(All figures are quoted in USD unless otherwise stated)
For the fiscal quarter ended 12/30/2022, the Gnostic Global Portfolio closed with a value of $677.31. This compares to the valuation for the 3rd quarter ended 09/30/22 at $576.60, resulting in a return in the quarter of 17.5%.
For the same fiscal quarter, the DJIA closed with a gain of 15.4%. The S&P 500 closed with a gain of 7.1% and the NASDAQ index closed with a loss of 1%.
Overall, for 2022, the Gnostic Global Portfolio generated a return of 2.4%.
In comparison, the DJIA closed out the year with a loss of 8.7%. The S&P 500 closed with a decline of 19.4%. The NASDAQ Index closed with a rather staggering loss of 33.1%.
If 2022 revealed anything, it is that real world experience with economic cycles has a definable value.
Too many individual retail investors, plus a mind-numbingly high percentage of professional money managers, to this day, have absolutely no applicable expertise to navigate the deleterious impacts of inflation as it applies to most sectors of the global economy.
In corporate finance, the word “inflationary” is most typically combined with another word, “pressure”, and that is apt; for the most part, inflation represents a bad thing to a corporate income statement. Were it any other way, the words that would be bandied about in the media would logically combine “inflation” with “benefit” and investors would be clamoring for more of it, not less.
Such lack of understanding about inflation was revealed in each and every fiscal quarter throughout 2022. Investors cheered on top line revenue increases but couldn’t fathom why profits on their favorite stocks went in the opposite direction, almost diametrically opposed to the percentage increases in consumer and producer prices.
Analysts were equally caught off guard, they failed to inform investors that inflation impacts both sides of the income statement on a ledger; inflation is only a net positive if a company can increase revenues per unit by some level above the higher assumed cost of producing that item.
The few old timers remaining in money management, dismissed by a new generation of investment managers, they saw through both the media ruses attempted to be foisted on a younger, naïve public as well as the bravado of the inexperienced. Tragically, inflation hawks of yesteryear have lost their abilities to influence the public due to decades of wildly erratic performance or perennial underperformance during the decade long bull market of the period 2010-2020.
There IS some expertise out there.
Not quite a generation out from the hawks resides a tiny cadre of investors, some who started at a very young age. They paid close attention when the old guard preached about the perils of inflation; some tucked the warnings into back-pockets, kept alert for tell-tale signs and developed a “what to do” play book in the event of inflation, a just-in-case file.
I fall into that category, not too old to be irrelevant, not too young to have dismissed the lessons out of hand, and continually on DEFCON 2 for a variety of economic scenarios. This year, maybe the first year ever in the history of the account, some ownership for the absolute and relative success of the portfolio is due to my efforts. Diligent oversight added to the return, removed sources of loss and today, I am “taking a lap“.
The Gnostic model portfolio generated a return of 2.4% for the year ended December 31st, 2022.
The year started with a value per unit of $661.14 and ended with a value of $677.31. As money supply growth raged on without meaningful central bank pushback, the account, for the past two years, was methodically oriented towards an objective of having the portfolio prove less vulnerable to PPI and CPI increases, with the ultimate goal of being in a net positive for incremental corporate profits due to be earned by the majority of the portfolio as a result of persistent inflation. At this point in the economic cycle, my view is that the objective has been achieved.
This return was above the rate of growth in M2 money supply for 2022. It was 11.1% above the index losses reported by those investing in the DJIA, 21.8% better than the S&P 500 and 35.5% ahead of the the NASDAQ composite index. Being fully invested, at all times, I consider it an accomplishment to outperform the major indexes by anything above 10 percentage points over any fiscal year. 2022 was a far better year relative to the indexes than my objective, but it seems my plan diverges from the new investment norms; the equity world for 2022 seemed disinterested in making money, nor were they interested in saving capital, their sole goal seemed to be to pretend that it was business as usual, to suffer and to commiserate.
45% of the portfolio is allocated to investments that closed out the year at/above/statistically near to their all-time highs. 69% of the portfolio is invested in specific companies or sectors that are demonstrating, by way of profit and margin, fiscal results which confirm the strengths of their business model during this inflationary cycle where present tailwinds buttress their investment cases.
Not every stock in the portfolio closed higher on the year, but there were enough that did, and the percentages of the portfolio allocated in those businesses were such that the result was a fine year overall, during a time when most are offering up little more than tepid justification.
