Link to PDF here. 

2Q24 INVESTOR LETTER

REVIEW

As the world turns: I’m sure we have all been preoccupied with the cascade of national news in the last few weeks. Our take is that while these events are not trivial, there is no cause for alarm, and we don’t see much of an impact on the economy or the portfolio at this stage. Of course, that could always change. We continue to monitor China’s economic slowdown and its effect on the global economy, as well as the ongoing geopolitical tensions in Eastern Europe, the South China Sea, and the Middle East. All the more reason to maintain a well-diversified and resilient portfolio.

Performance: This year has been a mixed bag for us. The portfolio is up 6.7%, which is not too shabby, given that we manage a more restrained portfolio. While we own several large tech stocks, including Nvidia, we did not have enough to keep pace with the S&P 500. However, we continued to outperform the classically diversified 60/40 stock and bond portfolio, which is arguably a more appropriate benchmark for our conservative strategy. Most investors who didn’t load up the truck with mega-cap technology stocks such as Nvidia, Microsoft, Google, Meta, and Amazon have struggled to keep pace with the S&P 500. The bulk of the market’s performance this year has been concentrated in just a handful of these mega-cap tech stocks. To be fair, other pockets of the market have done well, but their overall impact on the S&P 500 has not been enough to move the needle.

Mea Culpa: The one thing we clearly got wrong was our big bet on commodities (23%) at the expense of technology stocks (11%), which has weighed on the portfolio this year. While we remain confident in our long-term view that many commodity prices are likely to trend higher over the next few years, we recognize that our exposure to such a small and volatile segment of the market was simply too big and are actively taking steps to rebalance the portfolio.

Lemmings: Just in case anyone was wondering, we aren’t lemmings. Our equity portfolio does not seek to simply mirror the index. We manage an active strategy that aims to generate a compelling rate of return, albeit one that is more focused on defense and not hitting home runs. In a transitional world, we are careful not to make large one-way bets that could hurt our ability to protect assets or load the portfolio with too much risk. At the end of the day, appropriately sizing positions in line with investment objectives is arguably the most effective way to manage risk. Of course, markets can be fickle, so it’s important to maintain a proper degree of balance. What doesn’t perform well today might make us look like superstars tomorrow, and vice versa.

North Star: Our North Star is preserving capital while generating compelling risk-adjusted returns. To this end, we continue to deliver as intended. When the market was down 4% in April, the Fort Street Fund only fell 1%. Our strategy of outperforming on the way down not only protects capital but also allows us to acquire positions we favor at lower prices, thereby enhancing our long-term performance. 

OUTLOOK

We are still relatively sanguine on equities, even after such a big move in the first half of this year. Could we see a pullback? Absolutely. Markets, on average, experience a 10% correction every 12-18 months. Tick-tock. Regardless, we suspect this bull has more room to run. We would just highlight that our views and investment decisions are based on hard data – we don’t try to divine the future to determine when the markets go up or down.

Economy and Earnings: The economy is finally showing signs of slowing, but it does not appear to be breaking down. Thanks to higher rates and somewhat tighter financial conditions, inflationary pressures have continued to dissipate, which should allow the Fed to start making modest rate cuts this year. Despite an overwhelming number of predictions from an army of market pundits, ranging from apocalyptic to utopic, many companies are still guiding for decent growth, forcing Wall Street analysts to revise up their earnings forecast. Rising estimates are usually supportive of higher stock prices. Many investors wonder why big tech stocks have gone up so much this year. While the so-called Magnificent Seven constitute 30% of the index, they have accounted for a whopping 89% of the S&P 500’s earnings growth this year.

Statistics: While we certainly wouldn’t go out and bet the farm on the following statistics, they can provide some insight into what may come next.

1.) Re-Election Years: Equity markets have done well in every Presidential re-election year since 1944. Why? Self-preservation. Presidential incumbents will do everything they can to be re-elected, which is why we have seen a slew of policy initiatives (Inflation Reduction Act, Chips Act, Advance Act, Student loan extensions) intended to spur economic growth. Allegedly, elections are won on the state of the economy. Yes, this year is different, but we’d say regardless of who is running, it still qualifies as a re-election.

