For a very long time, seemingly beyond memory, the economic backdrop has been low-moderate GDP growth, low inflation, and historic-low interest rates. This 2% GDP Growth, 2% inflation condition, along with the unceasing flow of assets into indexes, has been extraordinarily supportive of a very select few sectors of the stock and bond markets. The … ContinuedRead More >
The most damaging stock market event of this generation may have been the unprecedented 3-year collapse of the Internet Bubble. Technology stocks dominated the market with the highest valuations ever before witnessed – though, in the moment, these seemed entirely reasonable to most investors. A measure of the damage: the S&P 500 returned 14.7% a year in the last 10 years; but over the last 20, since December 1999, only 5.9% – that’s been the 2-decade return for someone invested at that time.
But what if the Internet Bubble never really ended? The number of people on the internet today is 18x greater than it was then. On the back of that extraordinary rise, the technology sector is again the highest weight in the S&P 500. But that doesn’t include mis-labelled companies whose premium (some would say unsupportable) growth rates and valuations depend on continued expansion of internet usage: Amazon.com is classified as a Consumer Discretionary company; Facebook and Google are in Communications; the country’s largest cell-tower and cloud server data centers are listed in Real Estate. Add it all up, and one-third of the value of the S&P 500 is now in internet beneficiary companies.
Seems normal enough, again, yes? Except for one thing. Internet usage growth is about to face limits that cannot be avoided. The early edges of those limits are already appearing. As that unfolds, the normalization of profit margins and valuation multiples of these market leaders, from Apple to Microsoft, even to a level well above that of the average company, will, for those who did not get to witness the first Internet Bubble collapse, provide a front row seat.
Indexation’s great argument is diversification of security-specific risk and the performance benefit of low (or even no) fees.
The performance debate has now been answered; you need wait no longer. With ETFs’ 20th anniversary upon us, which also encompasses a full market cycle, equity ETFs as a class — growth and value, domestic and international, developed market and emerging, biotech index funds to IT to financials — have under-performed bonds. Over these two decades, they haven’t even come close to the universally presumed 10% return. From here forward, they might not do even as well as that.
The risk debate continues. But it has now moved to a higher-stakes plane. Acceded: indexation is an excellent means to diversify into and across the important asset classes much or most of the time. Counter: by definition, indexation also exposes one’s capital into and across all the systemic risks that have destroyed investors’ savings during economic and political crisis and upheavals. Those feel like rare events only to those who don’t review the history — even modern history. It happens again and again, and today’s valuations and systemic risks are measured in extremes. There is a time and place for indexation. Now is a time to learn about upheaval investing: concentration as a method to diversify against systemic risk.Read More >
Falling stock prices, swings in stock prices, a December like this December. They hit all of our buttons. The big red buttons hard wired to the emergency exit centers in that part of our brain closest to the nape of the neck. It’s what we do when he have patterns (data and statistics to our forebrains, shapes moving in the dark to our hindbrains) instead of information (qualitative context, or a light in the hand). That’s when we react and make decisions as opposed to exercise judgment. We’ve seen it before, and we’ll see it again.
To help illumine the landscape before us, we’ll compare the events and reactions leading up to the Internet Bubble of 1999 and its aftermath (and how and why we positioned our portfolios to be so far away from that party) to the events and reactions leading up to today’s bubble (and how and why our portfolios are again so far away from the index benchmarks). The parallels are quite clear and, once seen, the path (or paths, for there are many alternatives) are much clearer.
As a prelude to this review, we revisit a theme that has long informed our research: cognitive limitations in investment analysis. Reasonable minds may differ on what is or is not a good investment, but exceedingly few of those minds study or are even aware of the many ways our brains deal — automatically and without our conscious permission — with an excess of data (which certainly defines the securities markets). The shortcuts we unknowingly take amidst this onslaught of information can lead to the most unfortunate conclusions. Herein, some of our strategies for wading through the facts to address some client questions we received about inflation, U.S. debt levels, and the potential for continued corporate earnings growth. And a couple of new positions, CACI International and Science Applications International, that we believe add functional diversification to our portfolios.Read More >
A number of clients have been asking about inflation: are the recent numbers, 2%, benign? Encouraging? Cause for concern? Some of the answer depends on whether the reported inflation data are even real. The changes, over time, in the way that the sausage that is the Consumer Price Index is made seem, repeatedly, to have the effect of lowering it. Either way, it’s well neigh impossible to avoid earning a negative rate of return from the various bond ETFs, after taxes and inflation. We provide a brief survey.
