<March 28, 2024>
When it comes to basketball, I’ve always been on the B-team. I never made varsity but was a pretty good intramurals player. My B-team experience spans from childhood to today. In my 30’s I played in a local YMCA league. There were three levels—A, B, and C. If it was B, it was for me! During one of our games a fight broke out and the benches cleared. I couldn’t believe it. It wasn’t like it was the NBA or an important game! I tried to break up the fight and reduce tensions by yelling, “It’s the B-League!”
Currently I play in our church’s 50+ men’s basketball league, also known as “old man basketball”. It’s more of a get-together than a league, but if it was classified by skill level, it would likely be considered a B-league. I joined in my 40’s as the league was suffering from too many injuries and too few players. Over the past 10 years it’s been a weekly routine I enjoy considerably.
One of the unfortunate things about playing old man basketball is we occasionally lose players, usually to injury but sometimes to age and even death. We lost a good one last week to cancer. His name was Dan. Dan was a great player and teammate. He was one of the league’s best three-point shooters and a solid point guard. He was more talented than most of us but shared the ball and included every teammate regardless of skill level. One night I was in a slump and couldn’t hit a shot. I was laying brick after brick. Dan encouraged me to keep shooting and continued to pass me the ball. With the game on the line, Dan threw me the ball and I hit a game winning three-point shot. Dan walked over with a big smile, gave me a high-five, and said, “told you.” And that’s how I’ll remember Dan. A believer that never gave up on anyone.
Believing in someone or something when circumstances promote doubt isn’t easy. The current investment environment has many valuation-based investors questioning their long-held beliefs and disciplines. The popularity of passive investing, trillions of quantitative easing, and an overly accommodative Federal Reserve have pushed prices significantly higher since the cycle began in 2009. Regardless of valuations, inflation, and the unsustainability of the drivers of the current cycle, equities appear determined to continue their rise. It’s tempting to set aside investment rules, change stripes, and participate in one of the most profitable and carefree cycles in the history of the stock market.
While there was tremendous value in the earlier stages of the cycle, and pockets of value throughout, we believe our opportunity set has rarely been more overvalued. Nevertheless, given the strength and persistence of the current cycle, many investors are giving up on valuation as their guiding light when allocating capital. Actively managed value-based strategies are being replaced with price-insensitive passive funds that are often concentrated in many of the best performing and most expensive stocks.
While it saddens us to see capital give up on time-tested valuation disciplines, we’re empathetic to those who feel pressured to keep up with sharply rising benchmarks. In effect, it’s not an investment decision but a business decision, and response to a market cycle that isn’t being allowed to fail and appears invincible. For many investors, this time really does look and feel different.
Although some things have changed this cycle, most things have not. Human nature remains the same. Greed, envy, and the powerful forces of groupthink are stronger than ever. Confidence in the Federal Reserve and its ability to protect investors from overpaying hasn’t changed. Easy monetary policies have again led to significant asset inflation and credit growth, artificially boosting spending and corporate profits. Fed policies have also enabled the government to significantly increase debt and fiscal deficits. Wealth inequality is soaring again. Risk assets are being priced as if the economy and markets are no longer cyclical. We even have another housing bubble this cycle with millions of Americans being priced out of the market. Lastly, examples of overheated speculation are numerous, with the return of day trading and a boom in short-term stock options. No, things are not different this time. It’s all very similar to past bubble cycles led by asymmetrical monetary policy, debt creation, and the extrapolation of the unsustainable.
Valuation-driven investment disciplines have been the B-Team of the current market cycle. In today’s market, carefully considering the value of a stock may feel more like a hinderance than an investment discipline. It’s tempting to throw in the towel and change teams. Although switching may be comforting and possibly rewarding in the near-term, we remain committed to our valuation-based discipline and assumption that one thing will never change—the cyclicality of human behavior. As such, we do not believe the current market and profit cycles are perpetual. Like past cycles, we expect many of the trends inflating profits and asset prices will revert and be proven unsustainable. In basketball terms, this game (cycle) isn’t over. We plan to keep shooting, finish the game, and are prepared for the final shot. Instead of giving up, we believe valuations matter more today than ever.
Eric Cinnamond
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Definitions:
Wilshire 5000: a market-capitalization-weighted index of the market value of all American stocks actively traded in the United States.
Market Cap to GDP: a ratio used to determine whether an overall market is undervalued or overvalued compared to a historical average. The ratio compares the value of all stocks at an aggregate level to the value of the country's total output.
All Transaction House Price Index: a comprehensive collection of publicly available house price indexes that measure changes in single-family home values based on data that extend back to the mid-1970s from all 50 states and over 400 American cities. Also known as the FHFA HPI.