Not a lot changed in the 2nd quarter since our Q1 letter. What has changed is the market’s perception of global trade. This has undoubtedly impacted the trading narrative around the US Dollar and consequently commodities and emerging market stocks, the very assets we are most excited about. The fickle nature of “Mr. Market” often allows us the opportunity to buy when prices are down, as we maintain our value discipline. As Warren Buffett says, when prices go down we should get excited (and buy more), but we often do the opposite. We view this current downturn in emerging market stocks as a major boon to prospective 10-year returns.

As a quick follow up to our quarterly newsletter, I thought I would take the opportunity to update you on our investment thoughts in light of what appears to be a regime change in monetary policy expectations. To recap, we said that:

1. We expected inflation to become more of a concern than it has been in the recent past given the coordinated global growth we have seen.
2. Given the “goldilocks scenario” of ideal investment conditions, investors were bound to be surprised by a change in inflation expectations and potentially monetary policy.
3. All assets are priced from US short-term T-bills (we call this the “risk-free” rate). If these rates move up rapidly, asset prices may come under pressure. This pressure is further magnified by the fact that valuations are extremely high.

Global coordinated growth seems to be back and stock markets are up. This is in line with what we have expected. As discussed in last quarter’s letter, we expected the majority of returns to come from international and emerging markets and that has definitely been the case. Of course we will see volatility in the markets, so we must be prepared. With all of this growth, interest rate normalization is at the forefront of our minds.

I recently read the autobiography of Sam Zell, an extremely successful real estate investor known for his uncanny ability to buy low and sell high. In the book he tells the story of his father’s foresight and decisive action that preserved his family in Pre-world-war-2 Poland. As a successful grain merchant, his father kept apprised of political and social happenings in Europe through his extensive travel and interest in short wave radio. While some people looked at this “hobby” of international politics as a complete waste of time, it gave his father a unique outlook on the world. With this perspective, coupled with decisive action, the Zell’s were able to start a successful new life in the United States.

One of the first investing lessons I learned was, not to lose money. Not only is it mathematically a problem, as losing 50% means you must gain 100% to return to even, but it has lasting psychological impact that can cause all sorts of opportunities for misjudgment: pervasive fear that leads to selling at the wrong time, a reluctance to buy at the right time, or buy enough, just to name a few. It is nearly impossible to foretell how we will react, therefore if one is interested in earning a respectable return (greater than the risk free return of short-tem treasuries) we must develop what Howard Marks describes as, “risk Intelligence.” It’s the investors’ job to understand, recognize and control risk. I frequently revisit informative writings in order to ensure that the compass needle is pointing in the right direction. This letter was inspired by an article that Howard Marks wrote some time ago, Risk and Return Today.

“The Fed has spiked the punch bowl. You can get drunk on easy credit and once you do you start doing things drunk people do. We’re not there yet, but we’re a little tipsy. People should start thinking about not driving.” – Howard Marks