There once was a dream called America.

Ever since I can remember, I have known that the United States of America is a special place. My earliest memory of the Fourth of July was the biggest Fourth of them all, our nation’s Bicentennial. Here we are 50 years further on.

My family came to this country before it was a country, landing here in 1709 after fleeing the Rhine region between France and Germany. They did so for the same reason most colonists came to the New World: religious freedom. They also came to escape the rigid class system of Europe. The New World, unlike the Old World, was a meritocracy. Anyone who applied themselves and worked hard and wisely could achieve financial success. It did not matter whether your ancestors were aristocracy; here, everyone was created equal.

This was the beginning of what has been called the American dream – this strange experiment of a truly free market overlaid by Judeo-Christian morals. This odd combination created what has become the greatest nation on earth, surpassing our European cousins who in many ways still cling to their aristocracy and the ideas of a class system. This perplexing mix of Puritans, Quakers, farmers, and merchants melded together to create a combination that was unstoppable: free-market capitalism constrained not by the government, but by the morality of society.

This is America’s secret sauce: our love of freedom combined with the sense of responsibility. It has seemed hard to see in recent years. There is an alarmingly large group willing to sacrifice that freedom, at least in part because they don’t want responsibility – yet the two are symbiotic; we cannot have one without the other.

In our divisiveness and self-loathing, we have forgotten that America has stood the test of time for 250 years. We are truly fortunate to call the United States of America our home. If you don’t believe me, just look at the social media feeds of all those European soccer fans who have come here for World Cup soccer. Despite expecting a tense political climate based on international news, fans are marveling at how incredibly welcoming locals are. Sometimes we need to see things from an outsider’s point of view as we too easily take our blessings for granted.

Mississippi is the poorest state in America; yet, for perspective, according to data from the Mississippi Center for Public Policy, it has a higher GDP per capita than both Great Britain and Germany. It also has a higher literacy rate than both Great Britain and Germany. People are dying in Europe today because of a heat wave, while the Europeans here for the World Cup marvel at the wonderful American invention of air conditioning. We have even convinced them that sports are better when played in quarters instead of halves…okay, they are calling it a “hydration break,” but the fact remains they are stopping play roughly halfway through each half. A quarter by any other name is still a quarter.

Why all the love for America? Part of it is that the World Cup games have been so geographically widespread. It has given soccer fans following their teams a reason to see America for the first time in a lot of instances, but even if not for the first time, they have seen more of America. Kansas City is not a hot spot for European tourists, but it is a great city full of nice people, like most of America. They are loving America because America deserves to be loved.

We are the land of the free and the home of the brave. We are that bright shining city on the hill, even if we fail to see it ourselves. I think back to the bicentennial; 1976 was not a great time. We were licking our wounds from Vietnam and embarrassed at home by Watergate.  Four years later in 1980 came a turning point. That winter we had the “Miracle on Ice,” when the U.S. beat the Soviet Union in hockey and went on to win Olympic gold. That summer we hosted the summer games in LA. It became okay to be patriotic again.

I don’t know if our soccer team can repeat that miracle, but I for one will be pulling for them. Even if they fall short, maybe it is enough to read the average European review of Buc-ee’s. America has never been perfect, but from its first declaration it has always been great. Our secret sauce is freedom with responsibility; the belief that we don’t need an aristocracy because we are self-governed. We should all be proud to be American. At least that is my perspective.

Happy 250^th!

Warm regards,

Chuck Osborne, CFA

~Let Freedom Ring

SpaceX – the largest IPO to ever hit the markets – has everyone talking, and like most things in our society today, it seems to be very divisive. Some say it is a marvel of capitalism and something we should be proud of, while others say it is a monolith for inequality. Who is right?

To truly understand what SpaceX really means, we have to go back to 1981 and a trip to Washington DC. I was 12 years old, and my parents wanted me to see our nation’s capital while my uncle still lived in Bethesda, MD.  We did the whirlwind DC tour, and then my uncle took my father and me to spend the night on his sailboat, anchored out somewhere on the Chesapeake Bay. It was the first time in my life that I spent the night on a boat away from land. For a young boy, it was a magical night.

