3rd Quarter 2019 Commentary

Conference Call Replay   Listen to the Podcast

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 … Continued

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2nd Quarter 2019 Commentary

Conference Call Replay   Listen to the Podcast

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.

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1st Quarter 2019 Commentary

Conference Call Replay   Listen to the Podcast

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.

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4th Quarter 2018 Commentary

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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.

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3rd Quarter 2018 Commentary

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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.

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1st Quarter 2018 Commentary

Conference Call Replay   Listen to the Podcast

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.

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4th Quarter 2017 Commentary

Conference Call Replay   Listen to the Podcast

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.

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3rd Quarter 2017 Commentary

Conference Call Replay

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.

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2nd Quarter 2017 Commentary

Conference Call Replay

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.

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