September 2021 IssueLong scroll reading

Run-Away Train Coming

By Edward A. Studzinski

“It’s a scientific fact that if you stay in California you lose one point of your IQ every year.”

~ Truman Capote

Is THE MARKET overvalued at this point? How do share prices relate to the underlying fundamentals of the businesses they represent? Is inflation eating away the value of my savings (and our currency) now?

How should I invest to preserve my capital and lifestyle going forward?

These are all important questions to which, unfortunately, there are no easy answers. Should one be invested in small capitalization or large/mega-capitalization equities? A period of high inflation and high interest rates tends to present a favorable environment for small businesses. But now we have neither. We are perhaps moving into a period of high inflation, certainly higher inflation than we have had for many years now. And our interest rates have been artificially suppressed, by our central bank among others, ostensibly to keep our economy, now for many years, out of a severe downturn. And while we were not looking, we were not supposed to notice a shift by our own central bank (the Federal Reserve) to focus on attaining fuller employment rather than keeping inflation in check. We are not yet at a point that would favor small companies, which are generally more nimble than large companies at raising prices. Rather, a large capitalization company moves its prices more slowly upwards, growing at what its historic growth rate has been, without adjusting for inflation.

Alternatively, we appear to be in a period which in many respects mimics that of the “Nifty Fifty” during the late 1960s, where large cap growth stocks like Polaroid and IBM were trading at high multiples of earnings, valuations that were usually seen in small cap growth stocks. The future earnings levels that were being assumed and discounted required permanent economic perfection. Instead, what was coming down the tracks (train wreck) was OPEC price increases, America held hostage by Iran, and extraordinarily high inflation. In theory, fast-growing companies with moderate inflation and a decent dividend can continue to provide a return well above inflation. However, that ends once inflation begins to rise. The prices (and high multiples) of those securities will collapse.

What to look for? At some point, we will see high rampant inflation. And there will be a societal push to get it under control. That will happen, but it will also result in larger companies being undervalued again. What should be done for an investment program in the interim? And what is different this time that needs to be considered?

Some eighteen months ago, an institutional consultant I know told me that he was taking all of his personal money out of real estate as an asset class. My question to him was, if you get out, when will you know to get back in? His answer was that he wouldn’t, but he didn’t want to ride the class down to zero.

Starting this year, of course, real estate, if real estate investment trust prices are any example, is doing quite well as an asset class, equaling or exceeding the returns of some equity indices. Unfortunately, he was too young to remember the 70’s, when a similar period had seen banks and insurance companies shedding their real estate investments (at the lows), only to come back into those markets later, not at the lows. That, of course, is why we no longer have such vehicles from that period as the Continental Illinois REIT and the Northwestern Mutual REIT. Real estate does not get repurposed all of the time.

My advice is this. One should generally stick with a long-term asset allocation program that has been well thought out and implemented. Regularly review it, considering your current goals and risk tolerances. Where appropriate, tweak it around the edges. But, making wholesale changes when panicked can often result in a permanent loss of capital that cannot be recovered from, along with a degradation of a portfolio income stream. In terms of equities, as you tweak around the edges, maintain a concentrated portfolio where you are aware of what you own and why you own it. If possible, have a good representation of businesses with true pricing power that are not impacted by the swings of commodity prices. On occasion, pay attention to the opportunities in real assets throwing off an income stream that are selling for less than their replacement cost (e.g. pipelines and various kinds of shipping). And finally, when given a choice between a good to very good business at a fair price with no debt (leverage) and a poor or commodity business that is very cheap with a lot of leverage, opt for the better business.


Since every now and then, I feel the need to throw out book or movie recommendations, here are three that I think are germane to our world.

  1. Regularly we limit ourselves in this country to discussions about investment from Americans. There are good lessons to be learned by going across the pond to the United Kingdom on occasion. In that vein, I would suggest Investing Through the Capital Cycle: Capital Returns – A Money Manager’s Reports, 2002-2015, from Marathon Asset Management, edited by Edward Chancellor (2016)
  2. In terms of movies, I cannot think of a more timely production to be viewed than the original version of “The Manchurian Candidate.” It is as a good a compendium of manipulative personalities, all perhaps seen from their individual perspectives with the best of intentions, as has ever been put together in a script. It is superbly acted in the original version with Frank Sinatra, Laurence Harvey, and Janet Leigh.
  3. Finally, for cable viewers, I recommend both seasons of “The Godfather of Harlem,” which gives us an appreciation of how much we have lost in terms of societal leaders who, although often flawed individuals, were in many respects far more visionary and exemplary than those we see today.
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About Edward A. Studzinski

Ed Studzinski has more than 30 years of institutional investment experience. He was a partner at Harris Associates in Chicago, Illinois. Harris is known for its value-oriented, bottom-up investment approach that frames the investment process as owning a piece of the business relative to the business value of the whole, ideally forever. At Harris, Ed was co-manager of the Oakmark Equity & Income Fund (OAKBX). During the nearly twelve years that he was in that role, the fund in 2006 won the Lipper Award in the balanced category for "Best Fund Over Five Years." Additionally, in 2011 the fund won the Lipper Award in the mixed-asset allocation moderate funds category as "Best Fund Over Ten Years. Concurrently Ed was also an equity research analyst, providing many of the ideas that contributed to the fund’s success. He has specialist knowledge in the defense, property-casualty insurance, and real estate industries, having followed and owned companies as diverse as Catellus Development, General Dynamics, Legacy Hotels, L-3, PartnerRe, Progressive Insurance, Renaissance Reinsurance, Rockwell Collins, SAFECO, St. Joe Corporation, Teledyne, and Textron. Before joining Harris Associates, over a period of more than 10 years, Ed was the Chief Investment Officer at the Mercantile National Bank of Indiana, and also served on their Executive and Asset-Liability Committees. Prior to Mercantile, Ed practiced law. A native of Peabody, Massachusetts, he received his A.B. in history (magna cum laude) from Boston College, where he was a Scholar of the College. He has a J.D. from Duke University and an M.B.A. in marketing and finance, as well as a Professional Accounting Program Certificate, from Northwestern University. Ed has earned the Chartered Financial Analyst credential. Ed belongs to the Investment Analyst Societies of Boston, Chicago, and New York City. He is admitted to the Bar in the District of Columbia, Illinois, and North Carolina.