WHAT WE VALUE
Investing is very similar to golf: both are ultimately a test of patience. The greats practice their craft religiously. And the best are defined not by how good their best shots are, but by how good their bad shots were. The game is ultimately played over 18 holes and rewards consistency and not heroics. Here we see Jason’s oldest son, Christopher, teeing off…and learning that a round of golf is more than just one shot.
As the year unfolds, evidence is mounting that the economy is slowing, with multiple factors at play. The Federal Reserve reversed course quite suddenly at the end of December from raising rates to a more neutral, and even accommodative, stance. Some have begun to question whether we may see recession in 2020.
We have written extensively about risk, volatility, and valuations over the last several years. From our perspective, it’s important to continually talk about the fundamental values that drive our decision making.
Along those lines, we wanted to share a bit more about the process of evaluating a company and the decision to invest. This quarter, our portfolio manager Nick Fisher walks through his in-depth analysis of Peyto Exploration and Development and why he recently decided to add it to portfolios. Meanwhile, Alex Bridgeman, our newest employee, highlights why a modest allocation to a company like Peyto is a good idea that not every investor is able to make.
2018 had a little bit of everything. The beginning of the year got off to a roaring start with the fresh excitement of the new tax law and corporate tax cuts. But the party was short lived and concern creeped in around both trade and monetary policy. By the end of the year, 90% of global assets had a negative return.
It used to be so simple and straight-forward: republicans believed in free trade; Trump and the Clintons were friends; my car took regular gasoline; and the market always went up.
Now the republicans sound like democrats. The democrats sound like republicans. The Clintons won’t ever be invited to another Trump wedding. My next car will plug into the wall. And evidently markets go up AND down. Next thing you know, dogs and cats will be living together.
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.
I have previously discussed the biggest risk in today’s markets is that investors will be unable to achieve their goals. In terms of retirement planning, either investors will have to work longer or save more, and current retirees will risk outliving their funds. High valuations, and thereby low expected returns, are the culprits. We have been positioning our clients to weather this environment and fortunately, the significant increase in volatility recently seen is here to help.
The first three months of the year have reminded everyone that volatility is not just a myth: it actually exists. January opened the year on a tear, only to erase nearly all the gains in February. March saw the S&P 500 turn negative on the year.
This quarter, Nick goes wildlife tracking. In addition to searching for the proverbial lion in the grass, he’s noticed some subtleties in the investment environment that have shown themselves in the evolution of our portfolios. We are feeling great about our current stance and highlight how a conventional 60/40 portfolio with US growth stocks and interest-rate sensitive bonds is actually incredibly risky.
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:
2017 was a great year for our portfolios. And while the rising tide should hopefully raise all boats, we feel exceptionally proud of what we owned last year and where returns came from.
But change is on the horizon and an evolution is beginning in the portfolio that we are both excited about and preparing for. Jeremy Grantham, the co-founder of GMO, highlights this change that Nick will dive into much deeper in his report:
“Be as brave as you can on the EM (emerging markets) front. Be willing to cash in some career risk units. Bravery counts for so much more when there are very few good or even decent alternatives.”
We are preparing our portfolios to respond well whether we continue to muddle along or see inflation rise quicker than most are forecasting.
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.
As the current bull market continues, more investors are starting to predict the day it all comes to an end. Instead of trying to predict a market top, according to Mark Hulbert (of Marketwatch), investors should view market tops as a “gradual process in which equity exposure is slowly and deliberately reduced over time.” Predicting tops is not only unproductive, but it is also impossible to be accurate. Trying to pinpoint the precise date of a market top cannot be done because markets all reach their tops at different times.
Because we didn’t have enough to worry about already, earlier this week we learned of a massive data breach at Equifax, one of the nation’s three major credit reporting agencies. Hackers stole names, Social Security numbers, birth dates, addresses, and in some instances driver’s license numbers and credit card numbers.In light of this unprecedented breach, we want to provide you with the necessary information to lessen your risk of being a victim of identity theft:
Venture capital has become an important driver of the economy and investment returns for many institutions. Even mutual funds have joined the party with the likes of Fidelity and T. Rowe Price having acquired the shares of pre-IPO companies in the private market within their mutual fund products. Now we are finding that these highly valued, venture backed companies may be as much as 50% overvalued.
Often times in this business, firms and individuals spend an incredible amount of time and resources trying to sell and market to prospects. And completely overlooked is the actual research: the foundation of a thesis and the guideposts to build a portfolio. This isn’t to say that nobody does the heavy lifting in this industry, but more and more often, we see "really smart people” with “complex portfolios” who, at the end of the day, are simply passive investing. In other words, they are tracking an index. Whether it booms or busts. Ignoring the future prospects.
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.
If you are like most people, you have 75% or more of your stock market investment in US equities[1]. The truth is, it’s not just the lay investors that are subject to this “home country bias.” Most financial advisors and money managers are equally prone to this bias. With the US accounting for only around 50% of global output and at historically high prices, a diversified portfolio should consist of a much greater allocation to foreign stocks.
A business' intrinsic value fluctuates very little. Yet, the price that the ever-moody "Mr. Market" will pay at any given time can fluctuate dramatically based on outside economic and political forces.
At Pilot Wealth, we feel no need to explain it, no need to tell a story. Instead, we recognize volatility happens and we welcome it.
We share some thoughts about what we believe on our Pilot’s Log and Navigating Markets including words of wisdom inspired by the greats, periodic updates about current markets and timely seasonal reflections.
2233 NE 45th Avenue
Portland, Oregon 97213
Office: 503-847-9723
