Charlie Munger's HUGE Warning of a “Lost Decade” for the Stock Market (2022-2032)

It is no secret that the stock market is at all-time highs. This current bull market has been the longest and strongest in the history of the stock market, and this has people thinking that the good times and strong stock market returns will last forever. Charlie Munger, who has never been one to be afraid to speak his mind, says that this is maybe not actually the case and warns that the next decade won't look as good as the past decade.

Make sure to stick around till the end of the video because Charlie has some important advice for investors and how to best navigate the next 10 years in the stock market. Let's listen to what he has to say.

"You expect the next 10 years to have lower returns in the equity markets than the last 10."

"It doesn't give us an idea why?"

"The answer is yes. Could you give us a hint as to why that might be?"

"Guess because so many people are in it and the frenzy is so great, and the systems of management, the reward systems are so foolish that I don't think it's going to work at all. I don't think—I think the returns will go down, yes. In real terms, the returns will be lower."

One of the first things Charlie Munger says is that everyone is trying to get into the stock market. This is because ever since the great financial crisis, the stock market has pretty much gone straight up. Check out these annual return figures of the S&P 500: 26% in 2009, 15% in 2010, 2% in 2011, 16% in 2012, 32% in 2013, 13% in 2014, 1% in 2015, 12% in 2016, 22% in 2017, negative four percent in 2018, 31% in 2019, 18% in 2020, and 26% so far in 2021.

Since 2009, there has only been one negative year in the S&P 500, and that was only a four percent decline. This over-decade-long stretch of stock returns in the stock market has created what Charlie Munger refers to as a frenzy. Everyone wants to get into the stock market because they think it is easy money. Just look at free stock trading apps like Robinhood that encourage people with little knowledge of investing to start actively trading in the stock market instead of just buying great high-quality companies and holding them for the long term.

Another well-respected investor, Peter Lynch, refers to this concept as the cocktail party effect. When Lynch was at a party with his wife, a lot of people would come up to him wanting to know what stocks to buy. He took that as a sign that the stock market was potentially overvalued. Even worse was when people would come up to him and tell him what stocks he should be buying. When that happened, he knew that the stock market was too high and due for a decline. It seems like we are seeing a lot of that today, by the number of people saying that Warren Buffett is washed up because he won't buy tech stocks trading at P/E ratios of 300.

The other thing that I want to draw your attention to—and I don't know if you caught it because it was pretty subtle—was that Munger said that real returns would be lower. The real return of the stock market is what the return is after factoring in the impact of inflation. For those of you that don't know, inflation is simply the rise in the price of goods and services.

Did your grandparents ever tell you how when they were younger they could pay for a gallon of milk with five cents, but now it is three dollars? This is inflation at work. The price of goods and services tends to increase over time, making every dollar of yours capable of purchasing less goods.

This means that if the stock market returned ten percent in a year but inflation was six percent, your real return would be four percent. Or if the stock market returned six percent in a year but inflation was also six percent, your real return would be zero. Or even worse, if the stock market return was four percent and inflation was six percent, your real return would be negative two.

By specifically referring to real returns, Munger is pointing out that inflation is likely going to be higher over the next decade. So far, this does seem to be the case, as inflation recently hit a 39-year high. This inflation is, in large part, due to the United States government printing money, or to use a fancy finance term, quantitative easing.

Here's what Charlie Munger had to say on this: "What do you think of the combinations of quantitative easing and large fiscal deficit, and where are they going to lead us?"

"Well, there I've got a very simple answer, and that is it's one of the most interesting questions anybody could ask, and we're in very uncharted waters. We have—nobody has gotten by with the kind of money printing we're doing now for a very extended period without some trouble. And I think we're very near the edge of playing with fire."

One thing I have noticed that a lot of successful investors have in common is that they love studying history, and Charlie Munger is no exception. Throughout history, there are countless examples of countries that have printed too much money and were left with disastrous consequences. One popular example is Germany in the 1920s. Germany was already suffering from high levels of inflation due to the effects of World War I and the increase in government debt. Workers in the country went on strike, and in order to pay the workers, the government simply printed more money.

This flood of money led to hyperinflation. As the more money was printed, the more prices rose. Inflation got so out of control that a loaf of bread, which cost 250 marks in January 1923, had risen to 200 billion marks at the peak of hyperinflation in November 1923. As I'm sure you can imagine, this caused a lot of unrest within the country, and many historians credit this hyperinflationary period as one of the root causes of the Second World War.

Now, Charlie Munger is by no means saying things will get that bad in America, but what he's saying is that when a government prints a lot of money, things don't tend to end well. Inflation is something we as investors need to keep in mind because it will affect the real return we receive from the stock market.

Another thing that will affect our return over the next decade is the current price of stocks. Obviously, if stock prices are too high, future prospective returns will be lower. So this brings us to the million-dollar—or in the case of Charlie Munger, billion-dollar—question: are we in a bubble? Is the Nasdaq in a bubble?