What does that have to do with SpaceX? Everything. Fast-forward 39 years and that young boy had grown up but still remembered that night, since that was the night when he decided that he needed to have a sailboat of his own. Unfortunately, he lives in Atlanta, which is approximately 300 miles from the nearest ocean access, and he has a demanding career, a wife, and two children…not to mention two dogs and a cat. Sailing was limited to nearby lakes and occasional family vacations.

Then Covid happened. The entire office went remote, kids stayed home from school, and the final straw was when summer camps were canceled. His wife looked at him with a look of horror and uttered the most magical words he had ever heard, “I think we need to get that boat.” All of a sudden, the dream became possible. The remote work proved what he had always suspected: that he could work from anywhere, even a boat. He just needed his laptop, a phone, and of course the internet connection.

How much could it possibly cost to have an internet connection in the middle of the Atlantic Ocean? It turns out that in the year 2020, it cost a boatload (no pun intended) of money to have internet on a boat: The upfront hardware cost was approximately $20,000, but that was just the start. The service started at about $1,000 a month if all you wanted to do is send the occasional text message, but if one truly wanted to be able to work, the cost for high-speed internet was roughly $8,000 per month. The dream was crushed.

This is when Elon Musk enters the picture. Starlink, the profitable piece of SpaceX, provides high-speed internet almost anywhere in the world – and the hardware costs $500. The service varies depending on range and data usage but starts at a little more than $100 per month. It is also month-to-month, so one can change the plan whenever needed. SpaceX did what capitalism always does: It took a thing that already existed but only for the richest of the rich and found a way to deliver it to just about anyone at a significantly lower cost.

Most people are gleefully unaware of this because they live in urban areas where the internet is everywhere. They are not looking for the internet; they are looking to escape it. However, for that 12-year-old boy who dreamed of seeing the night stars miles away from light pollution, this was a game changer. Much more importantly, it was a game changer for remote parts of the planet, where building out the infrastructure we enjoy in the west was cost-prohibitive. Starlink can truly connect the world. They did not invent satellite communication; they found a way to deliver it affordably.

This is what capitalism does. Henry Ford did not invent the car; he invented a way to build cars cheap enough for every family to afford one. Bill Gates did not invent the computer; he found a way to put them in the home of just about everyone. Steve Jobs then found a way to put those computers in our pockets. When I ran One Atlanta Basketball, and we bussed kids from underprivileged neighborhoods to our gyms; their parents couldn’t afford lots of things, including youth sports, but they all had smart phones.

Elon Musk is now a trillionaire. What about the inequality? This may surprise lots of people, but I agree: this IPO is outrageous, and the amount of money is just crazy. What caused SpaceX to not go public until it was the fifth largest company in the world? The Sarbanes-Oxley Act of 2002 is the answer. Milton Friedman pointed out in 1962 that there is a direct link between inequality and regulation. In pre-Sarbanes Oxley world, SpaceX would have gone public years ago. The increase in value from a relatively small venture to one of the largest companies in the world would have been realized by millions of 401(k) investors. Musk would still be a very rich man, as would the thousands of employees who have earned the share of the SpaceX pie. His stake would likely be smaller and shared with many more.

As far as Iron Capital clients are concerned, SpaceX is very interesting. There are no guarantees in the stock market, but the usual pattern of the hot IPO is first a honeymoon period, then lots of investors who have been tied up in a non-liquid private investment will finally be able to sell. Usually sometime between six months and a year after the IPO, this selling sets in and provides an opportunity. We will see if that happens.

To the larger question: SpaceX represents America at its best and at its worst, both. No system has ever benefited the masses as well as our form of capitalism has; yet there is little that has promoted inequality, with almost no one willing to talk about it, like Sarbanes-Oxley.

