Read our full investment commentary and letter to clients by downloading the Mid-Year letter.
“The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”
-Benjamin Graham
Any number of things could have derailed the equity markets in the first six months of 2023. Despite a banking crisis, the threat of a U. S. debt default, and more rate increases from the Federal Reserve, the markets climbed a “wall of worry” with the S&P rising by 16.9%. Investors have been encouraged by the fact that the Fed’s rate increases haven’t ended the economic expansion. First quarter GDP increased at a rate of approximately 2% annualized, above the consensus estimate of 1.3%. About the time of the Silicon Valley bank collapse, investors’ attention shifted back to the old leaders, mega-cap technology. Mega-cap tech companies have fortress balance sheets and would likely be less impacted by tightening credit than other areas of the market. More importantly, mega-cap tech companies are expected to benefit from artificial intelligence (AI), which overnight, became all the rage and focus of the markets.
Read our full investment commentary and letter to clients by downloading the Mid Year letter.
Read our full investment commentary and letter to clients by downloading the Q1 2023 quarterly letter.
“Risk is not inherent in an investment; it is always relative to the price paid. Uncertainty is not the same as risk. Indeed, when great uncertainty-such as in the fall of 2008-drives securities to especially low levels, they often become less risky investments.” – Seth Klarman, The Baupost Group “The Forgotten Lessons of 2008”
“This current banking crisis involves far fewer financial players and fewer issues that need to be resolved.” – Jamie Dimon, JP Morgan Chase & Co. Annual Letter to Shareholders – March 2023
We feel one of our most important responsibilities is to communicate with you frequently about the markets, what we are paying attention to, as well as to provide planning insights to enhance your overall financial well-being. In the past, we have provided you with a deep dive into our portfolios alongside market data on a quarterly basis. As we mentioned in our 2022 Year End Letter, we will be adjusting the content of our quarterly letters to ensure that we are touching upon other important aspects of your financial life, while continuing to provide in depth commentary on our portfolio holdings in our Mid and Year-End Letters. The Q1 2023 letter will be the first one of these. In this letter you will find first quarter market data, a brief commentary on the disruption in the banking sector, as well as a piece from our Financial Planning team on digital assets and estate planning. So, while we may be changing the format of our quarterly letters, we remain dedicated to our philosophy about investing, our focus on financial planning, and our commitment to our clients.
Read our full investment commentary and letter to clients by downloading the first quarter 2023 letter.
Get Live Oak Private Wealth’s perspective on the shifting investment patterns and the impact on clients by downloading our 2022 Year-End Letter.
“In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes. I think we may be in the midst of a third one today.” – Howard Marks, Oaktree Capital, “Sea Change”; December 13, 2022
Get Live Oak Private Wealth’s perspective on the shifting investment patterns and the impact on clients by downloading our 2022 Year-End Letter.
We are incredibly proud of our Managing Director and Co-Chief Investment Officer, Frank Jolley, for being featured in the recent Business North Carolina Magazine article titled “Best N.C. Stock Picks for 2023.”
Read our full investment commentary and letter to clients by downloading the Q3 2022 quarterly letter.
“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.” – Fed Chairman, Jerome Powell Jackson Hole Speech August 26, 2022
Boy, that pain escalated quickly. Markets, both equity and fixed income, finally took Chair Powell at his word as investment sentiment shifted dramatically this quarter. Prior to the Federal Reserve’s annual August retreat in Jackson Hole, the U.S. equity market had rallied 17% from the June lows thru mid-August. For some reason, the markets sensed, incorrectly, the Fed was going to moderate its interest rate increases. Fed officials, especially Chair Powell, thought market participants were too complacent, misreading their intentions to slow the economy to combat high inflation. This perceived “pivot” was making the Fed’s job harder. Powell decided to send the markets a message and tossed the punchbowl into one of the Teton’s beautiful mountain streams.
