Grey Swans
The Middle East is getting more dangerous. Canadian and New Zealand property have already shown Australia its future. And the maths of losing money, the geometric return, the asymmetry of drawdowns, explain why the first rule of investing is to not lose it.
The Middle East is growing more dangerous, not less. Israel destroyed Hezbollah's primary bunker in Lebanon, twenty years of Iranian investment gone in a single strike. Oil tankers are being hit. The Strait of Hormuz remains contested. The longer this runs, the worse it gets for Iran's economy and the higher oil prices go.
The question for Australian property is not whether it falls, but how far. Canada and New Zealand both peaked in 2022 and have been falling in real terms since. Australia may think it is different, but we doubt it.
The CAPE turns a Black Swan into a Grey Swan. You do not have to be all in or all out on any single event. Markets take time to move, and the CAPE tells you where you sit in the cycle before the move happens.
A 50% loss wipes out 100% of previous gains and then requires a doubling to recover. That asymmetry is why "don't lose money" is not a platitude. It is the single most important rule in portfolio management.
Focus on the geometric return, not the average. The average flatters. The geometric is what you actually compound. And the gap between the two gets wider precisely when valuations are extreme.
Iran continues to struggle economically while attacking its neighbours, including Saudi Arabia. The Middle East region is growing more dangerous and more unstable with each passing week.
Israel landed a major blow this week, destroying the primary bunker of Hezbollah in Lebanon, a facility that took twenty years to build and was funded by Iran. Twenty years of investment, gone. That changes the calculus for everyone in the region.
The battle for the Strait of Hormuz continues with attacks from both sides and oil prices climbing. The longer the war runs, the more Iran struggles as countries make alternative arrangements, building pipelines to bypass combat zones and rerouting supply chains. The US is also targeting Iranian oil tankers directly, which cuts revenue for Iran and raises uncertainty for its main customer, China.
Which brings us to the question for Australia. The question is not whether property prices will fall, but how far. If we look at Canada and New Zealand, both of which share similar dynamics around immigration, low rates and a property-obsessed culture, the answer is that we may have a long way to go. Maybe Australia is different. We doubt it.
We keep coming back to the long-run S&P composite chart overlaid with the Shiller P/E10, and there is a reason for that. It explains visually and simply how markets cycle over time: long stretches above the regression trend followed by long stretches below it, with the CAPE sitting there the whole time telling you which phase you are in.
The P/E10 currently sits at around 39.5, in the top quintile of all readings since 1870 and 76% above its own regression line. The only time the CAPE was higher was 1999 to 2000 at 44.2. The real, inflation-adjusted S&P composite is approximately 207% above its long-run exponential trend.
Thinking about your portfolio over time is critical. Do not get lost in trying to buy and sell stocks at the exact bottom or top. That is not the way to success. We have spoken about Black Swans lately, but the real benefit of understanding market cycles is that it turns the Black Swan into a Grey Swan. You cannot predict the exact event, but you know the environment is fragile. And knowing that means you do not have to be all in or all out on any single event. Markets take time to go higher and lower, and using the CAPE as your guide gives you the advantage of positioning before the event rather than reacting after it.
The Crestmont Research chart we walked through this week makes the point about not losing money better than anything we could say in words. It compares a buy-and-hold investor in the S&P 500 from January 2000 to December 2025 against a hypothetical portfolio that captures only 50% of the upside and 50% of the downside.
The buy-and-hold portfolio technically gained more in percentage terms: 368% versus 312%. But look at the journey. The buy-and-hold investor suffered a 47% drawdown in the dot com crash, a 57% drawdown in the GFC, a 34% drawdown in the 2020 COVID sell-off, and multiple 10 to 25% corrections along the way. The 50% capture portfolio saw roughly half of each of those losses, and its ending portfolio value of $4,764 against $4,132 for the buy-and-hold investor actually came out ahead in dollar terms because the base was protected.
This highlights our core point about focusing on not losing money, and it leads to two further ideas.
First: keep your focus on the long term and your personal timeframe. Do not be distracted by recent results. As the diagram shows, losses can destroy much of the previous return, and the recovery period is always longer than the decline.
Second: focus on the geometric return, not the average return. The reason this matters is simple but brutal. A 50% loss halves 100% of your previous gains, and then requires a doubling just to get them back. The average return ignores this asymmetry. The geometric return captures it. This is why we are always on about not losing money, especially when the market is overvalued, because that is when the CAPE shows us the biggest losses occur.
The first rule is don't lose money. The second rule is don't forget the first rule. Everything we do at TMM, from the CAPE work to the Wells framework, is built around that single idea.
A more dangerous Middle East pushing oil higher. Property markets in comparable countries already well into their decline. A CAPE at 39.5 telling you the odds are not in your favour. And the maths of loss proving that what you keep matters more than what you make. The theme across all of it is the same: the investors who do well from here will be the ones who understood the cycle before the event, not the ones scrambling to react after it.
As always, this is general information about how we read markets and risk, not personal advice tailored to your circumstances.
Steve: The CAPE is the best early warning system we have. It does not tell you when. It tells you the odds. And right now the odds are not good for buying expensive markets.
Tom: The geometric return is the number that matters. Every time you hear someone quote the average, ask yourself what the drawdowns did to the actual path. That is where the truth lives.
Jacob: Canada and New Zealand are not some distant example. They are us, two years ahead. If you own Australian property and think it is different this time, you should at least be able to explain why.
This newsletter is for informational purposes only and does not constitute financial advice.
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