July 1, 2022
“The Difficulties and struggles of today are but the price we must pay for
the accomplishments and victories of tomorrow”
–William J. H. Boetcker
Dear Fellow Shareholders,
This month marks my 38th anniversary in the investment management industry, and to quote the former lead singer of the Grateful Dead: “my what a long strange trip it has been”. I have had a front-row seat for the ’87 crash and the failures of Drexel Burnham, Bear Stearns, and Lehman Brothers. In addition, I witnessed the “technology bubble” and subsequent bust circa 1998-2002, then the real estate bubble preceding the Great Financial Crisis (2006 – 2009), and survived the covid-19 pandemic “crash” in March of 2020.
What I have witnessed in the first six months of 2022 has been much more of a grinding affair with countless down days and weeks, not only with the equity markets but (unlike many of the prior examples) also the bond markets that have shared much of the pain. Both investment grade, as well as high yield indices, are showing negative 12% to 14% returns for the first six months of calendar 2022.
Frankly, the bond market is what got this party going to begin with as market participants came to the realization that the Federal Reserve Chairman’s use of the term “transitory” in regard to inflation was mistaken. The monthly CPI numbers went from “hot” in May of 2021 to “boiling” north of 8% by March of 2022.
To give you an idea of the magnitude of the change in Treasury rates, the 2 year note yield started 2022 at 0.73% and ended June 30th at 2.95%. The 10 Year Treasury yield started the year at 1.51% and finished June 30th at 3.01%.
In the run up to the problems we are now experiencing, I often remarked (with Treasury rates at 1%) that what was on offer was “return-free risk”. Even now, after the carnage, many broad bond indices display duration (measure of interest rate sensitivity) that is twice the coupon being offered. At Intrepid Capital, we are seeking a coupon that is twice the bond’s duration.
Speaking of duration, this gives a bond investor a rough idea as to how much interest rate risk they are exposing themselves to. Much of what I have observed in the capital markets so far this year is the effect that a higher discount rate (10 Year Treasury) has on what I call “long duration assets”. The most extreme example would be a 30 Year zero coupon bond, where your payoff is one day thirty years hence. One of the easier ways (I think) of considering the effect of the discount rate moving up (10 Year treasury from 1.51% to 3.01% this year) is to envision a see-saw on a kid’s playground. Move one side up (in this case, risk-free interest rates) and move the other side down proportionately (in this case, stock and bond prices).
So far this year almost every financial asset is worth less due to higher rates.
So what have I learned in that 38 years? Well, a couple of things come to mind:
- Many investors buy high/sell low, unfortunately. The volatility of the equity market is more than they can stomach. Please try to resist this temptation.
- They trade too often. Now with “commission-free” mobile trading apps, it is easy to move when one should be sitting still.
- For money committed to the equity market, one needs to prepare for the inevitable drawdown in share prices of 30-50% (we have observed these in the last 12 months) and should really have at least a 5-year investment horizon (the longer the better).
- Have a disciplined plan that you execute. At Intrepid, we like to use three “buckets’: one each for liquidity, longevity, and legacy.
Please keep in mind that the equity markets are a discounting mechanism that is always looking off into the future, trying to anticipate events 6 months or more away. Today’s prices reflect what market participants anticipate about sales, margins, cash flows, and net income. In the bond market, with the substantial upward movement in interest rates and credit spreads, prospective investment returns are substantially more attractive than six months ago.
This is a long-winded way of saying I think when we look back 12-24 months from now that returns will more closely resemble long-term results for a portfolio consisting of stocks, bonds, and cash. The first six months of 2022 have certainly been challenging for participants in the financial markets. What I have learned in 38 years is that patience is required and that this too shall pass.
Thank you for your continued support. If there is anything we can do to serve you better, please give us a call.
Top Contributors (Calendar Q2 2022).
Dollar General (DG)
FRP Holdings (FRPH)
Atento 8% 2/10/26
Top Detractors (Calendar Q2 2022)
Trulieve (TRUL CN)
Match Group (MTCH)
Earthstone Energy (ESTE)
Interactive Corp (IAC)
Thank you for your investment.
Mark F. Travis, President
Intrepid Income Fund Co-Portfolio Manager
Intrepid Income Fund Co-Portfolio Manager
Past performance is not a guarantee of future results.