2022 Q3 Commentary
By Nick Fisher, Portfolio Manager
In 1964 Henry Littlefield wrote an article explaining the political and economic allegory in the book, The Wonderful Wizard of Oz. The book, written by Lyman Frank Baum and published in 1900 describes a number of metaphors explaining the economic and political realities facing the country in the 1890s. Following the Mid 1800s “Gilded Age” and subsequent depression era, the wealth gap had become untenable and a number of politicians thought that an inflationary expansion of the monetary policy could be the answer to help the average American. Unfortunately, just like today, economic upheaval ensued. The tornado swept up Dorothy and displaced them into the land of OZ and she exclaimed, “We’re not in Kansas anymore.”
I would argue that the monetary expansion and low interest rates of the 2010s created a similar gilded age and we will be dealing with a temporary era of economic uncertainty and risk. I have written before that the next decade would likely not look anything like the previous 40 years. Simply put, interest rates fell for 40 years and the price of goods and services were kept low by globalization, and demographic tailwinds, which severely clouded the judgement of the Federal Reserve and investors alike. That era is over.
With the Pandemic induced disruption of supply chains, the war in Ukraine and the reversal of many demographic trends, this is a very different environment. We now have inflation at record highs, a massive amount of global liquidity competing for a limited supply of goods and services exacerbated by a very tight labor market. Of course, a tight labor market is leading to increased wages, which lead to more spending and more competition for a limited supply of goods and services and so on. Economists call this the wage-price spiral and unless it is interrupted it will continue. The wage-price spiral if left to its own will lead to a similar political upheaval as Littlefield described.
During the Federal Reserve’s meeting in Jackson Hole and again emphasized during the September FOMC meeting, Chair Jerome Powell said, “The FOMC is strongly resolved to bring inflation down to 2% and will keep at it until the job is done.” He continued, “Growth will slow below its long-term potential…We will bring the Fed Funds rate to a restrictive level and maintain it there for some time.”
The Federal Reserve is telling us to prepare for a recession. This is the only way to create slack in the labor market and interrupt the wage price spiral.
This is a big departure from previous periods in 2015, 2018 and 2020 where at the first sign of economic slowing the federal reserve had “pivoted,” reversed course and provided monetary stimulus once again. This time the Federal Reserve will intentionally slow the economy rather than save it from recession.
Market Performance
For the first time in 40 years the stock market and the (safe haven of the) bond market have declined by double digits in unison. This has only happened a couple times over the last 100 years. With inflation at 40-year highs, the purchasing power of a dollar is lower by double digits over the last year as well. We’re not in Kansas anymore.
Benchmark Performance Year-to-Date (as of 9/30):
S&P 500 (IVV): -23.8%
Bond Index (AGG): -14.2%
Blackrock 60/40 Target Allocation Portfolio (BIGPX): -20.8%
Resiliency
I have discussed in its various forms the importance of resilience or the ability for a portfolio to support your retirement goals in the face of all the risk. This is such a critical idea, as the saying goes: if you want to win the race, you must first finish the race. In these times of uncertainty and risks difficult to quantify, we must ensure that our portfolios are positioned for any number of outcomes. It’s a matter of both preserving and growing capital.
How is this accomplished?
Resiliency is not only marked by an allocation to specific asset classes. It’s an approach taking into consideration worst-case scenarios of inflation, deflation, liquidity, market volatility, etc.
Many of our holdings, such as Berkshire Hathaway, Fairfax Financial, Markel, Palm Valley Capital and more have resiliency at the core of their management/capital allocation process. In fact, we believe this approach of resiliency is a key differentiator that benefits portfolios in times of distress. These managers use their experience, cash and strength of balance sheet to weather the economic storm and occasionally act boldly when prices and liquidity deteriorate. This sows the seeds for future investment returns. These managers don’t just talk about it, but have a 30 and 40+ year track record of demonstrating resilience as a first principle and shrewdly acting when prices are low and future returns are favorable.
In times like these we are truly thankful for your trust in us. We own some great assets and enduring businesses. Accounts are down but nowhere near the market or traditional portfolios and this volatility will give us opportunities to put cash to work and earn respectable returns going forward. As this market and economy evolve we will keep you apprised of the evolution of our thoughts and your portfolio. Please don’t hesitate to reach out with any questions.
