2020 Q4 Commentary
By Jason Lesh, Managing Principal
This time last year, I was enjoying a few bluebird days at Bandon Dunes Golf Resort with some dear friends. Little did I realize what would soon ensue. The past 12 months have brought us a global pandemic, wildfires throughout the west, mass unemployment, an upended business environment, huge government financial intervention, social unrest, and a quickly changing landscape on nearly all fronts from healthcare to education to shopping.
I write this letter to you surrounded by boxes as my family prepares to move back into our house that we have been remodeling since July. On Monday of this week, after having taught remotely since last March, my wife welcomed 1st graders back into her classroom for live, in-person instruction. Yesterday afternoon, she received her 2nd COVID-19 vaccination. Next Monday our youngest son returns to school, followed closely by his older brother. We are turning the corner!
It’s been a year of unpredictability and at times, exhaustion. But I find myself counting my blessings this afternoon:
For the wonderful families I get to work with
For the scientists and health care professionals who helped produce and distribute the vaccine
For the good fortune and health that both myself and those around me have been given
And for a phenomenal friend and business partner in Nick Fisher
To this last point, I would like to elaborate just a little bit. 2020 was a wild ride that tested the conviction of any investor worth their salt. But I must say that Nick performed admirably: continuing his never-ending research, challenging his assumptions, and managing risk while looking for return at a time when so many assets were disconnected from fundamentals.
While portfolios weathered the storm quite well in March and April of last year, we did not see them mindlessly fly through the roof during the summer. But beginning in September, it appears some semblance of reason has returned to the market. Value investing is in fact not dead and our portfolios have outperformed the market. And while the phenomenal performance is sure to be commended, it’s important to acknowledge the work done behind the scenes. It is so easy in this business to chase returns or follow the lemmings off the cliff – neither path carries with it much career risk. But doing the right things while not being distracted by the noise of the day? Remaining laser like focused on long-term results? That is hard.
So for all the craziness, uneasiness and volatility that we have experienced in these last twelve months, I want you to know how grateful I am to be partners with Nick. And that I rest easy knowing he is in charge of both our clients investments, and mine.
Please do not hesitate to reach out if we can be of any assistance and here is to a healthy and prosperous 2021.
Warmest regards,
“I thought I was smart. Every trade made money, until it didn’t. And I realized I didn’t know anything.”
We are witnessing the 3rd asset bubble of my career. A vast majority of people are speculating in the stock market right now, which is to say their prime motivation for buying is nothing other than the fact that the stock or index or bitcoin went up in the recent past. This breeds over-confidence and a reliance on circumstances remaining the same. If 2020 has taught us anything, we know that the future can be uncertain!
In this environment, maximum caution is warranted. It is always important, but of utmost importance right now to understand your purpose for investing.
Our purpose as we know it is the following:
Responsibly stewarding your hard-earned savings to preserve and sensibly grow your purchasing power in retirement and/or to leave a legacy for the next generation. And we all need to sleep well at night. The only way to accomplish this is to build a collection of investments that have durable after-tax cash flows. What does “durable” mean?
Durability means that we are conservative in our assumptions. Taking into account current conditions, we want a high likelihood of success. Underlying the prices and figures you see on your your statements are real businesses and assets that are unique and in some respects irreplaceable. We believe this uniqueness and tangibility gives the investments we have collected to date a certain immunity from the loss of capital that comes from speculation and bubbles. Just as a collector considers unique characteristics to their art, so do we with your investments. Similarly, with rare exceptions do we purchase something to turn around and sell it like a trader would.
How do we know this is a bubble?
We know the market is expensive. Declaring a bubble is not as simple as saying the market is expensive. There are a couple of other factors that must be present. We discussed this in our last letter, but it has even more clearly materialized recently with the GameStop short squeeze among the Reddit crowd.1 When the meteoric investment success of a few retail investors move from the Wall Street Journal into mainstream media “front page” the last checkbox makes it a certain bubble.
On a side note, I was at a small local establishment and our server overheard us talking about GameStop and struck up a conversation. At the time the stock was over $300 per share and she had made nearly 20X her initial investment and declared that she was in it for the long haul and felt she would “never” sell. The stock dropped precipitously over the few following days and is now down more than 80% as of this writing.
A recent survey from Shroders of stock market investors, say they expect 15.3% annual returns over the next 5 years. “Our results show that 80% of people are still basing their predictions on the returns they have received in the [recent] past, with a decade of strong returns potentially inflating people’s expectations to unrealistic levels.” Meanwhile, long-term average returns (after inflation) average around 7%. We have seen this time and time again with each bubble, of course. This over-optimism is exactly what makes it a bubble. And it will lead to an inevitable reversion to average returns, which means a permanent loss of capital for many speculators.
Of course, none of our clients currently depend on 15% or more returns from equities in order to achieve their purpose. As we have discussed in the past we are excited about this current environment. We avoid those things we believe to be most susceptible to the bubble bursting. And we allocate yours and our own hard-earned savings to those things we believe are undervalued at this time. We absolutely think we can achieve a respectable return going forward, but the road will be uneven and bumpy.
The chart below with our 4 largest Exchange Traded Funds (ETFs) compared to the S&P 500 in red from beginning of September through January (before fees). These ETFs represent a meaningful portion of your stock market exposure.
In our last letter we also referred to how well our allocations to emerging markets, and “value” stocks have benefited since early fall. It is not uncommon for this rotation to be persistent and this outperformance to last for several years or more. To be clear, there will be fits and starts, just as we saw in the middle of January this year, but there appears to be a sustainable trend in place and we will continue to ride it so long as it is sensible.
To be clear, it is a difficult environment for the few of us who still consider the risks associated with investing. We are in this together and there is nothing wrong with patience. It is a virtue after all. We look forward, to the time we can meet again in person.
I believe this narrative of the little guy taking on the big bad hedge funds is an absolutely bogus narrative and provided perfect cover for the fleecing of the small and ignorant…investors beware.