In Search of The Tipping Point

To Our Investors and Friends,

The S&P 500 Index gave back about half of its early gains for the year in February, falling nearly 2.6% for the month.  Oil fell about 2% as well, finishing the month at $77 a barrel. The 10-year Treasury bond rose 40 basis points in February to end at 3.9%, while short-term rates rose 60 basis points, ending at 89 basis points above the 10-year. January’s economic data spooked the market, which now views inflation as something that the Federal Reserve will be combating for an extended period. Seemingly, every major index gave back some of their January gains. The Russell 2000 Growth Index declined 1.1%, the Russell 1000 Growth Index fell 1.2%, and the Russell 2000 Value Index dropped 2.3%. The Russell 1000 Value Index declined slightly more, down 3.5% for the month.

We believe that the short-term fluctuations of the market tied to inflation and interest rate projections are far less meaningful to long-term stock appreciation than behavioral change and its impact in shaping the future of business.  New technology adoption often creates a major behavioral change, as seen by the introduction of smart phones and how they transformed how people interact with friends and family, access information and connect with the world around them.  

In his book Change: How to Make Big Things Happen, Damon Centola examines how behavioral change occurs in society. Contrary to popular belief, change is not led by a select few influencers, but by people on the periphery of society that spread the change across their network and then onto other networks. Centola explains that “social life is a series of coordination games... Every coordination game has within it a tipping point in which a novel behavior gained enough traction that everyone’s opinion of what was acceptable would suddenly change.” Such behavior change is often resisted at first, but when 25-30% of the community adopts the change, it is suddenly accepted by the rest of the community. This is the level at which a tipping point is achieved.

Why does this matter? Tipping points are the reason there is an S curve of adoption of new technologies and is why the market often materially underestimates the magnitude of the change. Streaming services, electric vehicle adoption and migration to the cloud are all examples of change that most likely will undergo a dramatic phase of adoption as the tipping point is achieved.  COVID-19 played a big role in moving many of these industries closer to the tipping point. This suggests that the market’s newfound love of the old economy over the last year is just a temporary phase before a more meaningful change takes place.

At Kingsland Investments, we are searching for companies that offer unique products and services that we believe are materially better than what they are replacing. Furthermore, we believe that if that value proposition remains, it is simply a matter of time before a tipping point is achieved and mass adoption soon follows, often producing some of the best stock returns the market has to offer.

All the best to you,

Arthur K. Weise, CFA

The views expressed are those of Kingsland Investments as of March 1, 2023, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

“Best-in-Class” Growth Companies to Reveal Much Higher Profitability in 2023

To Our Investors and Friends,

The S&P 500 Index began the first month of 2023 up 6.2%, a great start to the new year after such a difficult 2022. Oil finished the month at $79 a barrel, the first down month year-over-year in almost three years. The 10-year Treasury bond dropped 36 basis points in January to 3.5%, while short-term rates fell 20 basis points, ending at 69 basis points above the 10-year. Expectations for both moderating inflation and the end of Federal Reserve rate hikes are encouraging investors to take on a bit more risk. Small cap indexes took the lead early in the year as both the Bloomberg 2000 Growth Index and Bloomberg 2000 Value Index increased by 10.3%. The Bloomberg 1000 Growth Index rose 7.5%. Large value stocks lagged as investors sold off staples, pharmaceuticals and utilities to make room for growth stocks that were shed over the last two years. The Bloomberg 1000 Value Index increased 5.0% in the month.

We believe the early gains experienced in growth stocks this year is the market’s recognition that these companies will take profitability more seriously in 2023 than in the past. The market has made it clear to both company management and investors that in the new era of tighter monetary policy, companies should prioritize positive earnings over top-line growth. Ultimately, the market favors a combination of strong revenue growth and even stronger cash flow growth. Growth stocks that are either not producing positive free cash flow or only moderately so have been sold off aggressively in the past two years, often falling 50-95% off their highs. We believe this “punishment” has hastened their focus on profitability faster than anticipated and investors are likely to see the results of corporate cost control efforts as 2023 progresses.

