Fort Street Q3 2023 Quarterly Letter

Aloha friends! We hope you are all well in these troubled times. While it’s been a confounding and sadly tragic year, the portfolio avoided stepping on any land mines and even managed to make some money. For the third quarter, the FSAM Fund was flat, outperforming the S&P 500 and a blended 60/40 portfolio, which fell -3.6% and -2.06%, respectively. Year to date, the Fund is up 7.3%, and the S&P 500 and blended 60/40 portfolio are up 11.6% and 5%, respectively. Once again, the Fund performed as designed. 

As the year progressed, we continued to spread our bets, incorporating a number of different views and possible outcomes into the portfolio. We were more bullish on the market than most as we saw inflation falling and what appeared to be a robust economy where consumers and corporations had plenty of cash to spend. Yet, we also remained concerned about the eventual impact of rising rates on the economy and the high probability that inflation would remain volatile. Accordingly, we were able to participate as the equity market went higher while insulating the portfolio against downside risks. In addition to implementing several protection strategies, our core equity portfolio is less correlated to the broader market, thereby increasing our odds of outperforming over time. 

During the third quarter, our index options, cash, and bonds limited losses as the markets fell, while our long position in energy was a major contributor as oil prices rose. The specter of higher for longer interest rates put pressure on some of our positions in the technology, consumer, and real estate sectors due to a combination of rising discount rates, falling premium valuations, and refinancing risks. 


After a dismal 2022 for both stocks and bonds, most investors entered the new year with considerable apprehension as the Fed aggressively hiked interest rates and political risks near and far became more prevalent. Many people opted for the relative safety of the sidelines and the comfort of rising money market rates. As recession fears loomed large, many investors anticipated that the Fed would have to reverse course and cut rates sooner than later, expecting bonds to shine and stocks to plunge. The market did not comply. 

In fact, equities moved higher, in spite of an incipient banking crisis in March that could have triggered a systemic liquidity crisis. It didn’t. Equities suffered only a momentary dip, before a surprisingly strong economy and an AI-inspired rally sent stock prices into orbit. By August, the S&P 500 index was up 19.5%, while bond prices continued to rack up ever larger losses. 

However, just as talk of a soft economic landing started to dominate the headlines by September, surging long term bond yields began to set off alarm bells, causing the S&P 500 to drop 10% from its August peak. Long-term Treasuries closed the quarter down a stunning 13%. Which begs the question, what is going on in the bond market? 

Bonds market goes bananas 

The transition to a new market era has not been kind to bond prices. Long-term Treasuries are down an eye-popping 42% over the last three years. In hindsight, it seems obvious as we bid adieu to the wild and wonderful days of zero interest rates. Still, the ongoing selloff and the velocity of such moves are nothing short of astonishing. Unlike equities, bonds usually move in teeny tiny increments, a few hundredths of a percent at a time. Swings of this magnitude are not “normal”. The 40-year bond bull market was preceded by a 35-year bear market. We sense that this new market regime may challenge bond prices going forward. Beyond current Fed policy, these abnormal moves seem to suggest that something else is amiss in the bond market. 

Surging long-term bond yields 

There seems to be a number of factors at work behind the recent surge in long-term yields: 

  1. For starters, the market has woken up to the realization that the Fed isn’t kidding about fighting inflation and the need for rates to remain higher for longer. 
  2. More critically, the sheer supply of bonds to fund the government’s burgeoning spending plans has met with a paucity of buyers, driving yields on longer-dated Treasurys ever higher. 
  3. Further complicating matters, traditional foreign buyers of U.S. debt are notably absent; while U.S. individual and institutional investors are more than content to gorge themselves on short-term high yielding, risk-free Treasury bills, present company included. 
  4. Additionally, it seems that some retail investors have been net-sellers of longer-dated bond ETFs, signaling their distaste and angst with U.S. government funding policies. 
  5. The upshot of all this is the growing concern about the fiscal health of the U.S. government and its exploding debt burden. 

