THE WINTER LETTER
If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.”
— Francis Bacon
There are more things in heaven and earth…than are dreamt of in your philosophy.”
— Shakespeare, Hamlet
Investment Philosophy
A few decades ago, never mind how many, when Columbia GSB Prof. Ramaswamy asked me a question in Baby Finance, I elected to pass. I was already grappling with the limitations of modern portfolio theory but had not, as yet, formed the words to express my dissent. Modern portfolio theory, like its economic cousin, presumes rational human actors. While a healthy starting point, especially for ease of mathematical modeling, it is incomplete. Already, in my student days, the modern portfolio theory edifice was adorned with anomalies. These have crystalized into an alternative hypothesis using human psychology as the edifice (see Nobel Prize winning work by Kahneman (and Tversky) and Shiller and Thaler).
Here, at Bache Capital Management we employ fundamental analysis to identify what we think are value and growth-at-a-reasonable-price opportunities in the stock market. We remain alert to the possibility that while stock prices are usually efficient (ie. they impound all currently available information), they are not always so. For example, in times of high stock market volatility like the present, is the January 27th closing price following a Dow plunge of 600 points or January 28th’s midday posting once the stock market has recovered from the prior day swoon, the “efficient” price. We endeavor to leave the temporary emotions of stock market participants out of the equation. And by taking a longer-term perspective, we hope to improve your investment results.
Economic Perspective
Economic participants must wrestle with the long-term consequences of the COVID 19 pandemic. The US economy experienced a quarter with the most substantial decline in GDP activity followed by a calendar quarter with the greatest growth in post-WW II history, all within the confines of 2020. Overall, for the year, the economy turned in the worst result since WW II. What are the consequences:
Market Prospects
The stock market, in 2020, rode a dramatic roller coaster. Much of the good news is already in the market. And the VIX, an index of volatility or riskiness of stocks is rising again after years of near comatose behavior. US Treasury 10 year yields recently pierced their cyclical high (set in 2014) suggesting that higher inflation and higher interest rates loom ahead.
In the long run, financial markets exist to facilitate the efficient allocation of capital. Short term they give market participants premature ulcers. Moreover, we will not be spared further intermittent volatility.
Geopolitical risks cloud the outlook. It may take some time to repair the damage to American reputation caused by the previous administration.
In an effort to navigate the treacherous market waters we emphasize certain sectors, including more resilient large cap names (Boeing, Illinois Tool Works); the out-of-favor pharmaceuticals and biotech (Bristol Myers, Gilead, Illumina); entertainment (Liberty Media, Disney, Comcast); technology (Ansys, Microsoft and Google), financial services (Wells Fargo, White Mountains); dividend plays like Prologis and ONEOK Inc.; and specialty manufacturing (Hexcel, Reliance Steel, Trane Tech).
Stephen K. Bache, CFA
Sources: Bloomberg Businessweek, The Economist, New York Times, The Wall Street Journal, T. N. Luhrmann, How God Becomes Real
