This work was inspired by UCLA Professor Michael Brennan’s efficient autopsy of the bubble.  Published in 2004, the piece broke down the mania that led to the historic bubble in 2000.  A misplaced belief in Efficient Markets, agency problems on Wall Street, and weak accounting rules figured large in his work.

This paper will do the following:

  • Update the simple yet powerful evidence he provided that equities had been in a bubble
  • Provide compelling evidence that the problems that drove the mania in 1999 are present again today
  • Offer a list of stocks where today’s accounting rules are most severely misrepresenting economic reality

Asset Allocation Gone Wrong: The Cult of Equity

The most basic evidence can often also be the most compelling.  In his first sentence, Dr. Brennan explains that price appreciation outstripped earnings growth by a huge margin between 1980 and the peak of the bubble.[1]  Figure 1 below shows this effect in raw form.

The navy blue line is the total return of the S&P 500 between 1980 and August of 2000.  The light blue line is the growth in those stocks’ earnings.  Stocks rose 2,526% while earnings only grew 327%.

Rarely have we seen a more compelling image of a bubble.  With hindsight, the evolution of price and earnings made it painfully clear.  Capital markets and fundamental valuations had totally detached.

The United States Financial System Decouples from Reality


Think that’s crazy?  Look at the next chart…

Democratizing Investing Gone Wrong

The chart below merely updates the one above. Just another way of visualizing extreme overvaluation.   Warren Buffett’s valuation metric and its long term predictive accuracy all indicate many investors may not understand the risks they are taking

KCR’s research team finds itself writing the phrase “this isn’t complicated” a lot lately.  Look at our chart about zombie firms[2] that can’t pay their interest expense.  The value of stocks priced for disaster.  Or our research on the soaring exposure of index investors to loss-making firms.

These charts conspire to tell one simple story: don’t buy stocks that fail the basics of common sense.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.


[1] Brennan, Michael John, How Did it Happen? page 1

[2] We chose to link to Lance Robert’s terrific piece “Could the Fed Trigger the Next Financial Crisis?” as he uses our chart on the market cap of stocks that can’t make their interest payments from earnings despite record low rates and, in that piece, speaks more comprehensively to the issue of Zombie Firms.  For those that don’t follow Lance’s work on Real Investment Advice we cannot recommend it more highly.   Neither KCR or its affiliates has any commercial relationship with Lance or Real Investment Advice.

[3] Warren Buffett, Letter to Shareholders, 2020, Page 12

[4] We understand this may seem hyperbolic.  But when you have to choose between making a lot of money or being sacked at what is often the low-point of your track-record and career, this stuff creates existential stress in our view.

[5] Brennan, Michael John, How Did it Happen? page 9 and page 2, respectively

[6] To see KCR’s Custom Index of “Enron Look-Alike Stocks” today click on our post offering a free hat to our subscribers – originally written in jest we have been stunned as some of the most accomplished and experienced Fund Managers in the industry have taken us up on the offer.  We would like to thank them for sharing our appreciation for the need to keep financial history’s darkest moments close!

[7] Brennan, Michael John, How Did it Happen? page 9


The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

February 16, 2022 |

Categories: White Papers

February 16, 2022

Categories: White Papers

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