Thank you, Charlie - January 2024
Ah, watch out, you might get what you're after
Cool babies, Strange but not a stranger
I'm an ordinary guy, Burning down the house
Hold tight, Wait 'til the party's over
Hold tight, We're in for nasty weather
There has got to be a way, Burning down the house
Here's your ticket, Pack your bags
Time for jumpin' overboard, Transportation is here
Close enough but not too far, Maybe you know where you are
Fightin' fire with fire
The Talking Heads – Burning Down the House, 1983
David Byrne and the Talking Heads must have written this song knowing it’d be the perfect opening for my financial newsletter 40 years later. Upon hearing the lyrics recently, I couldn’t help but connect it to the current market climate. It was too good (or perhaps too terrible) to pass up. We’ve been led down a path of fighting fire with fire, even when they want you to believe their foot is off the gas. In the meantime, our clients are happy to have been equity investors in 2023, albeit with the primary goal of downside protection. Others with a more euphoric appetite for risk might run into nastier weather than others at some point (as they did in 2022).
2023 Overview
The Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) all returned over 50% in 2023, carrying the S&P to a total return of 26% for the year. This was a welcomed sight for investors coming off one of the worst years in history for a normal blended stock and bond portfolio, where both were down double digits in 2022.
The US economy remained resilient in the face of inflation in 2023. Investor enthusiasm (euphoria) for artificial intelligence, along with the news of cooling inflation at year-end, pushed the S&P back near record highs. This was accompanied by a bond market rally that we haven’t seen in quite some time. Ten-year treasury yields reached 5% in October, the highest we’ve seen in 16 years. (Source 1: Morningstar) Yields have since come down slightly, but fixed income securities may provide meaningful opportunity.
Heading into 2024, inflation seems to be trending steadily lower. Some remain concerned the final leg of the Federal Reserve’s battle with inflation will be more difficult than expected, and a real US recession could still be looming. Unfortunately, there is often a lag in the timing between an interest rate change and its real effect on the economy. Regardless, our portfolios are built for resilience and for times such as these, where two very different scenarios could ultimately unfold.
- Scenario 1: If the Fed maintains current policy while waiting for inflation to reduce further, the impact of higher interest rates could generate a hard landing, contrary to the current thinking. This could solve the inflation problem at the expense of producing a real recession at some point.
- Scenario 2: On the other hand, if the Fed pivots to rate cuts before inflation fully recedes to its target level, pricing pressures could quickly re-emerge (as it has in the past) and require even higher policy rates at some point to extinguish the inflation.
The Fed wants us to believe things have cooled, with no signs of a recession, and a beautifully curated soft landing has evolved. Historically, inflation has been much stickier than many want to believe. Their 2% inflation target (currently still 3.2%) seems improbable without a major slowdown in growth, otherwise known as a recession.
2023 Returns
S&P 500 +26.4%
Developed Markets – Ex US +17.9%
Emerging Markets +11.9%
Core Bond +5.3%
10-year US Treasury +3.8%
Balanced Allocation +14.6%
(Source 2: Morningstar)
Key Stats: 2023 Stock and Bond Market Performance
- US stocks rose 26.4% (including dividends), the biggest rally in the US Market Index since 2019.
- The Magnificent Seven (M7) stocks contributed to nearly half of the stock market’s overall gain.
- Utilities stocks stumbled, losing 7%—their worst year since 2008—dragged down by higher interest rates.
- Volatility remained very high in bonds. The yield on the US Treasury 10-year note started and finished 2023 near 3.8%, but during the year rose to a 17-year high near 5%.
(Source 3: Morningstar)
Our focus remains on valuations given the rise in share prices for the M7. Although the long-term earnings estimate for the M7 remain substantially higher, uncertainty around them is much higher as well. They are not created equally, in our judgement. While a few of our managers are heavy owners of two of these stocks, others may potentially be overvalued.
Wall Street and the “Talking Feds” expect the following in 2024:
- Three rate cuts by the Federal Reserve.
- Earnings growth on the S&P of 11.5%.
- A soft-landing, meaning we won’t be mired in a future recession. Inflation has moderated and all is well.
