Thoughts on the Current Bull Run
Adapt your mental models to reality, not reality to your mental models
The market can stay irrational longer than you can stay solvent - a famous quote all investors will agree with. Much has been said about the current bull market, the longest lasting one which has witnessed the most stretched, insane valuations in history. You will find many quarterly letters talking about this, citing numerous charts, metrics and theses to support their viewpoint of markets being overheated and poised to crash.
The problem is, most investors already know and agree with this.
Restating the general conclusion on this bull market is just useless hand-wringing and intellectualization, in my opinion. It is better to figure out or chart a course of action instead of analyzing things which have already been analyzed.
There are 2 ways to function in this market as a value investor, but most investors just focus on the first one, which is to short overvalued stocks and hold traditional value stocks.
Now, the problem with this is underperformance, which is antithetical to the reason you want to be an investor in the first place. If you cannot provide risk-adjusted returns better than the benchmark than you should start thinking about your strategies. Look at Einhorn at Greenlight, Chanos at Kynikos, Paulson, Tilson among others, geniuses, all of them.
Even if your thesis is right, performance is what matters ultimately in the asset management business, as you’re managing other people’s money. You can always invest in correct theses which could underperform, but doing so with clients’ money is a fiduciary violation.
These are people who’ve imposed their will, their theses on the markets instead of adapting their strategies and theses to the market. Now, I’m a Nietszchean and a fan of imposing my will, but I’m also a fan of not losing money (when compared to the benchmark), especially if it belongs to my investors.
Then there are many who just withdraw their cash and sit on it, waiting for the next bear or normal market. Again, this is a great course of action if you do it with your own money. However, you must not do so with investors’ funds, and if you do, you should not charge any fees on cash held.
Then what is the second course of action, the one I do advise and practice myself? It is to take my money out of overextended markets and put it into undervalued or rational ones.
When the tide turns against you and you want to swim, you don’t swim against it or leave, you just go somewhere else with more favorable waves.
Here is a list of asset classes which aren’t party to the irrational exuberance everywhere, with examples for each. Read on for more.
As investors, we have developed an understanding of what a good business is and how to screen for one. Why not learn how to run one? And if the stress isn’t worth it, just buy an existing business and let previous management run it, while enjoying the cash flow, and then buying more businesses with it. This way you can have a portfolio of businesses which you run passively.
The other factor (which is common across all asset classes I’ve picked) is that while some businesses can be overvalued, though most aren’t in the private markets, there can never be a good business which will be undervalued for long. Low cash flow multiples? You benefit, because you get to buy at a discount, and when you want to exit just hire a competent investment bank.
The other common factor between all these asset classes is scarcity, barriers to entry, experienced operators, low liquidity and skin in the game. You have to have a high net worth to buy a business, be able to value it well and pay a reasonable consideration, otherwise you will lose your and your investors’ capital. Low liquidity ensures you have to buy a good asset you can stick with, which means there’s a market only for quality assets. Returns are good due to low competition, poor popularity, and aligned incentives for everyone in the market.
The only difference between this asset class and the previous one is active management, larger scale, leverage, and more competition. Although private equity is still a great investment with outsized returns, the influx of abundant capital by pension funds and insurers has lead to distortion in valuations and misalignment of incentives. I don’t have the link now but there was an article in Institutional Investor about an industry insider who is on a crusade to challenge the shitty companies being acquired by PE firms now, with the central example being Smile Direct Club.
If his talking points are true, then the PE market has devolved and degraded into a slightly more secretive version of public equity markets, where low quality companies are being bought and sold at extreme valuations.
My opinion is to go small, in a niche, non-competitive sector. My observation has been scale, competition and abundance tend to ruin everything, and I’ll be talking about them further in my next essay which will be about the paradox of abundant capital.
But I digress.
The thing with private equity is its scope is very broad, and there’s shops investing in all kinds of instruments and verticals. You can do debt, growth, distressed, conglomerate, buyout, infra, energy, tech, family businesses. My strategy for new deal flow is to just look at what Blackstone (or GSO), KKR or Apollo among others are doing and replicate their strategy in a smaller market.
You cannot go wrong with real estate, gold, physical or agricultural assets. It’s really hard to overvalue or undervalue something when it’s tangible and right in front of you. Financial instruments don’t have this feature, their being abstract for most people implies they are fake or somehow unreal, which leads to fallacies and surrealist thinking in both directions.
This asset class is one of the most misunderstood, neglected and subconsciously hated classes of all, which means inefficiency, which leads to opportunity. Inefficiency is always the source of asymmetric returns, and emotional capital is a fertile ground of opportunities. Many of you will remember how JP Morgan, Deutsche gamed precious metal prices, and weren’t caught for years.
There are other opportunities for alpha, but any investment has to be in a market which is either:
4) Hated or ignored.
There are always opportunities in equities, even today, but they are too few and the returns are arbitraged away by competition or the market continues to undervalue them. The time to return to equities would be in the event of a market crash, like in March, or once the ‘democratization’ of financial markets stops.
The Fed is unlikely to stop injecting liquidity, and the incoming administration is financially and economically impaired. There is asymmetric alpha if someone figures out how to successfully short T bills, I have an idea but low capital. Please email me if anyone is interested and able to partner up.
As always, there is asymmetric alpha in credit shorts, anyone with access to a Bloomberg and a scrappy attitude can replicate Burry’s short during 2008 and Ackman’s during 2020.
Thank you for reading, please reach out if you have comments. Please share with your friends and colleagues, and if you are not already, do subscribe. I write with no schedule, just type out my stream of consciousness and hope it resonates.
Please reach out to me if anyone has Michael Burry’s archives of his articles on sealpoint.com and valuestocks.net, I haven’t found any after scouring the interwebs for months.
Indian readers, how are you feeling during the small crash the past few weeks? I’ve had 10% of my returns wiped out, how about you? Do you think there’s a buying opportunity now in quality overvalued stocks like IndusInd, BSE, MCX, Dilip Buildcon, PSP Projects etc? Or should we wait? Looking forward to your comments.