Last quarter, I used the image of “own goals”—the embarrassing soccer error that scores points for one’s opponents—to characterize the chaos wrought by the new administration. Many of the new policies seem misguided, and most are being executed clumsily by inexperienced appointees. The “emergency” presidential orders, the dialing up and down of tariff rates for friends and foes alike, and the use of the federal justice system to punish the president’s personal enemies continue. There has been a lot of “tearing down” over the past nine months and precious little “building back better.” Politics aside, many of these actions seem likely to hurt business and the economy, and by extension, investor psychology and the stock market.
For all the confusion and flipflopping on policies, businesses are nothing if not flexible, creative and highly motivated to deliver returns to their shareholders. They are scrambling to understand and adapt to the new ground rules. Supply chains are being rearranged, and imports are being accelerated, postponed or rerouted to finesse the latest tariff rules. In some cases, orders and fulfillment have been delayed, so earnings will come in later quarters, but business value remains intact.
The Fed and its 400 or so Ph.D. economists (not a typo) are uncertain as to how strong the economy is. Domestic spending is strong, but there are signs of weakening in the labor market. The Fed is charged with keeping both unemployment and inflation low, and those somewhat mutually exclusive goals have left them in a bit of a quandary. Their latest move was to cut the overnight lending rate by .25%, but their stated “outlook” was ambivalent. AI-related businesses are maintaining a torrid pace of building data centers and power plants, but many of our “mere mortal” businesses are seeing modest slowing in growth. In the face of these crosscurrents, the better part of valor seems to be to “punt” on making predictions.
I spent some time in Scotland this summer. It is a beautiful country, and the golf courses are amazing. The ball takes funny bounces, and the bunkers can be brutal. Navigating the course there, I’m reminded of Tiger Woods’ response when asked how he planned to deal with the bunkers at St. Andrews at the 2000 Open (The Open, not the “British Open” to folks there). His response was that he would leave the driver in the bag and not go into the bunkers. As it happened, he won the tournament and avoided all of the 212 bunkers all four days.
With this approach in mind, we have “left the driver in the bag” and focused our portfolios on steady earners with long-term business prospects that we think we can understand. This has penalized us in a predictable way. We do not own Nvidia (NVDA), which is the runaway winner in the current AI boom, nor the handful of others that have accounted for a disproportionate share of market index gains. We have also suffered a bit from an unexpected phenomenon— “AI victims.” A number of other technology providers like Salesforce (CRM), Constellation Software (OTCPK:CNSWF) and Accenture (ACN) have sold off as investors fear that AI will undermine their competitive positions. We think these companies are well-positioned to profit by enabling “real people” to use AI in their own businesses.
We do own some more established tech companies that are active participants in the AI gold rush. Google (GOOG)(GOOGL), Microsoft (MSFT), Amazon (AMZN), Meta (META) and Oracle (ORCL) have been good contributors. We have also taken refuge in “life sciences” companies like Danaher (DHR) and Thermo Fisher (TMO) that are at the forefront of enabling medical and biotechnology research and development. Tariff confusion, cuts in federal funding, and the U.S. Department of Health and Human Services (HHS) rejection of the previously accepted vaccine policy have complicated their near-term sales and order pictures. We believe that people will continue to value cures for diseases and other varieties of scientific research, and that these companies will profit handsomely over the next 5-10 years. After a rough first half, our health care stocks showed promising signs of life in the third quarter.
Outlook
One lurking issue that is of serious concern to investors (and our investment team) is the level of long-term interest rates. The Fed can control the level of short-term rates, the Fed Funds rate, but what matters to investors and businesses is longer-term rates, e.g., the 10-year Treasury rate. This is the base rate that is used to price mortgages and other longer-term credit. Long rates are what investors use to calculate the value of a business, and it is the rate at which corporations borrow. No need to be melodramatic, but at some point, increasing debt and deficits may raise inflation and/or creditworthiness concerns that could make it harder for the Treasury to sell the bonds necessary to finance the government’s operations. If the U.S. needs to raise the interest rates on offer to sell new debt and refinance old, the impact on securities prices and corporate earnings will be negative.
The picture I’ve described here is not great, but from an investment point of view, not terrible. We are hunkered down, portfolio-wise, and waiting for some of the dust to settle. We are confident that our portfolio companies will do a good job for us as investors over the long term. These are interesting times for the country and for the world. We think we have built portfolios that can withstand whatever may come. With luck, common sense and the rule of law, we will be fine.
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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