(Source 5: Morningstar)
Re-emerging Inflation?
Others believe we’ll see a re-emergence of inflation. While much of the focus has been on the actions of the Fed, the fiscal side remains heated, as spending continues, with no end in sight. One example is the Inflation Reduction Act, which is not technically designed to reduce inflation. The interest on our debt is also the fastest growing portion of our spending, as interest rates have increased substantially. This interest will soon outpace military spending, and one could argue appetite for our debt is waning. Lastly, given the international community is facing two wars and we’re gearing up for a Presidential election, it’s not likely overall spending will be adjusted downward.
Perspective – US Budget vs. Average Family Budget
(Source 6: FedCharts.com)
Additional Fiscal Thoughts from First Eagle
“Loose government spending and aging demographics are a poor recipe for sustainable fiscal policy, and the US is a particularly acute example of the perils involved. From the end of World War II through the late 1990s, the country maintained a more or less balanced primary budget, but the trend has been structurally negative since. The deficit’s current magnitude is particularly troubling given the health of the labor market; the last time unemployment was this low, in the late 1990s, the US ran a budget surplus. And it’s expected to get worse from here, as expenditures—driven by growth in mandatory spending on entitlement programs like Social Security and Medicare, as well as higher net
interest outlays—are forecast to outpace revenues, resulting in persistent annual deficits, and deepening federal debt.” (Source7: First Eagle January 2024)
Let’s Factor in Geopolitics and Globalization
Roughly 50% of the world’s population will head to the polls this year. While one can speculate about rate cuts and projected PE ratios, this is the true wildcard. I’m often asked what my biggest concern is and it’s not the markets; they normally ebb and flow and take care of themselves. The geopolitical world is different. Democracy as we know it is severely threatened with autocracies and deglobalization on the rise.
China, Russia, North Korea, and Iran have grown together over the last few years in their desire to counter democracy at all costs. These alliances set the stage for greater friction in economic relations. Many developed nations (including much of Europe) have switched from being energy dependent, for example, to a more nationalist view. What has become a “me-first world”, has now morphed into more of an “anti-everyone else” campaign. Deglobalization is bad for economies and worse for international stability.
Now What?
It’s not all bad news. In fact, many of our largest positions are finding similar equity positions which gives us peace of mind. Our core philosophy remains the same in building portfolios on a client-by-client basis with managers who utilize a Margin of Safety and the primary goal of protecting capital. You can now find decent yield for your income buckets.
Therefore, we are re-visiting the following for each of our clients:
- Overall risk.
- Fixed income exposure relative to targeted buckets.
- Allocating domestic equities to quality foreign equity positions.
Summary: What Would Charlie Do?
No one has had such a profound impact on my career from afar than the legendary Charlie Munger. I must have quoted Charlie and Howard Marks more than anyone since I began my newsletters more than 15 years ago. Remarkably, in my quest to understand the investment world, I was fortunate enough to learn so much about life. Charlie’s lessons were so simple, yet so profound. His classic “Invert, always invert” became my motto. When analyzing a client’s financial picture, I first ask myself: “What can go wrong for this person?” He taught that many difficult problems are best solved when they’re addressed
backwards. Turn the problem upside down, and you’ll find your answer.
So, Charlie would tell us to focus less on the action of the Fed and more on the business from a bottom-up perspective. He taught Warren Buffett that the most important characteristic of stock picking is the quality of the business. “Buy great businesses at good prices instead of OK businesses at great prices. When you find that great business, pounce.”
Much like Charlie, we at Staub Financial strive to choose great investment partners. Together, we don’t get caught up in the minutia. Instead of short-term forecasting and trying to be right around every corner, we protect clients long-term, with a focus on where the fires may burn.
Thank you, Charlie.
"The game of life is the game of everlasting learning. At least it is if you want to win." -
Charlie Munger, 1924-2023
Source 1: Morningstar
Source 2: Morningstar
Source 3: Morningstar
Source 4: American Funds January 2024
Source 5: Morningstar
Source 6: FedCharts/com
Source 7: FirstEagle January 2024
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Investment involves risk including loss of principal. No strategy assures success or protects against loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Asset allocation does not ensure a profit or protect against loss.