The best companies have natural operating leverage that reveals itself once businesses reach a certain size. Profitability usually then explodes higher for years, surprising investors along the way, typically fueling higher stock prices. As seen in the following chart, once Tesla began to leverage its corporate overhead and factory expenses, profitability followed even as it expanded its factory footprint and investments in Artificial Intelligence and proprietary battery technology.

What is not appreciated by many market participants, especially quantitative funds and passive indexes, is that a young business has some amount of fixed costs to cover (corporate headquarters and staff, public company costs and investments that help create a corporate identity and culture) before being profitable.  More mature businesses that went public decades ago benefited from this operating leverage boost many years ago, and so do not have the same opportunity. Once these young companies can comfortably cover these costs, operating leverage generally is much greater than the market anticipates. This past year, most companies shed unnecessary expenses, and projects with little expected return for years and made efforts to make their people more efficient - often including layoffs. This set the stage for greater profitability in the growth space this year, which likely helps bring investors back to the group.

Kingsland Investments has always focused on finding what we believe to be the best new businesses the stock market has to offer. Our search starts with identifying companies with high, sustainable revenue growth and high gross margins, elements generally present in great companies. Once the companies reach a critical mass, high gross margins are translated into higher operating margins than most believe would be possible. It is this underappreciated earnings power that ultimately drives the stocks of these companies to much higher levels.

All the best to you,
Arthur K. Weise, CFA

The views expressed are those of Kingsland Investments as of February 1, 2023, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

2022 Declines Driven by Short-Term Growth Worries

To Our Investors and Friends,

The S&P 500 Index (S&P 500) declined 19.4% this year as the market exited out of growth stocks and anything that could be hurt by a Federal Reserve-induced recession in 2023. Initially pumped up by the war and fears of shortages of oil across Europe, oil prices closed at a modest 6.7% for the year, ending the year at $80 a barrel. The 10-year Treasury note yield advanced 225 basis points for the year, finishing at 3.88%. Midway through the year, the yield curve inverted and the 2-year Treasury note yield ended at 4.41%, 53 basis points higher than the 10-year Treasury note yield. All the popular indexes declined this year, even as value materially outperformed growth for the second year in a row as energy, consumer staples, industrials and utilities drove returns in indexes. The Bloomberg 1000 Value Index declined by 5.2% and the Bloomberg 2000 Value Index fell by 13.6% for the full year. The meaningful declines in technology and communications services pulled growth down even further. The Bloomberg 2000 Growth Index dropped by 27.2% and the Bloomberg 1000 Growth Index fell by 28.1% over the past year.

2022 was an incredibly difficult year for growth companies as many investors sold their winning stocks of the last decade to buy higher interest-bearing bonds and stable dividend payors including energy, industrials, financials, consumer staples and select dividend-paying healthcare stocks. As seen in the following chart, the top 10% of performers in the S&P 500 were significantly different from those that drove performance over the ten years from 2012 to 2022.

We believe that stock performance is highly correlated with revenue and profit growth over longer periods but may be driven by other factors over short periods. Over the last year, the primary factor driving stocks was both the stability of earnings and dividend yield, which favored the mature industries mentioned above. The top 10% of S&P 500 performers over the last year appreciated on average 44%, significantly higher than the -19.4% performance of the Index itself. This was a group of average growers over the last decade, increasing revenue at the same rate as the average S&P 500 stock over the same time period (296% for this cohort versus 290% for the average index stock). Excluding solar energy company Enphase (ENPH) and shale energy company Diamondback Energy (FANG), this group grew at a 96% rate over the past 10 years.  