Disclosure: this article has been written on a computer connected to the internet via Starlink.

Warm regards,

Chuck Osborne, CFA

~SpaceX: America at Its Best or Worst?

“In a moment of decision, the best thing you can do is the right thing, the next best thing is the wrong thing, and the worst thing you can do is nothing.”

That quote is often attributed to Theodore “Teddy” Roosevelt. Like many internet quotes, scholars can find no record of him ever saying it, but it sure does sound like the man who gave us “The Man in the Arena,” the most famous stanza in his “Citizenship in a Republic” speech delivered in Paris in 1910.

Teddy passed away a little more than 50 years before the first “passive” index fund was created, but I feel confident that he would not have been a fan. The world is full of people who will tell investors they should invest is index funds because you can’t “beat the market.” There are, however, far fewer who can explain why that is supposedly the case.

The theory that spawned the index fund to begin with was explained in Eugene F. Fama’s 1970 paper, “Efficient Capital Markets: A Review of Theory and Empirical Work.” Fama argued that the market was “informationally efficient;” in other words, all available information is reflected in the current price of any asset (in our case stocks). In theory, the market price of a stock is always the “right” price; thus, no value can be added by choosing to invest in one stock over another. This efficient market theory then brought us the capital asset pricing model (CAPM). Every former finance student just had a shiver go down their spines at even the mention of it. CAPM is predicated on the assumption that markets are efficient and if trading were free, then the most efficient portfolio would be one that simply weighted stocks based on their capitalization. In plain English, an investor should invest only in the largest companies based on nothing but the fact that they are already big. Index investing was born. This is what the vast majority of index funds do.

The point of explaining the theory behind index investing is hopefully to drive home one simple idea that very few index investors have ever thought about:  Indexing only works in an efficient market, but the market is made efficient by investors making independent active decisions based on the latest information available. Put simply, index investors are freeloading on the market created by active investors. It has worked for many years, but something has recently changed.

In their paper, “The Active Side of Indexing,” authors Rob Arnott and Lillian Wu outline the growth of index investing over the last 40 years. As recently as 2000, index funds held $0.4 trillion, or barely 3 percent of U.S. equities; as of December 2024, they now hold $13 trillion directly tracking the S&P 500 alone, which represents 21 percent of the value of the entire stock market and more than a quarter of the value of S&P 500 member stocks. In 2024, for the first time in history index fund assets surpassed those of active U.S. equity funds.

These numbers only scratch the surface. One thing the index investors get right is that the average money manager does not beat the market – after all, in a world without grade inflation, average is a C. Most of these average managers end up being closet indexers because they are afraid of ever trailing the index long enough to get fired. It is impossible to know exactly how many assets are managed this way, but it is a sizable number.

One thing index investors get wrong, which I pointed out in our latest The Quarterly Report newsletter and Arnott and Wu point out in their paper, is that they believe index investing is passive, when in fact it is not. The current turnover in the S&P 500 is approximately 15 percent, but Arnott and Wu use a much more conservative 5 percent. More important than the exact percentage is the index is weighted by capitalization, in other words the total value of the company. The companies being removed tend to be companies whose stock price has dropped, while the companies being added tend to be companies whose stock price has suddenly risen.

In addition, within the index, company weightings will change as some stocks rise and some fall. Every time an index fund gets new money invested, it has to then buy more of the stocks that have already risen and less of the stocks that have already fallen. Index investors are constantly buying high and selling low. This is active, but more precisely it is one particular active strategy: momentum investing.

The idea behind momentum investing is simple. Stocks have momentum, so when they are rising they will tend to keep rising, and when they are falling they will tend to keep falling. Of course, they do this until they don’t. At some point the stock price gets so high that no one will buy, and at some point, the price gets so ridiculously low that investors begin to buy. Momentum investing is therefore a short-term trading strategy, and it is very popular with traders.

