2023 | Q4 - Things that Go Bump in the Night
“I’ve had a lot of worries in my life, most of which never happened.”
- Mark Twain
We’ve all, from time to time, heard “bumps in the night,” those often-maddening sounds that wake us from our sleep. If we let our imaginations get carried away, we can become paralyzed with fear, convinced that dire consequences will result. Most often, those “bumps” turn out not to be unwanted intruders or monsters under the bed, but normal occurrences: a creaking floor or a gust of wind, that we magnify out of proportion.
Investors are susceptible to the same paralyzing fear, caused by various “bumps” that rattle the markets. They can influence investment decisions and cause investors to divert from the long-term path that they have carefully planned out. Such bumps occur constantly, and there’s been no shortage of them lately. Just consider events that took place in 2022 that still haunted investors as 2023 began:
Most major stock indices came off a difficult 2022, resulting in the worst performance for the stock market since the Great Financial Crisis of 2008, and a terrible year for bonds as well.
Skyrocketing inflation topped 9%, its highest level in over four decades.
In response to this surge in inflation, interest rates rose to their highest levels in decades, and the Federal Reserve raised the federal funds rate at the fastest pace in history.
The commercial real estate market was poised for a meltdown as the work-from-home trend persisted. Soaring interest rates put property owners at risk of declining property values if forced to refinance or sell properties in the higher rate environment.
Oil hit $120/barrel in mid-2022, leading to recurring memories of the bad old days of the 1970s and early 1980s.
China’s economy remained in semi-shutdown mode with its “Zero COVID” policy.
In late 2022, a Bloomberg article touted a 100% chance of a recession1 within the next 12 months, according to economists polled.
Joe Dator / The New Yorker Collection/The Cartoon Bank
The avalanche of worrisome news was far from over in 2023:
Consumers remained sullen about the state of the economy, as sentiment dropped to levels not seen since the Great Financial Crisis of 2008, and even lower than it was during the worst of the COVID era.
Three regional banks failed, triggering fears of a widespread banking crisis.
Washington policymakers squared off in a debt ceiling and budget showdown, with the threat of a federal government shutdown if they failed to reach a deal.
While the Russia-Ukraine war dragged on, a new bloody conflict broke out in the Middle East following the surprise Hamas invasion of Israel.
Although the “Zero COVID” policy was gone, China’s economy remained surprisingly stagnant.
These concerns are valid, and nobody can fault investors for losing sleep over their potential ramifications for the markets. But were those fears overblown? Were these truly calamitous events that necessitated a change in one’s investment strategy? Or were these headline events manageable concerns and relatively harmless bumps in the night? With the benefit of hindsight, it appears that they were relatively harmless to the market.
Overcoming exaggerated fears
Rather than experiencing the “inevitable” recession, the U.S. economy gained momentum. The Fed appears to be on track to realize a “soft landing”, meaning it may achieve its goal of lowering inflation without either driving the economy into a recession or causing a spike in unemployment. Other key events proved to be beneficial to investors in 2023:
Weakness in the banking sector was contained, limited to the failures of three poorly-managed regional banks.
The debt ceiling issue was resolved and the federal government continued “functioning” in its uniquely dysfunctional way.
Inflation moderated to a more historically normal level.
Interest rates peaked, but leveled off by year-end.
Corporate earnings outperformed expectations, slowing less than expected in the first half of the year, and returning to growth in the second half of the year.
Consequently, many major stock indices regained nearly all of 2022’s bear market losses.
Benjamin Schwartz / The New Yorker Collection/The Cartoon Bank
Sadly, far too many investors kept investable assets out of the markets. Money market fund assets, which started the year at $5.2 trillion, ended up at nearly $6 trillion by the end of the year.2
How to sleep at night (and still make money)
So how does one prevent bumps in the night from derailing their investments? The key to riding out the endless distractions created by today’s news flow is to root your investment approach in a strong belief system – an investment style that guides your judgment and generates decisions that will achieve long-term outcomes. It’s the most effective way to manage money when bombarded with constant headlines that can work against you.
