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A tale of two-markets

By: Devan Robinson

"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty." -Winston Churchill

Disclaimer: This post is for educational purposes only and is not investment advice.  The securities mentioned are for illustrative purposes.  Devan Robinson and clients of Fairlead Financial Group may own positions in the securities mentioned.

A tale of two-markets

Hey Devan, what's going on in the markets?

Great question!  

This has to be one of the most interesting markets I've experienced.  It's almost as if there's two movies happening at once:

Movie #1: The globally-diversified, index-based investor with a balanced portfolio.

In this movie you're a diversified investor.  You're experiencing the discomfort of a correction but nothing you haven't seen before.  The S&P 500 is off 15% or so from it's high; a below-average correction (-16% is the average for a correction).  

Bonds are under-pressure for the first-time in awhile but the mechanical nature of bond-funds will work itself out.  Rates going up will be great for diversified portfolios in time.

This correction is simply the normal-route markets take and it's how you earn your return.  You earn your paycheck when the world is uncertain and it arrives when the world returns to normal.

You throw your quarterly statement in the trash and continue living your life.  You sleep easy knowing American business will navigate these challenges.  Plus, a little diversification doesn't hurt.

Movie #2: The hyper-growth investor.

In this movie you're a hyper-growth investor.  For the past few years there has been no better investment than hyper-growth.  

You've humiliated value-investors.  You've outperformed all imaginable diversified portfolios.  Heck, you've almost certainly outperformed all financial advisors and most hedge-funds.

Well, as of 2022 this movie isn't fun anymore.  For example:

Past performance may not be indicative of future results.

Underneath the Nasdaq's -20% decline is some serious carnage.  Hyper-growth isn't just beat-up, the whole sector's been napalmed.

I feel terrible because a lot of retail & newer investors are drawn to this type of stock.  High-risk, high-reward right?  Well, it's a little more complicated than that.  The price you pay for a business makes a big difference...eventually.

And to be clear, I'm not grave-dancing on hyper-growth.  It has a place in portfolios for younger, aggressive investors.  I've used the sector in portfolios.  There's a big difference between a 3-5% allocation vs. making it your entire portfolio.

I've never seen such a disconnect in markets before.  Most of the time markets feel like ships on the ocean.  All of the ships sort-of bounce along the waves together.  

In this instance one ship is burning and sinking while the rest are cruising along just fine.

Are we rolling into a bear market?  

I wrote to clients back in Q1 that I thought this was a correction and not a bear market.  My mind hasn't changed. 

What's the difference?

I view corrections & bear-markets through different lenses.

A bear-market can last 2-3 years and they tend to happen slowly; sneaking up on investors.  They're often driven by events people don't see in the headlines.  Mortgage fraud in 2008, COVID in 2020 etc.

In a correction, markets sell-off quickly (and sometimes recover quickly) mainly due to sentiment.  A big-scary headline that creates fear & uncertainty in markets.  In time the uncertainty fades and markets resume pricing reality.  

Why does that uncertainty typically fade?

Often the big headline worries don't actually have a meaningful impact on corporate earnings.  

If an issue is in the headlines it's probably fairly priced-into  stocks.  Investors & businesses are knowledgeable & crafty (for the most part).  Risk is what you don't see.

In the stock market earnings are gravity; they're what ultimately matters over the long-haul.  Why else would anyone own a business?

When I look at issues driving sentiment lower today I don't see them having a major impact on earnings growth.

  • Inflation: As of the  inflation read yesterday it seems like inflation could be rolling over.  Supply-chain traffic-jams and energy will work themselves out in time.  Could inflation go higher?  Definitely.  Will it moderate in time?  Probably.
  • War-in-Ukraine: How does it end?  I don't know and I'm officially retired from being an armchair general.  What I do know is the war has zero-impact on whether or not my boys want a Happy Meal from McDonald's.
  • Interest-rates:  The Federal Reserve is raising interest rates in an attempt to tamp-down inflation.  This is a good thing.
  • Recession:  Are we entering a recession?  I have no clue and I'm terrible at macro; it doesn't impact my hunt for value.  If we are entering a recession it will probably be a shallow one.  This isn't 2009.  Anyone that says so either wasn't there or is being hyperbolic.

For long-term investors I don't feel any of these will permanently-impair the earnings of our investments.  That's why I think this is a correction.

How does market-turmoil like this end? 

Great question.  It always ends the same way: greed.  Plain-old greed.  

When will it happen?  I have no clue but human-nature doesn't change much.

Investors are greedy.  Deals emerge and the greed instinct kicks in:

  • I can buy Charter at a 10% free-cash-flow yield?  Russia could launch nukes at Ohio and I STILL wouldn't cancel my broadband internet.
  • Google, a near-monopoly, is cheaper than they've been in years?  I always kicked myself for not owning more in the past.  Time to change that?
  • M/I Homes is trading below the book-value of the land on their balance-sheet?  We didn't built any homes for millennials and now there's a shortage, perhaps we should build more?
  • I was jealous of the price Berkshire paid for Snowflake.  Wait, now I can buy near Berkshire's price?

That's the beginning of the end of any correction.  Sometimes it happens quickly, sometimes slowly, but that greed instinct will always emerge eventually.

Corrections always look like opportunity in hindsight but danger in the moment.

I invested in Q1/Q2 and now I'm down, did I do something wrong?

No, probably not.  It's simply the nature of buying into volatility & uncertainty.  It's not the last-time it will happen.  Be greedy when others are fearful is the old saying.

And trust me, I understand your pain.  I thought Amazon was cheap at $3,300/share and invested hand-over-fist.

Well, uh...Amazon got cheaper these past few weeks.  Whoops.

Past performance may not be indicative of future results.

Was I wrong?  It's certainly possible but only time gives us the answer.  I invest in stocks with a long-term view.  In a few years, after the long-term has happened, I will know if I was right or wrong on Amazon's business.  

As Ben Graham said: In the short-run, the stock market is a voting machine. In the long-run, it's a weighing machine.

The boys are back in town

Frankly, my main takeaway is that these dudes can pound some serious candy.  Five straight hours of just annihilating peanut-brittle and Cherry Coke.  Maybe that's the secret to longevity?

Berkshire recently had their annual-meeting in Omaha and for finance nerds there simply isn't anything better.  I'd love to attend one day while the boys are still around (I need to get an immune system first!).  With Warren aged 91 and Charlie at 98 you have to wonder how many more of these there will be.

I have this investing rule for myself I call my Berkshire-rule.  The rule is simple: I watch how Berkshire is behaving and I do the same if I can.   I definitely don't bet against them.  It's served me well thus far.

Inflation, Russia, interest-rates, elections, recessions...there's a lot happening in the news at the moment.  Here's one headline I feel has slipped through the cracks a bit: 

Warren & Charlie are buying stocks like crazy into 2022's correction.   $51 billion dollars thus far; the most Berkshire has ever invested.  As a percentage of their portfolio it's the most they've invested since Buffett's famous "Buy American. I am." op-ed during the 2008 financial crisis.

Not investment advice.  Just a detail to ponder.

Hang in there friends,

P.S. For some of my fellow Buffett-nerds: Buffett recently gave a great interview with Charlie Rose.  Here were some of my favorite parts:

As someone who is unequivocally not a genius I was really encouraged by Warren's comments.

This reminded me of my Dad.  He used to quip that he loved when real estate prices went down so he could buy more.  Forever the value-investor, pounding pavement where no one else was.  Dad was a natural contrarian.  He was the farmer through-and-through.

Also, Buffett has never had less than 80% of his net-worth invested into stocks.  I just love it.  The greatest of all-time.

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