We would also point out that it is the market and not the Fed that is the ultimate arbiter of longer-term interest rates; and the market has made it resounding clear what it thinks. The yield on the 10-year Treasury climbed from 3.8% on July 1 to 4.8% on October 2, while short-term rates stayed flat. 

Clown town 

As if the chaos in the bond market was not enough, we have had to endure Washington’s pathetic handling of a potential government shutdown. The recent actions of our so-called leaders in Congress leave us gobsmacked. Is this really the best we have? For the speaker of the house to lose his job because he did something that is good for the country is both confounding and depressing. Unfortunately, we can look forward to more dysfunction as the threat of a shutdown remains unresolved, which could have some impact on the economy. As the former comedian George Carlin once quipped about our political system, “garbage in, garbage out”. Fort Street Asset Management Q3 Update 


The possibility of a wider Middle East war, increasing odds of a recession, and the untenable fiscal situation in the U.S. increases risks to asset prices, encouraging us stay in a more defensive posture. Add a war of attrition in Ukraine, and the non-zero possibility of China invading Taiwan into the mix, and maintaining an optimistic disposition becomes a bit more challenging. 

With debt to GDP at 122%, the U.S. is in its weakest fiscal position in generations during the most challenging geopolitical environment since WWII. During times like these, we prefer our lucky color to be invisible. Not the best setup for risk assets especially if Israel’s actions in Gaza trigger a non-linear outcome. To be on the safe side, we are increasing our exposure to gold and Bitcoin, as well as adding to investments in other protection strategies. 

However, despite the increasing odds of a recession and the risk that the war in Israel escalates, not all is doom and gloom. Moderating inflation, improving earnings outlook, and an economy that defies expectations could see the equity market rally into year end. Markets, like life, rarely move in a linear fashion. Furthermore, we recognize that we could be wrong about a lot of things (shocking as that be to some of you), so will attempt to position ourselves accordingly. 


Risks are rising as the war in Israel could escalate, higher long-term rates and an inverted yield curve is likely to tip us into a recession, persistent wage pressures will probably reignite inflation, and exploding U.S. debt keeps interest rates elevated which is likely to hurt economic growth. 


As this is not an op-ed piece, we will keep our analysis and comments focused on the global investment implications of the war in Israel. It is of course beyond heartbreaking, and while we are realistic as to what lies ahead, we maintain hope, as difficult as that might be, and pray for a peaceful resolution. 

As long as men believe in absurdities, they will commit atrocities – Voltaire

If this conflict does go beyond Israel and Gaza, the economic and political repercussions are likely to be significant. However, it’s too early to tell how it will all play out. We will have to watch the situation unfold over the days, weeks, and months ahead. From a portfolio stance, we will look for ways to add to our protection strategies as the situation progresses. 

Recession redux

Hopes for a safe landing appear to be diminishing with each passing day as rising long-term rates and the threat of a wider war increase the risk of tipping the economy into a recession. We aren’t in the business of trying to time the market or predict economic cycles. We simply note tthat rate hikes work with a long and variable lag. We are no economist (that’s a good thing), but it seems logical that higher rates will eventually restrict credit creation to a point that it contracts economic growth. Our suspicion is that this will probably take time to play out as there still seems to be plenty of energy in the economy, but we would note that higher rates combined with an inverted yield curve suggest that a recession is probably lurking somewhere on the horizon.. 

U.S. Government Debt – a ticking time bomb

As the chart on the right illustrates, federal debt has increased by $8 trillion or 50% in the last two years alone. This is not sustainable. With debt to GDP at 122%, the U.S. is in its weakest fiscal position since WWII. 

Hamas’ incursion and massacre in Israel was yet another Black Swan – a rare event that no one expected. By contrast, the U.S.’s fiscal predicament is the opposite of a Black Swan. It’s more like an 800-pound gorilla sitting in our lap to which we have become oddly accustomed, except said gorilla is rapidly gaining weight, feasting on a diet of ice cream and cake. The good news is that the risks and remedies are strikingly obvious. The bad news is that nothing is likely to happen without some enlightened leadership and a more selfless and motivated public. 

