A preview of our second investor letter for 2022. Click here to read the full letter.
“In order to outperform, by definition, you have to depart from the crowd. You have to hold a different position. And you have to have resolve to do it. And, you know, it can’t be easy… There's nothing you can do in the interest of being above average that does not expose you to the risk of being below average… you have to be willing to be wrong.”
Howard Marks, Talks at GS – June 2022
“The worst thing you can do is invest in companies you know nothing about. Unfortunately, buying stocks on ignorance is still a popular American pastime.”
“Every man takes the limits of his own field of vision for the limits of the world.”
“The one important thing I’ve learned over the years is the difference between taking one’s work seriously and one’s self seriously. The first is imperative, the second is disastrous.”
Dear friends and valued investors,
This letter is coming about a month late. It wouldn’t be a fib to tell you I’ve been unusually wrapped up the past two months, having attended CNBC’s Delivering Alpha conference and the Wolfram Technology Conference, along with other travel. Yet that is not why I put off writing. Nay, this letter has been slow in the making almost entirely because of the level of mental and emotional energy required to write it. In terms of global asset prices, 2022 has been the most challenging market since 2008-09, each bounce meeting further unrest. Nearly every market participant, save short-sellers, has been humbled.
An investor asked me last December what the outcome might be if inflation were to persist and we returned to Volcker era rates. My answer: a bloodbath. And to a great degree that is what we’ve all witnessed. We just didn’t have to reach Volcker era rates to get there. I wrote and talked about the inflation risk and how rates would have to rise materially. I’d thought we were positioned well, and perhaps we were on a relative basis. But as it turned out, this has been a market interval with nowhere to hide. It’s not that I didn’t imagine the Fed would make a drastic pivot, but that so little was priced into the market as of earlier this year. My sense is the market has fallen too far for many positive cash flow companies, while not far enough for those with the opposite.
Surprisingly, volatility pricing and longer-term interest rates (and inflation expectations) have remained exceptionally subdued year-to-date. In other words, the market isn’t too worried about the medium- to longer-range. Or at least not yet.
Increasing (Rate) Pain
There is nothing more fundamental in finance than the relationship between interest rates and asset values. Rates are to values as credits are to debits; as temperature is to water. Rates are the hammer. Asset values are the nails. All else equal, asset values act inversely as rates (treasuries) rise or fall. Investors will require (or seek) some return over the risk-free rate—a risk premia.
The most threatening outcome in any economy is a worthless or rapid devaluation of the currency. Hence, higher rates and pain for a period are but a small price to pay for the prospective benefits: a healthy currency, a return of intelligent capital allocation, reasonable interest on savings and treasuries, and so on.
The last couple letters have been of the same aura. Really the bear market began in October or November of last year. We kept waiting on and hoping for a turn in economic and market fortunes which has yet to come. It is difficult at times even for me to keep in mind that price declines were expected all along—we just didn’t know exactly when they would occur. In the midst of those declines, our nature takes over, acting as a (generally) healthy defense mechanism. That is, we extrapolate those losses into the future and make a mental estimate, consciously or not, of how long it will take to be in the poor house. This is healthy. We certainly want to steadfastly assess and reassess if we’re holding assets that will, at minimum, preserve capital and purchasing power over time. Rough patches are nonetheless inevitable. Even if we were to know, conceptually not literally, that our holdings would perform well five to ten years out, periods of decline remain unavoidable.
 To illustrate the difficulty of short-selling, Stanley Druckenmiller speaking at Delivering Alpha told the story of Jesse Livermore, “the greatest short-seller ever.” Livermore made $100 million during the 1929 crash. Then a few years later in the mid-1930s, apparently having lost it all, jumped off a Manhattan building.