Q1 2020 Update



I continue to under-perform the S&P 500. I’m in year #4 of putting this blog together after setting out to out-perform the market with a value portfolio.

It’s not working so far. I believe this is because of where we have been in the market cycle.

I still believe that small value will demonstrate exceptional performance when it usually does: when we are emerging from a recession and bear market.

This is what we saw in years like 1975, 1991, 2003, and 2009. Small value delivered the following performance in those years:

1975 = +53.94%

1991 = +42.96%

2003 = +37.19%

2009 = +30.34%

Meanwhile, value always lags at the end of a bull market. It then goes down with the market during the recession.

Then, it delivers the out-performance emerging from the recession. This cycle doesn’t look any different to me.

Of course, we are not there yet. This is 2008 (small value -32%), not 2009. This is 1990 (small value -19%), not 1991. This is 1974 (small value -21%), not 1975.

We are only at the beginning of a recession and a bear market. Historically, this isn’t when the small value premium is delivered.

Based on the seriousness of shutting down large chunks of the global economy, this is likely to be a worse recession than the global financial crisis. The economy never grounded to an absolute halt during the GFC and that’s what is happening now.

What makes my under-performance even more incredible is that I anticipated a recession and went into the year with a significant amount of cash. Going into year end, I was roughly 30% cash and bonds. Going into March, I was nearly 50% cash.

Despite all of that cash and bonds, I still under-performed the S&P 500!

My assumption was that my cash would provide a nice cushion against the downturn I thought was coming in the market. The fact that I held so much cash and still under-performed is absolutely staggering.

Of course, this happened because most of my portfolio was in the deep value universe. Value is a universe that was annihilated this quarter.

Take a look at some of the popular value ETF’s this year:

QVAL – Down 40.23%

VBR – Down 34.98%

SLYV – Down 37.36%

Looking at the deep value EV/EBIT < 5 universe, the performance is even worse.


If I bought and held all of my stocks, then I would be looking at a very similar result today. My move to cash turned out to be the right decision.

Of course, my move to cash is not what a value investor is “supposed” to do. You’re not supposed to time the market, you’re not supposed to pay attention to macro, and you’re supposed to stick to the process no matter what. That’s what all of the mental models say and that’s what all of the experts say.

I’m done with all of that. I’m going to trust my own analysis going forward rather than mental models and superinvestor quotes.


I sold off most of my portfolio over concerns about the extreme recession and bear market that is unfolding.

I opened hedging positions with TAIL and SH to stay market neutral against the stocks that I still hold. I sold the short term bond ETF when rates went negative.

I bought one new position this quarter, American Outdoor Brands, a firearms manufacturer. You can read about the stock here.

The End of the Bull

How Bull Markets End

Since I started the blog, I have been worried about the next bear market.

Equities were rich and excess was everywhere. Venture capital firms were practically setting money on fire, as rich people gambled on the next Uber and Facebook, leading to situations like WeWork.

Private equity multiples and the leverage behind those deals grew more and more extreme.

We then had an ICO and crypto bubble, which bore many similarities to the dot com bubble. It was a mania. Manias are sure to end in tears.

Of course, market manias rarely end without a catalyst. That catalyst is typically a recession. In this cycle, we simply avoided a recession for longer than normal, so the mania grew more extreme.

I knew that once a recession came along, the market would be punished in an extreme fashion. I also knew that the frothy environment wouldn’t end until the recession came, so I stayed mostly long.

Now, the recession is here. It arrived faster and with more ferocity than I could ever have imagined.

Going into this year, I assumed that a recession was coming due to the yield curve inverting earlier in 2019.

The yield curve is the most reliable indicator of a recession that we have because it is a good proxy for how tight or loose the Fed is. I was really amused at everyone trying to rationalize the inversion earlier this year.

All of the “experts” lectured us about how inversions don’t matter, despite the yield curve’s excellent track record in predicting recessions. It’s different this time!

I expect the track record of the yield curve to remain intact. It will be even more useful during the next recession, because everyone will continue to dismiss the indicator.

Next time, they’ll say the 2019 inversion didn’t matter because what took down the economy was the Coronavirus. Then, a year later, we’ll have another recession.

