The war in Ukraine has put a fog on the market. The rising cost of oil will exacerbate the already-high inflation. There is significant risk of a recession in Europe. Russia is un-investable and, in our view, will remain so, at least as long as Putin is in power. China was already having issues with its economy, as its regime continues to reverse the liberating reforms that had made China the economic power it is today.
There is lots to worry about as an investor, which is why we have seen a market correction. Corrections are not fun; in fact they are scary, as it always seems this could turn into more than just a correction. There are always arguments for why this time it is really the end of days and the market will go to zero…which causes stress, and stress literally causes tunnel vision, and all we can focus on are the negative news items, of which there are plenty. It is like being in a fog: one cannot see anything around them, only what is right in front of them, which today is the conflict in Ukraine.
Eventually the fog lifts and the world reappears. When it does – and it may already be happening – there are opportunities for investors. It may not seem like it, but then it never does. Prudent investing is really simple but extremely difficult, because the best time to buy is when everyone else wants to sell, and the best time to sell is when everyone else wants to buy. That takes discipline.
We find that discipline by focusing our investments from the bottom-up. We analyze individual investments on their own merit, instead of guessing where the market is headed or what the outcome of this crisis will be, or when the next crisis will come. That does not mean one can ignore totally what is happening around them, but the environment needs to be considered from the point of view of each single investment.
I was an economics student when the Soviet Union was collapsing. I found it fascinating, and I took every course I could that touched on it… unintentionally I ended up with a minor in international studies. One of my professors had Russian stock certificates framed and hanging on the walls of his office. They had been issued during the period known as the New Economic Policy (NEP). Lenin had tried to go straight for socialism, but that made people’s lives worse (as it always does, but that is a subject for a different day). So, he relented to some market-oriented reforms, and some companies were able to raise capital through the issue of stock.
Stalin could care less if people’s lives were miserable, so he reversed NEP, and in one day, those stock certificates became worthless as those companies were now property of the Soviet Union. Putin resembles Stalin more so than Lenin; therefore, even after this crisis goes away and markets reopen for Russian companies, one has to know that any company in Russia could simply be taken over by Putin, making your investment worthless. In our view that makes Russian stocks un-investable.
However, most companies aren’t located in Russia or Ukraine, and will continue to do business regardless of the outcome of this conflict. When we look at these companies, we put an estimated value on their business, then we compare that value to the actual price of their stock. The difference between those two is our expected return, should we invest. Those expected returns are the highest they have been in several years. To be honest, I’m not sure how long it has been since we have seen the expected returns this high.
What does that mean? It means companies are doing much better than their stocks. We have been saying it for a while, but inflation boosts companies’ reported earnings, and valuations are based on earnings, or more sophisticatedly cash flow. Higher inflation leads us to higher cash flows, higher earnings and higher company valuations. Eventually the fog will lift, and this is what investors will see.
We already see signs of it any time there is good news on the war front. We could see further setbacks. It could take months before we are completely out of this fog, or it could happen between the time I write this and when it published. That is the hard thing about investing. It is impossible to time the market. However, the fog will rise, and when it does, the future will look bright.
Meanwhile, our job is to manage your investments, so that is our focus. Simultaneously, our thoughts and prayers are with those in Ukraine. We also pray for our leaders, may they rise to the occasion.
Warm regards,
Chuck Osborne, CFA
Managing Director