2.) Newton’s First Law—An Object in Motion, Stays in Motion: Based on historical data, a strong first half usually leads to a continuation of the bull market in the second half of the year with an average of +7.5%, approximately 79% of the time. 

3.) Investor Positioning: Even though we are now well into a bull market, the data suggests that many investors are still sitting on the sidelines with oodles of cash. As long as the economy or the market does not fall off a cliff, there is a good chance that money flows will eventually make their way back into stocks. The slide below suggests that investor sentiment has yet to reach the euphoric levels that typically accompany a bubble. Anecdotally, I’m still hearing many investors say, “I still have plenty of money that I’d like to invest, but I’m waiting for a correction”.

Valuations: At 21x twelve-month forward earnings, the broader market is certainly not cheap when compared to historical 5 and 10-year averages of 19x and 17x, respectively. However, excluding high-priced mega-cap tech stocks, the market looks much more reasonably priced, especially as earnings are likely to be revised up.

RISKS

Inflation: Inflation could be stickier than expected, especially as year-on-year comparisons start to become more difficult. While price pressures seem likely to continue to ease for now, we remain concerned about the potential for renewed inflation volatility in the future.

Election and Geopolitics: There is no denying that the political situation in the US and around the world is a lot more precarious and unstable these days. Have the odds of more violence domestically or a larger war externally increased? Sadly, yes. And as such, it makes sense to take precautions against these possibilities. However, it’s also important to make the distinction between events that cause greater alarm or fear and those that could actually have a material impact on the US or global economy. We do not see the US election, thus far, triggering an event that would substantially alter the course of the economy. At least not in today’s news cycle. At the end of the day, we suggest investors do not base their investment decisions on politics alone. It seems anytime we make a bet that is contingent on a political outcome, we lose money. Exhibit A: JetBlue’s bid to buy Spirit Air. We would also add that the sad fact is that Trump or whoever replaces Biden will continue policies that further stimulate the economy, further exacerbating our precarious fiscal situation. None of the potential candidates has the understanding, interest, or moral fortitude to try to defuse the ticking time bomb that is our national debt, which ultimately threatens our economic stability.

China and Taiwan Update: As we have pointed out over the last few years, China will struggle to find its economic footing as long as President Xi remains in power. His primary focus is not on fostering economic growth but on consolidating his and the CCP’s hold on power, as well as taking a more aggressive foreign policy posture as that plays best to his domestic audience. If Trump is elected, his talk of imposing tariffs of 60% or higher could set off a dangerous chain of events if such actions are perceived to severely threaten China’s already slowing economic vitality. To further unsettle the apple cart, Trump recently suggested that Taiwan pay the US for protection. Any question of our commitment to Taiwan could further entice China to take some sort of military action against the island formerly known as Formosa. Without clear US support, could the Taiwan government or its people decide to take their chances with China? Unlikely, but the odds will rise the more the US shows signs of stepping away. Despite the risks of war in the Taiwan straits, we remain skeptical that China will launch a full-scale invasion for several reasons. First, the odds of success are not high as China would probably struggle to overcome Taiwan’s inherent defensive advantages. History suggests that such an undertaking is more likely to fail than succeed. Second, even assuming that China was able to invade and win, the task of governing would be extremely complex, especially if Taiwan’s populace did not submit peacefully. Third, sitting at the epicenter of semiconductor manufacturing, it’s hard to imagine any scenario where the US and the West would not sit idly by as China tried to take over Taiwan by force. Oddly enough, Taiwan’s economy is doing well despite the risks of a confrontation with China. The island has benefited from its critical position in the technology supply chain and Taiwanese bringing capital back from China as relations deteriorated over the last few years. The Taiwan stock market has been one of the best performing in the last year or two. Whether this has any bearing on the future of Taiwan is hard to say. For Fort Street, most of our exposure to Taiwan is via Taiwan Semiconductor. As circumstances change, we would not be opposed to adding to our Taiwan exposure. 

Yield Curve: A few years ago, you couldn’t open a financial news site without seeing a headline warning that the yield curve was inverted (short-term bonds are higher than long-term bonds) and, therefore, a recession was nigh. Fast-forward to today, and there isn’t even a whisper about the yield curve, even though it remains inverted. We are not suggesting that an economic downturn is near; just that it pays to be aware when the curve un-inverts with short-term rates falling, for that does tend to signal a material slowdown in economic activity.