Also seen in the previous chart, the profile of the top 10% of S&P 500 growers over the last decade has a very different sector profile dominated by technology, consumer discretion and communication services. During the last 10 years, this group experienced top-line growth on average of over 2,000% (more than a 20x expansion) compared to the 290% (4x) expansion of the index and an 88% (2x) expansion excluding these top 50 performers.  Over the last decade, this top cohort experienced a price appreciation of 995% versus the average S&P 500 stock appreciation of 300% and the index’s 10-year appreciation of 169%. Contrary to market biases, the index appreciation over long periods does not keep up with the average company’s performance, as large weights tend to underperform and many additions and subtractions to the index are at inopportune times.

At Kingsland Investments, we focus exclusively on discovering and owning what we believe are the great growth companies of the next ten years. We maintain a long-term view and are not dissuaded by the market’s occasional short-term gyrations. Over time, as has happened through most bull market cycles, investors typically shed their slow-growing dividend payors in favor of the new growth leaders of tomorrow.  We patiently look forward to that opportunity again in the coming quarters.

All the best to you,

Arthur K. Weise, CFA

The views expressed are those of Kingsland Investments as of January 3, 2023 and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

Deglobalization and the US Industrial Renaissance

To Our Investors and Friends,

For the second month in a row, the S&P 500 Index (S&P 500) continued to recover from a brutal bear market, rising 5.4% in November. Oil prices sank by almost 7%, closing at $81 per barrel as demand continued to moderate. The 10-year Treasury bond retreated to 3.68%, down 42 basis points for the month on the view that Federal Reserve rate hikes will moderate from here. The two-year Treasury fell 13 basis points to 4.38%, ending higher than the 10-year by 70 basis points. All major indexes advanced in the quarter, driven by a robust recovery in both larger market capitalization companies and value stocks. The Bloomberg 1000 Value Index rose 5.8%, the Bloomberg 2000 Value Index increased 4.0%, the Bloomberg 1000 Growth Index gained 4.8% and the Bloomberg 2000 Growth Index moved up 1.7%.

The stock market’s recovery since the brutal October selloff has been largely driven by a view that the US economy is poised to hold up better than past slowdowns, largely due to a better labor market, especially for blue-collar workers. The past two years have been a hard lesson about the drawbacks of the globalization of our economy. Just-in-time inventories sourced primarily from China proved to be a poor strategy. The COVID crisis revealed that many global supply chains are frail and will break down under stress compared to the normal course of business.  In response to COVID, the industrial economy is undergoing a dramatic overhaul driven by more localized sourcing of products. This is creating the beginnings of a manufacturing renaissance in the US. According to Rana Foroohar’s Homecoming, The Path to Prosperity in a Post Global World, “64% of manufacturing companies are planning to re-shore some production to North America because of the fallout from the pandemic.”

In her book, Foroohar explains that the US’ blind confidence in laissez-faire free trade policy, which trusts solely in efficient markets and shareholder profits above all, has failed our country. Foroohar explains, “free trade doesn’t work as well when there is no shared political economic value system between partners,” especially given the vast differences between the west and communist China. “The Chinese used the world economy to advance their own domestic policy agenda,” Foroohar explains. The path forward is one focused on resilience over efficiency, and a return to local production versus global sourcing of goods.  Foroohar further explains that “the antidote to neoliberalism is mutualism…which is getting back to a notion of capitalism that is rooted in community.”

At Kingsland Investments, our focus on high-margin businesses leaves us with little exposure to the US industrial base that we believe will benefit from this emerging near-sourcing trend. Instead, we focus on companies that help enable these industrial businesses to improve their supply chains through robust technology solutions. Such solutions are using the internet of things, Artificial Intelligence and robotics to help companies build the factories of the future. All these efforts should enable the US to recapture its manufacturing leadership in the years ahead and provide great investment opportunities for the tool providers that will make it possible.

