January 6, 2020
Eagle, Colorado
Happy New Year!
With 2019 in the rear-view we look forward to 2020 with great excitement and a healthy dose of caution.
Only 6 days into the year and our country is all but on the brink of a new war in the middle east, this time with Iran directly. The market (so far) seems to not care all that much.
Much has changed in the past several years since we started fracking for oil in the USA. It used to be that when tensions flared in the middle east, the price of crude oil would spike meaningfully higher, but we assassinated the top military figure in Iran and crude went up a whopping [sarcasm implied] three bucks - $3. I suppose to be fair it was up almost $5 at one point. It is hard to believe, but here it is:
Something else that has noticeably changed is how much people are willing to pay for earnings today. A great example is the stock of Advanced Micro Devices (AMD). 10 years ago, folks were paying $10/share and getting around $1 of earnings from it. A P/E ratio of 10. Today, folks are paying $48/share and getting only $0.19 pf earnings for a P/E ratio of 255… This should astonish you, but it probably doesn’t. This would be like paying $25 for something that used to cost $1, say a pack of gum or a candy bar. It is truly amazing.
This is where all the inflation is going from the central banks of the world printing currency and playing with the price of money (in the form of manipulating money supply and interest rates). While the prices at the grocery store are not going up as fast as AMD stock, the portion sizes are shrinking. All the price inflation is showing up in asset prices like stocks, real estate and art.
The unfortunate part of this is that the only way to benefit from asset-inflation is to own assets before and while they are inflating… and many people simply could not afford to buy stocks or homes when they needed to, or even still today. They can’t afford it because wages (in real terms) haven’t gone up for basically 40-50 years if you measure in gold. For additional perspective, the average worker in the USA must put in 126 hours to buy 1 share of the S&P 500. In the 1980’s it took less than 20 hours.
So, things are weird out there.
Even Warren Buffet is taking heat for sitting on his cash hoard which now stands at $128 Billion. There are headlines out there like “Has Warren Buffett Lost His Touch?” Some would argue that he has. Others would point to times in the past where the same basic headline was written. In 2019, Berkshire Hathaway (BRK/B) underperformed the market by around 12% - with larger drawdowns than the overall market in May and again in August. Here is chart showing BRK/B vs. the S&P 500 (SPX) for the year 2019. The SPX is the purple line.
SOURCE: Thinkorswim
The last time I know of this happening was when Berkshire underperformed the Nasdaq by nearly 150% during the last stages of the dotcom bubble and Buffett was one of the only investors who resisted the urge to invest in eyeballs in favor of things he understood. The December 27, 1999 cover of Barron’s Magazine ran the title “A Lion in Winter“ and a lead article titled “What’s Wrong Warren?”
Today, I think what Buffett doesn’t understand is why people are willing to pay so much for so little. I can’t know for sure but based on all the things he has said over the years it would appear that he is being fearful while others are being greedy. He is waiting for the blood to be running in the streets.
When that time comes, he will buy. Until then, he will wait – and probably not really worry too much about the nonsensical articles being written by the Wall Street Machine, or the market getting away from him. The market tends to reward those who patiently sit on their cash.
I feel similarly.
For 2019, our models did their jobs well. Across the board, our stock picks beat their benchmark, our bond picks beat their benchmark(s) and out alternative investments were in-line with their benchmark. Like Buffet in 1999 and 2019, we left some money on the table by choosing to hold a little extra cash and not playing the market’s game. Overall, for grades, I give the Appreciation Strategy a “B”, the Income Strategy an “A-” and the Tax-Free Income Strategy an “A+”. We have made the necessary modifications to get the Appreciation Strategy into the A’s for 2020.
Overall, 2019 was a great year and exceeded our most optimistic expectations. I am optimistic about the market continuing to produce strong returns in 2020. Market crashes are rare, money is cheap if not free, and people are willing and able to pay huge premiums for small earnings. None of it will end well, but that is true of each bull market.
I am starting to feel euphoria creep back into the market, though. It seems like no matter how bad the news gets about trade wars, real wars, negative yields, massive homelessness, the market just keeps going up. As irrational as it may be to pay double or triple for the same (or even lower) earnings as 10 years ago, the markets can stay irrational for a lot longer than any rational person thinks possible.
And so, we keep buying when we have an edge and we keep selling when we hit our predetermined stops. These rules have served us well in all market cycles and I see no reason that the next cycle will be any different. We can’t know what the future holds – but we do know how we will exit our positions when the time comes, and we won’t be trying to figure it out on the fly.
OK, so, just for fun… let’s do some S&P 500 year-end 2020 predictions! Since I already gave mine on 12/31/19 (before we started dropping bombs in the middle east) my target for the index at the end of the year is 3,850 (a 19% gain for the year). Ken guessed 3,547, Jacob went with 3,485 and Olivia is at 3,501.
Send us your predictions and whoever is closest at the end of the year will win something awesome… TBD.
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisors
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