Heightened concerns about military conflict between Russia and Ukraine have rattled markets the past two weeks. Just today, the S&P 500 was down 2.12% and the Nasdaq was down 2.88%. The 30 second version is that Russia wants assurances that Ukraine won’t join NATO and has long-term cultural affinity with the territory. Ukraine wants its autonomy and is of course still upset from Russia’s territorial gains in Crimea from a few years ago. There would be steep economic losses if Russia chose to invade, and Ukraine’s military with assistance from its allies, would also likely impose steep military losses, but of course Russia has the advantage there. I don’t believe a truly serious conflict inclusive of the capital of Ukraine, Kiev, is very likely although of course we want to keep tabs on escalation. I wouldn’t let the stress of it eat you up, as the long-term impacts on markets aren’t likely to be too severe. Inflation and valuations are more significant factors in that regard.
The number of stocks that have declined by 75% or more from their highs continues to increase. We have seen formerly glamour stocks such as Palantir, DoorDash, Roku, and Sea Limited just get absolutely crushed. Many of these once high-flying technology companies are becoming more attractive, although, they still aren’t at our purchasing targets. However, we’ve been able to capitalize on this immense volatility by selling lucrative options very far out of the money, at prices where we would be more than happy to own the stocks for the long-term on many beat up names.
Some of our larger financial stock investments such as AGO and AIG have been making or remaining near their 52-week highs, which is very encouraging. More importantly, they are growing business intrinsic value at rapid rates, beyond the share price appreciation. Stocks such as Citigroup represent just a blatantly obvious undervaluation, trading at a massive discount to any conservative estimate of liquidation value. Fortunately, the bank is making money at an attractive rate, and is able to buy back stock at these discounted prices, enhancing intrinsic value per share. I’d expect major upside on some of these names.
Other winners have been the hated tobacco industry, where we’ve done really well with British Tobacco and Altria. These companies pay huge dividends, have consistent cash flows even in recessionary economies, and have traded at cheap valuations. Energy names such as Exxon, Enterprise Products Partners, and Kinder Morgan have performed really well as energy prices have risen. We still believe that there is a lot of long-term upside across the sector, but we want to be very disciplined on the prices we are paying and keep exposures in line.
Keep in mind, the major indices still aren’t in a technical bear market, as defined by a 20% drawdown. I’m pleased that we have been able to protect and grow capital in this challenging environment, but I think those simply looking to continue buying every dip might see different results than over the last few years. Sky high inflation and the prospect of higher rates/less fiscal stimulus, will likely continue to pressure valuation multiples. This isn’t a 3 month issue, this could easily be a 5-year to 10-year issue as we’ve seen in previous market cycles. If that indeed is the case, we should see value investing thrive, bolstered substantially by our income-generating options strategies. We have really exiting and attractive opportunities to invest in this volatile environment so I’m very optimistic. I’d expect to see a good percentage of our returns occurring later in the year as we get closer to when most of our options expire, which isn’t uncommon for our strategy, particularly with how we are positioning things. Hopefully you are noticing that on big down days, we tend to be down far less and often have actually been up. This impact should be even more noticeable as time goes by in my opinion, when volatility becomes less of a factor on our existing options pricing.