At the beginning of the year, I wrote to you about the constant uncertainty we live with when it comes to the immediate future, and how our investment strategy has to account for that uncertainty. Then Russia invaded the Ukraine and our hopes for a post-pandemic festival of economic activity were diverted into hopes for a ceasefire. Nevertheless, our bet on inflation has been reinforced by the resulting shock to commodity supplies (especially oil and fertilizers). In addition, you may recall that I purchased defense sector stocks last year in expectation that international conflict would resume with the passing of the pandemic. (I share your wish that this grim inevitability was not a constant feature of human political life.) In the end, we somehow generated positive returns in Q1 of roughly 4% in a typical balanced portfolio that hold 65% stocks.

Very significant to our progress in early 2022 has been our underweight position in fixed-income. Expectations of interest rate hikes by central banks to fight inflation has caused the government bond market to generate market losses of 15% year-to-date as I write. Bond prices move in the reverse direction of interest rates, since higher interest rates require lower prices for existing bonds so that today’s buyer will receive the updated higher interest rates. Bonds enjoy a longstanding symbolic and legal status as “low-risk” assets that I have argued has become obsolete. Especially when interest rates are made unnaturally low by government bank policy, the holders of government bonds bear disproportionate risk. Last year we took the unconventional step to shift ten percent of client assets that would normally be invested in bonds into direct commodity investments like gold bullion and crude oil. That has allowed us simultaneously to avoid some losses in the bond market and to enjoy some gains in the commodities market. Inflation protection and the avoidance of market losses related to interest rate hikes remain major themes for us going forward.

One encouraging event in Q1 was the announcement by Warren Buffett’s Berkshire Hathaway that it is buying Alleghany Corporation at a 24% premium to the last market price. Alleghany is a specialty insurer that we own in every client portfolio thanks to our most trusted source for investment ideas, Grant’s Interest Rate Observer. The $11.6 billion acquisition is the largest that Berkshire has made since 2016. We like to think that we are doing something right when the “Oracle of Omaha” makes one of our holdings his first major acquisition in years.

 

Mark Lloyd, Ph.D.

Senior Portfolio Manager