This is the Q3 commentary of Chuck Akre of Akre Capital Management.
I have just spend two days in New York attending a value investing conference at which some very smart folks separately argued for a reasonably robust economic and stock market environment while others argued for a decidedly more austere scenario. Here's what I know. The U.S. has an unsustainably high level of government debt, which by some estimates in 2025 will require 100% of government income (revenue) just to pay the interest on it. This is not workable! At the same time, a number of economic indicators, such as railcar loadings, clearly point to a steady pickup in industrial activity. Finally, while unemployment remains devastatingly high, businesses lack the confidence to make new investments in people, despite having record levels of cash. Against this backdrop, several of the speakers argued that stock valuations were as cheap as any time in the last 40 years, and others argued that on an inflationadjusted basis, valuations are currently very high.
All of us are faced with the dilemma of how to position ourselves for whatever comes our way. Will we encounter further deflation as interest rates go to zero, or perhaps even negative, while the Fed maneuvers to stimulate growth through quantitative easing (QE)? Or will we be faced with rapidly rising interest rates accompanied perhaps by rising inflation as the Fed scrambles to devalue the dollar in order to be able to pay back all of the U.S. borrowings? Just today I learned that the largest owner of U. S. treasury debt is no longer China, but is instead the U.S. Federal Reserve Bank. It makes my head swim.
Unlike the fall of two years ago, we are not now faced with the immediacy of the calamitous situation where investment banks and commercial banks were collapsing all around us. But perhaps today we face a much larger issue than the frightening experience of 2008. This is of course, 'how do we stabilize and accommodate all the competing demands for dollars which are not available?' This is broadly played out as individual households struggle to pay all their bills, and counties and cities and states also struggle with the exact same issues of how to pay all their obligations as they come due. Finally at the creditors, nor our bankers, nor our laws will allow us to individually carry on like the Federal government. We must pay our bills or face the immediate consequences.
One of my takeaways from the 2008 experience was that I felt a need to better integrate my 'world view' with my individual stock selection and portfolio construction, so as to try to be a better steward of the capital entrusted to me. This causes me to recall Buffett's two rules of investing: 1) don't lose money; and 2) don't forget the first rule. On the surface of it, the discussion above might reasonably leave an investor with an unusual level of uncertainty. The data is confusing, and the outcome is in fact unknowable. Therefore, in the face of these perplexing issues, we choose to hold more cash than usual, as we have done for nearly two years. One outcome of this is that in a robust market, our portfolios will likely do less well than the broader market. But we view this as a short term phenomenon. In addition, we are trying to make sure that our investments are not likely to be negatively affected by the current difficult environment dominated by the 'constrained consumer' nor by any of the scenarios which we may face soon, whether it be inflationary or deflationary. Our firm belief is that a concentrated portfolio of superior business characterized by high returns on the owner's capital, run by managers with equal parts of skill and integrity where there also exists an opportunity to reinvest all the excess capital to duplicate the high returns already being earned, will likely lead to an outcome we characterize as 'better than average with a below average level of risk.' Just maybe this uncertainty is not all that unusual, as again, Buffett reminds us: 'recall that the future is never certain, and that uncertainty is actually the friend of the buyer of long term values.' This all falls under the heading of 'risk management,' a primary focus of our job with your assets.
We are often asked about owning gold and bonds. As to gold we suggest that it is viewed as a 'defense' against political instability, fiat currencies, and general levels of uncertainty and anxiety. We know many who believe that it is an essential holding in light of the current situation in the U.S. and beyond. We don't personally own any today, but absolutely reserve the right to change our mind. As to owning bonds, we conclude that owning anything with a maturity longer than a few years is pure lunacy. We believe that two years is a proper target, and recognize that the return prospects from same are dismal today. Our record of correctly predicting the direction of interest rates is abysmal, so you may want to bear that in mind as you think about what to do. In lieu of bonds we do favor a few dividend paying issues where an investor desires to generate income which is not in fact a capital gain.
As always, we delight in our conversations with you, and look forward to them. Please be sure that we understand fully your true financial needs relating to these assets, as well as any concerns you may have in general about the market and the economy. After the horse has fled the barn, closing the door is of little use.
