Late Cycle Behavior

In case you missed it, now may be a good time to revisit, the value in boredom relative to the allurement of excitement.  A few excerpts below from our mid-year letter to investors:

A note on typical, late-cycle behavior:

While the market is still trading near all-time highs, gains have become increasingly concentrated in the largest, most expensive stocks, increasingly pushed higher by passive, momentum-driven buyers. This is typical late-cycle behavior.

Ten years of easy money has left the consensus comfortably numb. After shunning stocks and hoarding cash at the bottom of the cycle, the consensus now believes that the greatest risk comes not from holding stocks, but from not holding enough of them.

Passive investing and momentum investing are the primary manifestations of this belief. During the later stages of a bull market, they are one and the same. Artificially high demand for a small group of stocks benefits speculators in the bubble they help create.

Some thoughts on why defense wins championships:

What the herd buys differs from cycle to cycle. The common thread is that the herd buys the most popular stocks and drives up their value beyond rational justification. The herd buys what is in favor. And it sells what is out of favor—often driving prices far lower than reason.

The herd is often right—at least for a period of time.

And this herd has had a hell of a ride. But it appears that the most crowded trade of the past decade may now be reversing. If momentum’s decade-long leadership is ending, value investors stand to rake in phenomenal profits at the expense of the herd, who will be selling the most widely owned names in the market.

As capital flees momentum-driven names with little to no current earnings power, the herd will eventually pause long enough to ask: “Where should we put our money now?” At that point, we expect the market will come to recognize the value hiding in plain sight—boring, defensive businesses that are generating mountains of consistent cash flow. That’s where we are positioned today, because that’s where we are going.

Defensive sectors are now at an all-time low as a percent of total market capitalization. They have never been so out of favor.

Earlier this year, the relative strength of defensive sectors had reached levels not seen since March 2000 and got within spitting distance of their all-time low, which they hit in November 1980.



The performance of cyclical stocks, relative to their defensive counterparts, peaked when the rise in bond yields stalled in May of this year.



Since then, the tables have turned. And turned sharply. The most defensive sectors of the market have rallied double-digits while more cyclical sectors have posted dramatic declines.


Capital is now fleeing momentum-driven names and pouring into defensive businesses that are generating mountains of consistent cash flow. We think the boring beekeepers have room to run and are positioned accordingly:

Evolution has hardwired investors to buy sexy and sell humdrum. Possibility generates enthusiasm, eagerness, and anticipation, which investors pay up for. As a result, many of our peers find it hard to resist the temptations of hugging the benchmark, following the herd, or going for a little excitement even if it’s “just for a second, just to see how it feels.”

Near-certain outcomes, on the other hand, are regularly undervalued by investors. Certainty engenders boredom and requires endurance and persistence. These traits are not particularly common amongst traders anxious to disturb the hive.

What beekeeping lacks in sex appeal, it makes up for in patience. You are unlikely to see a beekeeper on Squawk Box talking about the latest trends in this season’s honey harvest anytime soon. It’s about showing up and having the discipline to wait. It’s boring.

People often confuse maximizing returns with minimizing boredom. Investing doesn’t work that way. Opportunity hides where others don’t look.

People stay away from boredom, for fear of being bored. But at the right price, boredom is as exciting as it gets. The big, boring, defensive businesses that comprise the bulk of our portfolio are far from “sexy.” But there’s a lot to get excited about here.

To revisit our full mid-year letter to investors, click here.