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Da Bull’s Deadly Epiphany

October 5, 2018 January 2nd, 2019

I rode my first real wave, I mean stand up surfing not just boogie boarding, when I was eight years old. From that time I was hooked. There’s just a connection with the ocean you get from riding a wave that is unlike anything else. After that point, I wasn’t much interested in the more classic sports like baseball, soccer or basketball, though I did play them. When I had the choice to go surfing it wasn’t ever really a choice at all.

One of the most exhilarating parts of surfing is that Mother Nature is entirely unpredictable and regularly humbles you. I can remember the fear I felt as a young surfer the instant I would see the horizon rise indicating a big wave coming in from way outside. Getting caught inside and having even an eight or ten-foot high wave crash right in front of you, if not directly on top of you, can be a harrowing experience, especially for a pre-pubescent boy out in the water alone. As I got older I always pushed my own limits in the surf and that feeling of adrenaline and excitement triggered by a rising horizon line has never gone away. Still, I found my limits many years ago and never came close to surfing waves nearly as big as those big wave riders do today.

Part of that finding my limits process was surfing in conditions that truly made me fear for my life. Having a healthy respect for the ocean is absolutely critical to enjoying it and, just like I see people in the markets doing today, I have seen tons of people lacking in this sort of respect suffer very painful consequences. Whether it was a compound fractured ankle from jumping of a pier into too shallow water as a wave was receding or getting decompression sickness from surfacing too soon during a diving trip or a broken neck and resulting paralysis from surfing in shallow water I have far too many memories of seeing others pay a steep price for recklessness that remain crystal clear in my mind to this day.

But perhaps the most applicable to today’s markets is the story of professional big wave surfing. Back when I was a kid I used to read every magazine and watch all of the (VHS) videos of the big wave surf spots to see who was charging the hardest and riding the biggest, most dangerous waves on the planet. Just looking at still photos of these events is enough to send a chill right through those who have ever felt the fear I mentioned earlier. While these guys were nothing but specs of color in contrast to the massive walls of water they were riding they were absolute giants in my eyes.

Waimea Bay on Oahu was really the principal battleground for these guys to push each other and, more importantly, to push their own limits. This really dates back to an era before my time when, in the late-1950’s, Greg Noll, known as Da Bull for both his physique and his surfing style, surfed what was then believed to be impossible: 30-foot waves at Waimea. About a decade later, Noll rode what many at the time assessed as the largest wave ever ridden. The wipeout he suffered afterward must have been unimaginable and essentially forced Da Bull into retirement. However, the photo of him contemplating his big wave heroics, and the dangers they entailed, is today as iconic within the surfing world as any National Geographic or Time cover is to the rest of the world.

And it kicked off a race over the coming decade to surf ever larger waves in ever more challenging conditions. In the coming years, Gerry Lopez would redefine big wave surfing just around the corner from Waimea at Pipeline and many others, inspired by Noll, would test their mettle at the big wave mecca. That is, until Eddie Aikau, big wave surfer and Waimea’s celebrated lifeguard with over 500 rescues to his credit in what was possibly the most dangerous beach in the world, was lost at sea in the spring of 1978 during an attempt to recreate the ancient Polynesian migration between the Hawaiian islands and Tahiti. Eddie’s death represented a massive shock to the surfing world. If the ocean could take Eddie, one of the greatest watermen of all time, then it could take any one of us at any time was the feeling. A degree of prudence towards risk taking in the water returned to big wave surfing… for a time.

It wasn’t very long before big wave surfers, inspired by Eddie’s story and accomplishments, created a big wave surfing contest at Waimea in Eddie’s honor. The event carried the tag line, “Eddie would go,” as if surfers needed the extra peer pressure from a famous ghost to paddle into waves that literally made the spectators on the beach shudder, not necessarily from fear but from the vibration of the wave crashing and sending a pulse through the earth.

By the early 1990’s big wave surfing was again pushing well past the limits of the prior generation. One of the standouts was Hawaii’s own Mark Foo. Mark wasn’t much for surfing the sort of waves you see surfers on when you go to the beach on any given Saturday. To me, Mark was the guy who would paddle out only when everyone else was too scared to and he made it look easy. He rode waves on par with the famous Greg Noll photo with regularity and an apparent impunity. He truly appeared to have no fear at all.

It was also around this time that a new big wave surf spot emerged out of the Monterey mist. Today it is a household name in the surfing world, uttered with a certain reverence, but before 1990, when Surfer magazine did their first story on the spot, nobody had ever heard of Mavericks. All of a sudden, the big wave surfing community was presented with a brand new challenge. And Mark Foo, master of Waimea, was all-too-eager to take it up.

