Summer is the time for picnics, outdoor fun, and high school reunions, but there’s also a lot of concern about what happened in the second quarter of 2022. Then there’s this…
“It’s great to see you Steve and oh, by the way, are my investments going to come back?”
This mostly comes from people who are not clients. I’d really like to tell them I have some special insight. I usually mention how investing is about the long run, and that returns from 12-18 months are not indicative of long-term success. I don’t give stock tips. Those are for clients only. But what I’d really like to say is, “I have no idea, because you’re not a client, and I don’t know what you own.”
Yes, a long-term view is an advantage for sure, but investment selection is more important today than at any other time in our lives. That’s because, for several investment classes, the party might be over for a very long time.
First, let’s look at some statistics about how the second quarter of 2022 went. Then we’ll dive into more detail.
For investors, the first half of 2022 was one of the worst since the 1970s. For those of you who remember (and yes I am one) — inflation, rising gas prices, and rising interest rates were the order of the day. And the markets did poorly too.
The major indexes have all lost money this year. The S&P 500, which measures the 500 largest and most traded stocks lost 20%. Even worse, the Nasdaq lost 30%.
Bonds proved a safe haven asset in the 1970s giving investors a cushion against loss as well as yield. However, that’s certainly not the case today. Bond returns were negative every month until May when most indexes eeked out a small return.
For the year so far, the S&P Investment grade corporate bond index (which is considered the highest quality asset) lost 13.05%. The High yield bond index performed even worse at -14.9%.
The classic 60-40 portfolio (60% stocks, 40% bonds) hyped by most investment firms was truly ugly, garnering a loss of just over 17% for the first half. When stocks go down so can bonds, especially if they are priced for perfection, or if you’re in the biggest asset bubble of our lifetimes, such as well, right now.
We’ve beat the 60-40 portfolio fallacy to death so I won’t elaborate more. You can go back and read my missives from last year as to why it will not suffice in this environment. In short, stocks and bonds can go down at the same time and by a lot.
Our hedge positions and fixed income alternatives are performing really well and should provide us not only protection but some cash when your neighbor has none left in his 401k. Let’s look further…
Bonds… no safe haven
If you read my newsletters you already know we exited the corporate and high-yield bond market several years ago. One investment that we added after much research was IVOL, which is a fixed-income vehicle that can profit in two ways:
1. If inflation is greater than expected, the fund will increase in value.
2. If the spread between higher risk bonds and lower risk bonds starts to widen, it will also increase in value.
We thought there was a chance that at least one or both of these situations would occur.
Since IVOL invests in US Treasuries instead of corporate bonds we also removed the risk of corporate defaults. Which in my view will increase, maybe even dramatically, going forward.
This has worked out pretty well so far. While IVOL hasn’t gained much this year, it has paid nearly 3% in dividends through the end of June. A positive return versus its competitors with double-digit losses. I would expect this outperformance to continue into the near future as yield spreads start to widen.
Insurance holdings update
At year-end, I focused on our insurance companies other than Berkshire Hathaway. Property Casualty insurance can be a great investment provided certain concepts are adhered to. Two of the best we own are Fairfax Financial and Markel. I’ve followed both for over 20 years.
Fairfax Financial stock tends to perform very well in down markets. In the 2008 market meltdown, Fairfax gained over 40% while the rest of the market lost half its value.
Markel is a specialty insurer in the same mold as Berkshire Hathaway. I attended their meetings in Omaha for 15 years before we bought the stock in 2019.
Fairfax is doing it again this year finishing the first half up 10%. Markel is up 8% so far in 2022. These stocks tend to grow with book value no matter what the stock markets do. My guess is both will grow their book values in the mid-teens from here. At that rate, the effects of compounding really kick in.