The link to the original file.
I have just spend two days in New York attending a value investing conference at which some very smart folks separately argued for a reasonably robust economic and stock market environment while others argued for a decidedly more austere scenario. Here's what I know. The U.S. has an unsustainably high level of government debt, which by some estimates in 2025 will require 100% of government income (revenue) just to pay the interest on it. This is not workable! At the same time, a number of economic indicators, such as railcar loadings, clearly point to a steady pickup in industrial activity. Finally, while unemployment remains devastatingly high, businesses lack the confidence to make new investments in people, despite having record levels of cash. Against this backdrop, several of the speakers argued that stock valuations were as cheap as any time in the last 40 years, and others argued that on an inflationadjusted basis, valuations are currently very high.
All of us are faced with the dilemma of how to position ourselves for whatever comes our way. Will we encounter further deflation as interest rates go to zero, or perhaps even negative, while the Fed maneuvers to stimulate growth through quantitative easing (QE)? Or will we be faced with rapidly rising interest rates accompanied perhaps by rising inflation as the Fed scrambles to devalue the dollar in order to be able to pay back all of the U.S. borrowings? Just today I learned that the largest owner of U. S. treasury debt is no longer China, but is instead the U.S. Federal Reserve Bank. It makes my head swim.
Unlike the fall of two years ago, we are not now faced with the immediacy of the calamitous situation where investment banks and commercial banks were collapsing all around us. But perhaps today we face a much larger issue than the frightening experience of 2008. This is of course, 'how do we stabilize and accommodate all the competing demands for dollars which are not available?' This is broadly played out as individual households struggle to pay all their bills, and counties and cities and states also struggle with the exact same issues of how to pay all their obligations as they come due. Finally at the creditors, nor our bankers, nor our laws will allow us to individually carry on like the Federal government. We must pay our bills or face the immediate consequences.
One of my takeaways from the 2008 experience was that I felt a need to better integrate my 'world view' with my individual stock selection and portfolio construction, so as to try to be a better steward of the capital entrusted to me. This causes me to recall Buffett's two rules of investing: 1) don't lose money; and 2) don't forget the first rule. On the surface of it, the discussion above might reasonably leave an investor with an unusual level of uncertainty. The data is confusing, and the outcome is in fact unknowable. Therefore, in the face of these perplexing issues, we choose to hold more cash than usual, as we have done for nearly two years. One outcome of this is that in a robust market, our portfolios will likely do less well than the broader market. But we view this as a short term phenomenon. In addition, we are trying to make sure that our investments are not likely to be negatively affected by the current difficult environment dominated by the 'constrained consumer' nor by any of the scenarios which we may face soon, whether it be inflationary or deflationary. Our firm belief is that a concentrated portfolio of superior business characterized by high returns on the owner's capital, run by managers with equal parts of skill and integrity where there also exists an opportunity to reinvest all the excess capital to duplicate the high returns already being earned, will likely lead to an outcome we characterize as 'better than average with a below average level of risk.' Just maybe this uncertainty is not all that unusual, as again, Buffett reminds us: 'recall that the future is never certain, and that uncertainty is actually the friend of the buyer of long term values.' This all falls under the heading of 'risk management,' a primary focus of our job with your assets.
We are often asked about owning gold and bonds. As to gold we suggest that it is viewed as a 'defense' against political instability, fiat currencies, and general levels of uncertainty and anxiety. We know many who believe that it is an essential holding in light of the current situation in the U.S. and beyond. We don't personally own any today, but absolutely reserve the right to change our mind. As to owning bonds, we conclude that owning anything with a maturity longer than a few years is pure lunacy. We believe that two years is a proper target, and recognize that the return prospects from same are dismal today. Our record of correctly predicting the direction of interest rates is abysmal, so you may want to bear that in mind as you think about what to do. In lieu of bonds we do favor a few dividend paying issues where an investor desires to generate income which is not in fact a capital gain.
As always, we delight in our conversations with you, and look forward to them. Please be sure that we understand fully your true financial needs relating to these assets, as well as any concerns you may have in general about the market and the economy. After the horse has fled the barn, closing the door is of little use.
The link to the original file.
