CONTEXT SETTING
Overall, the goal is simply to participate in the value creation stemming from the innovation machine that is the U.S. economy. That should be nearly every individual investor’s goal. For better or worse, that means there is not a need to listen to corporate earnings calls or read financial news.1 As it happens, without actively trying to digest less “junk” content, I tend to listen to more financial and economics-based podcasts than sports and entertainment. I read more of those types of books and articles, too. I enjoy it.
The danger for me is thinking about this stuff too much not too little. The associated danger is the natural propensity to be active. “The big money is not in the buying and the selling but in the waiting,” said the late Charlie Munger.
That doesn’t mean the minutia that follows this preamble is not useful.2 In 2023, I used this obsession active learning to my advantage precisely two times. More on those shorter-term opportunities momentarily. The rest of the year I was mostly doing nothing of interest. Just reading and waiting like Munger said.
Lastly, beyond these fleeting opportunities that present themselves every once and a great while, this is fun. I legitimately enjoy the process of learning about financial markets just a little bit more as each year passes.
This is not a family office, and at the end of the day, I mainly dollar cost average into index funds via a 401k retirement vehicle, IRAs, and an individual brokerage account.3 Overall, my actions reflect this reality. But that doesn’t mean I can’t enjoy sometimes acting like I am running my own family office. So here goes.
Let’s start the fun with interest rates, shall we?
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INTEREST RATES / FIXED INCOME
It’s not just a logical place to start. It’s the only logical place to start. As Warren Buffet said, “The value of any economic asset is 100% sensitive to interest rates.”
U.S. interest rates peaked in late October, at least as of this writing. The 20-year treasury specifically peaked October 19th (pictured below) with the 30-year peaking shortly thereafter on October 25th.
On October 27th I started getting long the longer-end of the yield curve via the iShares 20+ Year Treasury Bond ETF — betting that rates had peaked. At least for the time being.
The FOMC met a few days later and held rates unchanged. Since that week, yields have moved down in a straight line. This makes my October 27th trade a big winner over a short period of time, as TLT has risen 18% over the month and a half.
This is a good example of how reading and learning (with little to no doing) over the past 9 months set me up to be able to make this trade.
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EQUITIES / S&P 500
At this same time, in mid-to-late October, the S&P 500 index was going through a tough 3-month period from August through October (down about 10%). By late October the percentage of stocks in the index trading above their respective 50-day average price was hitting a recent low (around 10% of the index).
Historically, when the index gets that oversold, it tends to signal a reversal is near. Indeed the S&P 500 was up 9% in November alone.
Putting that into perspective, this was the 5th best month since 2009, which is approximately when I started investing. At the conclusion of the month, around 80% of the index was trading above 50-day average prices. A drastic change.
While, yes, I was “seeing the ball” very clearly in late-October when I made the interest rate bet; really, most things have been working. Overall, since that Friday, October 27th, the S&P 500 has marched up by 15% in a straight line.
It’s one of those moments when people who do not follow the market closely start asking, “What’s going on with the market?”
My answer is — markets are forward looking, so stocks tend to lead the economy.
Benjamin Graham said it a different way, and Warren Buffet has reiterated it, including in his 1987 letter to shareholders which I recently read, “In the short run, the market is a voting machine but in the long run it is a weighing machine.”
In this most recent short run period — from late October through mid-December — the market is projecting forward as it always does and, in this case, is “voting” that interest rates have peaked. This does not necessarily mean the recent price action is indicative of the proper “weight” of this market at this moment in time. We won’t know that until we gain the benefit of hindsight.
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CRYPTO / BITCOIN
Speaking of the anecdotal “people are talking markets” type of sentiment metric — we may have entered the part of the cycle where bitcoin reenters the popular conversation. Over the last 12 months (or even 24 months), boy, has it been quiet.
That’s largely because from March through late October, bitcoin’s price went nowhere.
And, even more broadly, the asset is essentially flat from Christmas 2021 through 2023.
The only other short-term trade I made in the second half of the year was in this market, and was specifically a wager that Grayscale would win its lawsuit against the SEC. It required a ton of research — such as, of course, determining what ruling was likely by listening to oral arguements, but also when the ruling was likely to happen and lining up the right stock option expiration dates.
Ultimately it seemed more likely than not that Grayscale would win its lawsuit and a leveraged long position was initiated. As we know, Grayscale won.
