“Successful Investing takes time, discipline and patience. No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant.”- Warren Buffett
The bull market that started in March of 2009 is now on the verge of its 6th and a half year, making it one of the longest bull markets in history. Meanwhile, U.S. GDP growth has been the slowest in any recovery and the situation is even worse in Europe. Despite the age of this bull market, we’ve yet to see the overwhelming optimism that has marked previous bubbles. Instead, due to truly unprecedented Central Bank policies, interest rates have literally never been lower. There is over $13 trillion dollars trading at negative yields, guaranteeing losses if held to maturity. Nobody would invest in this type of security if they were incredibly optimistic about the future like we have seen in the truly speculative market tops throughout history. Low interest rates have a reverse-gravitational impact on asset prices, as prices rise as the cost of funds decline. Market participants are balancing the need for yield and a lack of optimism, to drive prices of seemingly “conservative” investments to clearly absurd valuations; while other economically sensitive and out of favor businesses are being thrown out with the bathwater.
It is in this environment that we at T&T Capital Management have taken a truly contrarian stand. After witnessing the Technology bubble bursting in 2000 and the Housing Crisis in 2008, I told myself that I would not behave like a sheep in the midst of obvious madness. Madness is the only way to describe investing in government bonds 10 years out with negative yields. The same market forces creating this phenomenon have driven the valuations of sectors such as Consumer Staples, Utilities and Telecoms to the highest in decades. Not being in these slow-growth sectors at stratospheric valuations, have hurt our performance relative to indexes where they have a heavy and growing presence. My belief is that sacrificing short-term performance to avoid the eventual downfall, and instead positioning our portfolios in the great opportunities in this market outside these sectors over the long-term, is well worth the price. Similarly, not being largely exposed to technology in the late 1990s, or housing in the mid-2000s, would have hurt performance for a time, but the benefits more than made up for it over the long-term.
Many of our clients at TTCM are retirees or are near retirement. In just about any financial plan, the interest rates that are used to forecast if their nest eggs would last long enough in retirement were multiples higher than they are currently. The idea of shifting the majority of one’s portfolio to bonds as they reach this milestone to avoid the volatility of the market made inherent sense, but today it makes little. The math is very simple, there is no possible way bonds will return the same amounts that they have over the last 30 years. Interest rates will inevitably go up and most bonds and bond funds will lose staggering amounts of money.
Few money managers will get fired for recommending Procter & Gamble, Disney, or Pepsi. In today’s age, even fewer would get fired for offering index funds. Recommending these assets in what is an obviously expensive market is not “conservative,” if the risks you are concerned with is the risk of losing one’s clients’ money. This recommendation is conservative in not putting one’s “reputation” at risk because it is the consensus, hence the sheep’s approach to investing. Remember that most financial advisors are simply asset allocators, and their primary role is raising assets. This means that the actual investing process is outsourced completely. At TTCM, our core focus in on actually making investment decisions and our growth is through referrals and through organic marketing via our content distribution.
Conversely to most market participants, our value approach has led us to concentrated positions in stocks trading at historically low valuations, many of which are in the financial sector. The negative stigma from the Financial Crisis has created distortive pricing, where one can buy the finest institutions in the world for 30-40% discounts to a conservative metric of liquidation value. These companies are performing extremely well financially, and just about each quarter are growing their intrinsic values at attractive rates despite the low rate environment, which reduces earnings from what they could be. Because these institutions are now overly capitalized, they are finally in positions to aggressively buy back stock and raise their dividends. Since valuations are so cheap, these companies are able to increase intrinsic value at a faster rate of return than normal, akin to buying dollars for 70 cents. These types of buybacks are very different than other companies that are issuing debt and paying 25 times earnings to buy back their stock, as there are no other catalysts to improve earnings per share.
For the great investment banks such as Goldman Sachs and Morgan Stanley before they were publicly traded, one benefit of becoming a partner was the opportunity to buy stock at book value. High quality banks and insurance companies are compounding machines, capable of churning out increasing profits and dividends over very long-term periods. We are not targeting 10 or 20% moves in these stocks. Buying so cheaply has positioned us for 5-7 years of double digit returns, even if these companies just trade at the same discount to their growing book values as they currently trade at. If valuations revert towards the mean and we get a little better interest rate environment, we can make 2-3 times our money over a 6-10-year period. Just as importantly, we are avoiding the parts of the market that are likely to lead to many years of underperformance.
This article is long enough that we don’t even need to delve deeply into the conservative options strategies such as covered calls and selling cash-secured puts to generate income and to manufacture cheaper entry-prices into stocks that we want to own. This allows us to increase our portfolios’ cash flow dramatically over time. The negative to being concentrated is also the benefit and we’ve seen that this year. The beginning of the year was terrible for financial stocks in particular, not because of problems in their business, but instead because of fears of recession that proved untrue. Since then we’ve seen a nice recovery but we still have very far to go to get anywhere close to intrinsic value offering incredible upside. We are not trying to mirror the S&P 500. We want to zig while others are zagging in a very dangerous direction. This is the strategy, which we believe positions us to profit when others are losing their shirts and our downside is far more limited due to the cheap prices that we are paying. That meets Buffett’s definition of investing and it isn’t a coincidence that he and other successful value investors are large shareholders in many of the same stocks that we own in size.
The reason for this and all our communication is that it is exactly what I’d want if my money were managed by somebody. We have and will always be true to our deep value discipline. Following the crowd in investing has just about always led to disastrous consequences, just when people feel most complacent. We are willing to look silly over the short-term to protect and grow our clients’ portfolios over the long-term. As always, if you have any questions or if I can assist in any way, please don’t hesitate to contact me at 805-886-8140!