Q2 2023 Commentary
With Nasdaq up nearly 30% year to date, it was on track for its best first half in four decades. The S&P 500, up 14.5% through the first half, while the Dow Jones Industrial Average lagged, up 2.5%.
See MarketWatch for complete recap.
2022 was a painful year, as rapidly increasing interest rates have torn away the era of cheap money. Now it seems that the global economy may adjust to higher rates, interest rates may be reaching a level that would be considered more historically “normal.” The economic support provided by the Federal Reserve has been removed and the economy will now need to move forward on its own merit.
For investors, the 2023 upswing is a reminder that as prices fall, buyers can become interested. Principles, rules and perspective are what matters. To put a portfolio in the best position to grow, we must stay invested through the daily deluge of scary headlines and events. Through all of life’s potentials: pandemics, bear markets, and military conflicts, we must hold steady with diversified portfolios.
The United States has held its principles through Pearl Harbor, Vietnam, 9-11 and so many other existential events. America is distinguished by the three equal branches of government and its incredible geography along with a dynamic population of people from around the globe.
The US leads in areas good and bad. From the US dollar as the basis for the world’s financial system, to a high rate of incarceration, the United States reality is both inspiring and maddening. The foundation of American dynamism is rule of law. As messy as it seems sometimes, we persevere. Property rights, bankruptcy rules and ease of movement around the country are crucial components to economic success. Just as our country stoically grinds forward through its challenges, we must do the same on our investment journey.
Universal principles govern everything from the gravity that holds us on earth, to the sunshine that allows us to live. The human mind has been seeking methods to confront nature from the beginning of existence. The challenges of the earth have driven humanity to invent, adapt and aspire for abundance.
Innovation has created all of the incredible comforts of modern living from indoor plumbing and air conditioning to a robust supply of food. The constant drive of invention and reinvention may create an impression that any challenge can be resolved with diligent effort or clever thinking. The challenge of investing are the periods where it seems that the process is broken, and we need to “do something”.
Courage, patience, and rational perspective are the beginning point from which wealth creation takes root. The journey is filled with the frightening potential of deep setbacks and the constant possibility of systemic dysfunction. Military conflicts, natural disasters, and societal disruptions are continuously lurking.
The constant pressure of systemic risk creates all manner of clever sounding solutions that are unlikely to provide any reprieve from future shocks. Insurance companies, hedging strategies and seemingly safe government bonds can draw in the money during downswings. Once better times arrive, the money that sought “safety” must now make new, difficult decisions.
After the significant downswing of 2022. Media attention was directed to those that were now ready to forecast further declines in market values. In January 2023, Fortune Magazine noted, “Legendary investor Jeremy Grantham warns stocks could drop another 50% this year”. Forbes Magazine wrote of another dark view from Mike Wilson, “Morgan Stanley’s investment chief is warning clients that incoming reports will likely disappoint investors, pushing major stock indexes to two-year lows even if the economy ultimately avoids a recession”.
There is a contingent of individuals that are known as “Perma Bears” as they are always pessimistic. I have observed them since I was a kid. It scares me every time I hear how terrible things are going to be. Then I remind myself that what the bears forecast always seems to miss the human spirit and persistent innovation. It is impossible to calculate the inventions that are being imagined right now. Human ingenuity is the crucial element for how things move continuously forward. Creative invention, American capitalism, and people from all around the globe who come to the United States to seek greater opportunity is an unstoppable combination.
The global financial system has its foundations built upon the United States Dollar, US government bonds, American stock exchanges and American rule of law. These instruments dwarf competitors such as the Euro, Yuan, and Yen.
It is this robust American system of regulation, transparency and accounting standards that create a platform for economic dynamism and leadership. This is a precious system of trust amongst large regions of the globe that have seen consistent instability. Africa, The Middle East, and Latin America have been faced with systems that have been incapable of facilitating the productivity and relative stability that the western capitalist model has been able to produce.