One long held investment in the portfolio, PayPal, was sold in April after several consecutive years of income and balance sheet deterioration. Another key investment in the model portfolio, Costco, was sold from the account early in December on my assessment that it is more susceptible to the impacts of inflation than most believe, entirely due to what I consider to be poor executive decisions, qualitative gaps in the executive office and a complete unwillingness to execute tough actions required to offset the inflationary environment running at the highest level in half a century. Finally, dividends generated from the entire portfolio were allocated to investments, already within that account, likely to benefit from inflation inexorably rolling through the consumer economy.
Warning signs of inflation were evident since 2018 and predated Covid-19; the observable culprit was abnormal growth in money supply.
An almost 50% increase in the circulating amount of money on the planet within three years, the largest coordinated printing of currency in the last half century, was the determinant that something dramatic would almost inevitably ensue. The investment media did not choose to pay attention, because to pay attention was to conclude that the status quo was about to be upended and nobody wants their long-held investment beliefs and the stratagems, that benefit from the status quo, to be upended. Accordingly, media, analysts and investors alike, most chose to pin the sum total of their investment policies on the hopeful term “transitory inflation.”
Perhaps portfolio investing need not be a binary choice between hope and fear.
For the past two years, the data pointed out, for those choosing to invest time to read through some of my blog articles, that money supply increases would logically result in serious inflation; that inflation would roll through each and every sector of the economy, hitting producers and consumers alike but at different stages. We are not over with this story, much as most would like it to end.
Differing from perma-bears, who argue that the only choices are to buy gold, get a gun, buy seeds, hunker down in a survival bunker and await the end of civilization; differing from the many largely passive investment management firms, who pretended that inflation wasn’t a thing, that it would waft through the system very quickly and disappear into the ether, solely to comport with their business model that does not offer active solutions; I believe in active solutions and that demands the occasional hard choice.
What is missed by both passive investors and the perma-bears is the notion of purpose. Why ARE we doing this, if not for the opportunity and the probability of earning a positive overall return in a capitalist economy? MY thought was to assiduously pore over sectors of our global economy that are neither cyclical, nor are they being punished by the effects of inflation; sectors capable of passing on input costs in full and then some. The data is out there, often provided monthly, our only requirement is to read it.
Many professional investment management companies became “combat ineffective” in 2022.
A military phrase seems quite relevant to the scenario at hand. A fully manned combat unit, be it a platoon, a company, a brigade or an entire army, is considered to be combat-effective, entirely capable of carrying out its objectives as ordered. After losing a certain percentage of personnel, a unit is considered to be depleted and either requires reinforcements or to be combined into another unit. For most military planners, any unit that has lost a threshold of 30% of its fighting force is considered to be combat-ineffective. Once that loss threshold has been breached, the ability of any unit to engage in offensive activities ends and even defensive actions pose a greater risk to the remaining personnel within a group.
My nephew, presently recovering in a hospital in Kiev, Ukraine, was in such a depleted unit. Each time we talked, my first questions were not “are you rested, how’s your hearing, are you warm, are you eating”?; no, it was “is your unit still combat effective?” At the point when company losses were too high, he got hurt, not of his own accord, but simply because there was too much expected from a profoundly degraded combat force.
As to investment markets, I consider an index loss greater than 30% to be an index no longer capable of engaging in the economic fight that is capitalism. NASDAQ index stocks represent an offensive force for global GDP featuring few defensive characteristics; those investing in the NASDAQ just want to score more points than are scored against them.
With the NASDAQ index down by more than 33% in fiscal 2022, an entire swath of the US economic output, encompassing trillions in global GDP, has completely lost its combat capability. Executive of the corporations comprising the index, the managers of portfolios built around those indexes and individuals holding those portfolios, as an analogy, are all now suffering from a variation of investment PTSD. They have been reduced to doing little other than sobbing and rocking in a poorly dug foxhole, one largely exposed to mortar fire, all the while a globally vital economic battle rages. This massive repository of global equity capital, encompassing much of the new world economy, is at a growing risk of becoming illiquid. Lacking a fallback plan, NASDAQIANS have refused to displace, to regroup, and have subsequently, been overrun.
Cracks are now widening in some sectors of household and institutional net worth, based upon the interest rate hikes.
