Q4 Note & Commentary

By Jason Lesh, Managing Principal


2018 had a little bit of everything. The beginning of the year got off to a roaring start with the fresh excitement of the new tax law and corporate tax cuts. But the party was short lived and concern creeped in around both trade and monetary policy. By the end of the year, 90% of global assets had a negative return.

Our portfolios were down on the year as well but there is an incredibly important nuance to all of this: what part of the portfolio declined in value. We have been incredibly underweight in US stocks for quite some time because we just don’t like the amount of risk associated with low return expectations. And those low returns won't excite anybody or help achieve our client’s goals. For that reason, we have been focusing the long-term part of the portfolio on international and emerging markets while maintaining a fair amount of cash. As the markets declined, we continued our dividend reinvestments at cheaper prices.

The party has picked up again in early 2019. Through the end of February, accounts are up substantially. And while two months is almost meaningless, we continue to rest easy and feel great about how our short-term investments AND long-term investments are performing. We continue to welcome volatility in the markets as we know (and have demonstrated) that it benefits clients at the end of the day. The actual investments are real companies and we evaluate them as actual owners, ignoring the noise of what someone says they are worth on an hourly basis.

Speaking of this owner-like-mindset, our intern Alex Bridgeman has started a podcast which I invite you to follow as it is phenomenal! He regularly interviews investors, business owners and operators in his thirst to learn more about micro private equity and permanent capital.

Enjoy Nick’s commentary for a deeper understanding of our take on the market. And please do reach out to schedule a meeting if you would like our thoughts on your current plan and allocation as we would love the opportunity to help.

Wishing you all the best,

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By Nick Fisher, Portfolio Manager


2018 was a volatile year in the markets, which came at no surprise to us as we have been discussing the inflated valuations in the US stock market for some time. Clearly the corporate tax cuts benefited earnings in 2018 and therefore the stock market, but that’s a one-time event. What’s the next catalyst to propel earnings, and the market by extension? It’s certainly not easy monetary policy with the Fed currently in tightening mode, and it’s not global economic growth with the trade war weighing heavily.

Without a catalyst for higher earnings growth, the narrative justifying higher valuations is coming to an end. According to Deutsche Bank, 2018 was the worst year of asset returns since 1901 with more than 90% of global assets having a negative return. As Jeff Gundlach said on his conference call with investors in early January of this year, capital preservation should be everyone’s best investment idea right now.

Our portfolios did see some negative returns due to the long-term assets that we own having gone down in value. We expect this during a major market correction which will continue before the end of this cycle. We don’t see our current volatility as risk, but as new opportunities for reinvesting dividends and new capital at lower prices. Buy low, sell high.

We can focus on opportunities without fear since clients with near-term capital needs have much (if not all) set aside in conservative assets (which have not been volatile). Because of our asset allocation process, we have benefited in the past and will continue to benefit more in the future from market volatility.

What happened?

Volatility seemed to pick up steam at the start of October with the negative news around both trade and monetary policy. As a result, the risks of recession and asset re-pricing over the next 12-18 months have come to the forefront of market headlines.

In early October, an auto executive was quoted saying “Obviously, we will have to raise the prices of our cars,” in response to trade negotiations and requirements that manufacturers choose some higher cost locales. Shortly after, Jay Powell, the Federal Reserve Chair, was quoted saying, “We are a long way from neutral,” meaning rates are going substantially higher. It’s no surprise that these two ideas (higher prices and higher interest rates) really changed the market narrative from bullish to bearish.


A recession is becoming much more of a possibility, but the problem with recessions is you really don’t know when a recession will happen until you are in the middle of one. The likelihood that one arrives soon is fairly high and the NY Federal Reserve pegs the probability as meaningful. We need to go back to the mid-to-late 90’s to find a probability this high that was not followed by a recession.

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Several other “yellow” flags are beginning to show including lower consumer expectations, manufacturing, and industrial production and fewer mortgage applications.


Without a growth or earnings catalyst like the tax cuts in 2018, we have seen recent earnings expectations adjusted downward. Through the first 3 quarters of 2018, S&P 500 earnings were up 25.3%. (20%+ of that was due to the tax cuts) Now, 4th quarter earnings came in lower than the 16.3% analysts originally forecasted. Furthermore, according to Factset, 1st quarter 2019 earnings are expected to decline year-over year despite revenue growth over the same time period. I believe higher wages, interest rates and input costs are the prime culprits.

So what could stem the tide? At this point I see a few things that could prevent a recession. 1) Meaningful progress in the trade war could reverse a global slow-down, 2) Reversal of monetary policy at the risk of inflation pressures, or 3) An infrastructure-spending bill.

Unfortunately, I don’t see any of these options, except an end to the trade war, benefitting portfolios in a meaningful way long-term. Monetary policy and infrastructure spending will merely delay the inevitable crash and will do little to benefit 7-10 year returns.

Changing Tide

“When the tide goes out we’ll see who is swimming naked”

According to Jeffrey Gundlach (Doubleline CEO and our bond manager), corporate debt may be the worst place to be invested currently. Corporate debt, having fueled much of the earnings growth over the last 5 years, has never been higher. Gundlach estimates that there may be as much as $1.5T of investment grade corporate debt at risk of being downgraded to junk bond status. This could massively change the credit markets as a maturity bubble of refinancing begins with higher rates. With this risk in mind, we are extremely vigilant regarding the quality of balance sheets we are investing in.


Our portfolios are still relatively conservative. This reflects the fact that we don’t see a lot of bargains out there right now and assume there will be more volatility in the years ahead. We like the areas we are taking risks now, namely emerging markets, commodities and US companies run by great capital allocators with solid balance sheets. Speaking of great capital allocators, Berkshire Hathaway’s Warren Buffett was recently quoted in his annual letter to shareholders, “In the years ahead, we hope to move much of our excess liquidity [$112B or ~22% of equity capital] into businesses...The immediate prospects for that, however, are not good: Prices are sky-high for businesses possessing decent long-term prospects.”

There will come a time when we become more aggressive. The very nature of markets means that we miss some return at the top. Putting capital to work in the midst of corrections will mean that it will not be easy. Everything we can do now to prepare ourselves is helpful. We will stick with our process of buying $1 for .60 or less. Over the long-term this orientation to value pays off nicely, but investing is never a smooth, linear process. Helping our clients navigate this roller coaster is truly rewarding and a whole lot of fun. We are here to help and please reach out as we would love to hear from you.

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