We were headed into a recession and bear market without the Coronavirus. The Coronavirus is making a situation that was already unfolding into something more catastrophic to the global economy.

The Coronavirus is turning this from what would have been a normal, run-of-the-mill recession into the worst one that we’ve experienced since the Great Depression.

I do not understand the logic of the bulls who assume that the economy will just snap to life when everything re-opens. Will restaurant traffic immediately return to normal once everything re-opens? Will people return to movies, restaurants, and airlines right away? Will the millions of unemployed people suddenly get their jobs back?

Firms are going bankrupt right now. Their revenues are down 90%. Are they just going to spring back to life once everyone goes back to work? What about the deeper effects on the economy? Everyone’s spending is someone else’s income. Everyone’s debts are someone else’s assets. We’re witnessing a meltdown in asset values and income.

There is no way that is just magically resolved over a couple of months because the Fed is accommodative and some people get a $1,200 check and people can return to work. The bull case strikes me more as denial of reality than a valid thesis. It looks like an unrealistic fantasy to me.

Of course, this wouldn’t be the first time I’ve been wrong. I just think it’s highly unlikely that I am.


Valuation is destiny and the market has been overvalued since 2014.

The pundits have mocked bears since 2014.

The overarching attitude has been: “You keep talking about the CAPE ratio, but the market went up 20% last year, so you’re wrong and valuation doesn’t matter!”

The bulls were wrong in thinking valuation no longer mattered. The bears were wrong in assuming that valuations would come down without a recession. Based on the yield curve, a recession wasn’t a serious thing to worry about in the mid-2010’s. It wasn’t even a major concern at the end of 2018.

Overvalued markets don’t come down to Earth on their own. There needs to be a catalyst. In market history, the catalyst is typically a recession.

Valuation alone doesn’t push the market down. The multiple-compression comes during the recession.

The extent of a big equity drawdown is a combination of the overvaluation of the market and the severity of the recession. The bears miscalculated in the mid-2010’s because they didn’t take into account the fact that a recession was unlikely. The bulls miscalculated last year because they didn’t realize a recession was baked into the cake and a severe re-adjustment was likely going to happen based on how frothy the market was.

And yes, the market was insanely frothy. It was even worse than the internet bubble.

Last year, market cap/GDP went above its internet bubble highs.

Market cap/GDP is very good at predicting 10 years worth of returns.

What it doesn’t tell you is the sequence of those returns.

Usually, the sequence of those returns is wild and correlated with the timing of recessions and recoveries. In 2000, market cap/GDP suggested a .4% rate of return. The actual result was a .9% rate of return from that level. Market cap/GDP was a pretty damn good indicator through this lens.

Of course, the market didn’t return .9% per year for a decade in a straight line. This return happens in extreme bull and bear runs. When a very mild recession came in the early 2000’s, an overvalued market was knocked down to Earth.

From 2000-2003, the market went down 44%. Then from 2003-2007, it went up 90%. Then, from 2007-2009, it went down 50%. Then, from 2009-2010, it went up 50%. The market never moves in a straight line.

Let’s look at another decade with sky-high valuations that suggested poor returns: the 1970’s.

From 1973-1974, the market fell 45%. 1975-1980, it went up 200%. Due to inflation, all of these moves were null and the market was essentially flat over that period.

These returns were predictable based on valuations. What was less predictable is the sequence of those returns based on the timings of recessions.

An even better indicator of market valuation is Jesse Livermore’s indicator: the average investor allocation to equities.

The indicator predicted the poor returns of the 1970’s. It also predicted the poor returns of the 2000’s. It also anticipated the significant bull runs of the 1980’s, 1990’s, and 2010’s.


There is always a lag with the data for this indicator, but the latest data in Fred showed a 46% average investor allocation to equities at the end of last year. This was not as extreme as the internet bubble, when this went up to 51%.

Plugging this model into my equation based on this metric, this suggest a .7% return for equities for the 2020’s. Pretty similar to the 2000’s.

Market cap/GDP was at an all time high at the market peak this year, at 151% of GDP. This also suggests flat to negative returns to the 2020’s.

Will the path to these returns look like a straight line for a decade, or will it be like Mr. Market’s insane mood swings . . . that has always been the case through the history of markets?

