A volatile 2023 came to an amazingly strong end in markets. The S&P 500 produced unexpected returns of 26% primarily on the backs of the “Magnificent Seven.” The US economy proved fundamentally strong - full employment, persistent consumer spending (albeit with expanding consumer debt), and business resiliency despite higher interest rates. Many went into the holidays optimistic about future Fed rate cuts, fresh liquidity to fuel markets, falling mortgage rates unblocking residential real estate markets, accommodative energy prices, and a generally strong US economy.
The first weeks of 2024 revealed a lot of hidden, or at least temporarily ignored, worries.
· Can the non-Magnificent Seven (the “Frail 493”) catch up?
· What impact, if any, will expanding conflicts in the Persian Gulf and Suez have on energy markets and inflation via slowing of trade?
· Will China move on Taiwan?
· Whither goeth the long, miserable war in Ukraine?
· What will the “free” world look like with 2/3rds of the populations in global democracies voting on new leadership?
Closer to home, inflation appears to be stubbornly persistent with few immediate signs of a falling rate of rising prices (disinflation) much less lower prices (deflation). Employment numbers continue to come in strong with commensurate strength in labor costs. Most Americans respond to surveys that they are unhappy with the economy. Housing remains expensive with the cost of ownership exceeding rentals. And we face a presidential election apparently involving two of the most disliked candidates in history with a Congress fundamentally, diametrically opposed to doing anything productive.
In the marketplace, the EV transition in the US is in doubt. TSLA has sold off with falling prices and increased competition from abroad (and political attacks at home). Hertz is selling 20,000 EVs due to renter unpopularity and high cost of repair and maintenance. Ford is dramatically slowing production of the widely lauded F-150 Lightning to invest in gas combustion propelled Broncos. Organized labor opposes Big 3 plans to build non-unionized battery plants. And Commodity markets reflect (or predict) this conundrum with metals and materials – and hydrocarbons - absolutely necessary for the energy transition all falling in price.
Can big tech continue to lead the markets in 2024? Many wizards of Wall Street are predicting the likes of Apple, Meta, NVDA, Tesla, Amazon, Alphabet and Netflix will be unable to continue their rapid ascent.
So, 3 weeks into the New Year, we appear to be stumbling into the Exponential Age where AI, genetics, robotics, the energy transition, and space exploration/ exploitation will bring us into a new era of human prosperity. The geopolitical and economic hurdles appear to be more numerous and deleterious than expected. No pronouncements from the intelligentsia on Mt. Davos can resolve this.
What sayeth CrossGrain?
The US economy is fundamentally strong, and tech will continue to lead over time.
· US Inflation is slowing, and the Fed will start cutting rates though Goldman Sach’s prediction of 6 rate cuts - now down to 5 – starting in March are too many and too soon.
· Demographics and geopolitics favor the Western Hemisphere, Europe is stumbling toward economic malaise, India is the strongest amongst emerging markets, while China’s economy is rapidly slowing due to deflation, political and military purges, and extreme real estate debt.
· US Fixed income markets are boring but at least provide a positive return with potential upside if rates are indeed cut by the Fed.
Accordingly, we are leaning into US equities and specifically tech names/funds. This is a long-term trend, and we expect volatility. We look for the Frail 493 to gain chasing the market upside. More broadly, we expect US small and mid-caps to also play catch-up and to do well. We like our international and emerging market manager GQG to continue to outperform its benchmarks and contribute to portfolio returns with some diversification benefits. We maintain some fixed income in portfolios for (again) some diversification and stability. And we continue to hold decent levels of cash to mitigate volatility and provide for opportunistic investing.
Allow us to return briefly to Tesla. Our macro thesis of the Exponential Age involves AI and Robotics as leverage points likely to contribute to expanding GDP over the mid-to-long term. TSLA is a lot more than an EV company; indeed, they sit at the epicenter of change.
· Their DOJO computer is gathering data and information every second of every day by utilizing their millions of cars on the road collecting data.
· This data, along with their advancements in AI and related company advancements in the galactic economy at SpaceX, will propel them to be a leader in the new Exponential Age economy.
· At the moment, however, the Market is giving zero value to TSLA’s technology and trades only on the deteriorating EV market.