Then the markets woke up to the fact that Chair Powell was becoming Mr. Tough Guy, a la Paul Volker, and the machines kicked into gear, dumping stocks, bonds, and crypto, indiscriminately right up until the market close at 4:00 pm Friday, September 30. To make matters worse this quarter, central banks around the world also moved to combat the effects of rising inflation as banks from South Africa to Norway raised rates. When the Bank of England raised rates for the seventh time in a row, things started to break. The risks of a significant policy mistake leading to a global contagion started to heighten. Currencies started trading widely, and the British pound cratered to its lowest point in 37 years. Long-term U.K. Government bonds, or Gilts, flash crashed, losing a third of their value in four days going into the end of the quarter. While world markets were getting unstable, the U.S. dollar was soaring in contrast, along with U.S. Treasury yields, triggering the quantitative trading algorithms used by the massive macro commodity trading advisors (CTA’s) to drive ETF and index funds to dump stocks and bonds. The cherry on the top of the sundae of pain was a scary echo from 2008, another possible “Lehman moment” as fears surfaced that Credit Suisse, a globally systemically important bank was on the brink of collapse.
Read our full investment commentary and letter to clients by downloading the third quarter 2022 letter.
Read our full investment commentary and letter to clients by downloading the Q2 2022 quarterly letter.
“I think this is among, if not the most complex, dynamic environments I’ve ever seen in my career. We’ve obviously been through lots of cycles. But the confluence of the number of shocks to the system, to me, is unprecedented.” – John Waldron, Goldman Sachs
The S&P 500 just experienced its worst first half in over fifty years and its second-worst start to the year since 1935. Bonds, which typically perform well in times of market weakness, have become positively correlated with equities, leaving balanced investors with essentially nowhere to hide. Long-term treasury bonds lost 20.1 % in the first half, essentially matching the S&P 500 decline of 19.96%. Much of the decline can be attributed to inflation, which the Fed had assumed would be transitory, but has turned out to be more persistent than expected. This has forced central banks globally to pivot from holding rates near zero to a “hawkish” stance in an attempt to stem inflationary pressures. The S&P 500 has officially entered a new bear market (peak-to-trough decline of 20%), the 27th bear market since 1929. The worry is that central bank actions could push the global economy into recession. The chart from JP Morgan Asset Management below suggests that all of the market decline through the first half of the year can be attributed to price/earnings multiple compression. However, we are aware that with economic weakness, earnings will be under pressure to meet expectations over the next few quarters.
Read our full investment commentary and letter to clients by downloading the second quarter 2022 letter.
Our investment team believes philosophically that the current market volatility, while unnerving, is the friend of the long-term investor. Read why in our latest blog.
“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.
Disclosures
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.
Read our full investment commentary and letter to clients by downloading the Q1 2022 quarterly letter.
“You can be pretty sure you’re showing courage as an investor when you listen to what your gut tells you – and do the opposite”
– Jason Zweig
“At heart, uncertainty and investing are synonymous”
– Benjamin Graham
And just like that, the geopolitical news from the Russian-Ukraine conflict, coupled with 40-year highs in inflation, was the catalyst for an overdue global equity market correction. From the intraday high made on January 4th to the lows on February 24th, the U.S. equity market (S&P 500) declined almost 15%, before investors once again stepped in and “bought the dip” to try to take advantage of the price weakness. Despite a strong bounce back in March, stocks closed down for the first quarter, suffering their worst performance in two years. Stocks outperformed both long- term treasuries and corporate bonds which declined by 10.2% and 7.7%, respectively. International stocks fell 5.3% in U. S. dollar terms while emerging markets declined by 6.9%. The S&P 500 equal-weight index fared better than the S&P 500 index (market-cap-weighted) for the quarter, implying that the “average” stock performed better than the index, which is largely driven by mega-cap technology. The Russell 1000 Value Index outperformed the Russell 1000 Growth index by 8.3% for the quarter as investors gravitated to lower valuation issues. Studies have shown that the least expensive stocks (value) have historically outperformed the most expensive stocks (growth) when the 10-year U.S. Treasury yield is rising. During the past quarter, the top three sectors were energy (+37.7%), utilities (+4%), and consumer staples (-1.6%). The worst sectors for the past quarter were communication services (-12.1%), consumer discretionary (-9.2%), and information technology (-8.6%). The best and worst performers seem to be following the script of past periods of stagflation, according to a report by BofA Global Research dated 12/15/2020 (see chart on page 2). Stagflation is defined as a period of below-average GDP coupled with rising inflation.
Read our full investment commentary and letter to clients by downloading the first quarter 2022 Letter.