Then there is the failure with, now, a 20-year record, of the equity ETFs to provide the expected 10% rate of return. To avoid a continuous loss of purchasing power, which adds up pretty quickly, investing has to take place differently and elsewhere.Read More >
The value of the entire stock market relative to GDP – perhaps the most fundamental valuation measure – is pretty much at an all-time high; interest rates aren’t much above their recent all-time lows; the Federal debt/GDP ratio, despite one of the lengthiest economic recoveries on record, is at a high exceeded only in the immediate aftermath of World War II. Yet, despite this traffic jam of systemic risks, and for whatever reason, investors feel sufficiently at ease that they don’t require a real interest rate above zero, or lower stock valuations, as if there financial markets rest in a comfortable equilibrium.
But one of the systemic risks to the stock market, the continued rapid expansion of large scale passive investing, rests on such a faulty – and unexamined – foundation that it might raise eyebrows upon a little reflection. A basic presumption of indexation – its use of the free-rider principle, of the price discovery function that active management provides – is that indexation’s share of float, of the shares not held by insiders, remains a minority of the available shares in the market. Not so. The definition is methodologically wrong, and in a way that can (and, we’ll suggest, has already done so) seriously distort major-company share prices.
The indexation community is likewise operating under a serious methodological error in their security weighting approach. And also in a way that can (and we’ll suggest has) seriously distort major-company share prices.
Also, a review of some additional inflation-beneficiary, non-correlated holdings in our portfolios.
For the first time in quite a long while, clients have been asking about whether their portfolios contain any inflation beneficiaries, whether there’s much leverage. Really, these questions are about practical, functional diversification (as opposed to what the mind recognizes as ‘lip service’ diversification). There is a sense that all the investments are crowded into the same place and are more and more governed by a few shared risks. And perhaps there’s an unasked question, what happens when the music stops, whichever music it is that has made it all work so far.
We can’t know when the music stops or what exact shape events will take when it does. But the concentration of the crowd on the dance floor does facilitate the existence of the types of securities that answer the aforementioned questions. Our portfolios have been pre-positioned for some time in a variety of hard-asset and counter-cyclical securities that are remarkably cheap, have substantial optionality and often remarkably strong balance sheets. They can only provide these virtues because they are not popular with the dance crowd. Paradoxically — but entirely in accord with the realities of market behavior — the best time to purchase an inflation beneficiary, for instance, such as a gold royalty company, is when investors have yet to become concerned about inflation and are generally unenthused about the prospects for gold or gold mining.
This review describes the variety of less-systemic-risk securities in the portfolios, including the penultimate non-systemic exposure — because it’s entirely outside the system — consensus money (cryptocurrency), along with some Q&A around the latter topic, of which there’s been quite a bit.
In presentations to various sophisticated investment professionals, one of the most surprising revelations has been that many have far less knowledge about the systemic risks embedded in the broader markets than do our clients. While they are increasingly aware of well-respected investors voicing increasing discomfort with various structural excesses, such as the national debt, they are not cognizant of the very real and specific threats posed to them or their clients.
Unfortunately, the odds just shifted for the worse. A far greater threat has arisen: of technological disruption from outside the major indexes, with the potential to be destructive to large sectors within the indexes, in particular the Financials and Information Technology. This is the emergence of cryptocurrencies such as Bitcoin. The potential disruption to the status quo is sufficiently great, in our view, that all investors should, at the least, be exposed to this topic. It merits serious discussion.Read More >
It’s always nice to pay a lower fee for the same product. Who wouldn’t? But what if it’s not the same? The Nasdaq 100 ETF (QQQ) fact sheet says it is filled with growth companies and only trades at 22x earnings, the same as the S&P 500. They don’t tell you that they exclude any companies with losses. They don’t describe how they effectively eliminate the impact of companies with very P/E ratios, through a rather abstruse formula known as the Weighted Average Harmonic Mean. In the absence of having an MBA or statistical degree, if you calculated the P/E ratio of the Nasdaq 100 the way you know how, by simply averaging the P/E ratios of the 91 profitable companies, then the P/E is over 40x. It’s One Thing to Not Know, It’s Another to Be Told What Isn’t So.
As with every quarterly commentary, we’ll review just how indexed products that purport to be low volatility or low risk or provide exposure to a given country or industry actually are not or do not. You don’t get something for nothing, particularly on Wall Street.