"Well, I—nobody knows when bubbles are going to blow up, but just because it's Nasdaq doesn't mean it'll have another run like this one very quickly again. This has been unbelievable. Again, there's never been anything quite like it. If you stop to think about it, think what Apple is worth compared to John D. Rockefeller's old oil empire. It's been the most dramatic thing that's almost ever happened in the entire world history of finance."

If you've been following this channel, you know I am a big believer of fundamental investing. This means that the value of a stock is based on the cash the underlying business will produce in the way of profits over the lifetime of the business. However, sometimes the stock market gets ahead of itself, and the price for stocks is higher than the true value of the underlying company based on the cash the business will produce.

To show what I'm talking about, let's look at the Nasdaq, which is an index of mostly tech companies. This index had a high of around 4,800 in March of 2000. At the peak of the dot-com boom, investors became over-optimistic about the prospects for these new tech companies. Looking back, this is one of the biggest bubbles in modern finance. It took until the year 2015 until the Nasdaq finally returned to the level seen at the peak of the dot-com bubble—a long 15 years for investors who invested at the peak of the bubble until they finally broke even on their investment.

Think about how much companies within the Nasdaq grew over that 15-year period—companies like Apple, Amazon, and other high-growth tech companies. This is because the Nasdaq's price level has gotten so far ahead of the underlying value of the companies within the index.

The current level of the stock market has some investors worried that again prices in the stock market have gone ahead of the underlying fundamentals of the businesses. Another important thing that needs to be discussed is just how big the world's largest companies have gotten. Believe it or not, the five largest companies in America account for around 25% of the entire value of the S&P 500 index. That means for every dollar an investor puts in a market cap weighted S&P 500 index fund, 25 cents of that is going into the stock of the five largest companies: Apple, Microsoft, Alphabet, Amazon, and more recently, Tesla.

This means that a lot of the returns over the next 10 and 20 years in the stock market will be based on the performance of these companies. However, Charlie's quick to point out that the success of these companies is far from guaranteed.

Here's what he had to say on this topic: "Some people try to get on the cutting edge of change, so they're destroying other people instead of being destroyed themselves, and those are the Googles and the Apples and so forth. Other people, like me, do some of that, joining things like Apple. And, in some ways, we just try and avoid big change that we think is likely to hurt us. And so Berkshire, for instance, owns the Burlington Northern Railroad. You can hardly think of a more old-fashioned business than a railroad business. But who in hell's ever going to create another trunk railroad? So it's a very good asset for us."

"And we've made that success not by conquering change, but by avoiding it. Now, Burlington Northern itself has been quite clever at adapting technology to their railroad. Imagine the good luck of being able to take an existing railroad and double-deck all the trains and raise the heights of the tunnels a little, and so forth. And all of a sudden, you've got twice the capacity at very little incremental cost, which is what that railroad has done. So that is—a everybody uses new technology, but it really helps to have a position that almost can't be taken away by technology. How else are you going to carry goods from the port of Los Angeles to Chicago except on our railroad?"

To really drive home the point Charlie made, take a look at this chart that Warren Buffett talked about at the most recent Berkshire Hathaway annual meeting. On the left, it shows the 20 largest companies by market cap in March of 1989. On the right, it shows the largest 20 companies by market cap in March of 2021.

How many of the companies from 1989 made the list again in 2021? Not a single one. In 1989, there were companies like Exxon Mobil, General Electric, IBM, Philip Morris, and Merck. These companies all had extremely dominant positions in 1989, and most people would have guessed their dominant position would remain forever. However, that wasn't the case. Now on the list in 2021, we have amazing companies like Apple, Microsoft, Amazon, and even Berkshire Hathaway, the conglomerate controlled by Warren Buffett and Charlie Munger.

The important question to consider is how many of the companies on the list in 2021 will be on the list 30 years from now in 2051. Even better yet, how many of these companies will be on the list even 10 years from now in 2031. As mentioned earlier, with these large companies making up such a large portion of the S&P 500, if they do struggle, it could hinder the return performance for investors because such a large portion of the average investor's portfolio is invested in these large companies.

Finally, Charlie has some advice for investors and how they can succeed over the next decade. "I spent a lifetime trying to avoid my own mental biases. I rub myself—I rub my own nose in my own mistakes. B, I try and keep it simple and fundamental as much as I can, and I like the engineering concept of a margin of safety. I'm a very blocking and tackling kind of a thinker. I just try and avoid being stupid. So—and I have a way of handling a lot of problems—I put them on what I call my too hard pile, and I just leave them there. I'm not trying to succeed in my too hard pile."

"What I would say is the single most important thing if you want to avoid a lot of stupid errors is knowing where you're competent and where you aren't—knowing the edge of your own competency. And that's very hard to do because the human mind naturally tries to make you think you're way smarter than you are."

So there you have it. Make sure to give this video a like because a ton of work goes into making them, and I truly appreciate all the support you guys give. Thanks for watching, and I'll speak to you again soon.