As long-term investors, we must stay vigilant as the fire hose of nonsense information that is corrupted by conflicts of interest or fraudulent pursuit of profits. Forbes Magazine recently published a disturbing story about “group of hucksters, led by a cynical lawyer, from conjuring an excuse for meme-stock collapses — and creating a community now talking up violence against anyone in their way”. Forbes notes that “high-fliers that tend to fall from the sky because of pesky things like underlying financials.” The lawyer named Wes Christian “sees another culprit: the big trading houses who’ve “figured out a way,” he says, “to make more money killing companies than building them.”
The article continues to point out, “Unfortunately, the ramifications from people like Christian aren’t funny. Just as lies about things like vaccines and elections and cabals have created an unhinged class on the extremes of the political spectrum, undermining the institutions that have made America the global beacon of prosperity and democracy, this facts-challenged mindset is now coming for Wall Street. It’s the “markets are rigged!” zeal of the Occupy Wall Street days, with the absolutism, ignorance and digital tools of QAnon.”
Efforts to attack the crucial role that short sellers play by casting accusations of illegal, coordinated activity that is detrimental to healthy capital markets has produced no evidence and frivolous litigation. This small story of a corrupt attorney filing frivolous litigation with no proof is not as rare as one would hope. Where are you now, Rudy Giuliani?
China has recently faced rapidly slowing growth. Stagnation is a real possibility due to a combination of demographics, dictatorial overreach, and horrendous policy during the recent pandemic. The very basis of the Chinese system presents an incredible structural flaw in that the government owns and controls nearly everything. Chinese rule is by decree, not law. There is no “balance of power” for the Chinese.
Multi-national corporations have begun seeking alternatives as the Chinese pursue a belligerent geopolitical posture. Chinese support for the tragic war in Ukraine is likely to be a watershed moment for those who hoped for greater integration with western ideals.
The difference between The United States and other economies is complex and a subject for scholars. For this discussion, the key comes back to rules. The American system of regulation, law and accounting standards may be one of the great differentiators that attracts the flow of capital and economic dynamism.
On 4-15-23 The Economist published, “Riding high: The lessons of America’s astonishing economy”. It is delineated here that, “America remains the world’s richest, most productive and most innovative big economy. By an impressive number of measures, it is leaving its peers ever further in the dust… Start with the familiar measure of economic success: GDP. In 1990 America accounted for a quarter of the world’s output, at market exchange rates. Thirty years on, that share is almost unchanged, even as China has gained economic clout. America’s dominance of the rich world is startling. Today it accounts for 58% of the g7’s GDP, compared with 40% in 1990. Adjusted for purchasing power, only those in über-rich petrostates and financial hubs enjoy a higher income per person. Average incomes have grown much faster than in western Europe or Japan. Also adjusted for purchasing power, they exceed $50,000 in Mississippi, America’s poorest state—higher than in France.”
Unfortunately, this is not being celebrated in American political discourse but rather there has been a surreal stream of cynical expression regarding trade, regulation, and geopolitical relations. A dysfunctional reality TV presidency that ended with a riot has continued to spew cynicism towards the institutional framework that has been built in the post WWII era. We are entering the 7th year of grievance mongering as a certain cohort of the American political spectrum renders messages of “the deep state” and sinister conspiracies for which there has been no proof.
There is little to back up these allegations that are filled with vague, conspiratorial narratives that have offered little beyond criticism, grievance, and anger. The essence of American success is not built upon goofy theories and whining about how we got ripped off. The audacity of the snake oil merchant is limitless.
As 2023 has unfolded, political dysfunction was a growing threat to financial markets as United States debt reached a level that required what is known as, “raising the debt ceiling”. It seemed plausible that Congress would be incapable of an orderly renewal in credit and borrowing capacity of the US treasury.
The deadline was in early June and for many days pundits chattered about a potential catastrophic disruption to US and global financial markets. After substantial drama and acrimonious commentary by The President and the Speaker of the House, Congress functioned flawlessly and passed an increase to the borrowing limit by a vote of 63-36. This was a stark reminder that the fundamental mechanisms of the American system are working as designed. The measure passed easily, as it would be a tragic mistake to cut off our own credit.
The ultimate solution for American federal debt is economic and population growth. The normalization of interest rates is likely to force federal leadership to begin to face an honest accounting of how the rate of growth in the debt can be mitigated. A “Manhattan Project” of economics and government spending management will need to commence. The current aggregate federal debt is daunting yet manageable as the potential for the US economy and the taxpayer base is massive.
