The first half of 2020 was one for the record books. Every period has something happen that hasn’t happened before. But this time was more poignant. Historians will write about the global economy’s near-death experience in March 2020, when credit markets stopped flowing for a few days in all industries. Some money managers I talked with in mid-March were considering career options. It made just about every other market panic seem petty. With the rapid rebound in stock indices, anxiety levels have returned to normal. Investors seem to have already forgotten how close we came to the brink.
Canterbury’s core portfolio returned +21.4% in the first half of 2020, while the S&P 500 total return index declined by -3.1% and the All-World Index (ACWI) declined by -6.2%. Our recent performance, while satisfying, should not be extrapolated forward. As much as I firmly believe we will do well over the long-term, I similarly believe short-term ups and downs are inevitable and should be embraced. We should think of it as a mental game. When prices rise or fall, am I able to keep a calm mind? Am I able to say, in a near-Stoic fashion: “I’ve made the decision. Let the chips fall where they may.” or “When the fundamentals shift, I adapt. When prices vary, I remain unmoved.” A majority of results are produced in a minority of periods and investments. Hence, investors should not make performance assessments without giving far more weight to how something behaves at the extremes. Building wealth takes time. Losing it doesn’t. Reiterating what I’ve said before, returns are lumpy and, when they come, often do so swiftly. It looks like nothing much is happening for a while, then it all happens in a flash. Noise is all the supposed happenings that are really nothings in between the actual happenings.
I’ll take “Worthless equity” Alex, for $5
Among more notable recent events, the stock price of bankrupt Hertz was pushed up, apparently by retail/Robinhood traders, before nearly getting away with the issuance of worthless equity (which would have been wiped out in bankruptcy proceedings). JC Penney similarly and inexplicably rose after declaring bankruptcy. Rumors about the value of their real estate circulated on message boards to folks unaware of what happens when a company states their insolvency. In speculative endeavors, inevitably someone gets wiped out. They call these fellows bagholders. Similarly, meteoric and speculative rises—like that of Nikola or Virgin Galactic—lure novice traders. Unsuspecting bagholders presume each new, exciting enterprise (or bankruptcy?) will come out a winner. A few of these companies will go on to glory. Most fade into the oblivion.
There’s lots of talk about record high valuations. In just about every aspect this is true. KKR recently reported the U.S. market has been cheaper 90% to 99% of the time according to nearly every valuation metric. Every metric except for interest rates. As I wrote last summer, assuming a company’s cash flows will exist into the future, cost of capital is the most critical driver of values. Any appraisal of the market’s expensiveness that doesn’t explicitly consider interest rates and their corresponding effect on valuation misses a fundamental aspect of investing. Multiples like market cap to GDP and price-to-earnings are one of many symptoms of underlying conditions. They do not provide context or cause.
The challenge (and opportunity) today is choosing businesses that will be around in a few years. Per the KKR report, 41% of retail, restaurant, beauty, and fitness businesses have permanently closed. A hotel industry periodical I receive stated revenue per room is expected decline 52% nationally and 60-70% in many major cities. Hotels directly accounted for $40 billion in state and local tax revenue in 2019. Notably, this gets to the spillover effect: x effects y which impacts z. I don’t see how anyone could get bored in this environment. I’ve spent a great deal of time reading company filings and reports recently in anticipation of buying opportunities. Though these opportunities have not yet materialized, I remain optimistic that, in time, openings to purchase great firms at attractive prices will reemerge.
Some have mentioned how much of the S&P 500’s market cap is made up by the largest five or ten companies as a risk factor for equities. Most of the returns have been generated from a few firms (power laws in action!). I’d submit it is not out of the ordinary historically. It could become dangerous if valuations are pushed too far, which has already occurred in various parts of the market. At present, the mega-cap tech names are for the most part not wildly overvalued (though I am not loading up on Microsoft or Apple at current levels).
Two of our core investments, Facebook and Amazon are both remarkably cash generative, dominant in their respective markets, and run by founders with sizable ownership positions. (Might I also add, whatever the media’s hatred for them, Zuckerberg and Bezos have proven to be highly astute operators and visionaries. Titans of industry are often demonized in their time. Stepping outside prevailing narratives, one might ask if they’d have liked to have been invested alongside Carnegie and Rockefeller.) Each has performed well year-to-date but in my estimation are still underpriced. I could imagine a scenario where they are driven still higher by both valuation-focused investors and speculating traders. Then at the point where valuations are stretched, others come in to augment the rise. This is where the danger lies.
