To summarize: we seek disconnects between market expectations and business fundamentals. Stock prices move more than intrinsic business values. We carefully analyze the latter with a robust process developed at Patient and its predecessors over 40+ years. We focus our efforts on areas with a high likelihood of mispricings: extreme price moves, new companies or segments not yet understood. We buy things when others hate them, which is behaviorally challenging to do (eg- our “edge”). This approach has withstood the test of time and we have high conviction in it despite recent challenges to value strategies.
On a macro level, we see a disconnect between depressed sentiment and a resilient economy. Historically, similar sentiment readings have often been followed by robust market returns of 20%+.
The Most Hated Rally in History?
Everyone has seen the moribund consumer sentiment numbers. May came in at 52.2. There were only two lower troughs in the past half century: Jun 2022 (all-time low) and May 1980.
CEO confidence isn’t quite as extreme but registers at a dire level as well. In April, the index hit 4.99, the lowest level since Nov 2012, the early stages of the financial crisis recovery.
Historically, consumer sentiment troughs have preceded strong rallies, averaging 24% in the next year. No one seems to believe that’s possible from here.
The S&P 500 began its cyclical bull market in Oct 2022, following the Fed induced bear market of 2021. Since then (through Jun 9), the S&P 500 has gained 61%, or 20.1% per year – double long term average market returns. Yet in the ensuing ~2.5 years, consumer sentiment didn’t even make it back to its long-term historical average before tanking again (see charts at end).
How can returns so good feel so bad? Inflation, market volatility and geopolitical turmoil have created a toxic brew. Growth and pain have long been understood to be intimately connected.
- "Endurance is one of the most difficult disciplines, but it is to the one who endures that the final victory comes." – Buddha
- "Difficulties strengthen the mind, as labour does the body." – Seneca
- "Don't throw away your suffering. Touch your suffering. Face it directly, and your joy will become deeper." - Thich Nhat Hanh, a Zen Buddhist teacher
Who knew the Buddha was such a savvy market prognosticator? We believe equity market returns are compensation for volatility and drawdowns (eg- pain).
Since the financial crisis, disinflationary forces have been continually underestimated. In the 2010s, inflation only hit the Fed’s 2% target in two quarters. Since Covid, inflation returned to a 2.5-3.0% level from its 9%+ peak more quickly and easily than nearly anyone expected.
At the same time, the economy has shown remarkable resilience. Fed tightening didn’t stop it’s advance much to the surprise of most economists and investors. So far, initial weakness from the tariff induced uncertainty seems to be abating. Delta Airlines and Norwegian Cruise Lines both recently talked about normalization post April weakness.
Pessimism enhances return prospects. But with the S&P 500 valuation near record highs, at 22.8x 2025 earnings, isn’t it hard to claim muted expectations?
We see a bifurcated market, with high valuations in quality, large-caps and growth stocks and attractive opportunities in smaller-caps, some cyclicals and value-oriented areas of the market.
Our process seeks to capitalize on the behavioral tendency of the market to go to extremes. We look for beaten-down market expectations and solid fundamentals.
As stock pickers, we analyze companies on a bottom-up basis to assess their attractiveness. While over-arching patterns exist, like elevated valuations for the largest companies, our work focuses on each individual company. We still see opportunity in some areas with overall optimism.
We think Amazon is still attractive with some of the most enduring growth prospects of all companies. Fears about the durability of Alphabet’s search business have created significant upside in our opinion.
The Why Behind Your Portfolio:
We relentlessly seek to identify gaps between market expectations and fundamental business values. Intrinsic business value is the present value of the future free cash flows. Since the future is uncertain, we think probabilistically about a range of scenarios.
Most (but not all!) gaps are caused by problems that depress current market expectations. We run towards fires, though not blindly. We take calculated risks when we think Mr. Market has made a mistake. We also recognize that a small percentage of companies create most of the wealth in the markets. We explicitly look for these big gainers.
We exhibit plenty of patience. Patience in waiting for temporary market pessimism to correct. And patience allowing our winners to run (as long as we believe they can continue to earn sufficient long-term returns).
We are unique. In a world that requires the production of short-term, consistent returns, it’s high risk to buy troubled names that might take years to normalize. Bosses, risk managers and clients don’t have the same conviction and tolerance as a portfolio manager.
We benefit from the lack of competition in the types of opportunities we seek. We believe it’s a competitive advantage to have a PM managing the business. There’s complete alignment around driving investment outcomes.
Our process works, but not linearly. Our valuation focus mitigates risk. The biggest losses occur during large bear markets, which mostly occur after secular valuation peaks. We are sensitive to those risks. At the same time, we systematically attempt to find the companies that will be the biggest gainers over the long term.
Where We Get It Wrong:
As a group, stocks with high dispute underperform. When they work, they can work big. We are looking for the diamond in the rough. When we’re wrong, problems we deem temporary prove more enduring than we think. We’ve learned to exit these names more quickly.
The Risk For Us In This Environment:
Our fund has been overweight cyclicals. In an environment characterized by elevated recession fears, many cyclicals have been systematically mispriced in our opinion, especially those most damaged by Covid (eg- travel). At numerous times during sell offs, we’ve believed some names, like Norwegian Cruise Lines or OneMain Financial, priced in a recessionary outcome. We focus on long-term (5-year) through the cycle returns and ensuring we can make back any temporary losses. We also know if a recession occurs, it will get worse before it gets better. Alas, that’s the challenge of being a long-term investor.
As Tolstoy said, “the two most powerful warriors are patience and time.” In markets, nothing could be more true.
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