Q4 2023 Compass Review: Time

The cornerstone of investing is the tradeoff between interest and time. A dollar today is worth more than a dollar tomorrow because you can earn interest on that dollar. When interest is zero, time matters less. When time matters less, you take more risk to grow your assets. The most important consequence of higher interest rates is that it puts a time value on money.

As the saying goes, time is also our most precious asset. Sometimes it feels like we have an eternity ahead, but in the modern age we mostly feel like there is never enough of it: time with a loved one; time to accomplish our goals; time to help others.

This past September, I lost my grandfather, Stanley Tulgan, two months shy of his 96^th birthday. Stan was a brilliant electrical engineer and an even better person. In fact, the Compass team of 2024 wouldn’t exist if not for Stan. In 1984, Stan was introduced to Bill Matthes while looking to invest his company’s retirement plan. Long story short, thirty-one years later I was hired. We are so grateful for all he gave us and will miss him dearly.  

We also lost a legend of the value investing world, Charlie Munger, one month shy of 100. Best known as Warren Buffet’s sidekick, Munger was a brilliant investor in his own right, notorious for his cunning whit and use of multi-disciplinary, yet simple, mental models to digest complex problems.   

These two men made the most of their time. My grandfather was born in 1927, two years before Black Monday, the beginning of a 90% stock market crash and the Great Depression. Like many of the Greatest Generation, the lessons learned during the Depression and World War II never left him. As Munger said, “It’s so simple. You spend less than you earn. Invest shrewdly, and avoid toxic people and toxic activities, and try and keep learning all your life…And if you do all those things, you are almost certain to succeed. And if you don’t, you’re gonna need a lot of luck.”

It’s hard to fathom the societal and technological changes during their generation. My great grandfather rode on horseback to North Dakota from the lower east side of NYC to become a rancher. From horse drawn carriage to the Model T, to radios, TVs, camcorders, PCs, supercomputers in our pocket, and now AI chatbots. All we take for granted was beyond even their wildest dreams when they took their first steps. 

During their lives the stock market had a negative return 1 out of every 3 years, and in 5 different periods the return was negative for 2 or more years in a row. There was a World War, Vietnam and the domestic upheaval of the 60s, an oil crisis in the 70s, 20% interest rates and the savings and loan crisis in the 80s, the Asian financial crisis, the tech bubble, 9/11, the Great Recession, and the Covid pandemic. In each crisis we came out on the other side, but the duration and severity varied wildly.  Incredibly, though, 2020 was the first time in their lives that interest rates in the US went to zero.

The Street is lined with people who wrongly guessed the markets’ demise from each crisis. If you listened to the forecasters last year and sold your stocks in anticipation of a Fed induced recession, you would have left a lot of money on the table. Now there are talks of a “soft landing” as the Fed not only managed to bring down inflation but did it without a recession or an increase in unemployment. A crisis averted, and the Fed is now free to “pivot” and cut interest rates. Party on!

After 9 months of complaining about market returns being solely driven by the Magnificent Seven, the fourth quarter brought a reprieve with just about every sector rallying. Even our bond portfolios provided a boost. While our overall performance lagged the market cap weighted S&P500, there are times when being a value investor requires maintaining discipline when the market tells you otherwise. 

The positive equity performance makes it easy to forget that the landscape has changed. Interest rates are unlikely to go back to zero, where they’ve only been once in the last century. Time is a real factor in investing again. Disruption is in the air. For the first time in decades, the incumbents have new technology to contend with, which may or may not enhance their market power. Our experience of the last 20 years with lower and lower rates, almost no inflation, and expansive globalization are unlikely to provide the same tailwinds over the next decade.

We have been harping on the new interest rate environment for the better part of 2023 because it is so novel to many of today’s investors.  Edward Chancellor wrote a fascinating book, The Price of Time: The Real Story of Interest, in which he reviews centuries of interest rates and central bank decisions. Fun stuff! The book’s premise is that periods of abnormally low interest rates lead to significant speculation and irrationality. We saw that clearly during peak Covid mania. 

In summing up the book, Howard Marks quoted Munger saying, “Maybe we have a new version of Lord Acton’s law: easy money corrupts, and really easy money corrupts absolutely.” Marks argued that investors need to rid themselves of the idea that rates must return to “normal”, or much lower than they are today with the 10-year treasury at 4%, a sentiment we’ve expressed for months. Instead, this advice was ignored and the 2023 stock market mirrored 2020, with technology stocks overwhelming the broader index. However, the prior happened when the Fed actually cut rates to zero, while the latter happened as the market anticipated the Fed cutting rates. 

It’s possible the market is right, and the Fed cuts rates this year, and we avoid a recession. That would be an incredible outcome. Whatever 2024 brings, the benefit of being a value investor is that in any scenario, our philosophy remains steadfast: Buy great companies at reasonable or bargain prices and know when and what to avoid in the process.

While the market remains strong, there are potential landmines worth evading. Companies with substantial debt accumulated over the past years of easy money may run into trouble if rates remain elevated. At the same time, it’s hard to find an investment advisor who is not selling their clients leveraged private credit funds, which consist of highly indebted borrowers sponsored by private equity. We’ve already discussed at length the risks of market concentration amongst the large-cap tech companies. And right on cue speculative exuberance is back, with Fed pivot talk driving prices of Bitcoin and unprofitable companies higher. 

None of this, however, deters our optimism about the future. Even though we prefer a world of cooperation and trade, there are exciting opportunities with companies onshoring and nearshoring manufacturing and building the energy infrastructure of the future. As with the invention of the radio and the iPhone, it’s hard to even imagine how Artificial Intelligence will change our day to day lives. So long as we continue to invest and build, the technological arch of change remains as powerful as ever and will play an important role in all industries. 

Navigating that arch using the wisdom of Munger and Stan helps identify the signal through the noise. Now that time is on our side in the form of higher interest rates, we can be more selective with our investments. In a world where cash, Treasuries, and bonds provide a positive real (inflation adjusted) rate of return, the price and valuation of each company comes into even greater focus.

One of my grandfather’s favorite sayings was “luck is when preparation meets opportunity”, and he emphatically added, “but only when you take advantage of those opportunities.” That is the fundamental truth of value investing. We will remain disciplined in a market that seems to be driven by the Fed’s every word. Despite the pressure to act and react in our modern society, we patiently benefit from a higher interest rate world, and when the next great opportunity arises, we will be prepared. In the meantime, let’s all strive to make 2024 a year full of taking advantage of our own opportunities and not wasting any of our precious time.   

_{Compass Wealth Management LLC is a SEC registered investment advisor, clearing transactions primarily through Pershing Advisor Solutions and Pershing LLC subsidiaries of Bank of New York Mellon Corp. This letter is written by Compass for the benefit of its clients and does not necessarily represent the opinions of its affiliated organizations. It is based on information believed to be reliable, but which is not guaranteed to be correct. Nothing herein shall be construed to be a solicitation to buy or sell securities, indicate that past performance is predictive of future returns, or recommend individual investments.}