Historically, momentum would be kept in check by active investors who would take advantage of the short-term momentum to take profits or buy good companies on the cheap. This is what makes a market – some investors buy while other sell, and vice versa.

As more and more of the long-term investors have moved to the index, we no longer have people on both sides of any trade. Snowflake, a technology company whose stock we own in our most aggressive strategy, recently reported earnings and the stock jumped 38 percent on that day. Through June 1 the stock was up 66 percent over the last three months, which makes it up 27 percent year to date; So, prior to jumping 66 percent, the stock had been down almost 40 percent…one cannot be a snowflake if she wants to invest in Snowflake (I apologize for the pun but couldn’t help myself).

The company itself is doing very well, but it did not grow business 38 percent in one day and business had not been down at all, let alone 40 percent, previously. The fact is that there was just no one on the other side of these trades. Anecdotally, we have heard this over and over again from mangers who historically would have “bought the dip” in a company like Snowflake, but now they are scared to do it. They are afraid to jump in because momentum is overwhelming fundamentals.

It is not just Snowflake. Intel – boring old, been-around-forever-Intel – jumped 23 percent on its most recent earnings. How does Intel jump 23 percent? There was no one willing to sell. When everyone is on the same side of every trade, then we no longer have a market. Real-world investors have been poking holes in efficient market theory and CAPM for as long as I have been in the business. Nothing was in either of those earnings reports that would change the value of those companies dramatically.

Thus far the ordinary investor has not noticed this enormous increase in volatility as it gets balanced out at the index level. The question is, how much longer will it be hidden? Will we see double-digit moves in one day for the index?

The market has always been irrational in the short run, and it has done a great job in the long run. Will that still be the case when no one participates, and everyone just tries to freeload? I don’t know the answer, but I strongly suspect Teddy Roosevelt would tell us to look to our inner American spirit and make a decision. At Iron Capital, we are going to continue to invest intentionally; we might just need a little more patience.

Warm regards,

Chuck Osborne, CFA

~Is the Market Broken?

I love spring. In my home state of Georgia, there is a significant event which marks the season every year: The Masters Tournament, the annual golf tournament that transcends the game. One does not have to be a golfer or a golf fan to be a fan of the Masters; like the Super Bowl, Wimbledon, and the Kentucky Derby, it is bigger than its sport.

I don’t have the time to play as much golf as I used to, but I still enjoy watching the Masters. This year I missed most of it due to other obligations, so I caught up in the evenings by watching highlights and listening to the golf punditry. Rory McIlroy won his second Masters in a row. He leapt out to a 6-stroke lead after the first two rounds. While there have been six other players in Masters history with 5-stroke leads at the same halfway point, the 6-stroke lead was the largest. Of those other six players, all but one had gone on to win, and Rory was one shot better than all of those. The pundits all agreed the tournament was over and spent most of their time asking each other if anyone other than Rory would ever win The Masters again.

Then Saturday happened and Rory came back to earth. His 6-shot lead disappeared, and he would enter Sunday’s round tied for the lead. Every pundit who was all in on Rory just the night before now picked someone other than Rory to win. I was trying to watch purely as a golf fan, but I can’t help being an equity analyst at heart. I sat there thinking, “Nothing has changed, Rory is going to win.” Only one time in Masters history had anyone had a lead close to Rory’s and lost. Rory is one of the greatest golfers of this generation; he wasn’t going to lose.

Rory went on to win. Ultimately he won by one stroke, but he had a comfortable lead coming down the stretch that allowed him to bogey the last hole and still win his second Masters. All the pundits praised his resilience, ignoring the fact they had turned on him just 24 hours earlier.

What does this have to do with the market? Everything. This is human nature. When a stock is going up every pundit out there will tell investors how wonderful the company is and how it will grow forever. When the same stock has a setback, the same pundits will then tell you it is time to jump ship and bet on some other company. Then the original stock will bounce back, and the pundits will return to singing its praises as if they never doubted it for a second.