Volatility or the lack thereof: Despite a slew of forecasts that this would be a volatile year for equity markets, the truth has been the opposite. This year, the VIX (volatility or fear gauge) has averaged 13.7 (the five-year average is 21), while the maximum drawdown for the S&P 500 was 5.5%. Historically, the S&P 500 has experienced larger corrections (14.7% on average) the year following a year of low volatility. We are not predicting that the bull market will end in 2025; just pointing out the potential challenges ahead.

Portfolio Diversification – Eggs and Baskets: It’s easy to look at today’s equity market and conclude that it’s all a big bubble and that a nasty fall is right around the corner. Indeed, that is certainly a possibility that we wouldn’t deny. Again, we are neither sorcerers, witch doctors, nor economists, so we try to avoid making predictions on when the market will fall or rise or who will win the World Series (the Mets, obviously). Keeping an open mind, we prefer not to put all our eggs in one basket and take a more nuanced approach that allows us to position the portfolio for a range of possibilities, striking a balance between risk and reward. We just wish we had more of those tasty Nvidia eggs.

Nuclear Energy and The Advance Act: We remain optimistic about the potential for nuclear energy and what that means for uranium miners. The smoke signals coming from Washington and various climate groups looks encouraging. President Biden has signed the ADVANCE Act to address long-standing flaws in nuclear energy regulation. The International Energy Agency notes that to reach net zero, global nuclear capacity must double by 2050. However, building new nuclear plants in the U.S. is costly, slow, and burdened by bureaucracy, leading to industry stagnation and a projected decline in nuclear-generated electricity from 18% to 12% by 2050. The ADVANCE Act aims to reverse this trend by reforming the Nuclear Regulatory Commission. It would allow the commission to hire more staff, reduce licensing fees, expedite application processing, and simplify environmental reviews. The act also shifts the commission’s mission to consider the public benefits of nuclear energy, not just potential threats. Together with tax credits from the Inflation Reduction Act, this sets the stage for significant progress. While nuclear energy alone won’t solve the climate crisis, it is essential. The act’s bipartisan support, building on provisions from the Trump administration, signals a positive shift. The U.S. is finally addressing regulatory obstacles that have hindered new developments, marking a hopeful change. The portfolio still owns CCJ and NXE. 

AI: As a general rule, we don’t like to bet against technology. As we witnessed during the Covid pandemic, new technologies allowed vaccines to be developed in real-time. While the markets may be overstating AI’s importance in the near term, it is probably underestimating its significance in the long term, which is not unusual for new technologies. Is AI overhyped and misunderstood today? Probably. While narrow generative AI for basic consumer tasks may be overblown, the application of AI in areas like energy, manufacturing, and medicine will have a profound impact over time. For a thoughtprovoking and optimistic view on AI, we’ve attached a link (click here) to Ray Kurzweil’s recent article in The Economist. Subscription required.

Nvidia: Okay, so should we buy more Nvidia? Probably, but maybe size the position to account for current valuations and how much the company has to grow to justify current prices. The data suggests that Nvidia has a significant lead over its competitors and that capital expenditures for the AI buildout do not seem to be slowing down. Will there be significant drawdowns along the way? For sure. Our hope is that we have the cash and presence of mind to seize upon such opportunities.

Pink Elephants: Don’t think about pink elephants. Whatever you do, don’t think about a pink elephant. Don’t picture it in your mind. Just don’t do it. Now, what are you thinking about? The pink elephant paradox is a psychological phenomenon that describes how trying to suppress a thought can actually make it more likely to surface, which can negatively impact a person’s emotions, focus, and decisionmaking abilities. (this summary brought to you by AI) Because I like to torture my body, I’ve recently taken to running up and down the stairs at Koko Head Crater. It’s 1,048 steps up, or just over 1,000 feet of elevation gain, and reaches an incline of 35 degrees or 70%. Halfway up, there is a bridge section that stretches over a ravine with nothing underneath. Falling between the cracks is bad. When traversing this section, I try to expunge my thoughts of pink elephants, saying to myself that all I see are wooden railway ties. It kind of works. Okay, but how does this relate to investing in the markets? To be honest, I’m not entirely sure. I was kind of smitten with the concept and just felt like sharing it. I was intrigued by how we often selfsabotage, limiting our ability for more healthy, rational thoughts. For investing, instead of seeing all the possibilities (good or bad), we become fixated on a pink elephant at the exclusion of other opportunities or risks.