So, while TSLA appears to be the ideal public stock to play, we are near-term bearish on its prospects...which means we’ll buy when it trades off and hold the name for long term growth.
Importantly, we continue to lean into our private investment portfolio for qualifying and co-investment clients. We expect an improved year for venture and private equity which last year suffered a large measure of constipation due to low transaction volume and liquidity (i.e., distributions) what with higher costs of leverage and valuation concerns. We are excited about our private credit managers continuing to make outsized returns and cash distributions from lending to rapidly growing private companies as well as bridge lending to real estate owners/developers. And we are cautious, very cautious, about real estate ownership awaiting lower interest rates, but are looking for opportunities in stressed assets and mobile home parks (workforce/affordable housing).
Jeff and Biff just got back from CAZ Investments’ Themes conference held annually in Houston. CAZ is one of our most important investment partners with a family client model much like ours: high alignment in that they are investing big proprietary capital alongside ours in their investment opportunities, and strong fiduciary standards in terms of transparency, accuracy of reporting and availability. To sum up:
- The thesis around the General Partnership Opportunities (GPO) Fund remains intact. Investing in ownership interests in large and middle-market asset management firms in the US and abroad provides stable, strong cash flows with predictable total returns over time. We will continue to suggest that all of our qualified and co-investment partners invest in this capital compounding powerhouse.
- CAZ tech fund investment managers Khosla and Vista are performing strongly in CAZ Disruptive Techand CAZ Enterprise Software Funds, respectively. Still in early stages.
- Energy is a difficult, volatile space for investors. Allocation to oil, gas and energy transition opportunities should be done via private investments.
- Minute Maid Park, where the Astros (which started life as the “Colt 45s” but were renamed for the astronauts flying into space from nearby NASA) play, is a great stadium. Its predecessor, the Astrodome, is the location where artificial grass was introduced to major league baseball and came to be called “AstroTurf.”
To sum up, we believe we are in the early innings of the Exponential Age. "Artificial Intelligence" aka AI was the word of the year in 2023 and now every company mentions an AI initiative in their conference calls, but will AI really change the world, and for the better? We would be lying if we claimed to have an exact answer. We feel strongly that AI along with robotics, material sciences and genetic discoveries will provide solutions to our weakening demographics not only in the US but across the global. We also believe that AI will propel productivity levels to heights not seen previously. Both are key components to maintaining and growing national and global GDP, which growth is absolutely critical to keep up with, and eventually pay back or at least monetize away, Central Bank and world government printing of money.
So, 2024 will likely be an up year for global markets. Eventual Fed easing of rates, continued deceleration of inflation (don't be shocked if Deflation rears its head again as we get to 2025), the Election cycle (historically good for risk assets with currently elected officials juicing the economy and voters’ pocketbooks to get re-elected), the wider acceptance and availability of cryptocurrencies, and impact of AI.
This said, much could go wrong. Expansion of Middle East unrest, escalation in the Ukrainian war, a kinetic China/Taiwan conflict, and of course the unexpected. High levels of complacency often result in market extremes. Accordingly, the markets are likely to be very choppy with a possible draw down of 10 - 15% sometime in the near future. Although we believe the market priced in the current risk of recession in 2021 / 2022, we are likely going to see the actual recession happening with lackluster growth, continuing inflation, and upticks in unemployment, all of which will feel more like “Stagflation.” No matter the scenario, however, expect to see Fed easing.
As always, we value your friendships, your investments alongside ours, and your feedback. We look forward to spending time with each of you this year.
Warmest Winter regards,
Jeff & Biff
* Term coined by and borrowed from Raoul Paul of Real Vision. No Harvard plagiarism here!
CrossGrain Family Investments, LLC is a Federally-Registered Investment Adviser. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this communication's conclusions. Please contact us at 804.217.2561 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions. Additionally, we recommend you compare any account reports from CrossGrainFI with the account statements from your Custodian. Please notify us if you do not receive statements from your Custodian on at least a quarterly basis. Our current disclosure brochure, Form ADV Part 2, is available for your review upon request, and on the SEC website, https://adviserinfo.sec.gov. This disclosure brochure, or a summary of material changes made, is also provided to our clients on an annual basis.