All the best to you,
Arthur K. Weise, CFA

*Effective January 12, 2022, the Kingsland Growth Advisors name changed to Kingsland Investments. The views expressed are those of Kingsland Investments as of December 1, 2022, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

The Decimation of the Male Work Force

To Our Investors and Friends,

After a brutal sell-off over the first nine months of the year, the S&P 500 Index rallied nearly 8% in October. Oil bounced more than 10% in the month, closing at $88 per barrel. Fueling the rally are market hopes that Federal Reserve (Fed) rate hikes are coming to an end. The 10-year Treasury ended the month at 4.1%, a 27-basis point move from September. The two-year Treasury increased 23 basis points to 4.48% and remains higher than the 10-year Treasury by 38 basis points. Anticipating an end to the rate hike cycle, all major indexes rose in October. The Bloomberg 2000 Value Index rose 14.1%, the Bloomberg 1000 Value Index increased 12.6%, the Bloomberg 2000 Growth Index gained 8.5% and the Bloomberg 1000 Growth Index moved up 5.5%.

The Fed’s aggressive rate hikes this year are an attempt to moderate inflation, which many fear is on the verge of a 1970s repeat when corporations and employees alike suffered from reduced purchasing power. Back then, a significant amount of continuous inflation was caused by a wage-price spiral in which companies increased wages to help workers survive higher inflation, only to need to increase prices to pay for these higher worker expenses. We believe the economy is significantly different from the 1970s and most likely will not have the same experience today.  One of the greatest differences between these periods is that today we have a decimated male workforce with a larger percentage of prime working-age men not working than during the Great Depression.

According to Nicholas Eberstadt’s Men Without Work, “Between 1948 and 2015, the work rate for US men 20 and older fell from 85.8% to 69.2%. When 65+ is excluded, 22% of men between the ages of 20 and 65 were not engaged in paid work of any kind; 12.5% below the 1948 level.” Eberstadt dismisses the highly-flawed Bureau of Labor Statistics unemployment statistics that the government and the Fed both rely on to gauge economic health. “The unemployment rate was created in an age where mass withdrawal of the workforce was inconceivable…it takes no account of the very group that has been growing most rapidly…a group that now vastly outnumbers those formally unemployed.” In fact, there are more than three times as many men that are unemployed and not looking for a job than those that are unemployed and looking for a job. The societal costs are tremendous as these men are not only disengaged from the workforce, but also from family and community life, creating a significant drain on society and the economy. This unfortunate phenomenon invalidates a labor force comparison that led to the 1970s wage-price spiral.

While we cannot offer any long-term solutions, we do note that the consistent outsourcing of jobs to China and other foreign locations over the last 30 years has had far greater negative consequences for our economy than government statisticians can measure. This is another reason why we seek to invest in companies that are led by founders that take pride in both the products and services they offer as well as in the workers that they depend on to deliver them. We believe that such companies will produce better results over time than those companies that demoralize their workforce with multiple rounds of layoffs; decimated workforces carry a long-term cost that the statisticians and the algorithmic quantitative hedge funds will never be aware of.

All the best to you,

Arthur K. Weise, CFA

*Effective January 12, 2022, the Kingsland Growth Advisors name changed to Kingsland Investments. The views expressed are those of Kingsland Investments as of November 1, 2022, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

The Futility of Market Timing

To Our Investors and Friends,

The market decline continued through the third quarter, resulting in the third down quarter in a row. The S&P 500 Index closed the month with a 9.3% decline, flipping an attempted rally into a 5.3% loss for the quarter. Oil continued to sink, falling 11.2% in the month to end at less than $80 per barrel. A hawkish Federal Reserve (Fed) continues to increase interest rates to drive inflation down. In turn, higher rates are slowing economic growth and could push the economy into recession. An aggressive Fed helped boost the 10-year Treasury bond up 69 basis points, ending the month at 3.83%. The two-year Treasury increased 77 basis points to 4.22% and remains higher than the 10-year by 39 basis points. All major indexes closed lower for the month. The Bloomberg 2000 Growth Index declined 9.1%, the Bloomberg 1000 Value Index fell 9.4%, Bloomberg 1000 Growth Index fell by 9.4% and the Bloomberg 2000 Value Index dropped 11.5%.