In 1994, Foo made the trek to the mainland to take on the new monster wave. Surfer magazine was there to cover what was to the sport what Muhammed Ali versus George Foreman was to boxing. Rather than the Rumble in the Jungle it was the Fray in the Bay. The greatest big wave surfer in the world versus a massive mountain of wave that, up until that point, had only really been surfed by a very small group of locals who had taken years to learn the nuances of the wave and unique risks it presented.

Tragically, in this case the loser of the bout paid with his life. Foo suffered what appeared to all in attendance to be a routine wipeout on an average-sized wave. Surfers in the water at the time believe his leash was caught on the rocky bottom and he was held down underwater for not just the wave he fell on, which would have been a harrowing experience on its own, but the following wave, as well, which would have lasted several minutes. These theories were seemingly validated by Mike Parsons, another professional surfer who wiped out on the following wave, who told Surfer he believed he bumped into Foo’s body underwater.

Just a year later, Donnie Solomon, another professional big wave surfer, died at Mark Foo’s home break of Waimea Bay before he was even able to paddle into the lineup. And then in 1997, Todd Chesser, professional surfer and popular personality among the surfing community, was caught inside when a massive set came in at a remote surfing break in Hawaii and lost his life. These three deaths among accomplished big wave surfers over a span of just a few years set off a period of deep introspection in the surfing community and a renewed sense of respect for the ocean and its raw and unpredictable power.

Today, though, we have clearly reached the other end of the spectrum once again. Aided by new, more maneuverable boards and towed in by jet skis, big wave surfing has crossed the prior threshold of what was believed impossible. It’s not just the size of the waves being ridden today but the criticality of them. There is less margin for error than ever before and there are more surfers than ever before taking up the challenge. If history is any guide here (and I truly hope it’s not in this case) then the big wave surfing world is very likely headed for another tragedy if not a series of them.

The parallels to the financial markets today should be obvious. Risk taking in the markets goes through cycles very much akin to the risk taking in the ocean over the past half century. Investors start out with their normal, healthy skepticism toward taking risk and as they generate profits without any manifestation of risk they begin to take greater and greater liberties. At some point, selling naked put options, shorting volatility or merely just leveraging up the highest momentum trades with the maximum margin debt allowed becomes the norm. That is until the unpredictable, raw power of the market reasserts itself again and investors, humbled by the consequences of their own greed and sense of impunity, relearn the value of a healthy skepticism toward risk taking.

Watching the markets today I am filled with the very same feeling I felt as a surfer sitting in the lineup and staring at the horizon looking for a wave and seeing the skyline jump up in way that tells me very clearly that a very big wave is rapidly moving my way. In the very same way that Da Bull was humbled nearly 50 years ago and to a degree that forced him to give up big wave surfing forever, a humbling experience is heading for our markets and all the investors, retail and professional alike, that have scoffed at the idea of risk and the real dangers of pushing boundaries in an environment in which it could hardly be more foolish to do so.

Clearly, I’m not the only one that feels this way. Over just the past month a who’s who of super investors has come out to publicly send up a warning signal, each in his own way. Most notable of these, or at least the most noticed, was the interview Stan Druckenmiller gave to my friend, Kiril Sokoloff, for RealVision. You don’t need to see the interview to know Stan’s thoughts. These are issues he has been discussing for several years now. In fact, the speech he gave back in January of 2015 at the Lost Tree Club could easily have been delivered today. The only change you would have to make is that the numbers have only gotten larger and the debt covenants looser since then:

There are early signs… In 2006 and 2007, which I think most of us would agree was not a down period in terms of speculation, corporations issued $700 billion in debt over that two-year period. In 2013 and 2014 they’ve already issued $1.1 trillion in debt. 50% more than they did in the ’06, ’07 period over the same time period. But more disturbing to me if you look at the debt that is being issued in the last two years back in 0’6, ’07 28% of that debt was B rated. Today 71% of the debt that’s been issued in the last 2 years is B rated. So, not only have we issued a lot more debt, we’re doing so at much less standards.

Robert Shiller, Nobel Prize winner and author Irrational Exuberance, also came out last week with a warning of his own, comparing the current market environment to that of 1929 just prior to the worst crash in the history of our financial markets. Two of the parallels I have noted over the past year are first, the amount of margin debt being employed at present is comparable only to that ominous period, and second, the number of ETFs that have been issued in recent years is very similar to the proliferation of investment trusts in the late 1920’s.

