A disciplined weekly review of the forces shaping risk and return.
Key Points
- Gold and Russel 2000 lead the week with 4.8% and 2.1% gain respectively.
- Gross Domestic Product comes in at 4.4% QoQ growth, signaling a growing economy.
- The Shiller CAPE Ratio doesn’t look to revert to the mean. Are companies different now?
- No business is an island. Context matters in investing.
Markets
- Gold is still on a tear this week again with a 4.8% gain.
- The markets are mostly flat this week except for the Russel 2000 with a 2.1% gain.
- International still leads the 1Y with 31.3% gain.
So what?
I’m interested in learning why gold is doing so well. I suspect it’s because we are witnessing emerging markets behavior within US markets and a looming struggle to make the Fed no longer independent.
An independent Fed is an old institution that helps solidify the resiliency and long-term strength of the US dollar.
Macro — GDP Coming In
Gross Domestic Product
GDP Quarter over Quarter (QoQ) is still doing quite well, signaling a strong economy:
Contributions to GDP led by consumer spending. It’s also nice to note that updated numbers were very close to initial reports:
Information, Finance, and Professional services lead the way with contributions to Real GDP by industry group:
When we take a step back and look at the long term, GDP is growing steadily. Notice the dip after the Great Financial Crisis of 2008, and the Covid dip in 2020. Things usually bounce back over time:
“So what?”
There is always hype around macro and economy. This is yet another signal that our economy is growing, which is good! When coupled with the cooling inflation from last week, I think it signals a strong underlying current of steady economic growth without growing too quickly.
Education
If I had to choose one metric for looking at a company, it would be their Free Cash Flow (FCF).
Here’s one of the simpler formulas to get to Free Cash Flow:
Yes, it’s accounting, but “Accounting is the language of business, and you have to be as comfortable with that as you are with your own native language to really evaluate businesses.”1
What it is:
It’s the profit that’s left over from business operations after reinvesting in the business.
Why it matters:
Many businesses do not generate free cash flow but have a lot of hype and elevated stock prices. Other businesses generate loads of free cash flow but fly under the radar. Understanding how a business generates free cash flow, and the path to generating more free cash flow over time is a great way to understand the fundamentals of a business.
I consider this step 1.
Wealth
One quick note this week on how I think about wealth:
One of the main ideas behind wealth creation and protection is the word “inevitable.” In a world that thrusts so many arbitrary benchmarks and rules into the world of wealth, it’s important to remember that the individual is generally concerned with one thing: having a high likelihood of reaching their financial goals.
Every other aspect of wealth management feeds into this idea of inevitable success.
Quote of The Week
It’s just extraordinary what happens in markets over time. It gets sorted out eventually, but we have seen companies sell for tens of billions of dollars that were worthless. And at times, we have seen companies—not hard to find and with perfectly decent people running them—that sold for literally 20 to 25% of what they were worth. We have seen and will continue to see everything. It’s just the nature of markets. They produce wild, wild things over time. The trick is, occasionally, to take advantage of one of those wild things and not to get carried away when other wild things happen, because the wild things create their own truth for a while.
Warren Buffett, 2000 Shareholders Meeting
(You can tell I’m a fan of Warren Buffett and Charlie Munger. I promise, not every quote will be by them.)
Michael’s Corner
Cape Ratio Mean Reversion
The Shiller CAPE ratio is a measure that is supposed to help investors know whether markets are overvalued or undervalued.
The formula:
Over time the ratio has climbed to new highs and stayed relatively elevated for years:
The argument here is that the Shiller CAPE ratio is no longer relevant, since new technologies make modern companies less capital intensive.
There’s a lot of other arguments against using the Shiller CAPE ratio, but we’ll save those for another time.
Just remember this when someone brings up the “overvalued market” based on the Shiller CAPE ratio.
No Business is An Island
All businesses are intermingled with each other. That is why I look at the landscape in front of a business. That landscape makes up a lot of things: stakeholders, competitors, regulatory hurdles and tailwinds, geography, technological advances, and leadership. I could obsess about each of these items for a whole career, which is what makes this tough.
It would be so much easier if each company was an island, and we could all just look at profitability and price-to-earnings then call it a day. But it’s not.
It’s common for businesses that had a great 10 year run to hit a wall, or for hated companies to turn things around, or some seemingly random outside events thrust a company skyward.
It is one of my core investing beliefs that, if you dig for information in the right places, and pay attention to the things that matter, and keep the 4 horsemen of investor death at bay (fear, greed, hope, ignorance), then you might have a shot at doing ok.
Learning about a business in context and adjusting for the 4 horsemen of investing are just table stakes, and each of those items can also be expanded for an eternity, (and they’re constantly evolving, just like my CAPE Ratio section above).
Have a great weekend.
Michael
Disclosures
This newsletter is provided for informational and educational purposes only and does not constitute investment advice, an offer, or a solicitation to buy or sell any security. Walsh Financial is a Registered Investment Adviser.
The content is general in nature and is not intended to be advice tailored to any particular person, circumstances, or investment objectives. Any references to individual companies, securities, sectors, asset classes, market indexes, commodities, or economic and market conditions are for general commentary and discussion only and should not be construed as a recommendation or a call to take any specific action.
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