Extreme Ownership: A Whirlwind for 1 st Quarter 2023
Extreme ownership, the guiding principle of the U.S. Navy SEALs, is a mindset of no excuses and no one else to blame. The SEALs use this process on the front line of the battlefield. In the practice of managing money, I subscribe to this extreme ownership guiding principle because, as Warren Buffett has stated, “unusual and strange things happen in the market,” and leaders need to be prepared. I take full responsibility for every individual portfolio buy and sell decision. These decisions are with real client capital and not hypothetical classroom theory. In addition, we try to have a margin of safety with every portfolio purchase. Focusing on eliminating asset risk and only taking market risk.
However, there are times when black swan events shake the foundation of capital markets. When the news of the Silicon Valley bank (March 2023) situation happened, people started to fear there were run-on bank deposits. Normalizing interest rates triggered a tornado in the capital markets in the first quarter of 2023. It also triggered a typhoon in the banking sector. Unfortunately, some of our investment positions (which have nothing to do with SVB or the Bay Area) got caught up in this short-term fear. This hit our portfolio hard because we have had large positions in the banking sector for many years. Since this news, we have been speaking with the Presidents of several of our Bank holdings confirming things are fine. There are no run-on deposits and no wild asset lending to start-ups, as we saw at SVB. In fact, bank earnings generally have come in just as we expected. There were really no surprises; no runoff of deposits, a slight increase in rates on the liability side, and no assets in commercial office buildings in major cities that affected fundamental performance. Finally, no increase in non-earning assets. We continue to like the sector as a long-term investment because of consistent operating trends and solid return of capital via high dividend yields (current income). Stock prices of banks move up and down according to the sentiment of recession expectations and earnings momentum.
Regarding SVB fallout: My fundamental position is that the only way you stop foolish risk-taking is to force PE & VC firms to read the financial statements and be prepared to lose money when they take risks. Silicon Valley Bank should NEVER have gotten a bank charter as it was a casino for the super wealthy in Bay Area. It is just the natural fallout of tech companies that are now on hard times and laying off thousands of people in TECH land. Near-term, large mutual funds, pension funds, Index funds are selling first and asking questions later. There may be continued near-term price pressure on the banking sector. However, this is the time to buy when the market is dislocated and prices do not reflect economic reality.
For example, a large bank based in St. Lake City has a 25% ROE (highly profitable) and one of the West's best deposit footprints. The shares are trading at a large gap between price and value. The wealthy are leaving California and moving to cities like Salt Lake City, Boise, and Tempe, which should be a natural infinity for growth in the next 10 years. Easy money appears to have created a mindset that is much different than that of extreme ownership. This is making the current investment environment difficult to navigate. There is a lot of uncertainty in the world and many economic cross-currents. For example, the (CPI) Consumer price index data is now coming down from a high level. However, the Atlanta Fed Wage Growth Tracker appears to be accelerating upward. This means we still have wage inflation pressure in the economy. Again, for every positive data point, we can find a contra point. Furthermore, the geopolitical situation around the world appears to be changing. Concerns over China, Taiwan, Russia, the falling dollar, and the balance of power for energy-oil and natural gas in Europe continue to change the calculus of financial markets.
With a high degree of confidence, I can say that we have now left behind an era of low-interest rates and easy money. Interest rates at zero are unhealthy, as they give rise to extremely high asset values, misallocating capital, and high debt levels at the company level. The consequence of a higher interest rate policy and wild fiscal spending will be felt in the real economy and the capital markets. A profits recession for the S&P 500 companies is coming, putting downward pressure on price-to-earnings multiples.
From a portfolio asset allocation perspective, I continue to believe that jumping from one sector industry to another is the wrong approach, as a rolling profits recession will hurt all companies. An old and well-known saying rings true: Better the devil you know than the devil you don’t. Bottom Line: Based on better-than-expected fundamentals, it is conceivable that the banking sector can return to prior price/valuation levels by the first half of 2024. As with life, investing is full of challenges and opportunities. We remain committed to the extreme ownership mindset and our long-term value approach to managing money. We aim to make meaningful investments in businesses with long-lasting favorable economic characteristics.
Respectfully,
Dr. Christian Koch, CFP®, CPWA®, CDFA®, RICP®
