“I’ve realized a new reason why pessimism sounds smart: optimism often requires believing in the unknown, or the future, which seems fanciful and naïve.”
– Jason Crawford
“Pessimists sound smart. Optimists make money.”
– Nat Friedman
Public equity and bond markets are currently being driven downward by a multitude of fears and unknowns, primarily inflation and higher interest rates. This has introduced “stagflation” as a risk to the current economic and financial environment. Inflation has been reasonably tame for years and has now soared to 40-year highs. Central banks around the world and especially our Federal Reserve have been behind the curve in addressing the inflation risks that have been building from a combination of factors related to; overly accommodative policy (zero percent interest rates), too much fiscal stimulus, and virus-related supply chain disruptions. The Federal Reserve has now embarked on a path of raising interest rates with the expectation that this will cool off the economy and inflation.
Interest rates are like gravity to asset prices, especially stocks and real estate. The lower interest rates are, the higher asset values can become, and vice versa. Early-stage growth companies and other fast revenue-growing businesses with no earnings have been market darlings of late. Many very successful mega-cap technology-related businesses with proven concepts have been over-owned by every hedge fund, mutual fund, and broker in America. We own a few of these too, but we started writing about and communicating in meetings as far back as 2020 regarding the burgeoning risks in dominant tech stock (FANG) concentration in the market. Last year we witnessed ridiculous valuations for businesses with no earnings, and risky trading behavior by individuals in meme stocks, options, and cryptocurrency. These excesses are now being corrected.
Other factors affecting the increased public equity and bond volatility today are structural in nature. A large majority of public securities today are driven by Wall Street “models”. These models drive a majority of the trading in the short run: up or down, right or wrong. Interest rate assumptions and a myriad of economic factors that affect them are key components in these models. Indexation (another risk we have talked about) has exacerbated the effects of these models and when they change, computer-driven algorithms push exchange-traded funds (ETFs), which then drive stock and bond prices up and down without human reasoning or involvement. By thousands of points at times, unfortunately.
The Investment Team at Live Oak Private Wealth believes philosophically that this market volatility, while unnerving, is the friend of the long-term investor. Earnings and cash flows generated from a business drive stock prices in the long term. We feel we have a structural advantage because we manage patient, long-term capital for our investors and we have the ability to maintain a long-term time horizon. This is a key advantage for us, and our clients, when we are able to capitalize on significant discounts in value at times like this.
What separates great investors from the average has a lot to do about behavior. We think deeply about and craft our strategies based on the factors that affect our investee’s competitive advantages and the sources of their enduring business success. Therefore, we operate differently and stay laserfocused on factors that will contribute to a business’s ultimate advantage in the long-term through both good times and bad times (such as now).
In meetings, we have often discussed how good investment returns have been of late, except for the very brief March 2020 Pandemic sell-off. We have also said that we should expect not-so-great periods. We are currently in such a period, and it will pass. We are in a period where the macroeconomic picture (inflation, interest rates, Russia-Ukraine) is trumping the micro. Pessimism is winning at the moment.
Morgan Housel is a great writer and student of investment behavior. He penned a piece back in 2016 while working for internet-based Motley Fool, regarding how hard it is to own and hold great businesses through a serious correction like we are witnessing. Many times, the best-performing stocks for many years will go through a gut-wrenching decline. It is easy to think that the single best stock to own is the one that would make us smile every morning we woke up owning it. But it never is and never will be. On the way to creating substantial wealth in public equity investing, you have to spend some time losing wealth. It’s investment reality and we, therefore, must accept volatility as a normal, inevitable part of long-term wealth creation. Housel said, “capitalism is fierce about denying you something for nothing, and higher returns tend to demand the mental agony of higher volatility”.
We believe strongly that in aggregate our portfolio companies are wonderful businesses, managed by highly skilled management teams that can navigate the current very challenging environment. We believe our investees benefit from their durable competitive advantages and expansive opportunities to come out even stronger after this period has passed. Our eyes and ears are firmly on the business fundamentals of what we are invested in and the economic reality of today.
We believe the two most important factors in superior long-term investment performance are:
1) correctly identifying disconnects between the fundamental value of a great business and its current quoted price in the markets and
2) waiting patiently, sometimes for unbearably long periods, for opportunities to present themselves.
Bill came across this quote recently and thinks it is attributed to Vladimir Lennin…“there are decades when nothing happens….and then there are weeks when decades happen.” Much of an investor’s success and wealth creation is related to patiently waiting for just this type of environment to capitalize on. Today we feel we are witnessing a period of substantial disconnects with certain businesses.
Your entire Live Oak Private Wealth team is at your disposal should you have any concerns or questions about your portfolio of investments. Now would be a great time to check in with one of our many CFP® professionals to see how your goals and objectives are tracking to plan.
This material is not financial advice or an offer to sell any product and is not a recommendation to buy or sell any particular security. The opinions expressed are those of the Live Oak Private Wealth Management Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass.
CERTIFIED FINANCIAL PLANNERS™ are licensed by the CFP® Board to use the CFP® mark. CFP® certification requirements include: Bachelor’s degree from an accredited college or university, completion of the financial planning education requirements set by the CFP® Board (www.cfp.net), successful completion of the CFP® Certification Exam, comprised of two three-hour sessions, experience requirement: 6,000 hours of professional experience related to the financial planning process, or 4,000 hours of Apprenticeship experience that meets additional requirements, successfully pass the Candidate Fitness Standards and background check, agree annually to be bound by CFP® Board’s Standards of Professional Conduct, and complete 30 hours of continuing education every two years, including two hours on the Code of Ethics and Standards of Professional Conduct.
Live Oak Private Wealth is a subsidiary of Live Oak Bank. Investment advisory services are offered through LOPW, LLC, an Independent Registered Investment Advisor. Registration does not imply a certain level of skill or training. More information about Live Oak Private Wealth including our advisory services, fees, and objectives can be found in our ADV Part 2A or 2B of Form ADV, which is available upon request.