Existing home values in the upper middle price ranges seem under pressure throughout the United States. I track a selection of Zillow homes throughout most US states and have done so for years. What I am seeing are properties in the $1 million-$2 million price ranges steadily on markdown. Upper market homes are not being reduced yet but my phone is ringing off the hook to ascertain my level of interest, from realtors that were previously far too busy to offer me a viewing. This pricing action is consistent with an overextended housing market in the most active consumer discretionary market, the middle and upper middle classes.
Smaller McMansions may eventually wind up in forced net liquidations should another interest rate increase take hold, perhaps based on resets with mortgages or maybe from employment pink slips. There is a vast qualitative difference between newly constructed homes and homes constructed 10-15 years ago or greater. Pricing for new homes will need to be adjusted accordingly so as to persuade buyers about newish curb appeal representing a better proposition than quality of construction.
On the institutional level, some notable commercial and residential real estate equity funds are shopping properties to meet redemptions; if sales cannot be accomplished on a timely basis or adequate price, redemptions could be paused, frozen or more assets would need to be added to provide liquidity, which for real estate, then places pressure on valuations.
Prior to foreclosure activities, things get sold; collectibles, valuables, vehicles. Recently, I have also been peppered with replies for offers made, sometimes going back three years, “are you still in the market for…..?”
These personal anecdotes, when blended into retail sales data, data that encompasses roughly 70% of US GDP, suggests to me that the slowdown often talked about, is finally here.
A lack of perspective prevented many from understanding that a handful of sectors still exist where business was good, very good.
Higher interest rates and higher inflation impact every aspect of the economy, every sector, every person. Most impacts are bad, but some are not. According to the US Census Bureau, consumers spent 31% more of their household income in 2022 on groceries as compared to 2021. That is heads and tails above the top line inflation rates declared to the media. It suggests several things:
A. Core inflation is MUCH higher than reported and will therefore require longer timeframes to get under control than hoped for by policy makers, producers and consumers.
B. Some vendors of necessary goods to the public are earning a profit higher with inflation, than they were earning before consumer price inflation ran away.
As headline CPI was less than 31% in 2022, it was evident to me that grocers are generating some margin pick-up. The sector also appeared under-owned in early 2022. I held several retailers specializing in global grocery prior to 2022 and added to those positions as capital permitted. Grupo Chedraui ($4.29 USD), a fast growing grocer with more than 60% of its business generated in the United States, increased in share price by more than 112% in 2022. BJ’s Wholesale Club ($66.16 USD) in the United States rounded out my grocery participation in the USA. Sendas (ASAI-$18.31 USD) in Brazil was my grocery choice in South America.
Health maintenance organizations, sometimes referred to as health insurance companies, also performed extremely well. On an operations front, they benefit from high employment and from higher policy revenue than claims expense. From an investment perspective, they tend to do well when media is malleable or even better, when the media is kept ignorant of the profit trends. Accordingly, the HMO industry generally tries very hard to stay away from the investment spotlight. In 2022, the sector labored and lobbied mightily to remain out of the media line of sight, because even positive pieces spawn envy and envy can lead to additional regulation.
Cigna ($331.34), the largest HMO holding in the portfolio as well as the largest investment in the account on an absolute basis, appreciated by 44.3% in 2022, under the cover of relative obscurity. Cigna also paved the way towards a large business increase from their major division in 2024 by landing an important contract from a competing HMO. There is a broader implication to this development. It implies that the industry, rather than competing against one another on price, has adopted a far more cooperative approach in carving up the US health care business to fiefdoms with tributes (lobby funds) paid up to the ruling political class of the day, so as to permit a continuation of the concentration efforts. The HMO sector may no longer be freely capitalistic, it seems more feudal. Cigna closed out the fiscal year end by confirming the 2023 forecast, quietly slipping a piece of positive news into yet another bad day for equity holders.
Vacation sensitive publicly traded airports also had a bang-up fiscal year. Grupo Aeroportuario del Sureste ($232.99), the operator of the Cancun International Airport (among others), appreciated by 13% on the year, touched record highs by late December, reported record passenger traffic, and earned record income for the 3 quarters reported on thus far in 2022. Grupo Aeroportuario del Pacifico ($143.81), the operator of the Los Cabos and Puerto Vallarta airports, appreciated by 4.6% in 2022, reported similar business success and touched a record high in November.
