Circle of Competence Issue #33

Quote of the week: "We don't understand life any better at forty than at twenty, but we know it and admit it." - Jules Renard (H/T Tim Ferriss)

FOOD FOR THOUGHT

Where are we?

Last week, I listened to several interviews with Howard Marks and read his latest memo, and it got me thinking about several of the points he raised in his letter to clients. I re-read it this week and wanted to try to write a few observations on where we are currently in the market cycle from my reading

- interest rates are low historically but starting to rise. This artificially "low for long" period has allowed most asset prices to be inflated and bid up with cheap financing.

- we are just beginning to feel the effects of quantitative tightening as fed funds rates continue to rise and quantitative tightening begins to show its effects

- mortgage rates are rising, which may put more stress on marginal borrowers and dampen home sales

- inflation is starting to tick up consistently above 2%

- institutional venture capital and private equity markets have been raising money at incredible (historical) rates, and doing deals at rich multiples, reflecting the large amount of money chasing relatively fewer deals

- trade war is continuing between China & US with likely adverse economic implications for both economies which will show up in higher inflation and lower growth on the margin

- debt offerings are beginning to tilt in favor towards covenant lite vs. traditionally more stringent covenants

- the spread between the 2 year and 10 year notes hovers just above zero at 33 basis points (historically an inverted yield curve has signaled a recession on the horizon)

- according to Marks in his latest memo, there are several noteworthy leverage ratios such as the debt to earnings ratio of global companies, total global debt to GDP, debt of US non-financial companies as percent of GDP, and the absolute amount of leveraged debt (high yield and leveraged loans) that are all at record levels over and above what they were in pre-crisis 2007

In general there seems to be a trust in the future of most business fundamentals and a lack of skepticism of investment opportunities. Just this week, the public markets rolled over, showing signs of fear and weakness given the points above. Is the top near or past us? Are we just seeing some profits being taken in the public markets? Do we have another 2+ years of economic growth? Are we at the end of the economic expansion? I don't know and I will add that no one else does either. I abhor predictions and haven't the slightest clue where we're headed. Timing an economic downturn or market declines is nearly impossible. But as Buffett, Munger, Marks, Klarman, and the greats are so magnificent at doing, we can only try to understand the times given the data we have now and know how to respond most rationally. As Howard Marks has been quoted many times recently, the most rational move is to move forward but with caution.

Highlighted Investor

This week, I wanted to give a shout out to Nathan Reid out in Arizona. He recently released his Capital Allocation Partners Q3 Update and has been finishing up fundraising for his fourth real estate fund after performing well in his first three. I had the opportunity to speak with Nathan back in Issue #24 where I shared some of his wisdom from our conversation.

DEPARTMENT OF GENERAL FINANCE

- Pension funds are taking stands on the 'human cost' of private equity on businesses (NYT)

- China pumped $175B into its economy last weekend as the trade war wages on (NYT)

- Yale's endowment has invested in 2 cryptocurrency funds (CCN)

- Oil surges to multiyear high (WSJ)

- Andrew Walker's monthly 'things and ideas' of September

- Bruce Flatt (CEO of Brookfield Asset Management) talk at Google

- The government wants to buy your dying mall (WSJ)

- Pershing Square Capital (Bill Ackman) presentation on Starbucks

- China's nuclear option for the trade war (Dealbook, NYT)

- Sears could draw its final breath and hires bankruptcy advisers (WSJ)

- Is Warren Buffett ignoring his own favorite market indicator? (GuruFocus)