Investor frustration with the market is obvious and growing as the market failed to rebound from its June lows in the final days of the quarter.  We believe what is most frustrating is witnessing investor attempts at predicting the market on a short-term basis, only to be proven wrong repeatedly. Market predictions of where interest rates, inflation and company earnings are headed continue to surprise investors, resulting in volatile moves in the market in both directions. Morgan Housel’s The Psychology of Money explains why simply stating, “We are very bad at market forecasts. Forecasts give the illusion of predictability in a world where unseen events control most outcomes.” He further explains that “investing is not a hard science; it is a massive group of people making imperfect decisions with limited information about things that will have a massive impact on their wellbeing.”

In short, fear and greed are overwhelming forces that shape market tops and bottoms during relatively brief periods. The most successful investors ignore the short-term vacillations of the market, instead focusing on the most durable driver of long-term returns – the magnification effects of compounding growth. As Housel explains, “Compounding only works if you give an asset years and years to grow.” He further states, “If something compounds, a small starting base can lead to results so extraordinary they seem to defy logic.” Our focus on best-of-breed growth companies leads to the discovery and purchase of these compounders. The market often has a love/hate relationship with growth companies. Many stocks are hated early in their lifecycle, such as Tesla (TSLA), but eventually, become the most loved stocks after years of compounding growth alters public opinion.

Instead of attempting and consistently failing at market timing, at Kingsland Investments, we believe our time is far better spent understanding why our investments may succeed or fail. By intently seeking what we believe are the best businesses, we think this will enable us to take advantage of market volatility and build positions in what may be tomorrow’s market leaders. It is a slow process accomplished over months, but a rewarding process when such work reveals insight as to why success is more likely than not. We believe that once market fear subsides, investor attention will quickly return to finding great potential investments, ultimately uncovering many discarded gems.

All the best to you,
Arthur K. Weise, CFA

*Effective January 12, 2022, the Kingsland Growth Advisors name changed to Kingsland Investments.  The views expressed are those of Kingsland Investments as of October 1, 2022, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

Change’s Steady Progression

To Our Investors and Friends,

The market recovery that began in July took a step back in August as investor concerns again resurfaced. The S&P 500 Index closed the month down 4.2%. Unlike the first six months of the year, oil prices staged a second monthly decline in August, closing at slightly less than $90 a barrel as both oil supply and demand appear to have stabilized into a new range. The Federal Reserve’s message continues to be one of significant tightening ahead, causing the 10-year Treasury bond to rise 48 basis points, ending the month at 3.15%. The two-year Treasury increased 56 basis points to 3.45%, higher than the 10-year by 30 basis points. All major indexes closed the month lower. The Bloomberg 2000 Growth Index declined 1.9%, the Bloomberg 1000 Value Index fell 2.4%, the Bloomberg 2000 Value Index dropped 2.8% and the Bloomberg 1000 Growth Index had the worst performance, down 4.9%.

The market’s chaotic behavior during the summer as it tries to build upon the June low, is not surprising. On a recent trip to Greece to celebrate my 25th wedding anniversary, I was again reminded of how gradual, but persistent, change has been throughout human history. The ancient Minoans had working toilets, indoor plumbing and a variety of food, clothing and even entertainment. More than 5,000 years ago, humans sought similar comforts as today. Although we are unable to decipher their writing, by the human ingenuity we can see, I am sure this ancient civilization had its version of Elon Musk.

As we enter the fall, we believe many changes to the economy accelerated during COVID-19 (COVID) will prove resilient in the post-COVID world, the most persistent being the migration to the cloud.  Work-from-home increased the need for employees to securely access company data and last quarter revealed the trend continues. We believe with a few more quarters of strong cloud software growth, many of these companies will be back to their old highs. We also expect the shortage of workers to persist, due to competition for labor between the old brick and mortar world and the new digital economy, including examples of flexible work such as UBER driver, ETSY seller, AirBNB host, DoorDash deliverer and many other positions that came to the forefront during COVID.