In past reviews, we’ve titillated you with some of the more startling and story-worthy examples of the distortions caused by the indexation vortex. We have chosen far flung examples in order to direct one’s attention, through all the noise of conflicting information from the financial news media, toward the bubble conditions that ETFs have wrought. But, because those examples have been drawn from more marginal sectors on the market, many of you might have wondered whether they are relevant to their portfolios. So, in this quarter’s letter, we go mainstream, to see what’s going on in the most basic portfolio building blocks, the bread and butter asset classes: first, the S&P 500 itself, and then a typical mainstream growth fund and a mainstream value fund that an everyman or everywoman would use. The kind of fund that is relevant.Read More >
This past year was interesting on so many more fronts than 2015. And this coming year could be more interesting still. In 2016, the financial markets saw all sorts of records and precedents – and not in a good way. We have been taking some time to prepare our client portfolios for advantage. Advantage hinges on the ability to make opportunistic investments, to take what the market gives, not what it doesn’t. Opportunism has a field of play when prices have declined. Sometimes they decline suddenly, other times slowly, sometimes the whole market together, other times just pieces of it. But entry to that field of opportunity itself hinges on having sufficient liquidity; without liquidity, the opportunities are just an idea of what might have been.
Money flows into ETFs and similar funds have not only pushed up the prices of the major index-centric companies, but also created an artificial downdraft among the thousands of non-indexation securities. That is where the companies with less systemic risk will be found. There will be more in the way of idiosyncratic investments with the opportunity for true optionality. Perhaps our portfolios will have to have fewer, but more selective securities with perhaps larger weightings in those companies with truly discounted valuations and a truly superior business position.
So, the watch words are preparedness, and sobriety. Dr. Louis Pasteur said, “fortune favors the well-prepared mind.”Read More >
Cash. One of the most misunderstood terms in investing (except lately, alongside “defensive” or “low volatility” sector investing, perhaps now one of the most dangerous places to be). The accepted modern approach to investing is to be all allocated all the time. How odd, since the greatest investors for their own accounts, ranging, alphabetically, from Warren Buffett and Carl Icahn through Wilbur Ross and Sam Zell, make generous use of cash. Cash is put at risk not any ol’ time, but only when they believe it will earn a suitable return. And they have plenty of it now. As do we. Having 25% or 35% in cash is a wonderful feeling when you see everyone else is ‘all in’, and it hasn’t had any noticeable negative impact on our performance this year. We believe when you’re in that position, you have a special advantage the market doesn’t.Read More >
If it has ever been advisable to own idiosyncratic securities – which will rise or fall based on factors specific to each company’s circumstances – as opposed to widely-held stocks that will react primarily relative to systematic risks, now is the time. Many of our portfolios benefited from idiosyncratic exposures this quarter: positions in precious metals royalty companies, a content company that will soon be acquired, and a self-liquidating land trust all appreciated significantly, and none is a significant holding in a major index. As we look to introduce new “orphan” securities to the portfolios, we are finding extremely attractive investment candidates in out of favor sectors and outside the indexation vortex – accept some trading liquidity risk and the market provides a whole range of margin-of-safety opportunities. While their success as investments is not assured, at least their propensity for success or failure will be based more on their own fundamental financial attributes than on rising interest rates or other macroeconomic events.Read More >
Following years of steady flows into the major index funds, coupled with systemic supports for stock prices of the largest, most liquid companies, valuations in the broad stock market are excessively inflated. Yet, most sectors contain companies outside of the major indexes, which are creating shareholder value but which are relatively invisible to institutional investors. Accordingly, they can trade at deep discounts. Those are the stocks we choose to buy, and several are reviewed herein. The broader investing community, however, continues to allocate assets to index products, using descriptive data and backward-looking metrics such as market capitalization and beta (which is simply a measure of past stock price volatility) to make decisions, while ETF providers use beta as a guide when creating new products. But beta is merely a statistic – without context, it is not only uninformative, but potentially misleading, really misleading.Read More >
Why does one invest in an index? Surely one goal is diversified exposure to the market. It might come as a surprise, then, that without the 10 top contributors, the S&P 500’s return in 2015 would have been negative instead of positive. Those 10 stocks, out of the 500, which together amount to a 10% weight in the Index, had an average return (weighted by index position size) of 44%. What does that mean for Horizon Kinetics? Well, those stocks are not found in our strategies, as they trade at extremely high valuations. Meanwhile, the ETF providers are facing fee compression, which is forcing them to market new, differentiated, higher fee products. While the ETF providers move on to new products, we continue to position our strategies for the long-term.Read More >
