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Oct 2019 Commentary

October 2019 Commentary


History does seem to repeat itself. Impeachment is all the rage in Washington. The Middle East is once again conflagrant. The Yankees are in the post-season and Alabama is the best college football team in the land. It seems like the 1970’s all over again. For the sake of the leisure suit thankfully it is not. Societally, however, things may have been far better back then as competition was encouraged and success rewarded. Now, just being there is good enough. Success is no longer an outcome but an entitlement to anyone who participates.


A Brief Recap for September


US equity markets were up slightly, and the US Treasury term structure experienced a steepening twist around the 7-year maturity point. Energy commodities were generally down, both precious and industrial metals were slightly higher, and agricultural commodities were up meaningfully. Foreign equities were mostly up in September. Japan enjoyed the best performance amongst developed markets while the UK was the exception to the trend. A similar dynamic took place in the currency markets. The dollar weakened against most major currency except the UK pound.


Back to the Future and Leisure Suits


Major differences between now and the 1970’s also include that the US is now the largest carbon-based fuel producer in the world, interest rates are at record lows, the equity markets remain amidst a long trending bull market, and employment is at an all-time high. Interest rate levels and a decade long bull market are most relevant as they tend to lead to complacency throughout the investment industry. Complacency leads to inefficiencies.

Capital markets can’t operate efficiently if they are unable to allocate resources optimally. It’s quite simple. When markets are pushed to extremes and resources continue to pour into them, they tend toward mis-valuation. This dynamic is exacerbated when institutions like the central banks and governments interfere with the natural order of things. Artificial means like tariffs, quantitative easing, and negative interest rates merely distort prices. They end up being aberrations toward long-run equilibrium. Markets need to purge. Destruction of value can be cathartic and is often necessary. We are not nihilists by any stretch, but the capital markets haven’t had a proper cleansing in way too long. It’s coming and our fear is that improper risk management will lead to more wealth loss than necessary. Too many investment professionals don’t remember the 1970’s or weren’t even alive. We were, and it gives us significant perspective. That experience will be valuable when the time arrives.


The Phoenix Effect


The Phoenix effect is the ability of capital markets to rise from the ashes following a proper valuation adjustment. It properly aligns expectations and eliminates waste. Through this effect, markets become more efficient in allocating resources and investment professionals become more well-reasoned. Surviving to that point requires skilled risk management. However, the ultimate outcome of the Phoenix effect is a more proper alignment of investment characteristics. The economy and the capital markets are also far better off as long as misguided policy makers don’t insert themselves and delay the inevitable. Let the effect take place.


Competition verses Participation


In our view, the current capital markets are very much a reflection of our society. We have confused participation with competition. Participating doesn’t require hard work, discipline and sacrifice. Competing does. Competition builds character. Participation does not. Everyone doesn’t earn a trophy in our view. Our markets have too many participants but very few real competitors. Participants don’t properly evaluate asset valuations, competitors do. Asset valuations become inflated as result. We look forward to a capital market environment that rewards the competitor. It’s coming sooner than most participants realize. Competitors rise from the ashes. Participants disappear. We’ll be ready.

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