2022 Q1 Commentary
By Jason Lesh, Managing Principal
Volatility has returned. Nick has lots of thoughts to share in his note below, but this is the highlights from my vantage point:
Inflation is here and we were uncannily positioned to reap the rewards.
Interest rates have soared to the detriment of those that need money to sustain ridiculously high valuations and growth.
We love volatility and times like this! We continue to outperform the market so far and remind ourselves that this is when we sew the seeds for future returns.
And while we are watching the investments like a hawk, know that we are still very comfortable with our stance. We know what we own (and are keenly aware of what we don't own and want to stay away from). And the volatile portions of the portfolio are the long-term monies - something we are okay with.
Watching the news or following the market these days can feel a bit like riding a rollercoaster. But rest assured that these are the times we have prepare for and earn our keep. Evidently value investing isn't dead. And it pays to be a bit contrarian.
I hope this note finds you well and look forward to connecting soon!
Occasionally, an event happens that changes everything. Certainly Putin’s invasion of Ukraine qualifies as one of those events, as was Covid and the US change in trade policy a couple years before that. Come to think about it, these events happen quite frequently. This is why when short-term oriented prognosticators discuss growth to the moon or conversely the world is burning down, we tend to ignore them in favor of our value investing principles. A stoic might say that perhaps we should expect the unexpected and in doing so we actively ensure that our investments and importantly your “financial plans” can withstand such adversity. Many of our clients have entrusted their entire life savings to us and when it comes to absolute certainty, we tend to disagree in favor of probabilities and diversification.
Tied to each of the recent events is inflation. Trade policies, COVID and the Ukraine war have all contributed. Many investors have come to anticipate sub 2% inflation and have built significant investment frameworks around this simple assumption. Frankly, we are unsure of what happens next.
We view all these things as great reasons to be diversified and own commodities. Of course, it was a wild ride, but we added to the commodities as the events unfolded as opportunistically as possible and it worked out well.
Note: I don’t expect inflation to remain as high as it is now (ie. 8.5%+) for long. I do expect it to average much more than the sub 2% many of us had come to anticipate. The reasons are multi-fold and could be a full letter unto itself, but this only educated guessing. Suffice it to say, supply chains, commodity and labor costs are major contributors. The bottom line is that investors cannot expect to invest like they have over the last 40 years.
I have often discussed our scenario based framework for evaluating the investment environment. I have heard the most intelligent people disagree recently on the economic path forward from here, where they were mostly in agreement around potential inflation, they have begun to diverge in opinions. The answer to this uncertainty is always diversification.
Diversification in the portfolio management context is always a drag on long-term return. You are exchanging maximum returns for a better risk profile in terms of volatility. In the short-term you can have periods where diversification is quite beneficial. This has certainly been the case over the last year. With a traditional less diversified 60/40 portfolio you had much more exposure to US growth stocks for example and not much exposure to commodities.
Notice the short-term returns that make up the bulk of the average investors returns and contrast that with commodities which most investors are underexposed to:
And of course we have had a more significant allocation to commodities. This has been tremendously helpful and is responsible for our significant out performance. The war in Ukraine has caused some angst among emerging markets and international stocks, which were a drag on our returns. We view this as normal volatility at this point, rather than a long-term structural change to the return profile that these stocks will provide.
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Our view of the world leads us to some general observations.
We prefer to place capital in businesses where astute capital allocation prevails
US value stocks are still quite a bit cheaper than US growth stocks
Commodities will continue to do well as the dollar begins to show weakness over the next several years
Int’l stocks are much cheaper than US stocks, although will be more volatile
As we rebalance portfolios this quarter, you can expect a few changes reflected: We will slowly build cash, short-term fixed income, and precious metals to increase diversification. Of course, as we experience volatility we will be a buyer of those areas that become good values once again.
We find ourselves in familiar territory. We are in an expensive market and we see the winds of change beginning to pickup. We liken this to the end of summer and beginning of fall season when we harvest the fruits of our labor and prepare for winter. In this preparation we exercise patience until the next seasonal event occurs that changes everything once again.