CONCLUSIONS

• While the market’s current infatuation with AI may prove fleeting, the longer-term implications could be revolutionary.

• Don’t think of pink elephants. Allow your mind to stay open to all the possibilities, good or bad.

• Stay focused on the hard facts and figures, and don’t try to predict the future.

• Be prepared for the unexpected. Be open to adjusting course as circumstances change.

• Don’t let political events alone guide investment decisions.

• Ego is the enemy. Accept that we all make mistakes, and don’t let our ego stop us from changing our views and course of action as and when necessary.

Link to PDF here. 

1Q24 INVESTOR LETTER

Preamble – Random Musings Of An Aging Fund Manager

As I was staring vacantly into space (as I am wont to do), pondering the nature of today’s bull market, I found myself wondering why we use the terms “bull or bear” to describe the direction of the financial markets. Why not Chicken or Sea Cucumber? Anyway, according to the Internet, the terms bull and bear markets relate to how each animal attacks. A bull thrusts its horns upwards, while a bear swipes its paws downward. Riveting stuff. I’ll admit it wasn’t much of a revelation, but I suppose a possible takeaway is that we tend to accept certain “truths” without question. The earth was flat until it wasn’t.

(Electric vehicles will make conventional cars obsolete by 2035)

You’re probably asking what this has to do with the price of tea in China ($1.59 per kilo), and to be fair, I’m not entirely sure. The weather and waves in Hawaii have been uncooperative of late, so I’ve arguably had too much time on my hands. In any event, I think this underscores the importance of staying curious and questioning the prevailing wisdom. We humans can be a lazy bunch and are often happy to settle for the status quo, even when the facts have changed or are no longer valid.

Question everything. Learn something. Answer nothing. Euripides

Catch the Chicken. Cook the Chicken. Eat the Chicken. Cousin Peter

*for the record, he never actually said this, but I’m pretty sure he was thinking about it.

After years of evolution, most humans are hardwired to be cautious, often favoring the avoidance of loss over the pursuit of gain. We fear change. At Fort Street, we try to incorporate this psychological or physiological dynamic to enhance our investment approach as we strive to protect and grow assets.

Understanding human behavior is a crucial component of how we formulate our investment and trading strategies, empowering us to make informed decisions.

Who dares wins. British Special Air Service (SAS)

George Soros once said that it takes courage to be a pig. This is especially true in a herd sport like investing. The truly gifted money managers are not afraid to roam independently from the pack. So are the ones not playing with a full deck. There is a fine line between genius and becoming lion food.

Based in Hawaii and far from the madding crowd, Fort Street attempts to pursue its investment strategy with less distraction and temptation to conform. We just need to be mindful of not becoming shark bait in the process.

PERFORMANCE AND MARKET REVIEW

Speaking of shark bait, the waters were unexpectedly pleasant for equity investors in the first quarter of this year. Bonds, on the other hand, were caught in a tempest, as higher-than-expected inflation put the kibosh on hopes that the Fed will cut rates anytime soon. Why the markets obsess over what the Fed will or won’t do is beyond us; such a waste of time and energy. Rest assured that we do not base our strategy on the daily whims or utterances of the high priests at the Fed.

Our crystal ball has done a commendable job so far this year. While we did not predict that we would be on the precipice of a regional war in the Middle East, we did note that geopolitical risk was rising.

Equity markets continued to grind higher, clocking in a return of 10.16%. Over the same period, the Fort Street Fund was up 4.67%, but with significantly less risk. Our total equity exposure has averaged 55% this year, of which approximately 23% is in commodity-related stocks. The rest of our capital is spread out between bonds, cash, gold, protective strategies, and several externally managed specialized funds.

Despite being relatively bullish on the economy and equities, a variety of short-term and long-term risks has tempered our enthusiasm. The prospect of more inflation, higher interest rates, rising geopolitical tensions, stretched valuations, liquidity concerns, a polarized political climate, alien invasion (little green men), and a looming national debt crisis has led us to keep risk low across the portfolio.

