Dear Valued Clients and Friends,
Last week’s Dividend Cafe on AI and investing has created quite a stir, and I thank those of you who offered such positive feedback.
Today’s Dividend Cafe starts by looking at the fundamental flaw in today’s portfolio management culture (hint: it involves incentives, mentalities, and [non] convictions). From there, we bounce around to lots of nuggets, including energy, globalization, shiny objects, and some fascinating factoids about the market.
Let’s jump into the Dividend Cafe!
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The heart of the matter
Let’s say you were a portfolio manager who believed career risk was more important than fiduciary duty to clients. Let’s say you were paid on “relative outperformance” to some benchmark or index. Let’s say you were a person without a lot of convictions. Let’s say you were a person with convictions but not the courage to act on convictions. Let’s say your highest value system was “playing it safe” (for you, not clients). In those situations, when an index gets to be 30% technology and 10% communication services, and when five stocks become a massive part of how that index does, and even one stock becomes 7% of the 500-stock index, would your incentive structure and psyche be to own that top-heaviness, or to avoid it? If you DON’T own it, and those things continue a torrent pace of over-valuation, you mathematically and structurally assure yourself a return lower than the index (the horror!). But if you DO own it, and it drops, you merely lie in tandem with the index, hugging the benchmark despite the premium fee you charge to be active and different, and you inevitably say (with mathematical truth to it) that “well, sure, we went down, but just because all that tech stuff did.” Heads, you win; tails, you don’t lose.
Now, 100% of analysts have buy ratings on Nvidia (okay, 92%). Five years ago, a third of analysts did.
This is the mentality of the vast array of money managers in today’s world. They believe that they will be forgiven for a drop that captures all boats but are petrified of not riding the tide higher as long as the tide continues lifting the biggest boats. They consciously deem it to be for their careers to “hug an index,” knowing that a large part of the investing public has tragically bought into some form of benchmark comparison instead of goals-based analysis.
We speak a lot about being counter-cultural at The Bahnsen Group. And yes, a big part of that is the counter-cultural philosophy that believes in fundamentals, business models, free cash flow, and alignment with shareholders (again, the horror!). But there is perhaps nothing more counter-cultural than not caring about the popularity of something at all in your pursuit of doing what you believe is right. The system often rewards the faithless. The conviction-less can find ways to hedge their cowardice (ride the fad up, blame the fad down). This dynamic can be systemic.
And in the heart of all that, you can find our critique of that system, that culture, and that mentality, and beyond our critique, our commitment to being different. To that end, we work.
Goldilocks in energy capex
Capital expenditures in the energy sector hit nearly $250 billion in 2015 and were around the $200 billion level from 2011-2016. It proved to be an over-investment that did great damage to the capital position and health of the volatile sector. On the other side of the extremes, energy capex hit $50 billion in the COVID shutdowns, and I presume all of that was maintenance expense, as there was essentially no investment in forward productivity at all. Right now, we are sitting at $80 oil and $100 billion of capex (versus 2015, where we had $50 oil and $250 billion of capex). Capital discipline, leverage, price differentials, and virtually every other economic metric one could look at are night and day better for the energy sector than they were 8-10 years ago.
Deglobalization that we pretend isn’t there
If I were running for President, I would be bragging about this, but U.S. oil production is up 2.2 million barrels per day. OPEC, on the other hand, is down 3.1 million barrels per day. So prices are high, U.S. production is up, and U.S. market share is up, and yet a lot of people who could benefit from this development politically either really believe it is a bad thing or have to pretend they think it is a bad thing.
Globalization that we pretend isn’t there
Don’t look now, but foreign ownership of U.S. stocks is at its highest ever (in dollars and percentage terms).
Perhaps even stranger
While some investors find the big cap growth space an attractive venue for growth and momentum, believing with conviction that what goes high must go higher, and many money managers have deemed it safest for their careers to bet with the crowd, not against, many have rested in the serene territory big cap tech growth because, alas, they see it as a “safe parking spot.” Finding solace and shelter in the space most over-valued, most expensive, and most over-bought is, well, strange.
Not all shiny objects are created equal
It should be said in my persistent critique of investing in fads, momentum, popularity, and over-valuation they do not all go up or reach stratospheric euphoria at once (at least not always). The solar energy and clean energy sectors are decimated, as are the “disruptive innovation,” “rare earth mining,” and “cannabis” spaces (three areas where shiny objects go to renew their membership). So while the Mag7 has become 33% of the five hundred stock index known as the S&P 500, many other shinies have been brought out to pasture.
Some fun factoids
With a h/t to Ben Carlson, there are three companies right now with a market cap above $3 trillion (Microsoft, Apple, and Nvidia). There are two companies with a market cap above $2 trillion (Google and Amazon). And there is one company with a market cap above $1 trillion (Facebook).
After becoming one of the ten largest companies in the index, the average annual underperformance relative to the market was -1.5% for the next ten years. This study goes back one hundred years.
There are 406 companies in the S&P with a market cap below $100 billion.
A fun fact of math
What is the difference between a trillion dollars and a billion dollars?
More or less, it is a trillion dollars.
Another fun fact of math
When a stock is up +693% in 18 months and then drops -8% in a few weeks, one may be wise to avoid the temptation of thinking that it has gone “on sale”
A bipartisan moment
Regardless of your own political views and even your own preference for the 2024 Presidential election, it certainly appears that the response to last night’s debate in most categories is quite bipartisan in its agreement and consensus. But I will leave you in suspense for a more market-oriented and policy-driven response, with more to say in the Monday Dividend Cafe.
A closing thought
Tech funds are now 40% of the sector ETF market, up from 25% a year ago. In the meantime, flows into tech ETF’s have quadrupled in the last year, hitting record levels … after the 2022 bear market?? – no! – hitting record levels … now, like, as in, this quarter.
Do with that what you will.
Quote of the Week
“You don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur.”
~ Nassim Taleb
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I am looking forward to a special “mid-year” check-in next week in the Dividend Cafe. Not only will we look at some of our full-year themes for 2024, but a general update on the state of the market, the state of the economy, and what lies ahead in the second half will also be covered.
In the meantime, I will be heading back to New York on Saturday after a 10-day stint that has included some Connecticut, Atlanta, Grand Rapids, and Dallas. The whirlwind speaking, meeting, and flying ends tomorrow and I am looking forward to a whole week in New York with my family.
Enjoy your weekend, and let’s get ready for the wild second half of 2024 that lies ahead.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
dbahnsen@thebahnsengroup.com
The Bahnsen Group
thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
