What Actually Matters Anymore?

"The battle field hero is not someone performing an extraordinary act, but merely the man that can do the basic things when everyone else is losing their minds"

Had you told me, or anyone else that studies financial history that oil would be triple digits for an extended period, the 10 years would be over 4.5% and inflation expectations would be higher not lower I would have told you the market would be down with tech leading the way. Through all of financial history this was in fact the case. In my mind this points to the true anomaly of the current market environment. It is not to say that this time is "different" in that the ending will be any different but the facts and staying power of this current market environment is unique by any standard. Interest rates for the last 40 years have gone one way and that has distorted valuations and misallocated capital for decades. What the market misses is that true changes are somewhat subtle and do not move linearly. This is why we hear so often of the "overnight" success. The truth is there is no such thing as an overnight success instead, it is typically decades of both good and bad decisions that build great businesses or new investment themes and it is only after it has started working and the average joe catches wind does it become relevant.

This is the entire point of markets and why a bottoms up approach to company specific analysis is the true edge. When you are investing in business with strong balance sheets, tailwinds for growth and improving earnings with capable managements it does not matter if you made a bet on the trajectory of the market given where the 12-18mo forward oil price, inflation or the 10 year. There is an understandable frustration that comes with investing in an environment that feels overtly manipulated. It does feel today like the market is sleep walking through a potential energy & inflationary disaster. The thing I would remind you of is in investment things like frustration, anger, elation, confusion, sadness have no place. While you will no doubt feel these emotions it is important to have the ability to notice their effect on you in real time, and have a way in which you deal with them so that they never see the light of day in your investment decision. This is the goal, of course, but easier said than done, right?

While I cannot give you the "right" answer, what I can do is give you what I have done to address market irrationality. Investing is nothing like school where there are right and wrong answers. Thinking is not linear and it is more a mosaic of things you are piecing together that have varying degrees of relevance. This is what makes markets tough as well because all of our nationalized education does not prepare us to make decisions in this way. What I do is really fairly simply - when I find myself in an emotional hole I search for a rope not a shovel. In times of distress it feels good to do "more work" but what is actually important is doing the right work - and as we have discussed, the right work is inherently dependent on specific investment situations.

What I have found works for me is to study history. Not just broad history but history I find most relevant to what I am thinking about at the time. For example, if I am doing work on the steel industry I will find books and industry publications relevant to the steel sector and dig in. If I am feeling confused or angry with how markets are responding to relevant and important facts, I will seek out books or articles talking about other times in the past that mirror or echo current days. What I keep in the back of my mind in all of this is while these things are helpful for understanding economics 101 and eventuality of market forces, the timing remains uncertain.

The truth is while worrying about interest rates and what the Fed will do is folly, the importance of these decisions and their effects on valuation are very real. Not only do interest rates change valuation but they have massive effects on culture and psychology of markets. Low interest rates discourage savings and further the wealth gap while obviously inflating asset prices. Taking duration to try to get "some" yield with short term money is how Charles Schwab nearly went belly up and lost almost half their equity while it was the nail in the coffin for SVB.

The slow change we are seeing very clearly today began in 2022 but the market has ignored that shift. 2022 marked a structural shift that we think by 2035 looking back on the history of the market we will point to as the inflection point in the current bull market. It is not the Russia/Ukraine conflict only, but that does play a role. The most important thing the Russia/Ukraine conflict did was change market psychology as it relates to energy. Prior to 2022 oil, gas, coal etc were seen as fungible and a world wide connected commercial market. Wherever the hydrocarbon was the cheapest, that is where it was sourced. This persisted for so long that countries began dismantling industrial capacity like steel plants, nuclear power plants, etc just at the time when energy prices turned upward and Russia's invasion acted as the "match" in the room full of gasoline.

The truth is that inflation since then has persisted above the Fed target with no sign of coming close to 2.0%. I believe 2.7% was the lowest rate achieved since. Inflation is now a relevant market factor which was not the case for an extended period. The book I am reading now to deal with my curiosity about the state of this current market is The Price of Time and I would encourage you all to check it out as well. Keep in mind conviction is not something you gain or dont, it is something you develop and is earned every day.

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