William White, former chief economist at the BIS, issued a strongly-worded admonition of his own last week, in a piece titled Bad Financial Moon Rising, that echoed the concerns shared by Druckenmiller:

The most worrisome side effect of recent monetary policies has been a continuous increase in the ratio of non-financial debt to global GDP. Though the 2008 crisis offered an opportunity for deleveraging, the opposite has happened. Debt has piled up worldwide, with the biggest increases found in emerging-market private sectors… In addition to ballooning global debt levels, sky-high property prices seem to be heading for a turn, and “risk-free” long-term rates remain unusually low in many countries. Very low credit risk and term spreads, along with record-low measures of volatility, have invited still more risky behavior. Should these spreads normalize, the risks would come home to roost.

It’s probably important to remember that this warning is not being issued by a market operator like Druck or a talented observer like Shiller but by a former central bank insider. Very few people have such an intimate understanding of just how extreme global monetary policy has become and, more importantly, its potential to have devastating consequences on the economies actively pursuing it.

In addition, Howard Marks, perhaps the most successful distressed debt investor of all time, saw fit to publish a new memo recently title The Seven Worst Words in the World, referring to, “too much money chasing too few deals,” which aptly characterize the current environment. Like Druck, he harkens back to the period of time a decade ago when the signs of an impending financial crisis were apparent to anyone open to seeing them. He concludes that now is once again, “a time for caution.”

David Swenson, the world’s most successful endowment manager, seems to agree. Barron’s revealed this week that Yale is currently targeting a “meager” 3% exposure to U.S. equities at present. I have no doubt he understands well Warren Buffett’s famous saying: “the price you pay determines your rate of return.” Paying the highest prices in the history of our stock market means investors will very likely receive the worst long-term returns in history. It also likely means that risk to the downside is also as great as it has ever been. All risk and no return clearly makes David a dull boy.

Financial historian and GMO strategist, Edward Chancellor, makes no bones about calling the current market, “the mother of all speculative bubbles.” Coming from one of the most respected market historians in the world, this is really saying something. Not just the DotCom mania or the housing bubble or even the late-1920’s mania but the Japanese bubble of the late 1980’s, the Dutch tulip bubble in the 1630’s and the South Sea bubble can all look up to the current speculative mania in Chancellor’s view:

In the last decade the world has witnessed bubbles galore: in industrial commodities and rare earths; in U.S. farmland and Chinese garlic bulbs; in fine or not-so-fine art, depending on your taste; in vintage cars and fancy handbags; in “super-city” properties from London to Hong Kong, and across China’s tier-one cities; in long-dated government bonds; in listed and unlisted technology stocks; and in the broader American stock market.

The breadth of the current bubble in asset prices is entirely unprecedented. It is truly an “everything bubble” and, for this reason, presents an unprecedented risk to the global economy once it inevitably bursts.

The question investors always ask in response is, ‘when will it burst?’ Of course, just like the ocean, markets are unpredictable. Still, we can watch the horizon for signs of that huge set wave coming in and my friend, Dr. John Hussman, is doing just that and with some of the most effective and comprehensive tools I have seen. John, in my view, is a master of the market cycle and, more importantly, a master of holistic thinking about markets. His indicators appear to have identified the conditions that would allow for a wipeout like we haven’t seen since the financial crisis.

One thesis I have discussed in market comments here and in interviews I have given recently is based on the idea that the next crash will not be followed by a quick rebound as the past two were. The Japanese Nikkei provides an interesting analog for what the bursting of twin equity and real estate bubbles look like. In our case, it could be the bursting of a trio of bubbles. Add bonds to equities and real estate and it’s not hard to imagine the sort of “L” my friend, Eric Cinnamond discussed last week.

One other factor that could make such a scenario more like can be found in the warning issued by the most successful hedge fund manager on the planet (by assets as opposed to returns – Druck takes that cake). There is a very real possibility that the dollar loses its status as the world’s reserve currency. In fact, it already appears that many nations are already laying the groundwork for a new world order based on anything but the dollar-based financial system. Our current fiscal policy, seemingly supported by both sides of the aisle, is a recipe for investors to shun dollars in a way that could be very painful for all sorts of U.S. financial assets.

On their own, each of these warnings can be dismissed by market participants but taken together it becomes impossible to dismiss the collective wisdom of all of these financial giants harnessed into one harmonious warning. Here we have in a mere month’s time a cacophony of alarm bells being rung by the savviest share market participants in the world. Sadly, for investors to hear it they will first need to be reintroduced to the unparalleled power of a market in the midst of a bursting bubble to cause financial devastation. Only then will a healthy respect for risk be restored.

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