Right now, we’re facing the worst recession that we’ve experienced in 90 years at record valuations.

We should see at least a 50% drawdown from the highs. We had a 50% drawdown during less serious recessions with less overvalued markets. Why won’t it happen this time? Because markets are more efficient? Give me a break.

Does the last 30 years look like an efficient market to you?  Does it look like investors carefully calculate future economic prospects and cash flows during periods of prosperity and bear markets?

1990-2000 – Up 300%

2000-2003 – Down 45%

2003-2007 – Up 90%

2007-2009 – Down 50%

2009-2020 – Up 250%

Rather than carefully and rationally calculating future cash flows, it looks to me like markets simply extrapolate what is going on at the moment and assume that it will last forever, leading to extreme swings.

The bull case seems to be based on the idea that markets look forward and will see past this.

When has that ever been the case in markets? Looking at market history, I don’t see a group of rational actors that can see past the noise and look at the long-term picture of an economy.

At the peak of every expansion, markets get bid up to multiples that suggest it will never end. During most recessions (at high valuations, anyway), markets crash like prosperity will never come back.

Markets aren’t this efficient mechanism that we read about in finance textbooks.

This is how markets work. During prosperity, we have a wonderful bull market where multiples expand. Then, they come crashing down once we have a recession, based on how high multiples are and how bad the recession is. Fear and greed. It’s an eternal cycle of human emotion.

Why won’t this happen again, when we are facing the worst economic crisis we’ve had in a century? Have we broken the economic cycle? Are investors seeing the world more rationally than they did in the past?

This sounds absurd to me.

The Future

Of course, once all this is over, if history is any guide, we’ll have another rip-roaring bull market. We had a nice bull market from 1932-37 and we had a great bull market from 2003-07.

The good news is that the yield curve has un-inverted. Short term rates are now negative. I would expect this to continue.

Once the bond market begins anticipating a recovery, I would also expect longer term rates to start increasing again. This is happening now, but there is always a lag between the shift in monetary policy and its impact on the real economy. In the next year or two, markets will rebound. Of course, rebounds don’t happen after a mere 20% drawdown in the S&P 500 and at the opening gates of a recession.


The virus isn’t going to last forever. At some point, we’ll have a vaccine. At some point, the lock-downs will end. At some point, fiscal and monetary stimulus will have an effect on the economy. That doesn’t seem like it will happen anytime soon, though.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

American Outdoor Brands (AOBC)

Key Statistics

Enterprise Value = $670 million

Operating Income = $32.3 million

EV/Operating Income = 20.74x

Price/Book = 1.06x

Earnings Yield = 3%

Price/Revenue = .77x

Debt/Equity = 53%

The Company

American Outdoor Brands is a firearms manufacturer. They sell handguns, long guns, handcuffs, suppressors, and other firearm-related products.

Brands include: Smith & Wesson, M&P, Performance Center, Thompson/Center Arms, and Gemtech brands.

My Take

AOBC is not cheap on an earnings yield or EV/EBIT basis. This is because earnings are at a cyclical trough. Gun sales have been very poor for the last few years, and gun manufacturers have been punished accordingly.

The Obama Presidency was very good for gun sales. Gun enthusiasts bought up guns like crazy because they were worried about Obama imposing new gun regulations. Of course, the regulations never happened. This created a bonanza of earnings, cash flow, and sales for the industry.

At the peak in 2016, AOBC traded at a price/book ratio of 6x. Price/sales was 2x.

Then, the Trump Presidency came along and gun enthusiasts were no longer scared of regulation. Gun sales slowed.

Meanwhile, in the face of slowing gun sales and the recent bear market, AOBC shares were crushed down to below book value. Recently, all stocks have been dumped regardless of their prospects. The stock has also been punished in recent years due to the ESG fad, in which ESG investors don’t want to have exposure to an ugly industry like firearms manufacturing.

Unlike most of the economy, the firearms market now has excellent prospects. Last month, there was a 41% increase in background checks. Due to the Coronavirus panic, firearms sales are surging. I believe they are going to surge beyond the extremes experienced during the Obama Presidency.