Novo Nordisk ($135.34) surpassed a $300 billion market cap in December on continued growth in the sales of flagship and novel diabetes and weight loss treatments. The market value increased by 20.7% for the year. The greatest issue with Novo Nordisk is the challenge of expanding existing plants to meet current demand, which is the sort of problem most companies on the planet would love to report.
2022 was the year for an investment sniper, rather than those armed with a shotgun.
A sniper evaluates targets from afar, stays under cover as best they can and takes great care to measure factors that are considered unimportant by many close range hunters, such as wind velocity. Snipers spend most of their time in preparation, because they typically only have one shot at a target; if the shot goes astray, that target will move and all the preparation is for naught.
Throughout 2022, monthly CPI and PPI data indicated that just a very few sectors were consistently reporting revenue increases above reported inflation. Those sectors included grocers, restaurants, HMOs and travel related sectors. Therefore, I opted to focus more closely upon grocers, to increase my exposure to HMOs and to continue to reinvest dividends in the publicly traded airports that are of interest to me. I refuse to own restaurants as there are absolutely zero barriers to entry. Almost all other sectors of the global economy were unable to generate sufficient revenues to stay ahead of inflation, and here we are.
I believe that 2023 will continue to be a sniper’s market, at least until interest rates reverse course and start heading down.
It took more than 16 consecutive fiscal quarters of abnormal money supply growth to get us to this point, is it reasonable to predict that such excess be remedied in just 2, maybe 3, fiscal quarters?
I think not. Yet, newer portfolio managers continue to ignore Chapter #1, verse #1 of the Investment Old Testament: “though shalt not fight the fed”. Central banks have declared that the fight against inflation is not over, that they will continue to utilize an indiscriminate cold war era howitzer for a while further. There is absolutely no reason to expect that the global economy will magically improve on January 1st, 2023, simply because we wish it to be better.
Denial of the fed actions is still ongoing and hoping for the end is not a strategy, it is just a hope. Until rates stabilize and start to decline, this doesn’t get materially better for the global equity economy.
Where it becomes challenging to assess in the first half of 2023 comes about from a potential dry up in liquidity. Sales of NASDAQ equities have, for more than a decade, represented a globally significant source of expenditure funds fueling consumer purchases, capital sales that permitted the purchase of fancy electric cars, expensive houses, highly discretionary consumer items, frivolous value added services and follies to highly speculative ventures.
At these levels, NASDAQ equity sales start to hurt, so spending will likely be cut accordingly and off-bank leverage unwinding may become forced. Certain commercial real estate global players have already started to limit or suspend redemptions. Furthermore, dividend payments on equities are generally paid out as a percentage of net or gross profits. Should earnings stall out, or heaven forbid, head down, so will the dividend payments. If corporations start to cut, or simply hold dividend rates in 2023 as they did in 2022, there will be less “inflation adjusted” capital out there to sustain spending as it presently stands.
In order for corporations to improve underlying levels of profitability, input prices need to come in line with output final selling prices.
The final ingredient to putting inflation to bed is for wage pressures to abate. That will only happen when people are scared for their jobs and when governments stop providing assistance programs and subsidies at a level which permits those without work to maintain their lifestyle. Corporations can lay off people all they like, but if government programs fully replace those foregone wages, inflation will not be checked.
A combination of wage pressures and higher household expenses is a logical approach to putting a ceiling on inflation. The 2023 pressure point on consumer spending will almost certainly come via interest rate resets on various forms of indebtedness. Mortgage renewals at today’s rates, vs rates of five years ago, will further sap disposable incomes. Consumers are spending 30% more on groceries than they did a year ago, but that has been largely met via cutbacks on other forms of retail, more of a shell game than a legitimate household crunch. But, when interest rate charges remove an additional 30% of discretionary income from the typical American household over the 2023 full fiscal year, that will hurt and could force out remaining excesses from consumer spending. At that time, consumer demands for wage hikes will end, to be replaced by pleas to be not fired, and that should be when the economy bottoms and corporate profitability turns materially higher.
2022 was active for the account by historic standards. 2023 will be far less active.
With an investment industry overly focused on corporate revenue growth for companies they cover, few factored in input costs for 2022. Even fewer are considering input expenses for 2023 because they are down to hoping, perhaps against hope, that inflation is still “transient”.
Central bankers disagree and they keep lobbing interest rate mortars at the global economy. I will not stand in their way. Costs are now permanently higher and there is a time lag separating expenses and incomes, an interval between when corporations stop hiring and when they start firing.