As the stoic philosopher, Seneca stated, “it is a rough road that leads to the heights of greatness.” Those words are worth keeping in mind as we manage through a complex and volatile market, often driven by algorithms that quickly pile into one stock and out of another on such little information as a stock breaking through an arbitrary moving average.

At Kingsland Investments, we focus on understanding the drivers of persistent change and seek to exploit stocks where investors fail to appreciate or understand the great business opportunities in front of them. We believe this effort has the potential to deliver positive returns during the market recovery. Although the past few months have been rough, we think patience and good stock selection have the potential to be well-rewarded when the next bull market begins.

 
All the best to you,
Arthur K. Weise, CFA

*Effective January 12, 2022, the Kingsland Growth Advisors name changed to Kingsland Investments.  The views expressed are those of Kingsland Investments as of September 1, 2022, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

The Man in the Arena

To Our Investors and Friends,

After one of the worst six-month declines on record, the S&P 500 Index staged a significant rally in July, rebounding by 9.1%. Oil prices fell 6.8% in the month, closing at less than $99 a barrel as fears of a recession continue to impact the commodity.  The Federal Reserve increased rates by another75 basis point hike this month, causing the 10-year Treasury bond to fall 31 basis points on heightened recessionary fears, ending the month at 2.67%. The two-year Treasury fell three basis points to 2.89%, now higher than the 10-year, creating an interest rate inversion that often indicates a recession is on its way. After significant underperformance for most of the year, growth stocks performed better than value stocks in the July rally.  In July, the Bloomberg 1000 Growth Index advanced 11.8%, the Bloomberg 2000 Growth Index increased 10.7%, the Bloomberg 2000 Value Index grew 10.1% and the Bloomberg 1000 Value Index expanded by a less robust 5.1%.

Leadership is not just important on the world stage but also in corporate America, particularly during difficult times as we have experienced over the last several quarters. Teddy Roosevelt’s famous 1910 speech “Citizenship in a Republic,” more commonly known as the “Man in the Arena,” (April 23, 2010; Paris) highlights this well.

It is not the critic who counts; not the man who points out how strong the man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat, and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory or defeat.

The last several months have been especially challenging for company management teams that need to navigate significant fluctuations in the economy, unlike anything they have experienced in the past. We have always focused on finding what we believe are great leaders because they tend to make better decisions under stress than weaker leaders that often either don’t do enough or change course at the wrong time. David Gergen’s book Hearts Touched with Fire: How Great Leaders are Made examines the backgrounds and characteristics of great leaders. The book is a great reminder of how important leadership is in creating the next-generation blue chip companies that we seek.

In his book, Gergen identifies three important elements of leaders, traits that are as important now as in Roman times. These include character, courage and purpose – a focus on finding one’s true north. The most important characteristic of all is “grit - a combination of passion and perseverance” that is necessary in staying the course, especially during challenging times. It is difficult if not impossible to get others to commit to a cause if these traits are not present in leadership and are especially important during times in which difficult decisions need to be made. One example of inspiring corporate leadership comes from Josh Silverman at ETSY who successfully navigated both the expansion of business that came with COVID-19 and the slowdown that occurred as consumer spending slowed. We believe the best leaders are rallying their employees right now, which should lead to a separation of the best from the rest in the coming months and quarters.

Former President Dwight Eisenhower famously said, “plans are useless, but planning is indispensable.” We couldn’t agree more, and at Kingsland Investments, we have spent time during this downturn examining management’s planning and decision-making to best capitalize on the market opportunities they are seeking. We focus on understanding the drivers of these “best-in-class” businesses and determining where the market has failed to appreciate or understand these opportunities. We believe this effort has the potential for return during the market recovery. Unlike many of our peers that are abandoning these next-generation growth leaders to find safety in mature businesses, we’ve stepped up our hunt for the hidden gems thrown out by the market. Although it has been a rough couple of months, we think patience and good planning will be well-rewarded when the next bull market begins.