This suggests higher multiples for AOBC. I don’t see why the multiple can’t expand back up to a price/book of 6x from its current 1x multiple. It could also expand up to its 2x price/sales multiple, on likely higher sales. I think there is potentially a 200% upside to the stock from current levels. The market seems to be catching onto this quickly. The stock is already up 15% from my purchase price while the rest of the market is going down this week. I expect this to continue.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Risk Doesn’t Always Equal Reward


Traditional advice: Risk = Reward

Back in college, the traditional financial advice that I learned was that risk equals reward.

The logic is that equities are going to return more than bonds because equities are riskier.

Therefore, the traditional advice goes, if you want to compound wealth over time, then you have to go for the gusto and put everything into stocks. Otherwise, you’re a loser with no appetite for risk and won’t earn decent returns.

The FIRE movement has largely embraced this approach and encourages early retirees to put 100% of their wealth into US stock index funds.

Charlie Munger agrees with this logic:

“This is the third time that Warren and I have seen our holdings of Berkshire go down, top tick to bottom tick, by 50%. I think it’s in the nature of long-term shareholding, of the normal vicissitudes in worldly outcomes and markets that the long-term holder has his quoted value of his stock go down by say 50%. In fact you could argue that if you are not willing to react with equanimity to a market price decline of 50% 2-3 times a century, you are not fit to be a common shareholder and you deserve the mediocre result that you are going to get, compared to the people who do have the temperament who can be more philosophical about these market fluctuations.”

Another View

Charlie Munger might be okay with losing 50% of his money every 15 years.

Of course, this is easy to say when you’re a millionaire or billionaire that will always have plenty of money to live on no matter what happens. Even if stocks go down 80%, it wouldn’t have any impact on Munger’s abililty to put a roof over his head and food on the table.

I’m not okay with losing 50% every 15 years. You probably aren’t, either.

As a value investor, I don’t believe that volatility is risk, but I do think it accurately represents your level of heart burn and ability to sleep at night. I’d like to reduce my heart burn and sleep soundly.

Now that the Q1 results are final, many people will look at their stock-heavy portfolio returns returns and freak out a bit. Many will say to themselves: “This is the price of owning stocks and earning high returns. Risk equals rewards.”

There is a problem with this: it’s not true.

It is not a guarantee that stocks will always go up. It’s not even true over very long stretches of time. There have been 10 and 20 year periods of time when stocks had multiple horrific declines and were flat for the entire period.

Stocks frequently have lost decades, where they deliver horrific drawdowns and no return for the all of the stress. In other words, there are decades when stocks provide return-free stress.

The 2000’s and 1970’s are great examples of this. The 1930’s are a more extreme example.

Risk doesn’t always equal reward.

The truth is that there are different, less stressful ways to invest that can earn a satisfactory return on money over time without the stress of a 100% US stock portfolio.

This is readily apparent when looking at the returns of different asset allocations during the recent quarter, their financial crisis max drawdown, and comparing them to their CAGR since 2000.


As you can see, risk doesn’t always equal reward, and this has certainly been true over the last 20 years.

Look at the Permanent Portfolio, for instance. This portfolio only has 25% invested in US stocks. Meanwhile, it has beat the US stock market over the last 20 years with a fraction of the stress. It also made money in a quarter when it felt like the world was coming apart at the seams.

There are many allocations that diverge from 100% US stock market investing that provide for a much smoother ride and still provide a decent rate of return.

Combining volatile asset classes in a portfolio can provide a high and consistent rates of return over the long run.

To earn a satisfactory return over the long run, one doesn’t need to lose 50% every 15 years. One doesn’t need to look at their portfolio while chugging Pepto Bismol.

My own allocation was down down 12.83% this quarter. While I stressed in my active account about what stocks I owned and how they were positioned for the Coronavirus and how bad the extent of the drawdown and economic carnage would be, in my passive account I was able to take a “meh” approach.

With this approach, I don’t have to worry about security selection and I don’t have to worry about what the future holds. The portfolio has it covered.

Will the economy spring back to life? I have it covered. Small value, real estate, and international small caps will likely do well in this environment.

Will we face a deflationary and horrific recession, like the early 1930’s? I have it covered. Gold ought to hold up even though it won’t go gangbusters. Long term treasuries should do very well in this environment, as investors scramble for the safety of treasuries and interest rates will probably go negative in the US further up the yield curve.