In light of this backdrop, we are happy to invest in risk-free short-term bonds yielding 5% and spread our bets across a variety of assets and strategies. Coming to terms with our own fallibility, we are reformed egomaniacs. Our goal is not to beat the S&P 500 in all periods – we accept that we will often underperform during raging bull markets. As for the S&P 500 index, it is just one of our benchmarks – our main focus is on protecting capital in down markets and our ability to generate excess returns by taking advantage of falling prices. The portfolio is designed not to move in lockstep with the S&P 500, so our performance will often diverge on the way up and down.

THE MIDDLE EAST – AN INVESTOR’S VIEW

After more than thirty years as a market practitioner, I have learned that political events in and of themselves are generally not the arbiters of market prices. While they certainly affect sentiment and investor behavior, economic fundamentals are the ultimate determinant of price levels. Having said that, a direct war between Israel and Iran or an all-out war in the Middle East would likely send the global economy into a recession, ushering in a bear market for financial assets.

While certainly adding another layer of risk to an already volatile situation, our guess is that the current conflict will stay limited for now. Could we be wrong? Absolutely. Is the Fort Street Fund prepared for that possibility? To a certain extent, yes. Barring a major escalation in the Middle East, we are inclined to buy into a market that falls more on sentiment and less on actual economic data.

As a rule, we do not invest where the outcome is predicated on political factors. Decisions that are not based on economic considerations can lead to results that defy logic. It’s like gambling when you know the odds are stacked against you. This is one of the main reasons why we have minimal exposure to China. The Chinese government is making decisions that are more based on political objectives and not economic factors.

Our crystal ball is far from perfect. It’s not even made of crystal. How things play out is next to impossible to predict. As paranoid optimists, we can see the bull and bear case. Our sense is that an escalation is in no one’s interests and that cooler heads should prevail. We suspect many conversations are taking place that could create conditions for a more stable region. At the same time, a fair and durable political solution for everyone looks elusive. At the end of the day, we need to maintain hope, perspective, and, if possible, a sense of humor, although when people are dying, that is not so easy. I usually pray for surf (and ice cream). Today, I pray for peace.

FORWARD OUTLOOK

Cautiously Bullish: Despite recent inflation jitters and the Fed’s reluctance to cut interest rates, we remain relatively sanguine on the outlook for equities over the next 12 months. Contrary to the media headlines, the economy continues to chug along, and corporate profits are growing. Valuations for the broader market are not cheap, and certain sectors, such as tech, are priced for perfection and vulnerable to a correction. The situation in the Middle East remains fluid, and the recent surge in the VIX, the market’s volatility gauge, suggests that the road ahead could be bumpy. We would also point out that a lower base effect will probably keep inflation data somewhat buoyant, especially as we head into the second half of the year.

In bull markets, higher prices initially extend investor skepticism until the pain of not being invested (FOMO) and the data outweigh concerns that a bear market is just around the corner. A bear market is always around the next corner – or tree. It just depends on which tree we are talking about.

Market cycles: Sir John Templeton said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Our guess is that we are now in the maturing phase. Market cycles are inherently dynamic, so it’s hard to know with any certainty. The market’s path will gyrate as circumstances change. Stretched sentiment in and of itself is not reason enough for equity gains to reverse, but as the bull camp gets more crowded, weak hands can be quickly vanquished. We will, as always, tread carefully.

At the end of the day, trying to predict what the market will do in any given period is like nailing jelly to a wall. I’ve tried doing this at home with an assortment of jellies. The results speak for themselves.

Election Volatility: This year’s presidential election is likely to inject an extra dose of volatility into the markets. It doesn’t necessarily change our investment outlook, but it does suggest that we prepare for some potential turbulence. Clint and I have installed seatbelts on our chairs, and we often wear helmets in the office for extra safety. Mine is made of aluminum foil (aluminium for our British cousins) to prevent the aliens from further messing around with my brain and causing us to underperform.

Beyond the horizon: Part of our general thesis has been that we are transitioning to a more inflationary world. We are not saying that this is a foregone conclusion; we are just pointing out that it is a more than plausible scenario and that we want to ensure the portfolio is ready for whatever the future has in store.