This bitcoin anecdote accomplishes two things; (a) a second example of how continuous learning and voracious reading can lead to opportunity, and (b) a fantastic example of the age old fact that increased interest seems to typically follow an increase in price. Even from the most unlikely of actors.
What a strange ride it has been from 2017 to 2023, as exemplified in the two headlines above. That said, the recent price appreciation has been enough to impact my asset allocation and overall returns in a meaningful way.
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PORTFOLIO ASSET ALLOCATION
The simplest explanation of the year-over-year change in portfolio allocation is the price appreciation of bitcoin and ether. This in turn decreases the relative allocation to cash, fixed income, and even equities.
On a dollar value basis, the cash and fixed income positions are more or less unchanged, meaning I did not increase exposure there this year. The equities position is larger on a dollar value basis due to increased exposure, but also due to the broad price appreciation of the asset class over the year.
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2023 OVERALL RETURN
Through November, the publicly traded equities in the portfolio returned 25% compared to the S&P 500’s 19% appreciation. That’s the apples-to-apples comparison that I publish each year.
| % of Portfolio | 2023 Return | |
| Equities | 58% | 25% |
| Crypto | 21% | 156% |
| Cash | 17% | 4% |
| Fixed Income | 4% | 8% |
Taking into account all investable assets, across the four asset classes listed above, the weighted total return on investments (not including cash) was 43% year-to-date. Including cash, the weighted total return on assets was 34%.
The “magnificent seven” storyline has been widely dissected for months. A little more broadly, the 10 largest companies in the S&P 500 were responsible for the majority of the index’s return this year, with an average return of 75%.
And, a portion of the alpha in the portfolio is being overweight 7 of the 10 largest components of the S&P 500.
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2024 THINGS TO WATCH / PLAYBOOK IDEAS
It’s important to once again remember this is not a hedge fund or family office. The vast majority of new investment will be initated via averaging into indices. With that said, here’s what is piquing my interest.
Investor sentiment has turned on a dime over a 30-day period towards the bullish side. The last time sentiment was this positive was July 2023. And, of course, equities moved consistently lower for the next 3 months (see the S&P 500 chart above). Has sentiment gotten too bullish? To the meme!4
Okay, so investors are feeling good. Does it matter? Debatable.
What else? If rates are the most important data point, how does the equities market react once the Fed starts cutting rates?
These prior cycles show longer-term bonds tend to outperform stocks as the Fed gets looser — a potentially nice set-up for the iShares 20+ Year Treasury Bond ETF trade discussed above.
Action: initiate stop loss so not to give back gains on what is a great trade so far.5
Longer-term bonds might outperform relative to equities, but how are those equities going to perform in general?
The chart below shows that whether or not there is a recession (light blue line) would likely have a significant impact on the equities market in 2024.
Will there be a recession? One historical indicator is an inverted yield curve. Since the yield curve inverted (using the 10-year and the 1-year here), the stock market rally has been greater than other recent inversions (red line).
In all of these examples, there was a reversal with stock prices coming back down in a significant way.
What can we watch to anticipate a recession and/or determine if stocks are overvalued? Company earnings will be one key data point early in 2024. As of mid-December earnings growth for the upcoming year is projected to be almost 12%. This puts the forward 12-month P/E ratio for the S&P 500 is slightly north of ~19x.
While the 19x higher than the 10-year average of ~18x, if you carve out the top 10 largest companies (which have a P/E of ~27x), the rest of the S&P 500 is priced at a more reasonable ~17x multiple.
Action: initiate small short position as a hedge.6
Whether or not there is a recession seems to be the key piece of information. At this time last year, there was a full consensus on Wall Street; a recession would materialize in 2023. That did not happen. Today, there is again full consensus for 2024; there will be no recession.
Action: initiate prop bet that there will be a recession in 2024 as a hedge.7
What else does no one seem to have on their radar? Inflation. It’s old news. It’s not a problem. It was transitory?
Here is one alternative path for 2024.
- Companies do grow earnings, leading to…
- The stock market continuing upward trend, leading to…
- No recession
If that chain of events does happen, inflation may very much kick back up. If inflation increases, the Fed will become much more unlikely to cut rates as much as the market is currently projecting.
Action: initiate prop bet that the Fed will cut less than anticipated in 2024 and/or that inflation sticks at or above 3-4% as a hedge.8
Every year has unique storylines. There are no shortage as we head into 2024. Beyond that, it’s as simple as “just keep buying.”
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Happy holidays and best wishes in the new year!
