The only people who get hurt on a roller coaster are the ones who jump off

“The only people who get hurt on a roller coaster are the ones who jump off.”

– Dave Ramsey

The first three quarters of 2020 have been quite a wild ride. From reaching all-time highs in early February, to a bear market that ended on March 23rd, we have since begun a five-month rally that appears to have stalled in September.

There are several themes that continue to drive stocks higher in the third quarter: including massive monetary and fiscal stimulus, expectations for a vaccine, improvements in the labor market and a strong housing market. Another theme was earnings resilience, although this was against extremely low expectations. There were also headwinds which received increased attention in September when stocks suffered their first monthly decline since March. One of the biggest headwinds revolved around concerns of stretched valuations and crowded positioning in big technology companies. Politics and the election came into focus during the second half of September with the selection of Judge Barrett as the supreme court nominee to replace Justice Ginsburg. From a performance standpoint, the S&P returned +8.5%, with growth outperforming value stocks. The best performing sectors were consumer discretionary, materials, industrials, and tech; energy continued to badly underperform the market, declining – 20.9% for the quarter.

While these events certainly provide a framework for investors to explain the short-term action in the stock market, it is less important for those of us who are long term investors. As we look through our portfolio holdings, we continually ask if the businesses that we own adhere to the thesis that lead us to our original purchase. Indeed, many of the long term themes we have been investing in started pre-COVID: the transition to the cashless wallet through electronic payments, cloud based data storage, data analytics and telemedicine; and all have been accelerated due to the pandemic. We own businesses that are at the forefront of these themes and have a long runway ahead of continued revenue growth and strong cash flows. The short-term noise of the election, the speed of the vaccine and other headlines won’t have a significant impact on these businesses three years from now. Of course, there are businesses and industries that will be materially hurt from this pandemic, many of which are highly leveraged cyclical companies. We have always believed in the value of a strong balance sheet, and this pandemic reiterated the perils of companies that are over leveraged.

In general, we have learned to be very careful about using politics, the economy and valuation to drive our investment decisions and we try hard to tune out transitory concerns about politics and the economy. It has been our experience that we are at our worst as investors when we allow concerns about issues, such as elections, trade wars and fed policy to influence our investment decisions.

In addition, we try to resist the temptation to sell based on valuation alone. We are unfazed when our businesses are quoted in the market at prices above what we would pay for them. There are three main reasons for this. First, when selling because of valuation, it is often with the idea that there will be an opportunity down the road to buy back at lower prices. In our experience, timing like this seldom actually works out. Second, of the thousands of publicly traded companies, there are few that meet our criteria, and opportunities to buy them at attractive prices are few and far between. Unlike average businesses that can be traded based on valuation alone, growing and competitively advantaged companies are very hard to replace. Third, the very best businesses tend to exceed expectations. What may seem like a high price today may be proven to be perfectly reasonable in hindsight.

In our experience, this thought process and long-term mind set are the best antidote to the noise and helps us with the fortitude to stay the course and allow our investments in strong growing businesses with distributable cash flows to compound uninterrupted.
With COVID-19 persisting and a divisive election looming, the outlook for the remainder of 2020 and beyond feels as unpredictable as ever, and in times like these that our disciplined investment process provides stability in an unpredictable environment. We expect to continue to see broad market volatility over the short term, but our convictions related to the individual businesses we own remains strong.

We thank you for your continued trust and confidence and feel privileged to work with you through these unprecedented times.

Sincerely,

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