Markets perform in the face of constant accusation and angling for advantage. Conspiracy “stories” (the word theory gives too much credit) have always been circulating to feed the human mind. It is so much more compelling to think of an organized group of elite manipulators vs the vast random complexity that shapes our past, present, and future. People can be found contorting their sense of reality after being exposed to amateurish video of Princess Diana, the Moon Landing, or The Skull and Bones conspirators. Robert Kennedy Jr. has a presidential campaign effectively based on conspiracy accusations, without proof.
There are large numbers of people who are uninterested in the complex combination of factors involved in the decline of American manufacturing. The economic opportunities for hard work in a manufacturing job have diminished and broken many formally robust communities. Education requirements have increased substantially along with significant shifts in the geographical concentrations of economic opportunity and jobs in America.
A very difficult action for displaced manufacturing workers to take would be endeavoring for retraining and relocation in pursuit of greater economic and cultural opportunities. The decline of rural manufacturing communities is a tragic remnant of technological progress combined with globalized competition. These trends have run like a steamroller across many communities with unemployment and drug addiction left behind. What remains is often stagnation and population decline, while large urban regions accumulate concentrations of knowledge workers with the skills and education demanded for professional success.
A brutal component of globalization can be found in working class communities that have experienced a generational surge in drug abuse. A conspiracist would have you buy in to an explanation that this societal decline and the corresponding opioid crisis is the result of sinister forces pushing drugs to innocent citizens in the American heartland. “Empire of Pain” and “Dreamland” are two books that delve deeply into the opioid crisis. Examine the material for 20-30 hours and come away with some basic knowledge of the history and complexity of how we arrived at this point.
The two books mentioned above point out that there is a central economic element to how opioids have become a societal tragedy and challenge for our generation. “Empire of Pain” provides perspective on the economic incentives that drove Purdue to promote the safety of Oxycontin. The Sackler Family would not begin to acknowledge the damage that their product wrought. This 1998 clip provides a tragic exhibit of the reckless messaging that was based on fallacious data. “Dreamland” provides additional insight into the proliferation of pain clinics and the transition of desperate addicts from prescriptions to illegal drugs. The stories of Mexican heroin distribution are particularly disturbing.
The inaccurate notion that only a small percentage of patients that were prescribed opium-based pain relief could become addicted seems to be at the root of this scourge across American society. Rising prescription rates were encouraged via misleading marketing and repetition of false narratives. This spawned a growing group who could no longer access legal prescriptions and created a whole new generation of demand for heroin.
The messaging persisted for decades in spite of data that was indicating a terrible problem. Physicians were told that the risk of addiction was low when opioids were prescribed for chronic pain. A one-paragraph letter that was published in the New England Journal of Medicine in 1980 was widely cited in support of this, even though no evidence was provided by the authors Jane Porter and Hershel Jick in a letter to the New England Journal of Medicine. The brief letter–not even a study–was used to argue that medicines like Percocet and Oxycontin could be used routinely.
This is a tragic example of how the repetition of nonsense can create a false narrative that takes the place of facts. Constant messaging does not reflect proof. Economic incentives can often bias otherwise honest people to ignore data that may undermine or change a product’s viability. If the lie can create immense wealth, owners of the business can allow the money to create cult like beliefs and outright fraud.
Consistent headlines of difficult or scary events can drive our thinking into a foxhole of fear. Many are driven to a belief that humanity is in a persistent state of decline. Perception can become overwhelmed with the notion that crime is always growing in severity; civil behavior is persistently diminishing and opportunity for future generations is shrinking.
A fascinating paper published on 6-7-23 in Nature Journal provides insight that counters the negativity in theorizing that, “People believe that morality is declining. Is it? Societies keep (or at least leave) reasonably good records of extremely immoral behavior such as slaughter and conquest, slavery and subjugation or murder and rape, and careful analyses of those historical records strongly suggest that these objective indicators of immorality have decreased significantly over the last few centuries”.