This needs to be a central part of our political dialogue. We need political leaders who will tell the public the truth. Trump and Biden put us over the edge. Trump aggressively cut taxes, while Biden raised fiscal spending to unprecedented levels. Build Back Better became Build Back Debtor. The sugar high was so good that we went from eating a few cookies to binging on the entire box. As Albert Einstein said, the people who create the problem can’t be the ones to solve it. One can only hope that by some miracle we get better options for President than what’s currently on the menu. Time for fresh blood. 

Meanwhile, the costs to service the interest on our debt is reaching untenable levels. In just a few years, interests costs will soon exceed defense spending and 20% of our taxes will be used just to service the interest payments alone. We are caught in a vicious circle – higher rates increase our funding costs, which leads to an increase in the supply of bonds, and fewer bond buyers leads to back to higher rates, until the market sets a clearing price. Our fear is that rates could rise a lot more than most investors expect. 

We will have to elect politicians who are ready to put everything on the table, both higher taxes and less spending. Politicians who put nation before self-interest. I know, a crazy idea. The American public is going to have to listen, put their differences aside, and find a way to compromise. It will require sacrifice from all of us. Fiscal retrenchment is inevitable. It’s a question of when, not if. This is based on the hard numbers, not opinion. We either bite the bullet now on our own terms or leave it up to wishful thinking and risk even worse outcomes. We don’t know how long this will take to play but suspect nothing will happen until something breaks. Such is human nature. 


On a cheerier note, it’s not all doom and gloom. There is still some cause for cautious optimism as earnings are improving, households still have excess savings, an election year guarantees a surfeit of fiscal stimulus, and inflation is still moderating.

Earnings improving 

Recent data seems to indicate that economic growth remains strong and a year-long slump in profits for Corporate America is about to end. However, relief may be short-lived given the fragile economic and political outlook combined with the highest level of interest rates in 16 years. Analysts project that earnings for the S&P 500 will drop 1.2% in the third quarter – the fourth straight quarter of declines – before rebounding 6.5% in the final three months of the year. Consensus forecasts are seeing upward revisions which is usually a bullish sign for equities. Wall Street expects that earnings will grow 12% in 2024. We suspect those forecasts may prove too optimistic; a fragile recovery and the lack of breath tempers our enthusiasm. Most of the growth and outperformance continues to be driven by a handful of companies, such as the so-called “magnificent seven” technology stocks. At 18x forward earnings, the S&P 500 does not appear to be excessive, especially if we were to strip out those top seven stocks which now account for 30% of the index. 

Households still have excess savings 

Recent reports of the demise of excess U.S. household savings seem to have been greatly exaggerated. It appears that consumers still have more than $1 trillion in excess savings, which could help cushion the economy in the face of headwinds from surging bond yields. To be sure, the lion’s share of this excess wealth is held by households in the top 10% income bracket. We also suspect that the market is underestimating the accumulated savings when many individuals and corporations refinanced at rock-bottom rates during the pandemic. 

Election year guarantees a surfeit of fiscal stimulus

The incumbent party will do all it can to support the economy into an election year. Three massive fiscal stimulus programs (Chips Act, Inflation Reduction Act, Infrastructure Act) have already been enacted into law and will start distributing funds in the fourth quarter of this year. If there is one thing politicians are good at, it’s spending taxpayer’s money. The government plans on handing out copious amounts of money on infrastructure, defense, and technology. Elections are ultimately won and lost on the economy. 

Inflation: down, but not out 

Thanks to favorable year-on-year comparisons, inflation is likely to moderate over the next 3-6 months, easing pressure for the Fed to raise short term rates and perhaps tolerate less restrictive financial conditions. Unfortunately, persistent wage pressures are likely to reignite inflationary pressures down the road, especially as labor reasserts itself into the conversation and politicians seize on the chance to win more votes. Unionization efforts and an increase in labor strikes such as the United Auto Workers (UAW) and Kaiser Permanente, are likely a sign of things to come. Deglobalization, reshoring, commodity supply shortages and energy transition will also contribute to ongoing price pressures. Over time, we accept that advances in A.I. will boost productivity, offsetting some inflationary pressures. 