For the most part, game sought from my vantage point has been bagged. My portfolio remains fully combat effective and the investments under my watch are a combination of a recruit already in line for a battlefield promotion and supported on all sides with highly experienced businesses driving the show. For 2023, I only need to venture out to pick up what has been shot, drag it to my stand and let it age. If something opportune wanders past my blind, there might be a chance to benefit using dividend payments, but to leave a well-protected shelter solely out of greed and enable central bankers to shoot at me, potentially blowing my portfolio to smithereens; that is not something even worth debating.
The media, most investors and most portfolio managers have closed off 2022 losses with their traditional optimism promoting 2023 as likely to be a whole lot better.
“If wishes were horses, beggars would ride.” (Scottish proverb, 1628)
A badly degraded NASDAQ group of companies, portfolio managers and investors are all banking on some sort of capital reinforcement out of nowhere to stem the losses or to turn the tide. From my vantage point, I have to say that I don’t see any help on the horizon. Inflation and rising interest expenses continue to wreak havoc with corporate and consumer income statements. Neither issue magically ceased at the end of 2022. Near term optimism seems utterly misplaced.
Forecasters are now pinning hopes on the January effect, whereby institutions and individual investors repurchase investments previously sold for tax losses. But, what if investors don’t repurchase all those securities and instead deploy capital, quite recently withdrawn from equity markets, to maintain higher debt service expenses, or perhaps reduce leverage elsewhere, on say, commercial and residential real estate?
I don’t anticipate the account to remain in the black for 2023 and am not promoting a notion of a meaningful January rally with staying power; my objective is simply to lose less than others, going into the turn. Any potential January “blame game” will likely revolve around China and a winter storm in the United States. China is always an issue and there are storms every winter; to depend upon such excuses is tiresome indeed.
We are on our own, no reinforcements are on the way.
“Honesty is such a lonely word. Everyone is so untrue. Honesty is hardly ever heard and mostly what I need from you“. (William Martin Joel)
To have a non-cyclical, unhedged, fully invested portfolio of publicly traded liquid securities remain in the positive territory, when almost all others are in the red, that is rare air indeed. While the portfolio did not earn a return above the rate of inflation, which means that consumer purchasing power to be had from the account is lower at the end of 2022 than it was in 2021, a growth rate above money supply indicates that my equity investment purchasing power is higher than the prior year. The reduction in global equity values permits great flexibility for 2023. I can attack when prudent, defend as required, or stay in my blind and plink away at an occasional target of opportunity.
There is clarity when one holds the vantage point and today represents an “I told ya so” moment. The overall composition of the Gnostic account seems far better prepared for more inflation than the typical mutual fund or ETF out there, heads and tails so, and without the timing risks involved in cyclical materials or energy ownership. Proof is in the results as many institutional accounts purchased up key investments held by the model account in Q4.
Yet, nobody that is fully invested can legitimately expect to remain positive in the event of liquidity event shocks or significant valuation compressions. This is not a time for bravery, nor is it a time for folly; an economic inflection point, when it appears, will be evident to all who choose to pay attention.
Central bankers will let us know, by telling us so, when they have concluded raising interest rates.
Until that time, do not fall for half-baked investment analysts, forecasters and pundits that were proven to be wrong in 2022 and who became increasingly strident as the year progressed, do no fall for investment media that has proven to be wrong in 2022, do not repeat the 2022 mistake of focusing solely upon corporate revenues without paying equal attention to expenses.
Do not seek out confirmation to your own bias simply to make yourself feel good. Capitalism inevitably involves a separation of winners and losers. Inflation is at the highest level it has been in half a century and a dramatic change in business planning is required by more corporations to defend or expand their profit margins; a non-inflationary “laisse faire” business model gradually implodes under persistent input price hikes, and that could play out in the year to come. It is a mummers farce to presume that every reasonably well performing equity over the last decade-plus economic upswing, with reportedly benign inflation, will be equally advantaged to protect our hard won capital in an economic downswing featuring high inflation.
Understand the stage of the economic cycle that we are in, understand that businesses often fail, not at the bottom of an economic cycle, but as the cycle turns for the better.
Finally, stop pretending that we all know more about equities than those controlling trillions and who got out of, not into, markets in 2022. The global equity market fell for two reasons: interest rates went up and inflation got away from central bankers. Equity markets will not turn convincingly higher until both of those risks are determined to have been removed from the global economies.