Markets today move at an often-dizzying pace. No matter how fast you may think you can react to the rapid flood of developments in the endless news cycle, today’s professional investors, armed with computerized high-frequency trading, can do it much faster. Investors who expect to outsmart the market by pulling money out when bad news occurs, such as 2023’s “100% certain” recession, risk a significant opportunity cost.
There’s overwhelming evidence about the perils of market timing. Consider that from 1995 through September 2022, a period of nearly 28 years and representing approximately 7,000 trading days in the market, missing just the ten best days would have cut your total wealth accumulation by more than half. If you managed to miss the 50 best days out of those 7,000, you would have lost more than 40% of your initial investment.
Complicating matters further is that these “best days” tend to be clustered around the “worst” days. From 2000 through April 2020 seven of the best days in the market occurred within two weeks of the worst days, with five of those best days occurring within just one week of a worst day.3 Data from 1993 through 2022 shows that 78% of the stock market’s best days occurred during a bear market.4 In other words, the timing of the market’s best days is even harder to predict than you might think.
Our own longer-term, core belief system is to ignore the day-to-day gyrations of the market and focus instead on paying the proper price for a business. Those frequent bumps are not only disruptive to markets, but also to individual companies. During periods when negative headlines add to short-term price volatility, it's important to understand the essence of the businesses you own. It means assessing important factors that help determine the quality of an investment, such as a company’s balance sheet, its products and services, and the firm’s prospects within its competitive landscape. If you recognize real value at the time the stock is purchased, you can afford to exhibit patience when, at times, the stock price reacts to irrational forces. As Warren Buffet’s longtime partner, the recently deceased Charlie Munger stated, “The big money is not in the buying and selling, but in the waiting.”
Our approach reflects a belief in the companies in which we invest at a time when most people don’t. We aren’t following the crowd or trying to outguess the market. Rather than concern ourselves with short-term market bumps, we focus on owning quality, misunderstood, and undervalued businesses that can compound earnings and earnings growth over time.
The value of an underlying belief system
The markets were incredibly volatile in 2023, and the holdings within the MPMG All Cap Value Composite portfolio were no exception. Much of the volatility in the markets was driven by the inflation-fueled interest rate environment. Changes in the interest rate environment had some impact on stock valuations, but the extreme price movements in many of the companies in our portfolio was, in our opinion, overdone. Consider the price volatility of three businesses in our portfolio over an eight-week or less period during 2023:
Deere & Co. (DE), the pre-eminent manufacturer of mission-critical agricultural equipment. With the world’s population topping eight billion and an urgent need for more efficient farming due to strains on the water supply and arable land, Deere is critical to the process. The company is mapping 500 million acres of cropland to promote precision agricultural practices that will help generate superior yields with greater efficiency. The higher interest rate environment spooked investors for a time, as many customers finance the purchase of these machines. But the severe negative market reaction to Deere (fueled by higher interest rates that impact the borrowing costs) appears to have been grossly overplayed given the firm’s strength.
Generac (GNRC), the undisputed leader in home standby generators, with a more than 70% market share in this burgeoning industry. Growth potential is enormous, as only about 5% of U.S. homes own a standby generator. The company is also well positioned to capitalize on an increasingly distributed electric grid, with the ability to feed energy (including solar) back into the grid. The cost to buy and install a generator is, on average, less than $10,000, so the financing cost increase from higher interest rates would likely not be a significant deterrent for growth.
Qualcomm (QCOM), an often-overlooked technology company that holds patents on close to 75% of technology used in mobile device semiconductor chips. Without Qualcomm’s contributions, cell phones today would simply be clumsy cameras rather than the amazing devices they have become. Qualcomm remains poised as a leader in the ongoing advancement of wireless devices, the Internet of Things, and artificial intelligence.
Uncovering great opportunities requires investment discipline that can look past the headlines of the day and not feel obligated to follow the crowd into the popular stocks of the moment. We didn’t panic at the market’s temporary negative reaction to these stocks and are being rewarded for our patience.
The year that was
As is often the case, the reality of the world, the economy, and the markets can veer away from the presiding narrative of the day. We saw that repeatedly in 2023.