Asset Allocation: 

The Fort Street Fund’s net market exposure is currently around 65%. We will probably reduce overall portfolio risk after recent events in Israel and in the bond market. Approximately 25% of our assets are in cash and bonds, with the bulk concentrated in short-term bills yielding in excess of 5%. We have covered some of our index options but plan to establish new positions as the quarter progresses. We recently increased our allocation to gold to about 4% and started buying some bitcoin as they are less directionally correlated to moves in the equity market and tend to protect the portfolio when times are hard. We also plan on increasing our investment with Ruffer, as they tend to shine whenever markets take a significant turn for the worse.

In a world of higher interest rates and more elevated levels of inflation, we may need to add some more arrows to our investment quiver. Howard Marks, co-founder of Oaktree Capital, recently proposed that investors should make a much bigger allocation to high yield bonds as they now offer equity-like returns but with a lot less risk. Perhaps. We would need to do a lot more work before making any major allocation to non-investment grade bonds. We do agree that a new market era is upon us and demands that we explore alternative investment ideas. What worked in the past is unlikely to work as well going forward. 

Equity Portfolio: 

Our core equity portfolio accounts for 70% of our gross asset value. We are likely to trim some positions if it appears that a recession is closer than expected. Thematically, we remain bullish on energy, selective base metals, infrastructure, and defense. We try to avoid playing flavor of the moment. Our holdings are predicated on either specific industry trends or bottom-up investment opportunities with solid, long-term fundamentals that we can own for years to come. We are fairly agnostic when it comes to things like factor and style investing, not paying much attention to industry-defined categories like growth, value, defensive, momentum, and volatility.


We often talk about being prepared for the punch we don’t see coming as that’s often the one that knocks you out. Clint Dodson, my erstwhile partner-in-crime, is the living embodiment of such a mindset. He is hard-wired to be ready for anything and everything, partly due to his military training and partly a function of who he is. I once witnessed this in action when a person had a medical emergency in a theater and Clint was Johnny on the spot before I even knew something was wrong. It was impressive to see. I’m grateful and honored that we all get to share a foxhole with Clint. 

Just in the last couple of years, it seems like those punches are taking place with greater frequency – Covid, Ukraine, Silicon Valley Bank, Maui, Israel. What next? If this keeps up, they’re going to have to replace Black Swan with something slightly more common. Speckled Marmot? 

Our sense is that periods of transitions often experience an uptick in Speckled Marmot events. We have had the benefit of living in a post WWII period of incredible prosperity and peace, at least on a historical basis. Change by its very nature is uncertain, which leads to an increase in volatility and fear. We seem to be at the beginning of an economic, political, and social sea change. 

Recognizing and accepting this transition allows us to craft an investment strategy which can navigate all manner of conditions. Be it represented by Black Swans, Speckled Marmots, or Fluffy Bunnies. While we don’t possess a crystal ball, we must rely on our ability to construct a portfolio that can absorb whatever punch, or animal, the market throws at us. Conversely, we would be willing to pay good money if anyone has a functioning crystal ball for sale. 

We don’t mean to make light of the state of the world today. Far from it. In difficult times, humor is one of the most powerful weapons we possess. And hope. 

“It is well known that humor, more than anything else in the human make-up, can afford an aloofness and an ability to rise above any situation, even if only for a few seconds.”― Viktor Frankl, Man’s Search for Meaning

As fiduciaries and guardians of your hard-earned treasure, we will use whatever tools necessary to protect and grow the assets you have entrusted to us. Our mission is not to swing for home runs but to survive in order to thrive. We are forever grateful for the trust you place in us, especially in these trying times, and thank you for your ongoing support.