While, indeed, nearly all things live in a perpetual state of change (save I suppose for human (investor) nature; it follows very predictable patterns IMO), the "Essential Rules of Investing" featured in last year's Part 1, and the "essential characteristics" from every Part 1 for several years running hold firm, perpetually.
So here they are:
So here they are:
The Essential Rules of Investing:1. Risk Control First: Focus on managing downside over chasing upside.2. Value Over Price: Buy for less than something’s worth. Quality means nothing if you overpay.3. Long-Term Patience: Success doesn’t happen on a schedule.--Howard Marks
Or, simply:
Rule #1. Never lose money.
Rule #2. Never forget rule number #1.
--Warren Buffett
And the question we (at PWA) must answer yes to every single day:
"Can you observe without any prejudice, without taking any sides, without protecting your own personal conclusions, your beliefs, your dogmas, your experience and knowledge? And therefore be totally free to observe clearly?"
--J. KrishnamurtiThe following is our list of what we believe to be the essential characteristics of the world’s best portfolio managers -- traits we everyday strive to embody:
1. A passion for macro economics and market history.
2. A firm understanding of intermarket relationships.
3. A firm grasp of global macro and geopolitical developments.
4. An obsessively strong work ethic.
5. The ability to transcend his/her ego and political preferences.
6. A willingness to buck prevailing market trends (diverge from the crowd) when the risk/reward setup inspires it.
7. An understanding of and appreciation for the uncertainty of markets.
8. A flexible and open mind.
9. Utter humility.
Now, to the business at hand.
During one of our recent every-morning company meetings, I shared a chart that showed each major US sector's weighting in the S&P 500 Index... I then shared history's accounting (and my own experience) of how, when the business cycle's whiskers grow excessively long, and when a single sector dominates the major average's weighting, you can place a fairly certain bet on which cluster of stocks is most likely to sit at the lower rung of the relative return ladder during the next cycle.
On that note, here's Larry McDonald from one my favorite 2025 reads, How to Listen When Markets Speak; Risks, Myths, and Investment Opportunities in a Radically Reshaped Economy:
"By 2021, $20 trillion of wealth was found in just one hundred stocks inside the NDX (Nasdaq 100). This was the most crowded trade in the history of asset bubbles (an overwhelming majority of investors piled into these Nasdaq stocks). Over and over the lesson is clear: Whether it was big oil in 1981, tech stocks in 2000, or financials in 2007, when a sector is dominant over an extended period of time, this is where the most significant downside is lurking. When the buy-in to the prevailing investment narrative is that loud, run, don’t walk, the other way.
As the genesis of a large secular change is upon us, it’s very difficult to read the tea leaves in real time, but if you look carefully, all the signs are there."
While I do believe opportunities remain, selectively, in the tech space, I very much share Larry's sentiment right here... But, yeah, the thing is, the timing -- make no mistake, bubbles can stay inflated for a very long time.
In other words:
"The market can remain irrational longer than you can remain solvent."
-- Attributed to John Maynard KeynesNote the line in the subtitle to Larry's book "Investment Opportunities in a Radically Reshaped Economy." Operative words there being "Radically Reshaped Economy."
I.e., keeping our heads around the, I'll call it interesting, global investment setup these days demands..... well, let's just say there's more to it than simply reading research, parsing data and working the charts.
As I sit here this early-December (3rd) morning, staring at the screen I'm typing into, I also find myself glancing at the screen directly below which features the symbols of all of our core portfolio positions.
It's 8:10 am pt, and I'm seeing SLV (silver) up 2.4% (it's up 103% year-to-date), then RRC (Range Resources) up 2.3% this morning (up 12.62% ytd), then SQM (a Chilean Lithium miner we recently added) up 2.01% (up 70.1% ytd, 62% since we added it), then DECK (Deckers) up 1.67% (up 21.82% since we bought it a few weeks ago), yada yada!
Suffice to say that our core portfolio, only 58% targeted to stocks currently, has had a very good (exceptional, on a risk-weighted basis) 2025. And, notably, it has as much if not more to do with things other than stocks. Like shiny things -- like things that would hurt your toe if you were to drop them... And while US stocks -- after a rough go of it in the spring -- have done fine, the stocks we own in other nations have done better.
