Don't Wait for the Robins
Co-Chief Investment Officer, Portfolio Manager
Co-Chief Investment Officer, Portfolio Manager
The Fed's campaign against
inflation continues. U.S. Treasury yields in the area of 4% are dramatically
higher than any we have seen in recent years. Mid-single-digit interest costs
are moderate by historical standards and should pose no major issues for
individuals and companies over the next few years, but the “sticker shock” of 7%
mortgage rates and the squeeze on borrowers who must refinance at higher rates
The economy is slowing, with
housing being the most visible example. Many companies› earnings have held up
fairly well so far, but with each earnings report, managements are issuing very
cautious/negative “guidance” about business prospects for the next few
Investors tend to obsess
over near-term prospects — the next data point, the trend and even the “rate of
change” within the trend. The financial media fan their fears because, as with
weather reports, raising anxiety levels is good for business. This leads to
active trading and volatility in stock and bond markets.
So, fear is driving markets
these days. The third quarter began with a strong rally off the June lows but
resumed its slide in mid-August and ended the quarter at new lows for the year.
The S&P 500 was down nearly 25% as of September 30, and gloom was very
How serious is this
The Fed is getting what it
wanted. Fed Chair Jay Powell seems to have channeled his inner Paul Volcker
(the former Fed Chair who raised rates to a peak of 20% to combat rampant
inflation in the early 1980s), so we would not expect Powell to
relent any time soon. Interest rates are expected to rise further, and the
money supply, which has already contracted considerably, is likely to shrink
further. These credit tightening moves will continue to slow the economy. Even
the very strong labor market is showing some signs of cooling. Whether the
National Bureau of Economic Research eventually defines this period as a
recession isn›t really important. The fact is, it feels like a
recession, and companies and investors are acting accordingly.
Nothing is ever simple in
global economics, but there is an extra wildcard this time — the war in
Ukraine. The war has exposed Europe›s dependence on Russian energy. Western sanctions
and Russian countermoves have caused disruptions of supplies and an energy
crisis in Europe. Less visible, but perhaps more important, is a global food
crisis that has been exacerbated by the war. The inflationary impact of these supply
disruptions complicates the roles of central banks in fighting inflation.
A by-product of higher U.S.
interest rates and spiking global energy prices has been a big move up in the
value of the dollar relative to other major currencies. There are positive
aspects of a strong currency, but it can be negative for domestic companies
because our exports are more expensive/less attractive to foreign buyers and
profits earned abroad in other currencies translate back to fewer dollars/lower
So, the headwinds for stock
and bond prices are real, but the outlook for investments is
always about the value of future cash flows relative to the current price.
If bonds default or a company›s competitive position is permanently impaired, investors
can incur permanent loss of capital. But a temporary slowdown in the economy
and lower earnings per share for a few quarters do not impair the
business value of a strong company. Bonds trade lower when new investors have
higher-yielding alternatives, but sound bonds mature at par value — 100 cents
on the dollar — and in the meantime, interest payments can be reinvested at
higher rates (this “interest on interest” is a significant component of total
return for bonds).
Back to the Future — A
Return to “Normal” Capital Markets
Over the decades, the Fed
and Congress have occasionally intervened to stimulate or cool down the economy.
In our experience, those fiscal and monetary moves didn›t last long, and
investors learned what to expect and how to respond.
Since the Great Financial
Crisis (GFC) of 2008-09, though, it has seemed that the government has felt the
need to protect investors from any financial pain. Near-zero interest
rates for over ten years and very aggressive fiscal stimulus in response to
Covid inflated stock and bond prices and taught a new generation of investors
that valuation did not matter. We responded to this surreal environment by
placing even more emphasis on business quality and by holding onto great
businesses, even as they reached fairly full valuations.
Last year the Fed recognized
that we had an inflation problem and made a 180-degree shift in policy. This is
the Fed we remember, and if they stick to their plan and bring inflation under
control, we think the return to “normal” will be positive for long-term investors.
Weak, over-indebted companies will not be subsidized with “free” money. Bonds
will provide competition for investment dollars, and savers will be rewarded
again. Stocks can still be great long-term investment vehicles, but to
paraphrase an old commercial for the brokerage company Smith Barney, they will
have to win the old-fashioned way, they will have to earn it. (Can
those of a certain age hear John Houseman snarling the punch line?)
In the Meantime — Business
Values Are STILL Our North Star
At this stage of a bear
market, most stocks are falling just because sellers are motivated and buyers
are not. We can protest that our stocks are misunderstood and “cheap,” but the
flow of investment funds is out for the moment, and that is what
matters in the short run.
In the longer term, though,
we believe that a stock›s price will eventually be determined by the value of
the business. Covid disruptions and potential recession may temporarily impact
the path of earnings, but it is the long-term future cash flows
We think there is also some
confusion about the value of “long-duration” stocks. The criticism relates to
rapidly growing companies with little or no earnings today but
promises/hopes of lots of earnings in a (perhaps somewhat distant) tomorrow. It is fair to note that rising rates are especially hard on these
companies' valuations because of the math of discounted cash flow analysis. These
stocks may have been very over-valued going into the higher-rate environment. However,
many investors seem to have made the incorrect generalization that rapid growth itself is a negative in the new environment. We would contend
that some great businesses (e.g., Google, Visa, Mastercard) have lots of
earnings today and will have even more tomorrow. This
makes for very valuable businesses, and we own a number of them.
While this bear market runs
its course, we continue to monitor our current holdings and look for others that
offer solid business value at attractive prices. This requires patience, and
investors who have been through distressed times know that holding, or even
adding to, positions can be the key to long-term compounded returns. We are
grateful for the long-time shareholders who have stuck with us through times
like this before.
The Gloom is Thick—But
Bear Markets End When You Least Expect It
The bad news for corporate
profits is likely to continue for a while, and the bear market may have further
to run (drop). But after the selling has run its course — after desperate
sellers stop accepting distress prices and buyers regain some courage — the
bear market ends. There is no way to predict with any certainty when this will
happen, but the turn will probably not come because the news has turned
positive — it will come before the coast is clear. As Warren Buffett
said in late 2008, “If you wait for the robins, Spring will be over.”
Our companies have been
going about their businesses, generating cash and growing their future earning
power. They are taking market share at the expense of weaker competitors and
buying productive assets from others that need the money. It may seem
counter-intuitive, but long-term growth in earning power and business value is
very often enhanced by periods of adversity. Market drawdowns can
be painful in the moment. But over the long history of the stock market, bears
— even deep ones — have tended to disappear into the steady, upward-sloping pattern
of long-term stock charts.
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The opinions expressed are those of Weitz Investment Management and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through 10/02/2022, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor's specific objectives, financial needs, risk tolerance and time horizon.
As of 09/30/2022, the following portfolio company constituted a portion of the net assets of Balanced Fund, Hickory Fund, Partners III Opportunity Fund, Partners Value Fund, and Value Fund as follows:
- Alphabet, Inc.: 1.8%, 0.0%, 6.5%, 7.0%, and 7.2%.
- Visa, Inc.: 1.6%, 0.0%, 5.6%, 4.3%, and 4.2%.
- Mastercard, Inc.: 1.6%, 0.0%, 4.4%, 3.8%, and 4.2%.
Portfolio composition is subject to change at any time. Current and future portfolio holdings are subject to risk.
Investors should consider carefully the investment objectives, risks, and charges and expenses of the Funds before investing. This and other important information is contained in the prospectus and summary prospectus, which may be obtained at weitzinvestments.com.
Weitz Securities, Inc. is the distributor of the Weitz Funds.