Q2 2023 Quarterly Report

Q2 2023 Quarterly Report

Last year, we did quite well by staying defensive. This year, that has looked like a horrible decision. What changed?

Very little, in my mind. The big story this year has been the amazing run in mega cap tech stocks. The popular story seems to be that this is because AI has suddenly changed their future, but not other companies, apparently. I think a far more accurate explanation is heavy use of structured products distorting markets, as discussed last week. That influence is likely to wane, and it’s quite possible it already is, after the monthly OpEx, last Friday.

That said, before every US recession I’ve looked at, the market has a double-digit rebound, first. If I knew that, why weren’t we in position to catch it? I’d say it was letting perfect be the enemy of good, which seems like a dumb mistake. I was waiting for the perfect conditions to start investing.

In retrospect, we were certainly getting constructive signals, particularly in October and January. It would have been much better to use those signals to get more constructive, rather than wait for perfection.

To that end, I’ve built a model to better show what the market is actually doing. I certainly don’t like making mistakes, but the bigger sin would be to repeat them. Lesson learned.

To be clear, there’s no way I would have caught all of that first-half move, at least with my current systems. The risks were very high, with valuations worse than what we started 2022 with. I could have shrunk the gap, but the methodology that tends to involve blindly chasing expensive stocks on momentum is the same system that got so many people into trouble in 2022.

Going forward, should we now just plow into big tech and chill? No. We’ve been setting up for a volatility event, where volatility spikes hard since late May. Recent earnings, particularly in tech, reinforce fears that tech is aggressively overvalued. The Fed is about to raise rates again, further stressing the economy.

A more interesting idea is if we should buy the casualties of the structured product war. As vol has been forced lower, everything low risk started to struggle. Should we be buying more in that area? We’ve made baby steps that direction but have been taking it slow. The concern is that if we do get a volatility event, correlations start heading to one, which is just a fancy way of saying everything goes down to some degree.

In general, everything we’re seeing, from slowly rising unemployment to slowing sales to tighter lending, tell us we’re walking into a recession. The trick is that an actual recession still could be months, perhaps many months, away. It’s entirely possible we get a volatility event, stocks dip, and we still haven’t seen a recession. That interregnum would be an excellent time to invest, if only for a limited time.

I plan to be less binary in decision-making, going forward. We’ve gotten a lot right, in terms of calling macro events this year, but have done a terrible job in getting paid for that. I will use broader, more diversified measures to ease in and out, more in conjunction with the pace of events. I’m a big fan of trying to improve systems, rather than stay static in a changing world.

The start of this year has been unpleasant, but I think we’re in much better shape going forward. Lately, that seems more true, with defensive stocks starting to outperform. This year, a couple of stocks are trying to recreate 2020, while world stocks in general are acting how they do ahead of a recession. The vast majority of the time, outliers revert. That’s certainly how I’d position, now.