Among the many consequences of the financial crisis of ’08-’09 and the ensuing recession has been the apparent belief by stock market participants that they can see the macroeconomic future. And they don’t stop there; they believe that they can predict with precision what that putative future means for individual industries. In some ways, it was ever thus. The market, especially in times of economic change and discontinuity, is hungry for whatever guidance it can find, anointing many a false prophet in the process. Blame it perhaps on the revamped touchy-feely Fed and its new age of transparency and public outreach (no more Delphic utterances but a veritable Greek chorus of often contradictory opinions), but today everyone seems to be getting in touch with his or her inner macroeconomist. What results is a market that can’t seem to visualize the trees for the forest. The danger to an investor of looking at the market through a tinted lens is that it colors both judgment and actions, making it easier, not harder, to do intemperate things. Therefore, tempting as it might be for us to channel Keynes or Summers and bloviate about the future, we will refrain from making airy macroeconomic predictions and focus instead on what we can actually know: that companies that have demonstrated an ability to make money over a cycle, are in advantageously structured industries and have a strong and dynamic culture are likely to do well over time, even if [fill in scary event here] occurs.
Speaking of scary macroeconomic events, or at least of events with the potential to affect the macroeconomy, we wrote about Brexit the day after, expressing our opinion that the market seemed to be overreacting. Nothing that’s happened since has changed our opinion, although of course it is early days. Having said that, we try very hard not to incorporate any macroeconomic views we might have into our investing. But we do find that our valuation discipline drives us away from popular sectors, including the “comfort” stocks that have been so popular lately. We don’t (and probably won’t ever) own any utilities or telecom stocks or REITs. We don’t own any consumer staples, mostly for valuation reasons (we do own a couple of restaurant stocks, but for some reason those are considered consumer discretionary while food manufacturers and food retailers are considered consumer staples). And we own very little healthcare, again for valuation reasons (and concerns about the government’s willingness to allow them to continue raising prices as much as they have). Oh, and yes, we’re quite happy not to do all of these things.
The reasons for sharp moves in the market as a whole can therefore never be evaluated without understanding the prevailing psychology of market participants. It is our view that what we see today is not so much investors responding rationally to the failure of China to sustain its supercharged growth, the strengthening of the U.S. dollar, the decline of oil and gas prices, or even the elevated levels of the stock market itself but rather investors frightened by disruptions to their expectations about each of these. Discontinuities are inherently destabilizing from an emotional perspective, and when they cumulate, the impact is amplified. You have—literally and figuratively—disturbed the equilibrium of market participants and they respond the way they have historically done, by selling indiscriminately.
As is usual in any quarter, we didn’t change much in the portfolio. We did fill out our small position in Chipotle, a currently controversial name in a business we know well. Partly to make room for this, and partly because we’ve become more skeptical about their asset-heavy operating models, we sold some of our Toll Brothers position and all of our Leucadia position.
We’ll end by stating that we are doing what we are doing on purpose. We know that many other investors are positioned differently. We hope that is typically the case.