There is a reason that major golf tournaments are played over four 18-hole rounds for a total of 72 holes, and that prudent investing is done over the long term. Over that long haul, everyone will experience ups and downs. There will be hot streaks and cold streaks. That is how life works: everything comes in waves. What matters is having the discipline and resilience to keep going, knowing that in the end, if one has done all the right things, then the result will be a good one.

Things are never as good or as bad as they seem – whether it’s 6-stroke leads, attacks on Iran, AI, whatever it may be. Unfortunately, most investors are like those pundits who couldn’t abandon Rory fast enough – they get excited when things are up and abandon ship when the downturn comes. The winners are the disciplined ones who choose their investments carefully from the bottom-up and then have patience. Winter always comes, but it is also always followed by spring. I love spring.

Warm regards,

Chuck Osborne, CFA

~Mastering The Market

Does anyone else know what it is like to have teenagers in your house? The only way parents survive the drama is with the knowledge that these volatile creatures were once their adorable little boys and girls, and will one day be endearing humans once again.

When I take a deep breath and remind myself that our little girl is still in there somewhere, I remember back to when my daughter’s favorite show was a Disney cartoon entitled, “The Lion Guard.” There was one episode in particular when the Lion Guard was trying to help a zebra whose herd was under attack by hyenas. The zebra’s reaction was to panic and run. I can still see my daughter dancing around the house singing, “Panic and run, panic and run!” It made for a cute children’s show, but obviously panic is not really a good investment (or life) strategy. One wouldn’t know that if he was paying close attention to the markets today.

If there is one strategy in investing that is universally preached, it would be diversification. We all know that we shouldn’t put all of our eggs under the same layin’ hen (at least you do if you read the First Quarter 2024 issue of The Quarterly Report). We have to diversify our investments. The theory of diversification rests on owning assets that have low (maybe even negative) correlations with one another. For example, stocks and bonds: The idea is that when stocks sell off, investors should go towards the perceived safety of bonds and therefore bonds will increase in value as stocks decrease in value, helping to reduce the volatility of one’s portfolio.

Asset allocators, whose job it is to figure out how exactly investments should be mixed together to optimize risk and return, obsess over correlations. It does work, most of the time. However, there is one problem: In times of true market distress, all correlations go to one. In plain English: When something really scares the market, such as a financial crisis or a war in the Middle East, all well-conceived investment strategies turn into “panic and run.”

Since the first attacks on Iran on February 28, the S&P 500 is down approximately 4 percent.  On February 27 (the day before the attack), the 10-year U.S. Treasury had a yield of 3.97 percent. In other words, the interest rate on a 10-year loan to the U.S. government was 3.97 percent. On March 24, that interest rate is now 4.4 percent. As a reminder, bond yields and bond prices have a see-saw relationship. When yields go up, it means prices have gone down. So, investors are selling stocks and they are selling bonds.

Maybe they are only selling U.S. bonds since we started this war? Nope, the German Bund (German for bond) had a yield of 2 percent on February 27 and now yields 3.03 percent.

I know what you are thinking: Gold is the safe haven, that is where smart people put their money today. Nope, gold was $5,230 per ounce the day before the attack and it is now $4,375 per ounce. Should I keep going?

In times of crisis, correlations go to one and diversification is not of great help. So, what are investors to do? It is at times like this that investors need to know what they own and know why they own it. Great investors are owners of companies, not traders of stocks. While Wall Street is in full panic and run mode, selling almost everything, out here in the real world, life goes on. Apple is still selling phones. Alphabet is still helping people Google the latest information. Have you seen the lines at the airport? Delta is still flying people (or leaving them if they didn’t get through security in time).

Sometimes the best way to handle a storm is to batten down the hatches and just sail through it. This too shall pass. That is the mantra for the day in the market and in all those households with teenagers. The war will end and we will get on with our lives, at least that is what my wife and I keep telling ourselves.

Warm regards,

Chuck Osborne, CFA

~Panic and Run!