I Just Don’t Know…

Long-time readers of this site know that I prefer an investing style that is both highly-concentrated and hyper-aggressive. My only goal is to maximize returns over rolling three-year periods. As a result, I’m completely agnostic about volatility, usually running my book well over 100% net-long, while rarely hedging. At the same time, I’m not a masochist. I have come to learn that there are times to press it, and times when there’s rather little to do.

You see, in finance, good investments should be painfully obvious. Otherwise, they’re not worth making. Sometimes, there’s simply nothing to do. I point this out as the concept of doing nothing is, itself, quite contrarian. We work in an industry where everyone is supposed to be an expert and have an opinion on everything. Given the fee structure and marketing imperatives of most funds, they do not have the flexibility to say the obvious “this is a really strange moment currently, and I just don’t know how it will all play out.”

I live by two core investing rules; invest in situations where next year’s results will improve dramatically OR invest in situations where the underlying asset is so amazingly bombed out that it really cannot get worse. The latter point is always subjective and hard to quantify, unless you’ve been in this game for a while, while the former point comes down to simple cognition. Naturally, extreme undervaluation is always my North Star in all circumstances.

Look, I think investing is really simple. Buy cheap assets that are inflecting positively. That’s all you need to know. Everything else is superfluous, an own-goal; often designed to further the marketing efforts of your fund or convince yourself that you can out-think the market. Far too often, investors dive into the minutiae around them and lose sight of their overriding goal; buy cheap assets that are inflecting positively.

As I analyze the world today, I don’t see many easy calls to make. What sectors are cheap and inflecting positively? In my view, not much outside of offshore energy services and physical uranium. Even guessing the price of oil (where I have a lot of exposure) is fraught with risk—while I think oil is going much higher, there are plenty of variables that go into that calculus, potentially deferring my thesis. At least with offshore energy services, I can look at the backlog and have a good degree of confidence that results will get dramatically better, and with physical uranium, I believe the deficits will blow out to such ludicrous levels that barring a nuclear accident, I cannot fathom how the price isn’t higher in a year. In my view, these are such easy calls to make, that I’ve made them into very substantial positions. Everything else seems like a crapshoot based on macro factors that are difficult to predict over the coming year. That’s not to say that I don’t have other positions, but I have far less confidence that this is the year that they work. Hence, I’m not sizing them up.

With that view in mind, I want to delve into why it is that so many investors feel a compulsion to always be doing something—even when it’s not obvious why something should be done. It all starts with the marketing function of most funds. We live in an industry that is fixated on capital raising. You simply cannot go to a prospective client and say, “the world is really complicated, I’m going to hold onto lots of extra liquidity and wait for a layup” as the potential client will say something like, “that’s nice, let me know when you find something interesting, and we’ll start our six months of due diligence then.” Six months is a lifetime. By the time capital shows up, the opportunity has passed. As a result, the marketing necessity is to make it appear that there’s something to do, a once-in-a-lifetime situation. Otherwise, how do you get potential investors to prioritize your offering over the hundreds of other offerings that are all promising an even better opportunity-set? How does a paid newsletter or podcast or televised financial show get your attention? They appeal to the same script. Something important is happening and you have to be involved.

Now, retail investors may be wondering how this narrative applies to them as they should be immune to its grip. Left unsaid, is that retail investors are the remora eating the scraps off the great marketing machine that is professional capital markets. It is inevitable that the ethos and nomenclature of our industry seeps into their thinking—even if they believe that they have a degree of self-awareness. Look, we’re all constantly bombarded by stimuli. It’s all designed to make us trade something. We’re supposed to have opinions about the next non-farm number and what the services component of the CPI ought to be. In reality—who cares?? These are just discrete moments of intense, yet truncated volatility. They’re captivating yet signify nothing. No one gets wealthy on the next data-point. Meanwhile, fortunes have been missed while trying to avoid a few percent pullback, and even larger fortunes have been squandered on hedging against that pullback.  Real money is made on multi-quarter to multi-year trends with exponential torque. Everything else is just drama, meant to distract investors from the larger prize.

Amazingly, few of us can seem to break away from the scrum, look around and accept that at times, there’s nothing to do. At least for me, very little appears obvious and actionable today. No great trend that’s suddenly awakening. Instead, there’s the daily whiplash of policymaker speeches and speculations about Central Bank objectives. Why not cut back on exposure, build liquidity and wait until it is blatantly obvious?? Why not be honest with yourself and honest with your clients?? There will be a moment to press it, but today isn’t that moment.

I say all of this as a successful hedge fund PM that is trying to raise capital. There are times when it’s obvious and there are times when it isn’t. For the first time since January of 2020, when Covid first showed up in Wuhan, my near-term crystal ball is rather obscured here. After over two decades in the markets, I’ve matured to the point where I can admit that I just don’t have a feel for what happens next. In fact, I’m willing to wear that view as a badge of honor. For most of last year, I kept my exposure light, and it seems like 2023 will be a continuation of that trend. As far as I’m concerned, the crosscurrents are complicated and getting it wrong could be tragic. Meanwhile, it’s not clear what the prize is for guessing correctly about the Fed, which is what’s driving most of the macro world, and superseding the other trends I’m tracking.

Over the past few decades, the Fed always had our backs. There was the proverbial “Fed Put” where they’d intervene on any substantial pullback, but now there is the proverbial “Fed Call” where equity strength is met with hawkishness. Do you want to be long into that turmoil, with your upside capped, especially when the unwinding hasn’t even started? Sure, some Ponzi Schemes have unraveled, and others are on the precipice, but legitimate companies haven’t even felt any pain. The fastest rate cycle in decades will not end with a whimper. Something cataclysmic seems inevitable—likely driven by energy prices going parabolic. Why do anything today, before the crisis. Sure, I may miss some zigs and zags in the broader market, but my mandate isn’t to guess the next 10% movement in the market. My mandate is to buy powerful trends coming out of highly depressed valuation levels. I don’t see that setup in many places, and it is not for lack of trying.

I’m the “Project Zimbabwe” guy, but I’m doing a lot of waiting, traveling and more waiting. It all seems “too hard” in the markets. There will again be a time to absolutely max it out, a time when the markets get 110% of my attention. I just know that moment isn’t today. I also know that by fixating on the markets, I’ll only get coaxed into second-rate positions and suffer losses. There’s a reason that I take so many vacations. I want to refresh my mind and prepare for those moments when important decisions are needed. Stepping away gives me a remarkable level of clarity and perspective. It reminds me of how amazingly liberating it is to step into a crisis with a full quiver of liquidity.

I wish that more investors could be honest about how best to run a portfolio. In my opinion, you hoard liquidity, wait until it’s obvious and then pounce. Everyone knows this is how it works, everyone worships Buffett for having done it, yet few investors seem capable of following such a simple script. Then again, if this game were easy, there wouldn’t be opportunities. When today’s buyers get pressed against the wall, that’s when I want to buy. Until then, I’m waiting until it’s obvious.

In summary, there’s nothing wrong with saying, “I just don’t know.”