What year is this?

Quarterly Letter

Is this 1999?  It sure feels like it…

We don’t know how many of you remember the internet bubble which started in 1995, reaching parabolic ascension from late 1998 to 2000 before blowing up in the most spectacular fashion, taking the Nasdaq index down almost 80% from its high.

Historically, companies that produce profits, or at least that are expected to do so in the foreseeable future, are considered valuable. Somehow, during the late ‘90s, investors have concluded that there was no need for profits as long as companies could show growth in a different form, like “eyeballs count” for internet companies (e.g., counting the number of people who have visited the websites). It was sales growth at all costs. A well-known CEO then pointed out how insane it is to think you can sell 1 dollar for 90 cents and try to make it up with volume. Even adding the 2 words “dot com” in the name would increase the share price on the market. The euphoria eventually ended with many internet and e-commerce companies that were initially given the benefit of the doubt being worthless.

It seems to us that profitless companies seem to be back in vogue …

Recently, companies like Uber and Lyft have gone public with very disruptive business models but no profit in sight. At best, profit might come a long way down the road. Yet they are given market valuations at levels that suggest a wildly profitable business model.

Beyond Meat went public in June and has gone up 600% in 1 month. For those who wonder what they do, this is a company that makes a veggie burger that is supposed to taste like meat. Last year revenues came in at around US $90 million, losing US $30 million in the same time frame, and yet the company is currently trading at a market value of US $9 billion, with a “B.”

We can go on with Shopify, Lightspeed in Canada, Slack Technologies, Zoom Technologies to name a few. None of them are profitable and according to their prospectuses, the respective managements actually do not know when they will be or if they will ever be.

We expect that much like 2000, some of these companies will survive but most will be worthless. Picking the right ones will be a challenge, but holding on to them through the next correction will be an even bigger struggle.

One of the most successful high-yield bond managers, Howard Marks, wrote back in 2016:

“That is one of the crazy things: in the real world, things generally fluctuate between “pretty good” and “not too hot.” But in the world of investing, perception often swings from “flawless” to “hopeless.” The pendulum careens from one extreme to the other, spending almost no time at the “happy medium” and rather little in the range of ‘’reasonableness.”

In the last 2 to 3 years, although the US economy has had fairly good growth coupled with low inflation, it also expanded its deficits and increased its national debt at a scary pace. Meanwhile, it continues to enjoy an environment of low interest rates and rising stock markets. We think it is important to realize that some of these things are not compatible in the long term. They have not been historically and it is imprudent to assume they will in the future.

To be successful in investing, it helps to understand the economic cycle, the profit cycle and particularly the market cycle.  To quote Howard Marks again:

“There are three stages in a bull market:

  • The first, when only a few forward-looking people begin to believe things will get better;
  • The second, when most investors realize improvement is actually underway;
  • And the third, when everyone concludes that things can only get better forever.”

If we venture a guess, we are probably somewhere in the third stage… we just don’t know how long it will last and how high the market will go. As the euphoria builds up over the next several quarters, we will err on the side of caution by gradually underweighting the equity portion of our portfolio.

We do wish to mention two things:

  • The market can stay irrational a lot longer than we can stay solvent; (John Maynard Keynes)
  • Anecdotally, a well-known market analyst used to compare the stock market to a big party in a ball room. At midnight, when the party is most exciting, the best spot to be is usually right in the middle of the dance floor. However, in the event of a fire, being in the middle of the dance floor has a likely outcome of death. He then recommends people to dance closer to the exit door: it might be less fun but hopefully you’ll get out alive…

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In case you are wondering….

Several questions have come up during clients’ meetings recently:

  • Several clients were wondering whether we take smaller accounts for their children since these accounts do not meet our minimum requirements. The answer is a definite yes. We consider our clients as a family unit encompassing all assets that need to be managed. We encourage you to tell your children that not only will we welcome their business, we strive to offer them the level of service that you are accustomed to and at the same management fee which will apply to your whole ‘household.’
  • Many of you have been with us for a long period of time now and we are grateful for your loyalty. Some of you did ask about our succession plan: who would take care of your investments in case something happened to us? With new senior management in place for over two years, Claret has hired several young candidates that we have committed to train over the next many years. Notwithstanding the fact that the three partners are only in their 50s (with no plans for retirement), we are committed to building a structured succession plan over time so our clients can enjoy the high levels of knowledge, advice and service we have been offering from the outset. We will continue to grow and strengthen our team for the future.

Have a wonderful summer.

The Claret Team