“It’s remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” Charlie Munger
We honor the memory of Charlie Munger, legendary partner of Warren Buffett at Berkshire Hathaway, with one of his most famous quotes. Mr. Munger stressed the importance of consistency and logic, but also the importance of learning and being humble in face of the unknown.
No doubt, these elements helped him dearly in the many years next to the Oracle of Omaha, when markets gave and took away, when risk fell and rose, when rules and technology changed. The world of investing is simple and difficult simultaneously and it is up to us to make clarity and find discipline in a noisy context.
This year, markets felt unpredictable as they rose in the face of restrictive monetary policy, the economy was always one step away from a recession that never came, and bonds did not blossom until the very end of the year.
As we always do at this time, we will attempt to bring clarity knowing perfectly well that what the future will bring might be quite different from our expectations and yet we find value in the discipline of being prepared while recognizing the eventual need for flexibility and tactical changes.
We start with Fixed Income, an asset we liked for a while, which has started to bear fruit in the last quarter of 2023. In the previous five rate tightening cycles, the US Treasury 10-year yield peaked 3 months prior to the last hike and then it proceeded to fall by about 150 basis points (sources: JP Morgan). If we follow a similar pattern, we should have just about another 50-basis point reduction for the following months. A switch from money markets and short duration to intermediate duration would seem a good trade at this juncture.
As far as equity, while profits are still growing, we are a little more concerned. Not only, we still think a recession is more likely than not, but valuations are also a bit stretched and dispersed. The top ten stocks are 38% more expensive than the 25-year average while the rest of the SP500 is 14% more expensive. This occurs in a low volatility environment and volatility tends to be remarkably cyclical. This combination of factors makes us cautious and biased toward large caps, franchise owners and defensive plays. From a defensive and valuation perspective, we do like pharma. We are conscious that we liked the sector last year as well, a preference that eventually did not materialize in an outperformance. International equities continue to show better relative valuations compared to the US and now they may also benefit from a weakening dollar.
Alternative asset classes can be very helpful in an uncertain environment, and we feel they should be beneficial in 2024. Starting with the most traditional of the alternatives, Real Estate, we note its inflation hedging characteristic and the value correction that has endured since the first interest rate increase. We also note that while we do see opportunities in this sector, income and inflation protection, we also believe it is not a blanket solution. There are structural changes occurring in Commercial Real Estate which make sub-sector selection and an active approach paramount.
Hedge Funds should also be able to continue to provide attractive risk adjusted performance within very low correlation to the SP500. Private Equity may see a harder path ahead in the short term while retaining a strong advantage in the long term.
We also note that infrastructure investments should do well while also lowering portfolio volatility. A combination of a positive industrial policy backdrop, decent valuations and good income should earn this asset class a place in most portfolios.
Ultimately, we expect a year marked by some volatility that may be exacerbated by the political cycle and presidential election. Diversification and long-term horizon remain foundational elements in most portfolios.
As always, we would like to thank you for the renewed confidence in our work,
Youri Bujko
Davide Accomazzo