Nassim Taleb is one of the greatest investors, traders and thinkers of our time. As the founder and former hedge fund manager at Empirica Capital, Taleb was reported to have made an incredible 60% return forecasting the market bubble of the year 2000, as well as making single digit gains in 2003 and 2004. Today, Taleb is the scientific advisor of Universa Investments LP, an investment management firm that specializes in risk mitigation. This fund has averaged a 10.4% annual return but with wildly different payoffs each year. For example, one time Universa racked up an astronomical 3,700% return on invested capital in a single month, according to Bloomberg terminal data.
Taleb is the author of several famous books such as “Antifragile: Things That Gain from Disorder” and "The Black Swan." He is known for forecasting black swan events, which are rare occurrences at the tail end of a normal distribution curve. A prime example is the financial crisis of 2008. Antifragile is a complex concept that refers to a phenomenon in which something can get stronger through impact, as opposed to something that is fragile, which means it breaks upon impact. Examples Taleb gives in his book are airlines, restaurants and Silicon Valley.
In this article, I will provide an overview of a recent interview from Taleb, in which he shared his thoughts on the stock market and the economy, as well as my own commentary. The original Jan. 31 interview was conducted by Bloomberg's Sonali Basak at an investor day in Miami.
Finance 101 and 'tumors'
Nassim starts the discussion with a level set on “Finance 101," in which he states “happiness equals positive cash flow." But in 2008, Taleb recognized that this notion disappeared. He cites this was due to the Federal Reserve lowering interest rates to zero to stimulate the economy. This worked, but it was supposed to be a temporary measure and thus this created other problems when it persisted. Taleb likes to call these situations “tumors,” i.e. something harmful that grows uncontrollably. He believes this created “illusionary wealth” of over $100 trillion.
Great examples of “tumors," which I think can also be called “bubbles” or “asset-based inflation,” included “crypto and real estate (pre 2008)." I'll add that I also think the growth of SPAC (Special Purpose Acquisition Company) stocks 2020 was a tumor. Another more surreal example is the “billionaires” cited on many lists of top billionaires. Taleb points out that many of these billionaires become “rich” from valuation, not from actual cash flow. He believes this is just “cosmetic wealth” and that it also helps to spur inequality.
A great example I can see of this is Elon Musk, the CEO of Tesla (TSLA, Financial) who rose to become the “richest man in the world” in 2020 on the back of the sky-high valuation of Tesla stock, which at one point surpassed over a $1 trillion market cap. At the time, even Musk Tweeted that “the stock was too high,” and since then it has been sliced down to a valuation of ~$500 billion, showing just how dependent on Tesla stock Musk's wealth is. Taleb said that Musk's acquisition of Twitter for $49 billion may have made him learn about cash flow.
Is the stock market still overvalued?
The stock market reached a major bubble in 2020, which many believe “popped” as the rising interest rate environment caused a compression in multiples of many growth stocks. The Nasdaq ETF (QQQ, Financial) is down 24% from its all time highs and the S&P 500 previously plummeted by 21% from its highs before rebounding somewhat. Despite this sell off, Taleb believes the stock market is “still overvalued” for interest rates at 3% or 4% which is the 10-year Treasury bond rate. He suspects the stock market is valued as if interest rates were closer to 1%.
A positive is inflation is on a downtrend, with 6.5% reported in December, down from the 9.1% high in June 2022. This shows Fed rate hikes are working in slowing down inflation, thus a drop in interest rates would be expected after in the future.
Is Bitcoin a good investment?
Taleb was initially a fan of Bitcoin as it was “not the Fed” so potentially a useful alternative currency. However, once he studied it deeply he wrote a paper called the “Bitcoin Black Paper.”
In that paper, he explained that Bitcoin was “not a hedge against inflation," as previously assumed, due to its limited supply. This was because when high inflation occurs, this causes the Fed to raise rates, which in turn harms asset valuations.
He also believes that the fact that Bitcoin is seen as a positive because its “decentralized” could also be negative. This is because “one flaw” in the system could cause a ripple effect which Taleb terrifyingly predicts could cause Bitcoin “go to zero." However, this would be categorized as Black Swan event, which would be very rare.
Long-term investment strategy
Taleb doesn’t like to use a single year as a time period for measuring investment performance. In my mind, this makes complete sense as I’ve often thought that a company, stock or other investment doesn’t know when a year ends. Taleb prefers to measure returns based on a five-year, 10-year or 15-year plan.
The goal is to protect investors from “tail risk” while ensuring an asymmetric payoff. Taleb aims to “insure clients” against adverse events. To do this he uses advanced algorithms and options trading to make big payoffs during Black Swan events.
The changing world
Taleb believes that thanks to globalization, prices adjust much faster than they used to. A prime example is oil, which went negative in 2020, before skyrocketing to over $100 per barrel. Taleb also compares the Russia-Ukraine oil/gas crisis to the Oil Embargo of the 1970’s but with major differences. In recent times, Russia aimed to choke Germany through the restriction of gas supply, but it only took nine months for gas supply to recover. Whereas during the 1970's, this took many years.
Taleb forecasts that “prices will still crash." He is also skeptical of how inflation is measured as it depends upon what you buy. In a simplified manner, Taleb forecasts both housing and lumber will be cheaper in the years to come.
The dangers of debt
The U.S. government has recently approached its $31.4 trillion debt ceiling, and many companies are also high levered. This is a risk for organizations as it means the cost of debt servicing will go up.
Taleb explains that in the “old days,” if a company couldn’t pay its debt it went bankrupt, which is normal. However, this hasn’t happened so far for many companies and thus could be a painful possibility for many businesses.
I believe a quote from Warren Buffett (Trades, Portfolio) sums up this scenario perfectly: “When the tide goes out, you see who has been swimming naked." In other words, those that have become zombie companies reliant on debt will collapse once the tide (of easy debt) goes out.
A positive for the U.S. is it is still considered the safest place to invest with the highest credit rating. Taleb believes things will be much worse in other countries such as Egypt, Europe and even Japan.
Final thoughts
Nassim Taleb is one of my favorite figures in the financial world. His unique thought process and strategy is truly contrarian by nature. Taleb isn’t afraid to bet against the consensus and has strong opinions which call out the problems with modern-day finance. From his style we can learn to think independently when investing, keep a long time horizon and hedge our portfolios against Black Swan events.
