One of the most important disciplines in investing, whether personally or professionally, is to look back on investments made and take stock not just of how they performed but why. What decision-making or other avoidable errors led to bad outcomes? What lessons can be learned so that any future mistakes are new and better ones, not the same ones made before?
I recently undertook such a review for investments made coming out of lockdowns and general madness of the pandemic era, including revisiting the themes, investment decisions, and positions taken or exited between 2020 and 2022. I had some great wins and some equally spectacular failures. But nothing is ever for naught. There were important new lessons to be learned, and reminders of principles learned long ago that should have been better applied.
I had a few strong convictions in this period, some of which were contradictory. We’d had years of deflationary pressures, the economy was shut down, yet the more I looked at it, the more I saw inflation on the horizon. I started publicly warning of looming inflation in 2020, at a time when such views were fringe. Reopening of the economy was going to be a driving force for inflation, but more fundamentally, I was concerned about the rapid monetary expansion that had occurred after the global financial crisis of 2008–09 and again during the pandemic years.
In an inflationary environment, bonds would do poorly and cash would be trash. Equities usually perform in inflations. But I also felt that the stock market, participating in the “everything bubble” caused by ultra-low interest rates and pandemic relief, was unsustainably expensive. Equities had gotten ahead of themselves in 2020–21, so surely a correction was in order—but when? Timing is everything.
I was confident that commodities, including food, energy, and metals, would benefit from inflation, from the war in Ukraine, and from the reopening of the world.
I believed that the U.S. dollar would suffer in the face of all-time high debt levels (now $31 trillion), eye-watering deficits (totaling $6 trillion in 2020–21), and a money supply that had tripled—growing at an annual average of 7 percent while the economy grew 2–3 percent—since the eve of the financial crisis in 2007. China and others foreign buyers had stopped buying U.S. Treasurys, and were reducing positions.
(Dado Ruvic/Reuters)
My expectations for dollar weakness proved to be my biggest error, as large bearish bets got hammered by forces I later came to understand through the Dollar Milkshake Theory. Basically, as interest rates rose rapidly, capital returned to the United States, and variable foreign debt was either repaid or defaulted on. As liquidity was pulled out of the market, the demand for and price of dollars went up rather than down. The United States wasn’t alone in money printing, as the European Central Bank, the Bank of Japan, and other central banks were increasing money supply at rates similar to or in excess of the United States. For these reasons and others, the U.S. dollar massively outperformed.
I also got gold wrong. I was bullish the barbarous relic as an inflation hedge and went long in 2020 for the first time. In retrospect, I see two main reasons for gold’s perpetual bear market since August 2020. First, as the dollar rapidly rose, the price of gold–quoted in dollars—fell. Second, I was slow to realize the outsized role that derivative contracts—and the small number of large banks writing them—play in distorting the price of gold. The notional value of derivative gold contracts—futures, forwards, and options—is more than $800 billion, dwarfing the underlying market. I still believe gold is undervalued, but until the gold derivative oligopoly is broken, price distortions will continue. The manipulation that is happening in gold is, in my view, analogous to what happened with mortgage and LIBOR (London interbank offered rate) markets in previous cycles.
Finally, I got crypto wrong, at least in the time horizon. I believed, and still believe, that established cryptocurrencies like Bitcoin and Ethereum have attractive value propositions, including as anti-inflationary “hard money” alternatives that can help protect from the debasement of fiat currencies. What I did not anticipate was the string of frauds, most notably FTX, that would shake the industry in 2022. The sifting of scamsters will act as a cleansing agent for the industry, which should ultimately be stronger (and safer) as a result; but in the meantime, values—and investor sentiments—were torched. I also didn’t expect the dramatic rise in anti-crypto rhetoric and enforcement actions coming out of U.S. government agencies such as the Securities and Exchange Commission and the Federal Reserve. Regulatory interference, therefore, remains the largest risk to the crypto bull case.
Avoiding losing money is often as important—if not more important—than making it.
Acting on my inflationary view, fixed income was the first to go, and thus an early win. The decades-long trend of falling interest rates was ending. With rising interest rates, bonds and other fixed-income assets would suffer. I’m not a trader but a long-term investor, so I wasn’t concerned about timing the market. Better to stay safe. Exiting these positions freed up capital for investment elsewhere.
Another solid win was getting out of overvalued growth stocks, and especially the high-flying stocks of FAANG (Facebook, Amazon, Apple, Netflix, Google) and tech generally. FANG and NASDAQ indexes have recovered somewhat, but are still down more than 25 percent from the highs in 2021. Investment firepower was reallocated to dividend-paying value plays, including those described below.
What absolutely worked was investing across the commodities complex, especially in energy, but also in food and some strategic metals. The oil and gas sector was a particular success, with companies like Exxon tripling in value from 2020 lows. I fully expect the energy bull run to continue in 2023 as the underlying forces, including disrupted trading patterns from war and sanctions, limited refining capacity, and especially China’s reopening, have not abated.
(Agustin Marcarian/Reuters)
Mining companies performed well because of their high dividends and low valuations as a result of tepid institutional demand. Many pension funds and Wall Street investors have woke ESG-induced anaphylactic reactions to things like coal, iron ore, copper, or other extractives which are still necessary to run the modern world. That constraint on institutional demand should continue to present an attractive and dividend-rich opportunity for retail investors, for the same reasons as oil and gas.
Finally, the other big win was real estate in certain segments and in geographic areas with favorable demographic trends. I’ve always liked industrial REITs like Prologis, one of the largest holders of warehouse and distribution space, because of the experienced management team, steady cash flow, and growth potential for logistics in the Amazon era. While housing has absolutely cooled in overheated markets, migration patterns show that states like Florida and Texas, with good governments and booming economies, should continue to do well despite higher mortgage rates. This sector may see wide divergence in performance between regions in 2023.
Some of the key lessons learned (or relearned) through this process include avoiding confirmation bias, i.e., the tendency to cherry-pick information that supports your preexisting view while ignoring contrary data. Invest in what you know best, take only small positions in what you don’t. Never ride wins (or losses) for too long. Once you’ve hit your target, get out. Being right, but being wrong about timing, is the same thing as being wrong.
Most important, never bet the farm—no matter how convinced you are of your ideas. By not investing beyond your means, you can live to fight (and invest) another day.
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