise over time, so too will the market.
- [44:12]
A
Okay, so. Right. These are inexorable forces moving forward. They don't stop because of a crash. As you said, they compound, but they're small. But again, we know how small things can compound. Especially when you add, like you said, there are five of them that you just ticked off just off the top of your head. So profits rise over time. That makes sense. What else should people consider with this profits rising over time? Because again, I want to not just gloss over some of these things because it sounds good, but I think somebody would say, okay, but what if we're talking about a Specific company, you're talking about the market as a whole. Is that fair to say? Yes, let's just dive into that for a second because again, like, I think some people get lost in the weeds. It's easy to get lost in the weeds. We're talking about the economy and the market as a whole as opposed to individual companies. Because somebody could say, but Brian, geographic expansion, like, what if my company that I'm invested in just isn't expanding geographically? And then your rebuttal might be, all right, well, that's all well and good, but we're talking about systemically here. Or one company, like you said, might be self cleansing. It might go down to zero. Well, they're not expanding, obviously, they're not raising prices, etc. But you're talking holistically for the market.
- [45:26]
B
Yeah, I'm talking macroeconomic level. What are the forces that causes the stock market to go up? And if you're an index investor betting on VTS X or an S&P 500 fund, those core drivers that I just ticked off are the reasons that your investment will grow over time. And the hard thing about them is, which of those have you ever heard reported in the news? You ever heard the news say productivity ticked up 1.5% over the last year? And even if they did report that, that's a very hard concept to get across. Like, oh, productivity went up, therefore you benefited by that going up. Or you ever heard them say 100,000 babies were born today? Or like 2 million people global middle class over the last month? These are slow moving, good news things that happen very slowly. It's not newsworthy. The things that are newsworthy are dramatic changes in prices and bad news. Right. But these are the fundamental good news things that combine and work together for you that if you're betting on the stock market, you are actually betting that these things will continue to happen totally
- [46:37]
A
unbeknownst to you, which is actually pretty cool, that there are these growth drivers that are just happening again. They're these inexorable forces that are just moving forward. Brian, that's. That is really interesting. I personally would have never ever considered that ever again. It's like opening your aperture to things. It's a paradigm shift. This is really important. That's something I'm really going to consider for a while. I like that a lot. So we've done our three forces. Where else do we move from here?
- [47:03]
B
Well, I think as long as you actually understand those three forces, and again, let's say them again, stocks follow earnings that's really a core one. You really have to understand that. And whatever you need to do to truly believe that on the inside, really, really focus on that, like tattoo it on your arm or something. It's that important. So stocks follow earnings. Earnings always recover and earnings always, always rise over time. If you believe those core factors, then the next time the market crashes, you should have so much more calmness and relief to you because, you know, you're not just betting on hope or I'm not just betting on I hope the market will recover. I just have faith, invisible faith that this will recover. There's actually a process that you can look to, think through and that will kind of prove to yourself that, that it's not magic that causes the markets to recover. It's a couple of core principles.
- [48:00]
A
All right, are there any closing thoughts? I mean, that to me seems like, all right, those are your marching orders again. It's, this is going to happen. There are going to be these crazy shocks. We know that it's guaranteed. It is truly preordained. And I think this is why, Brian, we talk about a lot of these things, right? Like, because we understand that a lot of investing is really between our ears and that is the hardest part. And that's why we have or try to implement investor policy statements. That's why we understand this is a 50 year game. This is not the Morningstar rating from last quarter. Nobody cares. And understanding that there are going to be significant drops, but understanding why the market does go back up, why profits rise over time, why earnings, why, why that man. And again, that's such a cool thing. Yet another thing I'm going to take away here, Brian, but why this keeps working.
- [48:55]
B
My call to action, Brad, would be to take this episode and save it and put it in your investor policy statement because you don't really need to know the information that we just said. When things are going well, when you see your net worth going up, when prices are rising, the time to really listen to or re listen to this episode is the next time the market crashes. Because so much of investing, in fact, you could almost say 90% of good investing is how you behave in the 10% of time that things are not going well. Nobody needs a pep talk about staying with the market when they just saw the value of their portfolio rise or when they get like a dividend check. You need a reminder in handholding. When your value of your portfolio is plunging, the news is screaming and everyone on social media is freaking out. That's when I find it to be most helpful to. To go back and really think through the core fundamentals and that will help to calm you down.
- [49:49]
A
Yep. I would add a friend of ours, J.L. collins. He has a Just Google a guided meditation for when the stock market is dropping. I think that'll be the perfect compliment to this episode. So you have the soothing, dulcet tones of J.L. collins and Brian informing you on why this is normal and how this recovers. Yeah. Brian, as always, I really, really appreciate you. I mean that as sincerely as possible. This is an immense help to our community and will be for many, many years to come. So thank you so much.
- [50:18]
B
Well, thank you for letting me get the message out. I know that I feel better when I think through these principles when my portfolio is seeing red, so I hope it helps other people do the same.
- [50:28]
A
Indeed. Brian, you have a bunch of different places to go on the Internet for people to follow you. I'm going to throw it over to you. Of course, X is an obvious one, but where do you want to send people?
- [50:40]
B
Well, whatever platform you like to consume content on, with the sole exception being podcasts, I'm pretty much there. So if you like YouTube, if you like Twitter, if you like Instagram, if you like threads, just type my name in and follow me on whatever platform you like to consume content on.
- [50:55]
A
Brian, as always, thank you for being here and to the community, really take this in. This is important and like Brian said, this is an episode you're going to come back to. The market's going to drop and it's going to drop significantly. Come back to this, understand why the market's going to recover, why earnings are going to recover, and why we think about investing as a long term mindset. Thank you for being here. Thanks for being part of the choose by community.