All the best to you,
Arthur K. Weise, CFA

*Effective January 12, 2022, the Kingsland Growth Advisors name changed to Kingsland Investments. The views expressed are those of Kingsland Investments as of June 30, 2022, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

Standing up to Fear, Uncertainty and Doubt

To Our Investors and Friends,

A rapid increase in both the 10-year Treasury bond yield and the Federal Reserve (Fed) discount rate since the beginning of the year prompted one of the worst market selloffs on record, significantly intensifying this past quarter. The S&P 500 Index (S&P 500) declined 16.5% in the quarter to finish in bear market territory - down 20.6% year-to-date. This decline matches the worst drop in the first six months of a year since 1970. That year, the market finished the year flat, recovering all the losses in the following six months.

For the month, the S&P 500 dropped 8.4%, as commodities joined the rest of the market’s decline. Oil prices fell 7.8% in the month, closing at $106 a barrel as fears of recession finally began to impact the commodity.  A surprising 75 basis point interest rate hike by the Fed drove the 10-year Treasury bond up 13 basis points, ending the month at 3.0%. The two-year Treasury moved up 39 basis points to 2.9%, shrinking the spread between the two- and 10-year to six basis points from 32 basis points just one month ago. For the first time in many quarters, growth stocks declined at a slower pace than value, but remain well behind value for the full year.  In June, the Bloomberg 2000 Growth Index declined 7.3%, the Bloomberg 1000 Growth Index dropped 7.8%, and value fell a little harder as seen by the Bloomberg 1000 Value Index’s 9.3% decline and the Bloomberg 2000 Value Index’s 11.6% drop.

Fear, uncertainty and doubt have taken over the market since the beginning of the year, leading to one of the fastest drops in the market in memory. The market’s rapid decline has impacted just about every sector this year, except for energy which remains up almost 30% year-to-date. The most severe declines reside in technology, communication services and consumer discretion, areas that generally both benefited from the expansion of the digital economy during COVID-19 and are now facing significant skepticism regarding their future growth prospects. The prominence of trend-following quantitative strategies and the growing influence of passive index funds, which buy and sell entire sectors at the same time, has created an environment that is the most indiscriminate in its selling of individual stocks than at any time that we can remember over the past 25 years. The result has been a broad-based selloff of both speculative stocks for which there are few prospects for recovery and we believe some fantastic businesses that likely prove themselves in the quarters ahead.

We have spent a considerable amount of time studying the development of leading companies and believe that most notable is their ability to rebound much faster than the overall market as they take share from others and recover their robust growth rates before the averages. The chart below illustrates both fundamental growth (dotted line) and stock performance (solid line) over time for four types of businesses: (S) speculative businesses that never develop, (H) high-growth businesses (20% annual growth rate), (M) medium-growth businesses (10% annual growth) and (L) low-growth businesses (5% annual growth). For simplicity, we kept fundamental growth consistent and altered stock returns according to how they behave over time. Speculative stocks tend to increase the most in bull markets, are discredited and never recover. High-growth companies tend to move up with speculative stocks, are knocked down aggressively as speculative fervor dissipates and then recover as their business models continue to compound. Medium-growth companies more closely track their fundamental growth through the cycle. Finally, low-growth companies often underperform their growth until the market downdraft, at which time they move up as investors seek safety. Ultimately, as we see it, the higher the growth, inherently the higher the volatility.

Source: Kingsland Investments as of 6/30/2022. For illustrative purposes only.

Kingsland Investments focuses on powerful long-term trends and the businesses and management that drive them to help discover new market leaders. This effort creates the greatest return potential during market selloffs like the one we are experiencing now. Unlike many of our peers that are abandoning these next-generation growth leaders to find safety in mature businesses, we’ve stepped up our hunt for the hidden gems thrown out by the market. Although it has been a rough couple of months, we think patience will be well-rewarded when the next bull market begins.