After years of writing about the flow of assets out of actively managed funds and into index funds, there are signs that the inevitable reversal may be near. This quarter witnessed the highest ETF trading volume on record, and the pricing anomalies resulting from flows into index products, both in equity and in fixed income ETFs, are ever more numerous and obvious. How else can one explain that, for several years, a biotechnology ETF had a beta well below that of the S&P 500, or that the Republic of Lebanon’s bonds trade at lower yields than bonds issued by Wendy’s?Read More >
This quarter, we return to our previous inflammatory statement that the standard macroeconomic variables considered critical to the portfolio management process – GDP growth expectations, interest rates, etc. – probably detract from performance more than they help. Also, why, even if we gave you today’s World Bank results for the last decade of GDP growth for all the major emerging market nations, as well as for the U.S., – but gave them to you 10 years ago, a private crystal ball –and gave you the pick of which emerging markets ETFs to buy, you would still probably have made the wrong decision.Read More >
This quarter, we question what it means to take a long term view, discuss the holding periods for some of the Core Value strategy’s holdings, and compare valuation characteristics, both descriptive and predictive, for selected Horizon Kinetics holdings as compared to well-known major index constituents.Read More >
This quarter’s commentary discusses the anomalies we observe in the current market, and the risks we see for investors following the current prevailing trends. In particular, we discuss the continued and growing prevalence of indexation, and the risks to sectors such as real estate investment trusts, which have been sought out for their high dividends in a low interest rate environment. Finally, on the occasion of the new year, profiles of the larger holdings in a number of our strategies are available on our website.Read More >
This quarter, we continue to examine the fallacies embedded in some widely held assumptions regarding asset allocation. We discuss the surprising correlations among what one might assume are unrelated asset classes and the impact of indexation on stock prices, factors impacting the utilities sector, and the benefit of idiosyncratic, diversifying securities. In addition, we review a new position in the Core Value strategy: Royal Gold, Inc.Read More >
Understanding the basic presumptions of asset allocation can hardly be more critical, since we all invest based on these foundational assumptions. This quarter, we examine the historical returns from investing in private equity, revisit the topic of slowing revenue expansion at the largest companies, identify some common attributes of companies that do not appear to be suffering from a lack of growth opportunities, and discuss the potential diversification and inflation hedge benefits of land.Read More >
This quarter, we question some widely held views on investing, focusing on the nearly universally accepted assumption that emerging markets investing provides higher returns than investing in the developed markets. In addition, we review two positions in the Core Value strategy: The Wendy’s Company and Platform Specialty Products Corp.Read More >
As we enter the 20th year since the founding of Horizon Kinetics, we take a look back at recent commentary themes, revisit the sway of the media on investment decisions, and discuss selected current positions.Read More >
This quarter, we review the important and often surprising ways in which indexation is impacting security valuations, risk, and returns, and point out the merits of the antithesis of indexation: active management and individual security selection.Read More >
While the S&P 500 Index level has appreciated significantly over the past year, revenues at the 20 largest constituents of the Index have increased only modestly. This quarter’s commentary considers the impact of indexation methodology on the representation of entrepreneurial companies that are likely to generate expanding revenues, many of which have significant insider ownership, by looking at the historical insider holdings and performance of two famous owner-operators: Wal-Mart and Microsoft.Read More >
This quarter’s commentary addresses some tax reduction techniques utilized by owner-operators, continues our review of owner-operator actions, and discusses master limited partnerships as part of our series on the challenges faced by investors seeking yield in the current low-interest rate environment.Read More >
This quarter, we examine the pitfalls of using standard valuation metrics as a substitute for thorough analysis. We consider a different valuation metric: management actions, which we believe is more predictive of future performance than most standard metrics.Read More >
Following strong performance by several of our larger holdings, we take this opportunity to highlight some of the companies that contributed little to performance for the year. We also address the many challenges facing equity investors, including the prevailing low interest rate environment.Read More >
We review the current bond market environment and discuss the implications of an extended low-interest rate environment. We also offer a discussion of the predictive qualitative and quantitative attributes we consider in assessing investment opportunities.Read More >