Embrace the Suck: To consciously accept or appreciate something extremely unpleasant but unavoidable. It's necessary to achieve your goals. Over the long term it’s the only way to add value and it exists precisely because many others can't tolerate it."
-Military Saying
The S&P 500 was down 4.38% in 2018. The first down year since 2008. It was also the worst December since 1931! According to Bespoke Investment Group, 34% stocks in the S&P were down well over 20%. 50.5% were down 10%+. Indeed, the market internals was quite grim, especially given where we were at the end of Q3. However, I believe fear is a useful and necessary aspect of investing. There are two types of fear when it comes to the markets. Fear of missing out, and fear of losing too much money. For most of the year, investors were afraid of missing out. Stocks are much easier to buy when they go up. The higher they go, the cheaper they look. Moreover, when they are going down, it’s hard to 'put money to work.' That was indeed the case in the last quarter of 2018. Going into 2019 the market is cheaper than it was in the middle of 2018. The forward multiple on the S&P is around 14.5x, a double-digit discount to its multiple over the last 20 years. In comparison, Ten year Treasury Bonds have a 'multiple' of about 39x, which is expensive compared to equities. Market participants are adjusting to dynamics that have rarely if ever been seen. For instance, technology deflation seems to be affecting the relationship between the Federal Reserve and Inflation. Whether its Amazon in retail, fracking in energy or fintech in financial services, new technology is putting downward pressure on prices, perhaps keeping inflation in check. Plus international government debt pays next to nothing to own, pushing more capital into US Treasuries which also puts downward pressure on rates. All this seems to be creating a quandary for the Fed.
Going into 2019, I have a few thoughts. First, stocks are cheaper and more attractively priced than just a few months ago. Second, the Fed has backed off ‘auto-pilot’ and 'will be patient and flexible with monetary policy.’ Perhaps no rate increases in 2019? Or even a rate cut? Possibly a moratorium on their balance sheet runoff? In any case, a more dovish Fed should be good for equities. Next, China has also stated it is undertaking measures to boost its markets like providing ample liquidity by issuing govt bonds, less stringent lending, and stopping ‘Forced Technology Transfer,’ a huge sticking point in the trade negotiations.
The world’s two biggest economies simultaneously undertaking more dovish monetary policy should be a tailwind for risk assets, which have become inexpensive by historical standards. It’s always easier to buy stocks when they are going up. The higher they go, the cheaper they look. Conversely it’s always easy to sell a bottom. However, as most experienced investors have learned, Selling into a downdraft has never been the right thing to do. As much as the market is predicated on data, i.e., earnings, cash flows, book values, and so forth, it's also one giant complex neural network which adaptively incorporates the collective expectations of investors into stock prices.
There are times when securities are a reflection of investor angst and not of company fundamentals. Those are the periods to be bought, not sold. I believe you own great franchises. Many are generating high levels of free cash flow, have low debt, growing their top and bottom lines and are genuinely disruptive. My goal is to invest in companies with a long tail. In due time, I believe investors will regret not adding more capital to these investments.
Regards,
Andre McClure
KDM Capital