All the best to you,
Arthur K. Weise, CFA

*Effective January 12, 2022, the Kingsland Growth Advisors name changed to Kingsland Investments.  The views expressed are those of Kingsland Investments as of June 30, 2022, and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index. 

The Math and Science Behind the Decline in Growth Stocks

To Our Investors and Friends,

The trend that began the year, energy stocks up and technology down, continued for May. At this point, many energy companies have posted gains between 70% to 90% year-to-date while technology companies have contracted 30% to 50% since the start of the year. Oil is the primary driver of these trends, advancing an additional 10% in May to close at $115 a barrel. Fearing recession, the 10-year Treasury bond is now moderating and fell four basis points in the month ending at 2.85%. Short-term rates fell even more, leading to a widening between the two and 10-year to 32 basis points from 19 basis points a month ago. Commodity-heavy value indexes rebounded, while technology-heavy growth indexes declined. The Bloomberg 1000 Value Index expanded 3.2%, the Bloomberg 2000 Value Index rebounded 2.2%, while the Bloomberg 1000 Growth Index declined 2.5% and the Bloomberg 2000 Growth Index dropped 2.2%.

After a brutal sell-off in growth stocks this year, we decided to examine both the math (return calculations) and the science (human reaction to stocks) of two prominent companies that we believe are representative of what is going on in the market. In the following example, we used Alphabet (GOOGL) as our growth proxy and Pepsi (PEP) as our safety proxy.  As seen in the chart, GOOGL has grown its revenue at an average rate of 23% over the last decade while growing its earnings at a 23% rate over the same time frame.  This is far more robust than safety holding Pepsi, that on average, grew revenue by 2% and earnings by 5% over the same time frame. Until this year, the market has paid up for this growth, as the average premium investors have been willing to pay for GOOGL’s higher growth has been about 30% (PE of 30 vs Pepsi’s PE of 23). Investors have been rewarded for the risk they were taking… from December 31, 2012, until December 31, 2021, GOOGL has appreciated 719% vs PEP’s more modest 154% appreciation over the same timeframe.

Source: Kingsland Investments, as of May 31, 2022. For illustrative purposes only.

This long history of paying up for growth has undergone a material change this year. GOOGL’s 21.5% year-to-date decline has reduced its multiple to 22 times current earnings and can be compared to PEP’s 3.4% year-to-date decline that has reduced its multiple to 27 times current earnings.

Why is the market now willing to pay a 23% premium for subpar growth out of PEP? We think the answer has to do with human behavior and place significant blame on the feeling of dread investors experience when constantly checking their portfolios. In fact, 50,000 years of evolution was not enough time to turn the human mind from prey to predator, and it is obvious in how we respond to perceived threats (such as shrinking retirement accounts). Investors en masse have sold technology stocks this year without regard for the growth, profitability or cash return profile of what was being sold, and paid steep premiums for safety. We think this shift from growth into safety is overdone and expect a significant recovery in growth stocks once the fear of inflation, the Federal Reserve rate increases and the recession dissipate. We promise… investors are not at risk of being eaten by predators but are certainly at risk of having their pockets picked by savvy, patient investors.

Kingsland Investments focuses on powerful long-term trends and the businesses and management that drive them to help discover new market leaders. Although these companies may be briefly out of favor at times, we believe strong, sustainable growth could lead investors back to them. After the last few months, growth is trading at an unusually attractive level. We think now is a good time to consider investing in these emerging technology leaders.

All the best to you,
Arthur K. Weise, CFA

*Effective January 12, 2022, the Kingsland Growth Advisors name changed to Kingsland Investments.  The views expressed are those of Kingsland Investments as of June 1, 2022 and are not intended as investment advice or recommendation.  For informational purposes only.  Investments are subject to market risk, including the loss of principal.  Past performance does not guarantee future results.  The stocks mentioned are for illustrative purposes only and are not a recommendation to buy or sell. There can be no assurances that any of the trends described herein will continue or will not reverse.  Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index.