Will the Fed’s actions fuel horrible levels of inflation? Will they actively pursue inflation as a means of reducing the US debt/GDP ratio? I have that covered, too. My long term treasuries will be crushed in this environment and stocks will likely be punished, too. But, it’s hard to imagine how gold won’t do extremely well in this environment. Real estate will probably do well, too. Rents will increase with the inflation rate, along with the replacement cost of that real estate. The dollar will probably weaken, but that’s alright, as I have a global portfolio and foreign assets will benefit from a weaker dollar.

Will civilization implode? If that happens, I don’t think my portfolio matters much, anyway.

With the balanced approach, it doesn’t matter if my analysis is wrong, which it may very well be. With a balanced approach, I know that I have built in protections for different types of economic environments and should be able to earn a satisfactory return on my money over the upcoming decades.

Combining uncorrelated asset classes in a portfolio can achieve a better result that doesn’t require forecasting the future accurately, doesn’t require superhuman security selection, nor does it require Pepto Bismol when looking at the brokerage statement. Most importantly, it can often be implemented without paying a manager high fees.

Not only that, but safer portfolios with even lower rates of return than US stocks can have higher perpetual and safe withdrawal rates. This is evident using the ranking tool at the Portfolio Charts blog.

US stocks, even though they can deliver high rates of return, actually rank worse in perpetual withdrawal rates than most asset allocation strategies. This is because of the high volatility and long stretches in which they do not deliver a return. In other words, an investor does not even need to earn the super charged returns of US stocks when using a safer portfolio. This is useful for someone contemplating early retirement. The perpetual withdrawal rate matters more in this scenario than the CAGR over a long period of time.


In the case of my portfolio, the data since 1970 assumes it can sustain a 5.4% perpetual withdrawal rate. If I need my portfolio to generate $30,000 a year, this means that I need at least $555,555.56 to retire. In contrast, to obtain a $30,000 income from the stock market’s 3.5% perpetual withdrawal rate, one needs to save $882,352.41. The two portfolios have have similar CAGR’s – but the volatility and consistency of return for my portfolio creates a higher perpetual withdrawal rate.

My approach is not the only approach. There are many solid asset allocations. Harry Browne’s Permanent Portfolio is a particularly stress-free stud of a portfolio. The portfolio made money this quarter amid all of the horrifying headlines.

Or, maybe you want to go for the gusto and own 100% US stocks. I don’t think this is the optimal approach, but whatever. It’s your money.

You do you. There isn’t anyone else on Earth with your same goals or the same tolerance for risk.

It is worth examining other approaches that have a lot less stress and can still earn a satisfactory return over time.

The Allocations

If you want to explore different asset allocations, there is no better resource than the Portfolio Charts blog.

Another great backtesting resource is Simba’s backtesting spreadsheet at the Boglehead’s forum.

In terms of the allocations that I’ve examined since 2000 and described in the above chart, here they are:

Harry Browne Permanent Portfolio – 25% US stocks, 25% Gold, 25% Long Term Treasuries, 25% Cash. Here is a book on the approach.

David Swensen Individual Investor Portfolio – 30% US stocks, 20% REITs, 15% International Developed, 5% Emerging Markets, 15% TIPS, 15% Short Term Treasuries. I wrote about this portfolio here. Swensen’s book on the subject is great, and I highly recommend this read.

Ray Dalio All Weather – 30% US stocks, 40% Long Term Treasuries, 7.5% gold, 15% intermediate term treasuries, 7.5% commodities. Tony Robbins wrote about this portfolio here.

Boglehead Three Fund – 50% US stocks, 30% International Stocks, 20% Total US Bond Market. You can read about this portfolio with this book.

My asset allocation – 20% US small value, 20% international small, 20% global real estate, 20% gold, 20% long term treasuries. You can read about my approach here.

Wellesley – Want a portfolio that you don’t need to rebalance and can put zero effort into maintaining? Just buy the fund and let it ride? Wellesley has a pretty long track record since 1970 of helping investors do just that. The expense ratio is only .23%. Wellesley investors lost only 7% this quarter and lost only 10% in 2008, while stocks went down 37%. It has also beat the US stock market since 2000.



PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.