In our first quarter newsletter (“Artificial Intelligence”), as the excitement of new developments in AI captured headlines, we reminded investors that it wasn’t the pre-2022 economy anymore. Momentum-followers and speculators could no longer rely on an artificially-stimulated environment featuring “free money.” Yet driven by AI-mania, many investors looked for comfort in the old standby technology companies that dominated the market before inflation and higher interest rates emerged on the scene.
In the second quarter (“Don’t Mistake Longevity for Validity”), we focused on the importance of having a long-term perspective when making investment decisions. We noted that many investors, who became accustomed to a prolonged period of low inflation and low interest rates, forgot that such a scenario doesn’t always last. We reiterated the point that investments that “worked” in an environment where the Federal Reserve added mountains of liquidity to the markets would not be as well positioned now, when the Fed has reversed course and turned off the “free money” spigot.
In the third quarter (“In Order to Think Outside the Box, You Must Know What’s in the Box”), we recalled biographer Walter Isaacson’s appearance at the 2023 MPMG Speaker Series event. We specifically noted Isaacson’s passion to document the lives of people who look at the world from a different perspective (Leonardo da Vinci, Benjamin Franklin, and Steve Jobs, among others). There’s a parallel to stock investing – rather than follow the crowd, investors can set themselves apart by identifying stocks that are outside of mainstream conventional wisdom. This opens the door to amazing, long-term wealth creation potential.
Opportunity on the horizon
2023 was, in many ways, a rerun of the pre-2022 era. A concentrated group of mega-cap technology stocks dominated the markets. In this case, it was the so-called “Magnificent Seven,” Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia and Tesla. These stocks generated more than 18% of the S&P 500 Index’s 26% total return in 2023.5 In other words, without the contribution of the Magnificent Seven, the S&P 500 would only have shown a gain of 8% in 2023. The valuation of the Magnificent Seven stocks is now so extreme that their combined market capitalization exceeds that of stock markets in Japan, Canada and the United Kingdom put together.6
As a narrow group of seven stocks thrived in 2023, only 27% (135 stocks) of S&P 500 stocks managed to gain more than the index as a whole. That’s notable because it represents the narrowest level of leadership in the market since 1987. With nearly three-quarters of stocks underperforming the index in 2023, investors can find plenty of opportunity in solid, inexpensive companies. We saw the first signs of broadening market leadership in the late 2023 stock market rally. If this trend persists, it boosts the potential for investors dedicated to actively identifying value opportunities in the market.
For much of the past decade-plus, adhering to our value-based belief system in the face of a flood of speculation benefiting momentum stocks felt a lot like a salmon swimming upstream. Today, however, the journey does not appear to be as arduous. With the normalization of interest rates and less “free money” sloshing around in the markets, the current is flowing in a different direction. There will continue to be “bumps”, of course, but investors who are firm in their beliefs about the benefits of owning well-positioned companies at the right price should not be deterred. Instead, it’s a time to remain diligent and pursue the journey with confidence and vigor.
~MPMG
1 Wingrove, Josh, “Forecast for U.S. Recession Within Year Hits 100% in Blow to Biden,” Bloomberg.com, Oct. 17, 2022.
2 Board of Governors of the Federal Reserve System.
3 American Association of Individual Investors, “Missing the Best and Worst Days of the Market.”
4 Hartford Funds, “Timing the Market is Impossible.”
5 Irvine, Dan, “The Year of Terrible Market Predictions,” Forbes, Dec. 31, 2023.
6 Source: Apollo Global Management
Established in 1995, Minneapolis Portfolio Management Group, LLC actively manages separate accounts for individuals, families, trusts, retirement funds, and institutions. Our proven value-oriented investment philosophy has created long-term wealth for our clients.
Visit our website at: www.MPMGLLC.com
Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted. Market returns discussed in this letter are total returns (including reinvestment of dividends) unless otherwise noted.
The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG’s future investments. As with any investment, there can be no assurance that MPMG’s investment objective will be achieved or that an investor will not lose a portion or all of its investment.
Companies mentioned in this document were chosen based on MPMG’s view of the products and/or services offered or provided by the companies in light of current economic and market observations and reported trends. For a complete listing of MPMG’s recommendations over the preceding 12 months, please contact MPMG at (612) 334-2000.