Who’s printing money?
Muted inflation may be in jeopardy given the government has been sending checks of late. Discretionary income increased from February to early summer. Regarding inflation, sending people money would do the trick once it reached critical mass. With interest rates at zero few are yet worried about rates rising due to a pickup in inflation, creating a double whammy for most assets. Gold and silver markets have quickly priced-in a devaluation of the currency. But the entire issue is more complicated than often presented. As much as people talk about “money printing,” it is of interest to note that much of that currency hasn’t reached the real economy. Hugh Hendry pointed out that credit extended by banks has grown modestly in recent years relative to the Fed’s balance sheet. This could be another downward force on inflation in addition to more structural deflationary pressures like demographics and technological advances.
Know your assets
Contrary to expert opinion, the prosperous do not diversify their way to wealth. Rather, wealth is created via the founding, running, and/or acquisition of great businesses. In all cases (that I’ve seen), concentrated ownership is involved. The bulk of returns—for great investors and entrepreneurs—comes from a minority of decisions; a small number of outstanding commercial enterprises, allocated to wisely.
You may know John D. Rockefeller as the richest person to have ever lived. What you probably didn’t know is how inadequate he was as an investor. Rockefeller was a bold businessman who emphasized honesty and efficiency, but he was far too trusting of friends and overly distrusting of those outside his (Baptist) circle. He entrusted millions with two church-going friends who, it turned out, made all manner of land and industrial investments without seeing much financial information or what they were buying. There was no record of fraudulent intent, only ineptitude leading to severe losses. After this had gone on for some time, the ruse was detected by Frederick Gates, who would later head the Rockefeller family office and be considered by Rockefeller as the greatest business mind he’d ever known. The damage though had been done.
Most of Rockefeller’s wealth remained in Standard Oil stock. The terrible investments didn’t impair his wealth, but it did change the way he thought about investing outside The Standard. He eventually did very well in stock and other investments with Gates at the helm. One wonders how long it might have gone on without Gates discovery. The question pertinent to all investors is, if John D. Rockefeller had to learn this lesson the hard way, what about those who can’t afford to lose millions? Here I would submit the only reliable method of allocating capital—by either business operators or investment managers—is to know what one is allocating capital to. This seemingly obvious statement gets to another problem with indexing that has become increasingly apparent in the wake of looming economic destruction.
Regardless of its proponents’ intentions, indexing subtly slips the bag into the hands of the citizenry, creating an ever-ready supply of fresh bagholders unaware they’re holding any bag at all. Indexing is only beneficial insofar as it gives one an arbitrary way to invest in a certain sector or country’s economy. But the use of the 20th century as a proxy for what the U.S. economy will produce now and forevermore is naïve and dangerous. Bear in mind this isn’t the first time the “experts” have nudged the general population to some set-it-and-forget-it scheme. From railroad stocks in the latter half of the 19th century to real estate and mutual funds in the mid-2000’s, there exists a common historical theme of the general populous somehow getting the raw end of the stick. Granted, many times the damage is done by their own speculative fervor. Just as often it is caused by some grand narrative taking hold — some newly discovered absolute truth.
None of this refutes the basic argument for indexing—that the average investor cannot expect to select decent investment managers, hence should accept market returns. But they should understand they are getting both the good and bad, and they should not expect great wealth to be generated via the approach.
Other points of interest
We want to welcome Upama Roy onboard as our very first intern. She previously worked at JP Morgan in Mumbai and New York. Upama completed her MBA at Cornell in the spring and received her M.S. in statistics from the Indian Statistical Institute in 2009.
Regarding holdings, I have written detailed reports of three of our top holdings. They can be found at canterburytg.com/letters.
Wishing you a wonderful second half of 2020.
All the best,
B. Chase Chandler
Founder & Chief Investment Officer
 As of 14-July-2020. https://www.kkr.com/global-perspectives/publications/the-end-of-the-beginning  According to data gathered from Yelp.
 https://www.kkr.com/global-perspectives/publications/the-end-of-the-beginning  In the context of “strategic asset allocation.”
 As told in “Titan”, Ron Chernow’s brilliantly written biography of John D. Rockefeller
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