To Our Investors and Friends,
The S&P 500 ended the month of May up 4.8%, a level that is close to an all-time-high. This bull market continues to be driven by a very narrow group of mega cap stocks, and is the most concentrated market in the index’s history. The 10-year Treasury Bond backed off on moderating inflation data to 4.51%, an 18-basis point drop from last month. The 2-year Treasury ended the quarter 15 basis points lower to end at 4.89%. Oil continued to moderate, ending the quarter down almost 5% to $78 a barrel. The major indexes all rallied. The Russell 1000 Growth index advanced 6.0%, the Russell 2000 Growth index increased 5.4%, the Russell 2000 Value index moved up 4.7%, and the Russell 1000 Value index gained 3.2%.
We have noticed some unusual activity at the beginning of this new bull market as some unexpected stocks make moves that are uncharacteristic of both their histories and their businesses. Abercrombie and Fitch (ANF) advanced 470% in the last year but declined by 30% the previous decade. Industrial equipment provider Powell Industries (POWL) advanced 211% in the last year and increased just 22% over the previous decade. Finally, insurance provider Jackson Financial (JXN) shot up 169% as its revenue and earnings declined since its 2021 IPO. These incredible moves have generally been made by incremental positive improvements in fundamentals that are supported by steeply increasing stock charts. It is important to note that these businesses have mid-single digit operating margins. Such low margins can lead to both significant positive and negative surprises and that is why the long-term stock performance of these businesses has historically been less than stellar.
We think the extremely short-term view of market participants including hedge funds, algorithms, and day traders is creating a game of hot potato with many stocks. They rocket up on price momentum, only to come crashing down when the momentum stops. The reason for this behavior is clear – these market participants are primarily interested in immediate price changes and are playing a game of the greater fool theory (a belief that a greater fool will buy the stock at a higher price from them in the future) as justification for their purchase. We fear that many of the AI hardware stocks, which also have low operating margins, will follow this same volatile path as soon as their growth slows down.
We believe this market behavior is far closer to gambling than it is to investing and expect that it likely will generate a significant number of losers as it plays out. It may be the only way to rationalize one of the biggest developments over the previous two decades, the incredible proliferation of hedge funds. As can be seen in the chart below, there are now almost 5 times as many hedge funds as there are stocks in the US indexes. It is not a surprise that when there are so many market participants seeking short term gains, a significant amount of randomness, for which there is little fundamental rationale, is the result.
At Kingsland Investments, we recognize that there is an unusual opportunity to buy the next generation leaders that we seek at uncharacteristically low prices when the momentum players sell. We believe that the most patient investors will be the most rewarded over time. At some point, great businesses experiencing transformational growth will be discovered and valued at much higher levels. By sticking to our process of buying and owning great young businesses, we think investors can benefit materially from the advances these companies will experience in their stocks over time.
All the best to you,
Arthur K. Weise, CFA