If you'll recall those charts we offered up a year ago, US stocks were very expensive on the global equities stage, and commodities were due for a run, particularly given our view on the dollar... Thing is, a year later, foreign equities are still too cheap, relative to the US (see updated charts below)... Or, you might say -- and you should take these words seriously -- US stocks are still VERY expensive, relative to foreign equities.
But, as I articulated in a recent blog post:
"...suffice to say that the stock market is bigly essential to the overall health of the US economy… The K-shaped nature of present conditions demands that the wealth effect remains alive and well if the expansion is to continue.I.e., suffice to say that the powers-that-be have the stock market's back!
And this is in no-way lost on Washington..."
BUT! To once again quote renowned macro thinker Larry McDonald:
emphasis mine...
humanly politically possible to keep this stock market boat bubble afloat has us thinking that equities have yet more runway ahead of them -- notwithstanding the heavy dose of volatility we'll certainly have to endure in the months to come.
Here's more from that recent blog post I mentioned above:
"...what happens when volatility is suppressed for years and central banks come to the rescue at any sign of danger? It injects a misguided sense of safety into markets and lures investors into dangerous waters."And:
"...if central banks continually suppress volatility, preventing market corrections by deploying lifelines at the first signs of trouble, the market professionals will figure out one thing real fast. And that’s how to get rich. But scheming the markets has always had a nasty habit of ending in tears."And:
"The U.S. government opened the floodgates with spending at the same time. The world was ending, and the only thing that could save it was a fire hose of money flowing directly from Washington."
"In March, Republicans and Democrats in Congress came together to pass the largest financial rescue package in American history, the $2.2 trillion CARES Act.But, AGAIN — inflation be damned — the massive incentive to do whatever is
This massive bill was passed with lightning speed and allocated spending across the country’s economy. It propped up floundering state and local governments, funded loan programs to support small businesses, and even sent no-strings-attached money to every American household. Commentators might quibble about the CARES Act’s impact on the American economy for a long time, but the country did manage to avoid a real recession during the chaotic, crazy year of 2020. Of course, it added trillions to the national debt and a new menace on the horizon: inflation."
Here's more from that recent blog post I mentioned above:
"We are essentially reliving the dotcom setup; in that a bear market in stocks would be the catalyst for an economic recession (adding massive insult to injury for the bottom half of the K), versus popular wisdom, which says the opposite.Ironically, on the day I wrote that note, futures were pricing in a mere 27% chance of a December rate cut, and stocks were correcting (down) low-to-mid single digits... While indeed that's barely "correcting," it was sufficient to have the Fed send out the governors to signal that they really didn't mean to spook the market, and that a December cut is very much on the table... As I type, futures are pricing in a 97% chance of a .25% cut, and the S&P 500 is bumping up against its all-time high.
The political motivation to keep the market afloat is huge right here… Thus, I anticipate notable tariff relief over the coming months, along with generally-friendlier geopolitical rhetoric coming from US policymakers, and potentially yet more pro-market schemes (akin to the “Trump accounts”) being hatched.
Then there’s the Fed… The market is having a rough go of it of late based largely on the fact that Fed funds futures have suddenly priced in less than a 50% chance of a December rate cut (1 month ago those odds were 90%)... Should equities continue to sell off, the Fed will no doubt grow very concerned about the risk that they’ll cause (be blamed for) the dynamic that will bring on the next recession… I.e., all else equal, they’ll be cutting rates."
Yes, the market indeed owns the policymaking decision process these days!
And, alas, allow me to requote:
"...what happens when volatility is suppressed for years and central banks come to the rescue at any sign of danger? It injects a misguided sense of safety into markets and lures investors into dangerous waters."And:
"...if central banks continually suppress volatility, preventing market corrections by deploying lifelines at the first signs of trouble, the market professionals will figure out one thing real fast. And that’s how to get rich. But scheming the markets has always had a nasty habit of ending in tears."But we're seemingly not to the tears stage just yet.
So, what matters here, on behalf of our clients, is how we plan to navigate this late-cycle setup going forward?
We'll tackle that in Part 2.
In the meantime, here are the updated US vs Foreign Equities valuation charts -- early 2000s to current.
Green = US, Orange = Emerging Mkts, Purple = Eurozone, Blue = Asia Pacific:
Price to Earnings Ratio:
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