On August 5th, the Japanese stock market declined by 12% in a single day and the next day it increased by 10%. There is no possible way that Japanese businesses were worth 12% less on one day and 10% more the following day. Academics and the wall street money machine would have us believe that “markets are efficient.” The prospects of this theory are as absurd today as when Benjamin Graham wrote his seminal work on value investing, The Intelligent Investor.

2024 marks the 75th anniversary of the prescriptive investment wisdom by the late Benjamin Graham. After his own father - Warren Buffet considers Benjamin Graham the second most important person in his life, saying "He embodied what Walt Whitman described as, ‘Men who plant trees that other men will sit under.’ ”

Over the last couple months we have seen many analyst reports calling for a reemergence in the growth of earnings and generally an upbeat/bullish outlook for the economy and stocks. The narrative goes: The Fed has finished hiking interest rates, and it will soon lower the fed funds rate creating a stimulative impact on the economy and market. The market has celebrated this narrative with many calling for a “soft landing” and pricing in as many as 5 Fed rate cuts. As a result, many market analysts are “all in.” Some of those young folks have proclaimed a generational buying opportunity. We couldn’t disagree more with this outlook.

From our founding days at Pilot Wealth Management, we have been consistently and unabashedly value investors. We like to buy things that are undervalued by fundamental measures and ideally aligned with principled people who steward their investors capital as if it were their own. With any investment style, there are times when it has “underperformed” and there are times when it has “outperformed” the market averages. The performance of the “60/40” traditional portfolio’s performance has been abysmal of late. This is not the case with the portfolios we have assembled for you. Since the S&P 500 peaked at the end of 2021, our largest holdings have certainly outperformed. 

Over the last week we have had two banks in the United States fail. One of those banks, Silicon Valley Bank was the 16th largest bank by assets and deposits with over $200+B and $170+B respectively. While I don’t want to minimize the importance of this as there are a significant number of depositors and businesses exposed, I don’t believe this is going to lead to a widespread systemic banking crises. This will be resolved in short order, but we do have reason to be worried. 

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.” 

We have written in the past that all eyes are on the US Federal Reserve - and they are in quite the pickle. The Fed funds rate, or the rate at which the Fed regulates the overnight lending rate for the US banking system, is used to set the bar for the valuation of all assets around the globe. The Feds most important mandate is to hold inflation steady at 2% and there by facilitate the orderly functioning of the US (and global) economy. With this over simplified measure, the Fed has failed miserably having held interest rates too low for far too long…

I’m not sure anyone was prepared for the wild ride that was 2020, let alone the rosy market that we have experienced in the first half of 2021. While technology investors aren’t too happy with their recent losses, we are pleased with our results. Emerging markets, international value and commodities related stocks have done well, but real economic growth (after inflation) is far from certain, as is real returns from bonds. Inflation of course has reared its head, but how stubborn will commodity and labor prices be? And will it be enough to spur longer term inflation? Our non-conventional portfolios have paid off handsomely over the last 12 months. We will likely continue to do well in this Federal Reserve, stimulus driven wonderland we are experiencing.

This quarter has been a wild ride in markets. By just looking at the major indexes (S&P 500 for example) it appears to have been a fairly ordinary, run-of-the-mill quarter. When you look at the sectors and individual names you get a much more turbulent picture, however. This turbulence is important to be aware of and is giving us clues of potential market weakness. Over-valued technology names, excessive leverage in the system and a significant change in inflation expectations foreshadow volatility and necessitate a cautious stance.

With the election behind us, many are wondering what’s next in a year that has proven to be a very volatile market. As such, I thought it would be helpful to review what we own and some recent performance. In our last letter I mentioned that we were in a stock market bubble. Why weren’t we reducing our exposure to stocks then? Recall I described a Jekyll and Hyde type scenario where large tech-oriented companies were approaching record over valuation, while other industries and broad asset classes were very reasonably valued.

We have been consistently telling our clients for the last 18 months this is a difficult environment, do not expect returns like those of 2016 and 2017, and volatility is likely.  Well, I guess we got what we wanted. 

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.

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.