Amazon’s tumble is temporary
While investment losses hurt, it’s important to understand you can own a great asset (a great stock) and it can still go down in value. Sometimes a lot. Last year we added Amazon to our portfolios. The stock has been a casualty of the bursting asset bubble, losing 35% of its value this year. We view Amazon’s stock fall as temporary. Like all our investments, we know Amazon well and have done extensive analysis. In the opinion of well-known analyst Peter Keefe, Amazon’s cloud services business is worth the entire company’s market cap. At today’s price, that means you get the world’s biggest and most competitively advantageous retail business for free. Keefe sees 15-20% annual growth going forward for many years. We concur and are quite comfortable owning it in our personal portfolios as well as our clients’ portfolios.
Down markets hold plenty of opportunities
If you are younger (40 or below), down markets should excite you. It actually excites me, but for someone who is early in the investing process, down markets mean you’re buying cheaper assets. If my investments fall by half I would do all I could to add to my existing portfolio. Dollar-cost averaging every month gets the best results. Valuations and market fluctuations for the younger set don’t matter much. I wish I was 25 again and knew all this. I probably wouldn’t even be working still.
Believe me, if you’ve been investing since 1987 you’ve seen a market tumble or two or three. I can’t emphasize enough how important it is to stay the course and invest INTO and not out of these markets. Owning high-quality businesses over a long period of time is the only way to compound and beat inflation. Don’t run scared. Embrace it.
It happens over and over again. Investors loved Facebook at $350 a share a year ago but don’t want to own it today at $160. Has the value of FB/META fallen that much? Of course not. The market is fickle. The true value of that particular investment is well north of its stock price today.
So, are your investments coming back?
To our clients, I say of course. We’ve witnessed this rodeo before. I know our investments inside and out and have great confidence in them. What I don’t know is the timeline. The stock market is a leading indicator of when the economy will begin to improve.
If you’re NOT a client I would say “Your investments might recover. Or they might not.” Markets do recover but never in the same way as before or the way you think.
We’re exiting a great asset bubble. Getting through the next 18-24 months is crucial. Doing the wrong thing here will bring regrets later. I’ve had old friends and clients say, “You were right in 1999 or 2008. I wish I would have listened.” Investing is a marathon, not a race.
Today some of the best companies in America have lost 50-70% of their value. Many are priced for zero growth going forward. This is simply illogical. Remember, investor sentiment will continue to drive markets in the short term but in the long term it’s fundamentals that drive returns. What really counts is owning competitively advantaged businesses. Examples such as Amazon, Meta, and Berkshire will continue to compound proving to be outstanding investments.
A few weeks ago, analyst Alex Haissel of Redburn Securities, a London boutique firm, initiated a buy on Amazon. His detailed analysis puts the value of Amazon’s Web Services business or AWS at 3 times the current stock price. This would imply a less than zero value on Amazon’s retail business, which arguably is the world’s most cost-advantaged business. This mirrors my write-up of last month. His value seems high, but if it’s directionally correct, Amazon is worth more than twice its current stock price.
Your losses, while temporary in nature, can still hurt. I understand.
For our older clients, safety features have been added to their accounts. I discussed these well before the markets went south. The result is many of our retired clients have experienced less volatility and less downside. 5-12% drawdowns are typical for these clients. (Versus the market loss of 20% or a 60-40 portfolio that’s down 17%.) So it’s clear that our hedges have worked very well.
For our younger investors, you have experienced greater temporary losses. Over time these losses will reverse and the great businesses that you own will compound. I believe that once we’re through this economic challenge (which could take 12-18 months), these investments will appreciate at a much greater rate than the market as a whole.
- Markets are down in the second quarter of 2022 and can continue to lose value in the short term.
- The largest asset bubble in history has busted and it will take time to work through.
- Stocks and bonds can continue to struggle but that only means values will be more compelling.
- Many of America’s great businesses are fantastic values today and will return double digits.
- It might take some time to work through this bubble. Stay patient and understand the winners play the long game.
My Personal Positions
As of June 30, 2022, my largest personal holdings are the same as many of yours:
Berkshire Hathaway, Triad Business Bank, Amazon, Occidental Petroleum warrants, and Meta Platforms.
If you have any questions or would like to make an appointment to speak with us, give us a call at 217-824-4211. We’ll be happy to speak with you!