Our world is consistently becoming a better place, it is our perception that is vulnerable to a negativity bias. The subtle nature of progress in the world or our portfolio is not something that is easy to appreciate as the pace of change can be slow and our immediate surroundings may not reflect improvement in ways that we understand. It could be argued that our survival instinct is always sweating the things that could go wrong. Negativity bias allows us to avoid danger and creates the disposition that things are not going well.
The tendency to sift through the landscape for threats and danger is counterproductive for investors. Pessimistic instincts can route strategies into so-called “defensive” instruments that may miss out on the rewards that optimistic equity-based strategies can deliver. Owning the great companies of the future in a broadly diversified portfolio allows us to possess shares in some of the companies that have great potential.
Our predecessors had great opportunities to accumulate companies like Coca-Cola, Google and Visa at much lower prices than people pay today. It is impossible to forecast which companies will be the great ones of the future, and thus we diversify with a bias towards stocks over bonds, and optimism over pessimism.
Markets are a brutal and competitive place. This year has seen numerous reasons for worry and defensive strategies. The threats have proven less damaging as the real economy has shown persistent strength and markets look forward to further growth. As the Covid-19 crisis recedes, the disruption to the labor pool has begun to normalize. This resumption of worker behavior may have a positive impact on inflation.
As labor markets become more robust, the monetary element of inflation may prove to be more persistent. Interest rates were abnormally low from 2008 through 2021. This period created a significant increase in the supply of money across the financial system in the US and globally. It is unlikely that the consequences of all those dollars have yet to be digested.
Additionally, the current leadership in the United States has legislated the ironically titled “Inflation Reduction Act” which may produce excessive demand and therefore inflationary dynamics. Efforts to implement “industrial policy” are likely to ebb and flow with the political pendulum. There has been an unfortunate dynamic of each successive presidency seeking to undo previous policy.
Americans may be tiring of the current class of elderly leadership and there may be new personalities that appear on the scene. The likes of Washington, Lincoln, FDR, and Kennedy come along periodically to provide vision and inspiration. We can only wish for a political platform that would transcend personality.
Maybe there can be a new movement, let’s call it the march of the Econocratarians.
The movement will begin with this declaration:
Our brightest future resides in a world that facilitates growing productivity and output. The binary system of Republicans and Democrats battling via political marketing initiatives has led to a counterproductive treadmill of fundraising and gerrymandering. The inspiration of moonshots, Marshall Plans or a bullhorn on the rubble of 9/11 has fallen by the wayside.
The optimism of Ronald Reagan or the 1990’s Clinton market upswing has been replaced by ugly demonization of the opposition. Both parties of our two-party system are mired in perpetual political competition. The presidency and senate are staffed by individuals who passed retirement age decades ago.
To this generation of politicians, we say thanks for your service, it is time for a generational shift towards rational and optimistic vision. An ambition for America to reassert its dynamic and innovative ethos that has produced so many breakthroughs and so much bounty. A growing economic pool that can raise and lift all. For the most ambitious, there shall be no ceiling that limits achievement and reward. Those at the lower rungs of the ladder shall have more opportunity, while in between we must all strive for the highest levels of education, achievement, and productivity.
This America presents the beauty of the highest level of creative arts, scientific development and manufacturing prowess. Our mission is to carry forward all that our ancestors have founded and build it ever larger and more bountiful.
Econocratarians will avoid political combat with a message of economic optimism. We hereby call forward those individuals willing to serve a mission of positivity, opportunity, and continuous improvement. We hope that this message can refresh a balanced and respectful brotherhood among all Americans. There will be vigorous debate in the place of argument. We seek optimistic plans that can be transparently and sustainably funded to build this country upon the greatness of our past and the limitless potential of our future. Hope will cast aside petty arguments and grievance and replace the recent narrative of vitriol with inspiration and positivity.
Long-term investors can subscribe to this same optimistic vision of a growing and bountiful future. The years ahead will be propelled by adaptations and innovations that we cannot currently imagine. There will be high standards for the quality of our air and water, new and more effective treatments for disease, and an ever-rising realm of opportunity for generations to come. It is incredible that by investing, we can all own our piece of the ever-brighter future.