Decades of excessively loose monetary policy and irresponsible fiscal spending, turbocharged by COVID-19, have created the preconditions for a period of higher prices. In addition, deglobalization, geopolitical tensions, dysfunctional political systems, populism, deteriorating demographics, wage pressures, and a looming national debt crisis could all conspire to fan the inflationary flames / stoke the inflationary embers. Conversely, we fully recognize that technological advances will help boost productivity and could offset many of these burgeoning inflationary pressures. While we are hopeful, we aren’t completely convinced that these productivity gains will be enough. Time will tell.

We recommend watching this interview with Jonathan Ruffer, the founder of the eponymous asset management firm (link here). Ruffer LLP is a unique investment house that provides an unconventional and uncorrelated strategy in a world dominated by conformity. In the interview, Jonathan paints a rather dreary picture of the long road ahead. Granted, their investment strategy is constructed to weather and ultimately profit handsomely during times of extreme duress. While we don’t agree with all their assumptions and expectations, we respect their approach and plan to increase our investment with them as time goes on.

Swiss Cheese School of Investing: In the event that Ruffer is 100% correct, the Fort Street portfolio should be able to survive and thrive. We liken our investment approach to adding layers of Swiss cheese, one on top of another, to help minimize risk.

Fun Fact: Why Does Swiss Cheese Have Holes?

In 1917, William Clark published a detailed explanation of how Swiss cheese holes were caused by carbon dioxide released by bacteria present in the milk. Clark’s idea was accepted as fact for almost

100 years — until a 2015 study by Agroscope, a Swiss agricultural institute, blew a hole right through his theory (pun definitely intended).

The eyes are actually caused by tiny bits of hay present in the milk, according to Agroscope researchers. This theory explains why the holes have mysteriously become smaller — and sometimes nonexistent — in recent years. When cheese is made in barns using open buckets, it’s likely that hay particles will find their way into the collected milk. It’s those little bits of hay that cause a weakness in the structure of the curd, allowing gas to form and create the holes.

“It’s the disappearance of the traditional bucket” used during milking that caused the difference, said Agroscope spokesman Regis Nyffeler, adding that bits of hay fell into it and then eventually caused the holes. Milk for cheese-making is now usually extracted using modern methods, which explains why we don’t see nearly as many holes in our Swiss any more.

COMMODITIES

While we are bullish on commodities in general as a hedge against inflation and for their underappreciated role during the transition to renewable energy, we also fully recognize that they are cyclical assets whose prices are prone to the invariable vagaries of supply and demand. Supply tends to have a way of increasing when demand spikes. It’s often just a question of time. However, we suspect that the run-up in commodities will be more than a fling, lasting longer than investors expect or are accustomed to. We subscribe to the notion that macroeconomic and structural changes could see a sustained period of outperformance, akin to the 1970s. Exxon’s market cap just overtook Tesla. A harbinger?

Fossil-fuel Consumption: While the fossil-fuel percentage share has declined, the absolute amount of fossil energy consumption rose by approximately one-fifth over the last 12 years. For all of the emphasis on renewable energy and electric vehicles—there is no escaping the utility and ubiquitousness of petroleum, petrochemicals, and other non-renewable energy forms, such as natural gas and coal. Meanwhile, governments continue to throw gobs of money into EV subsidies. As Ronald Reagan said, the nine most terrifying words in the English language are: “I’m with the government, and

I’m here to help.”

Outlook for Oil: Our sense is that today’s prices more than fully reflect the current conflict in the Middle East. If political tensions and the threat of a supply disruption dissipate, oil prices are likely to ease.

Additionally, the US presidential election and Saudi Arabia’s spare capacity may put further pressure on oil prices. Biden needs the economy to stay strong if he hopes to be reelected. High oil prices could dampen growth while hitting voters right in their wallets. Elections are often won or lost on the state of the economy. We expect to see the Biden administration continue to release more barrels from the Strategic Petroleum Reserves (SPR).

Furthermore, the current administration is frantically trying to secure the normalization of relations between Saudi Arabia and Israel. Such a deal would usher in a new security pact, the prospect for Palestinian statehood, and a slew of economic agreements; it would also conveniently translate to a higher chance that Saudi spare capacity would be brought back sooner than later. