Tag Archives: Eric Cinnamond

A Walking Contradiction – Warren Buffett

I have ways of making money you know nothing about.” – John D. Rockefeller

Contradiction- A situation in which inherent factors, actions, or propositions are inconsistent or contrary to one another- Merriam-Webster’s Dictionary

Investors and the media can’t seem to get enough of Warren Buffett. They hang on his every word as if he was sent from the heavens offering divine words of wisdom. Unfortunately, Buffett is a mere mortal, and like the rest of us, he tends to promote ideals that benefit his self-interests over yours.

The purpose of this article is not to degrade Buffett, as we have a tremendous amount of respect for his success and knowledge. In this article we look at a few recent statements and actions of Buffett’s to highlight some contradictions that lie in their wake. Our conclusion is that it is far better for investors to watch what “The Oracle” does as an investor rather than hang on his words.

This article also serves as a reminder that the most successful investors think and act for themselves. These investors are not easily persuaded to take action from others, even from the best of the best.

Buffett on Stock Buybacks

Warren Buffett has, for a long time stated that corporate stock buybacks should only occur when the following two conditions are met:

“First, the company has available funds — cash plus sensible borrowing capacity — beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.”

The quote above was from nearly 20 years ago, however based on more recent quotes his thoughts about buybacks remain the same. The following comes from a recent CNBC article:

At the 2016 meeting, Buffett said that buyback plans were getting “a life of their own, and it’s gotten quite common to buy back stock at very high prices that really don’t do the shareholders any good at all.”

“Can you imagine somebody going out and saying, we’re going to buy a business and we don’t care what the price is? You know, we’re going to spend $5 billion this year buying a business, we don’t care what the price is. But that’s what companies do when they don’t attach some kind of a metric to what they’re doing on their buybacks.”

Buffett added: “You will not find a lot of press releases about buybacks that say a word about valuation,” but he clearly believes they should.

Knowing his opinion of buybacks, let’s explore his own firm, Berkshire Hathaway (BRK/A). It turns out BRK/A is now “seriously considering” buying back their own stock. Given their cash and cash equivalent hoard of over $320 billion, such an action would seem to fit right in line with Buffett’s first qualification noted above. Unfortunately, the stock is far from cheap and fails his second test. Currently BRK/A trades at a price to book value of 145% and at a price to earnings of 28 (28 is considered a very high multiple for a company that has consistently grown earnings at a 4% clip over the last 8 years). Altering the firm’s buyback policy would require relaxing or eliminating Buffet’s price-to-book value requirement of “below 120%”.

When stock can be bought below a business’s value, it is probably the best use of cash.”

The bottom line: Buying back BRK/A at a price to book value of 145% and P/E of 28 is clearly not the “best use of cash”, and the market certainly is not valuing BRK/A at “below intrinsic value.” To counter his contradiction, it would be nice if he either came out and said he has changed his opinion about the optimal factors promoting buybacks, or stated that BRK/A does not have reasonable opportunities to grow earnings and returning cash to shareholders is the best option.

In the end, Buffett is unreliable on this topic, and BRK/A does not make a habit of returning cash to shareholders. In the long history of the firm, they have only conducted a few very small share buybacks and only once issued a dividend of $0.10 in 1967. It seems to us he is feeding the buyback frenzy occurring in the market today and will likely avoid meaningful buybacks in BRK/A.

Buffett on Valuations : Market Cap to GDP

One of the most widely followed equity valuation gauges is what is commonly referred to as the Buffett Indicator. The indicator, Buffett’s self-professed favorite, is the ratio of the total market capitalization to GDP. Currently, as shown below, the indicator stands at 132% and dwarfs all prior experiences except the final throes of the Tech boom in the late 1990’s.

The following section highlighted in orange is from a recent article entitled Would You Rather with Warren Buffett by Eric Cinnamond:

Question to Warren Buffett: “One of the things you look at is the total value of the stock market compared to GDP. If you look at that graph it’s at a high point, the highest it’s been since the tech crash back in the late 90’s. Does that mean we’re overextended? Is it a better time to be fearful rather than greedy?”

Eric Cinnamond (EC): What a great question, I thought. I couldn’t wait for his answer. Let him have it Warren! It’s your favorite valuation metric flashing red – tell everyone how expensive stocks have become! I was very excited to hear his response.  Buffett replied,

Warren Buffett (WB): “I’m buying stocks.”

EC: But in 1999 when this valuation was actually less than today he said this…

WB: “Let me summarize what I’ve been saying about the stock market: I think it’s very hard to come up with a persuasive case that equities will over the next 17 years perform anything like–anything like–they’ve performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate–repeat, aggregate–would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%. If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that’s 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more.”

Our take: Stocks are far from cheap. Based on Buffett’s preferred valuation model and historical data, as depicted in the scatter graph below, return expectations for the next ten years are as likely to be negative as they were for the ten-year period following the late ‘90’s. To read more about this graph click on the following link –Allocating on Blind Faith.

The article provides a glimpse of the value added in our new service RIA Pro.

The more compelling question for Mr. Buffett is not whether or not he generally likes stocks but which stocks he likes. As a value investor, he ardently discriminates on price within the context of which companies operate with unique pricing power. This characteristic, more than any other, best defines Buffett’s investment preferences. He routinely speaks about the competitive “moat” that he likes for his companies to have. Understanding what he means by that is important. The following quote captures the essence:

“If you’ve got a good enough business, if you have a monopoly newspaper or if you have a network television station, your idiot nephew could run it.”

Keyword: Monopoly. That is how a company retains pricing power. The empire of the perceived champion of American capitalism and free markets is built on monopolistic companies. Yes, I think we can add that to the list of contradictions.

Buffett on Bullish Market Prospects

The following recent quotes are from a CNBC interview of Mr. Buffett on June 7, 2018 about bullish market prospects:

  • “The decision on the stock market should be made independent of the current business outlook. When you should buy stocks is when you think you’re getting a lot for your money not necessarily when you think business is going to be good next year. The time to buy stocks in America generally has been always with a few exceptions because the long-term outlook is exceptionally good and I don’t think you should buy stocks based on what you think the next 6 months or year is going to bring.”
  • “I like buying stocks. I’m a net buyer.”
  • “I’m no good at predicting out 2 or 3 or 5-years from now although I will say this, there’s no question in my mind that America’s going to be far ahead of where we are now, 10, 20 and 30-years from now.”

If the economic outlook is so constructive, and you can afford and are willing to hold investments for long periods, why does BRK/A hold so much dry powder as shown below?

A growing war chest of over $300 billion in cash certainly appears to be inconsistent with his stated outlook.

Buffett’s True Concerns

The general platitudes of market and economic optimism Buffett shares in his CNBC interviews, letters to investors and shareholder meetings often run counter to the actions he has taken in his investment approach. Not only does he seek out companies with monopolistic characteristics and pricing advantages, he seems to be increasingly positioning to protect against imprudent central bank policies that have fueled this bull market.

His purchase of Burlington Northern Santa Fe (BNSF) railroad is an acquisition of hard assets. Control of BNSF affords a multitude of other benefits in the form of rights of way and adjacent mining rights, and it allows him to move other energy resources he has been steadily accumulating as well.

Four of his top ten holdings are financial services companies such as Wells Fargo (WFC), Bank of America (BAC), and American Express (AXP). Additionally, he is also known to hold large offshore assets in Asia and elsewhere which generate non-dollar profits that can be held tax-free.

The common theme behind these holdings, besides the fact that they each have their monopolistic “moat”, is that they serve as a firebreak against an uncontrolled outbreak of inflation. If monetary policy sparked serious inflation, the hard assets he owns would skyrocket in value, and the off-shore holdings in foreign currencies would be well protected. As for the financial institutions, inflation would effectively minimize the costs of their outstanding debt, while their assets rise in value. Further, their net interest margin on new business would likely increase significantly. All of that would leave BRK/A and Buffett in a position of strength, allowing them to easily buy out bankrupt competitors from investors at pennies on the dollar.

Summary

Warren Buffett is without question the modern day icon of American investors. He has become a living legend, and the respect he receives is warranted. He has certainly been a remarkable steward of wealth for himself and his clients. Where we are challenged with regard to his approach, is the way in which he shirks his responsibilities as a leader. To our knowledge, he is not being overtly dishonest but he certainly has a way of rationalizing what appears to be obvious contradictions. Because of his global following and the weight given to each word he utters, the fact that his actions often do not match the spirit of his words is troubling.

Reflecting back on the opening quote from John D. Rockefeller, Buffett has ways of making money that we know nothing about, and he seems intent on obscuring his words to make sure we don’t figure it out. Putting that aside, Warren Buffett did not amass his fortune by following the herd but by leading it.

Triffin Warned Us

Trade negotiations and threatening global tariff volleys are contributing to significant volatility in the financial markets. Although applicable in many ways, the Smoot-Hawley protectionist act of 1930 is unfairly emphasized as the primary point of reference for understanding current events.

In 1944, an historic agreement was forged amongst global leaders that would shape worldwide commerce for decades. The historical precedence of post-WWII trade dynamics offers a thoughtful framework for understanding why trade negotiations are so challenging. This article uses that period as a means of improving the clarity of our current lens on complex and fast-changing trade dynamics.

The following article was originally published to subscribers of 720Global’s The Unseen. We are now releasing it to the public to provide a glimpse of our coming service, RIA Pro.

Triffin Warned Us

“We are addicted to our reserve currency privilege, which is in fact not a privilege but a curse.”  –James Grant, Grant’s Interest Rate Observer

Folklore states that Robert Johnson went down to the crossroads in Rosedale, Mississippi and made a deal with the devil in which he swapped his soul for musical virtuosity. In 1944, the United States and many nations made a deal at the crossroads in Bretton Woods, New Hampshire. The agreement, forged at a historic meeting of global leaders, has paid enormous economic benefits to the United States, but due to its very nature, has a flawed incongruity with a dear price that must be paid.

In 1960, Robert Triffin brilliantly argued that ever-accumulating trade deficits, the flaw of hosting the reserve currency and the result of Bretton Woods, may help economic growth in the short run but would kill it in the long run. Triffin’s theory, better known as Triffin’s Paradox, is essential to grasp the current economic woes and, more importantly, recognize why the path for future economic growth is far different from that envisioned in 1944.

We believe the financial crisis of 2008 was likely an important warning that years of accumulating deficits and debts associated with maintaining the world’s reserve currency may finally be reaching their tipping point. Despite the last nine years of outsized fiscal spending and unprecedented monetary stimulus, economic growth is well below the pace of recoveries of years past. In fact, as shown below, starting in 2009 the cumulative amount of new federal debt surpassed the cumulative amount of GDP growth going back to 1967. Said differently, if it were not for a significant and consistent federal deficit, GDP would have been negative every year since the 2008 financial crisis.  

Data Courtesy: St. Louis Federal Reserve (FRED) and Baker & Company Advisory Group/Zero Hedge

Bretton Woods and Dollar Hegemony

By decree of the Bretton Woods Agreement of 1944, the U.S. dollar supplanted the British Pound and became the global reserve currency. The agreement assured that a large majority of global trade was to occur in U.S. dollars, regardless of whether or not the United States was involved in such trade. Additionally, it set up a system whereby other nations would peg their currency to the dollar. This arrangement is somewhat akin to the concept of a global currency. This was not surprising, as a few years prior John Maynard Keynes introduced a supranational currency by the name of Bancor.

Within the terms of the historic agreement was a supposed remedy for one of the abuses that countries with reserve currency status typically commit; the ability to run incessant trade and fiscal deficits. The pact established a discipline to discourage such behavior by allowing participating nations the ability to exchange U.S. dollars for gold. In this way, other countries that were accumulating too many dollars, the side effect of American deficits, could exchange their excess dollars for U.S.-held gold. A rising price of gold, indicative of a devaluing U.S. dollar, would be a telltale sign for all nations that America was abusing her privilege.

The agreement began to fray after only 15 years. In 1961, the world’s leading nations established the London Gold Pool with an objective of maintaining the price of gold at $35 an ounce. By manipulating the price of gold, a gauge of the size of U.S. trade deficits was broken and accordingly the incentive to swap dollars for gold was diminished. In 1968, France withdrew from the Gold Pool and demanded large amounts of gold in exchange for dollars. By 1971, President Richard Nixon, fearing the U.S. would lose its gold if others followed France’s lead, suspended the convertibility of dollars into gold. From that point forward, the U.S. dollar was a floating currency without the discipline imposed upon it by gold convertibility. The Bretton Woods Agreement was, for all intents and purposes, annulled.

The following ten years were marked by double-digit inflation, persistent trade deficits, and weak economic growth, all signs that America was abusing its privilege as the reserve currency. Other nations grew increasingly uncomfortable with the dollar’s role as the reserve currency. The first graph below shows that, like clockwork, the U.S. began running annual deficits in 1971. The second graph highlights how inflation picked up markedly after 1971.

By the late-1970’s, to break the back of crippling inflation and remedy the nation’s economic woes, then Chairman of the Federal Reserve Paul Volcker raised interest rates from 5.875% to 20.00%. Although a painful period for the U.S. economy, his actions not only killed inflation and ultimately restored economic stability but, more importantly, satisfied America’s trade partners. The now floating rate dollar regained the integrity and discipline required to be the reserve currency despite lacking the checks and balances imposed upon it by the Bretton Woods Agreement and the gold standard.

As an aside, The Fifteenth of August discussed how Nixon’s “suspension” of the gold window unleashed the Federal Reserve to take full advantage of the dollar’s reserve currency status.

Enter Dr. Triffin

In 1960, 11 years before Nixon’s suspension of gold convertibility and essentially the demise of the Bretton Woods Agreement, Robert Tiffin foresaw this problem in his book Gold and the Dollar Crisis: The Future of Convertibility. According to his logic, the extreme privilege of becoming the world’s reserve currency would eventually carry a heavy penalty for the U.S.  Although initially his thoughts were generally given little consideration, Triffin’s hypothesis was taken seriously enough for him to gain a seat at an obscure congressional hearing of the Joint Economic Committee in December the same year.

What he described in the book, and his later testimony, became known as Triffin’s Paradox. Events have played out largely as he envisioned it. Essentially, he argued that reserve status affords a good percentage of global trade to occur in U.S. dollars. For this to occur the U.S. must supply the world with U.S. dollars.  In other words, to supply the world with dollars, the United States would always have to run a trade deficit whereby the dollar amount of imports exceeds the dollar amount of exports.  Running persistent deficits, the United States would become a debtor nation. The fact that other countries need to hold U.S. dollars as reserves tends to offset the effects of consistent deficits and keeps the dollar stronger than it would have been otherwise.

The arrangement is as follows: Foreign nations accumulate and spend dollars through trade. To manage their economies with minimal financial shocks, they must keep excess dollars on hand. These excess dollars, known as excess reserves, are invested primarily in U.S. denominated investments ranging from bank deposits to U.S. Treasury securities and a wide range of other financial securities. As the global economy expanded and more trade occurred, additional dollars were required. Further, foreign dollar reserves grew and were lent back, in one form or another, to the US economy. This is akin to buying a car with a loan from the automaker. The only difference is that trade-related transactions occurred with increasing frequency, the loans are never paid back, and the deficits accumulate (Spoiler Alert – the auto dealer would have cut the purchaser off well before the debt burden became too onerous).

The world has grown dependent on this arrangement as there are benefits to all parties involved. The U.S. purchases imports with dollars lent to her by the same nations that sold the goods.  Additionally, the need for foreign nations to hold dollars and invest them in the U.S. has resulted in lower U.S. interest rates, which further encourages consumption and at the same time provides relative support for the dollar. For their part, foreign nations benefited as manufacturing shifted away from the United States to their nations. As this occurred, increased demand for their products supported employment and income growth, thus raising the prosperity of their respective citizens.

While it may appear the post-Bretton Woods covenant was a win-win pact, there is a massive cost accruing to everyone involved. The U.S. is mired in economic stagnation due to overwhelming debt burdens and a reliance on record low-interest rates to further spur debt-driven consumption. The rest of the world, on the other hand, is her creditor and on the hook if and when those debts fail to be satisfied. Thus, Triffin’s paradox simply states that with the benefits of the reserve currency also comes an inevitable tipping point or failure.

Looking Forward

The two questions that must be considered are as follows:

  • When can our debts no longer be serviced?
  • When will foreign nations, like the auto dealer, fear such a day and stop lending to us (e., transacting in U.S. dollars and re-cycling those into U.S. securities)?

It is very likely the Great Financial Crisis of 2008 was an omen that America’s debt burden is unsustainable. Further troubling, as shown below, foreign investors have not only stopped adding to their U.S. investments of federal debt but have recently begun reducing them.  This puts additional pressure on the Federal Reserve to make up for this funding gap.

Data Courtesy: St. Louis Federal Reserve (FRED)

Assuming these trends continue, America must contend with an ever growing debt balance that must be serviced. In our opinion, there are two likely end scenarios. Either the resolution of debt imbalances occurs naturally via default on some debt and paying down of other debts or the Federal Reserve continues to “print” the digital dollars required to make up for the lack of funds the debt servicing and repayment requires. Given the Fed has already printed approximately $4 trillion to arrest the slight deleveraging that occurred in 2008, it does not take much imagination to expect this to be their modus operandi in the future. The following graph helps put the scale of money printing in proper historical context.

Data Courtesy: Global Technical Analysis and St. Louis Federal Reserve (FRED)  

Summary

In a 2013 interview, Yanis Varoufakis, economist, academic and the Greek Minister of Finance during the most recent Greek debt crisis, mentioned a manuscript that he had recently read.  The document, written in 1974 by Paul Volcker was directed to his then-boss, Secretary of State Henry Kissinger. Volcker stated that the U.S. need not manage its deficit as would be typical. Instead, he opined that it is our job to manage the surplus of other countries.

America’s ability to run deficits and accumulate massive debt balances for over 40 years, while maintaining its role as the global reserve currency, is a testimony to the power of our politicians and central bankers to “manage the surplus of other countries.” The questions to consider are:

  1. How much longer can the United States manage this tall and growing task?
  2. What is the tolerance of foreign holders of U.S. dollars in the face of dollar devaluation?
  3. Is the post-financial crisis “calm” the result of a durable solution or a temporary façade?

If in fact 2008 was a first tremor and signal of the end of this arrangement, then we are in the eye of the storm and future disruptions promise to be more significant and game-changing.

This concept has far-reaching implications well beyond economics and investing. We intend to provide future articles to extend the analysis on this topic and shed further light on how and when Triffin’s paradox may climax. We will also offer investment strategies to protect and grow your wealth during what may be tumultuous times ahead.

Value Defined: An Interview with Value Investor Eric Cinnamond

“Instead of relying on central banks as the foundation of my risk mitigation strategy, I plan to remain committed to my absolute return process and discipline.” –Eric Cinnamond

The world’s oldest investment philosophy, buy low and sell high, is not only the most logical but it is also most neglected when it matters.

Outside of the financial markets, we seek deals on everything. We drive past three gas stations to find one that is a nickel cheaper. We shop at the Costco in the next town instead of the grocery store around the corner. We haggle with car dealers for hours to save a few hundred dollars. Juxtaposed to rational consumer behavior, investors frequently take the opposite tack. Interest in buying stocks and many other financial assets tend to rise as prices increase and decline when they get cheaper.

Toilet paper, gasoline, and most other consumer items in which we seek the best price lack potential financial rewards. Said in current jargon they do not provoke FOMO or the “fear of missing out” in us. This condition which preys on hope and greed is a trap that drives investors to pay top dollar for some assets.

It is said that being a contrarian when markets are at major turning points can be lonely. To help those of you currently in this camp we introduce the rationality of professional value investor Eric Cinnamond (EC). In answering questions we posed to him, Eric provides insights into how he thinks about investing as well as the current investment environment. While he may not win a popularity contest, the logic he shares is irrefutable and extremely valuable.

Eric puts out a free investment letter that we consider a must read. His insight into small cap companies and the broader macro messages we can glean from these companies is invaluable. For access to his commentary, please email Eric directly.

Biography- Eric Cinnamond, CFA

Eric Cinnamond, CFA, was most recently a Vice President and Portfolio Manager at River Road Asset Management, LLC. Prior to this, Eric was a Vice President and Lead Portfolio Manager of the small-cap strategy at Intrepid Capital Management Inc. which he joined in 1998. Previous to that he held similar roles at Evergreen Asset Management, Aston Funds – ASTON/River Road Independent Value Fund, and the asset management arm of Wachovia Corporation, formerly First Union National Bank.

Eric is a member of the C.F.A. Institute having received the Chartered Financial Analyst designation in 1996. Eric received an M.B.A. from the University of Florida and a B.B.A. in Finance from the Stetson University.

Q&A – Eric Cinnamond

What is your investment worldview?

EC: “I am a small cap absolute return investor. My goal is to generate attractive positive returns relative to the risk assumed over a full market cycle. To do this, I follow some basic, but historically effective guidelines. First, when getting paid to assume risk, take it. Every cycle I’ve found there are periods when valuations are attractive and investing opportunistically and aggressively is necessary.  Second, do not overpay.

Over the past three market cycles (including the current cycle), equity valuations have reached very expensive levels that, in my opinion, have not properly compensated investors for the risk assumed. In effect, near valuation peaks, future returns are often inadequate, and the potential for permanent losses to capital are elevated. In such periods, instead of staying fully invested, I attempt to avoid large losses by holding cash and waiting for an improved opportunity set. In conclusion, my investment process is flexible, opportunistic, and often requires considerable discipline and patience.”

Compare your style of investing to the more common passive – 60/40 approach.

EC: “Most passive and relative return styles of investing tend to remain fully invested throughout a market cycle. My strategy is much more price and risk sensitive. Valuation, or what I’m paying for an investment, is very important to me. As such, during periods of inflated valuations, my process often requires me to avoid risk and remain patient. Conversely, passive investors with fixed asset allocations often assume market risk throughout the entire market cycle.

During periods of expensive valuations, instead of assuming significant market risk, I’ll assume career risk and incur an opportunity cost. Until the market cycle ends, it isn’t knowable if remaining patient and avoiding overpaying was the right course of action. Over the past two cycles ending in 2000 and 2009, my absolute return approach worked well by allowing me to mitigate losses and eventually invest opportunistically. However, the current cycle (2009-2018) remains intact and remains too early to determine if the absolute return path was correct, in my opinion.”

Can you explain what you mean by “I’ll assume career risk and incur an opportunity cost”?

EC: “The willingness to assume career risk is similar to the willingness to look different from your peers and benchmarks. I have found there were times during my career when it was very important to look differently. In 1999 technology stocks were the largest weights in many of the benchmarks, but were also the most expensive! By avoiding technology stocks in 1999, my relative performance suffered. In fact, in 1999 I was one of the few portfolio managers to lose money. This was quite an achievement, or underachievement, as the Russell 2000 increased 20% in 1999, with the NASDAQ up 85%!

For portfolio managers, large performance dispersions such as these can increase the risk of losing assets under management (AUM) and ultimately, your job. Hence, the term, career risk.

My absolute return process has historically caused me to incur considerable AUM and career risk. As such, I’ve avoided managing money with an emphasis on maximizing AUM. Instead, my goal is focused on achieving an adequate absolute return on investments over a market cycle. If market conditions warrant that I am unable to do that, I’ll sell overvalued equities and raise cash. And in extreme cases (2016), I’m comfortable with $0 AUM or returning capital.

While remaining patient and holding cash is often a necessary part of my process, it is not risk-free. Holding cash can result in significant opportunity cost, especially in sharply rising equity markets. However, during periods of excessive overvaluation, I believe opportunity cost is preferable to overpaying and risking substantial losses to capital. Significant losses resulting from overpaying can be much more damaging to a portfolio, and in some cases, can be permanent. Conversely, opportunity cost is often temporary, and can be quickly recovered once valuations revert and opportunities return.”

How would you characterize current markets and contrast that with a time when you thought them meaningfully different?

EC: “Broadly speaking, this is the most expensive small cap market I’ve ever seen. My possible buy list is trading at over 30x earnings and 2.5x sales. This is very expensive and suggests large potential losses assuming valuations normalize. Most of the businesses I follow are mature small caps with slow to moderate growth rates. They should not command these type of valuations, in my opinion. Although small caps were expensive near the peaks of the past two market cycles, the current environment of overvaluation is much broader. In 1999 there were large pockets of opportunity and undervaluation in small-cap stocks. In 2007 overvaluation was more widespread, but there remained some pockets of value where an absolute return investor could allocate capital. This cycle, overvaluation has become much more widespread. You can see this in many median valuation measures, which are all near or higher than previous market cycle peaks. I often ask, if we can all agree that 2000 and 2008 were bubbles, how can we not agree that current valuations are as well?”

In your opinion, what are the implications of the damage that would occur in the event of a 2000/2008 market collapse? What do you think the odds of that occurring are?

EC: “Given current valuations, an end of the cycle decline similar to 2000 and 2008 is a real possibility. Will the market crash, go higher, or will we have a decade of stagnant markets that allow fundamentals to catch up with price? I don’t know for certain. However, I’m not aware of a market cycle with valuations as high as today’s that did not end with meaningful declines.

I believe the end of the current market cycle, and its resulting losses, will be partially determined by the effectiveness and ability of central banks to respond to declining asset prices. While many investors assume central banks will come to the rescue during the next meaningful market decline, I believe there are significant risks to relying on the Federal Reserve’s “put option.” For example, in an environment with rising inflation, a weakening dollar, and a declining bond market, will central banks be able to bail out markets with another round of asset purchases (QE)? It’s a good question and one I would be asking myself if I was fully invested. Instead of relying on central banks as the foundation of my risk mitigation strategy, I plan to remain committed to my absolute return process and discipline. Currently, that process is keeping me out of the markets until prices and opportunity sets change.”

Summary

With a large holding of cash and few opportunities to invest wisely, Eric chose of his own accord to close his fund and return investor capital in 2016. Essentially he deemed that the small-cap market, in which he specializes, offered no value. He is currently patiently watching the market for signs that value will return.

What truly sets Eric apart is his ethical judgment regarding his willingness to assume career risk as opposed to imposing undo market risk on his clients. While most managers go to lengths to rationalize their holdings and are content clipping a paycheck, Eric, in good conscience, could not buy overvalued stocks offering paltry long-term returns (and large downside risk) for his clients.

In time, markets will correct, and valuations will normalize. When this occurs, we have no doubts that Eric will be in a great position to once again manage a portfolio and take advantage of prices that will be on sale. After all, isn’t it low prices we should be chasing?