Investing and Markets

While finding appropriate historical analogies is always tricky, the current economic environment, in our view, seems most reminiscent of the mid-1960s. Those years represented an inflection point, much like today, when fiscal spending accelerated, and the Federal Reserve financed that spending with low-interest rates assuming that historically low levels of inflation experienced in the early 1960s would continue.

“Deadly Charybdis—can’t I possibly cut and run from her And still fight Scylla off when Scylla strikes my men?”  ─ the Odyssey, as spoken by Odysseus In Homer’s legendary epic, the Odyssey, Odysseus is forced to navigate his ship through a treacherous passage with...

“It’s the economy, stupid!” ─ James Carville The reputations for presidents in the annals of history often rise and fall with the fluctuations in the economy.  As President George H.W. Bush would tell you from personal experience, the health of the economy plays a...

“Gold gives to the ugliest thing a certain charming air, for that without it were else a miserable affair.” ─ Molière The first six months of 2020 have been historic. Thus far, the year has offered up a global health pandemic, a synchronized global recession, rising...

“There are decades where nothing happens, and there are weeks when decades happen.” ─ Vladimir Ilyich Lenin Out of seemingly nowhere, the world is engaged in the most significant crisis since World War II. First and foremost, this is both a health crisis and a...

The 2010s represented the longest-ever period of sustained, uninterrupted economic growth and associated market gains. With shrinking unemployment, growing average household wealth, and increasing income disparity – driven by the most activist Federal Reserve in history – the stock market climbed to historic highs and the housing market was resuscitated, as bond yields declined to all-time lows.  The economy has experienced 110 months of sequential job gains thus far, and unemployment has reached a 50-year low.

Slowly but surely, the world has been moving from compromise and coordination to name-calling and tribalism. We read news of impeachment inquiries, trade wars, mass demonstrations, accusations of treason, worsening geopolitical tensions, conspiracy theories, fake news, and Twitter curses, sometimes all in the same day. The current period will likely be studied closely by historians trying to make sense of the many seemingly irreconcilable conflicts that have surfaced.

As the S&P 500 Index reaches all-time highs with an extraordinarily high valuation by most measures, how can the 10-year Treasury bond yield simultaneously be declining towards all-time lows?

In our most recent investor commentary, we discussed the drivers for the stock market downturn during Q4 2018. We suggested that monetary tightening from central banks across the world was the primary culprit in deflating equity prices. Specifically, we postulated that markets would remain weak without a reversal in quantitative tightening. And, in January 2019, the Federal Reserve did a stunning about-face and reversed its interest rate tightening stance. This policy reversal helped to drive the U.S. equity markets to the best start to the year since 1998.

The S&P 500 Index generated a total return of -9.0% in December, which was the worst December return since 1931 in the midst of the Great Depression. The quarterly return of the S&P 500 Index was -13.5%, representing the worst fourth quarter return since 2008, which was in the midst of the Financial Crisis.  Outside of cash, there was no place to hide for investors in 2018, which was just the opposite of 2017 when nearly every asset class generated a nicely profitable return.  Judging by the December decline in market prices, it appears that the wheels may be coming off the bus.

Famed investor Warren Buffett generated fantastic returns over the course of his life by following a specific strategy of making investments in deeply undervalued companies when nobody else was interested in them. 

It’s different this time, and it’s also not different this time. It’s different this time because the credit-driven U.S. economy is burdened with a monumental level of financial obligations relative to GDP.  According to the Bank of International Settlements (BIS), outstanding loans and debts that burden U.S. corporations, households, and government entities have reached $48.3 trillion or 250% of U.S. GDP.  Including off-balance sheet items, the effective level of debt outstanding is almost $100 trillion or more than 500% of GDP.  It’s different this time because the U.S. economy has never in its history piled on so many financial obligations.

History often repeats itself; when the economy is persistently weak, populism and trade protectionism tend to rise.  In light of President Trump’s recent tariff threats, financial news articles are citing the Smoot-Hawley Tariff Act of 1930 with increasing frequency.  Signed into law by President Hoover, Smoot-Hawley raised tariffs on 890 products, increasing the average industrial tariff from 37% to 48%.  While U.S. industrial workers cheer on new tariff proposals, free traders sternly warn that Trump is on the verge of making a Smoot-Hawley like mistake by starting a global trade war that could throw the world into a global depression.

Prince captured the zeitgeist of the late 1990s in his classic pop hit, ”1999,” although he wrote the song during the early 1980s. As the year 2000 approached, fears of a looming apocalyptic event increased, even while investors on Wall Street seemingly lost their minds with bullishness and greedy optimism. During that period, the S&P 500 Index, the Dow Jones Industrial Average, and the Nasdaq Composite Index all hit new all-time highs, buttressed by the euphoria of the unlimited possibilities of the Internet, the easy money policies of the Federal Reserve, and the illusion that the most expensive stock market ever accurately reflected the strongest economic fundamentals ever.

After refusing to give up his properly assigned airplane seat to an off-duty United Continental employee, Dr. David Dao was assaulted by O’Hare Airport security personnel this spring.  Dr. Dao was subsequently pulled from his seat, thrown violently against an arm rest, and then dragged off the plane, much to the horror of the other passengers. Many who watched the online video clip of this assault might have wondered, “How could this be allowed to happen?”

The stock market has been ripping upwards ever since the U.S. election on November 9th, with investors pouring more than $100 billion into U.S. equity ETFs during the last two months of 2016. As stocks continued to rise into the close of 2016, several bullish Trump-centric investing narratives have been put forth to explain the increase in animal spirits behind this rally. These narratives, we believe, are overly optimistic and incorrectly dismissive of several important fundamental factors that are likely to stand in the way of strong U.S. stock market returns during the intermediate period ahead.

Value investing can be a challenging endeavor, even in the best of times. It involves investing long-term capital in companies that are unknown, unloved, or unpopular. In our view, the only reason value investing receives any attention is that it has historically outperformed the broader equity markets over the long-term when applied in a disciplined and consistent manner. That being said, when value investing underperforms over multi-year periods, as is the case today, skeptics wonder what the heck value investors were thinking by investing in such undeserving companies.

Over the past year, strength in the value of the dollar has largely dominated asset class returns and has been at the front and center in driving investor sentiment. Ever since the end of the Second World War, the U.S. dollar has acted as a fundamental linchpin of the global monetary system. As the premier reserve currency, the dominant medium of exchange, and a store of value, the greenback deservedly warrants the moniker, “King Dollar”. Despite an ongoing tilt eastward and a concurrently diminished role of the United States in terms of global trade and GDP, roughly 60% of the global population still lives in a world in which their local currencies either 1) are the dollar, or 2) are pegged to the dollar. Indeed, the dollar’s pivotal role as the “straw that stirs the drink” has powerful economic repercussions, particularly so during dollar volatility spikes like the one occurring now.

Etsy is an online marketplace for handmade and vintage objects, and we have at least one jewelry-maker client who has had a fair amount of success marketing her handmade wares through the Etsy platform. Etsy’s business has grown at a rapid pace in recent years, and, as we are writing this letter, the company has offered its shares to the public market through an IPO. Etsy opened trading at $31 per share, suggesting a valuation of $3.4 billion.

It perhaps goes without saying, the key to success as an investment professional is to pursue investing principles that properly inform decision making.Many years ago, famed investor Benjamin Graham laid out his timeless investment wisdom in The Intelligent Investor, which has become a bible of sorts for value investors (including ourselves).  Graham’s advice about acquiring suitable securities at suitable prices is easy to understand but difficult to execute consistently, and, we would add, particularly so in the present zero-interest rate environment.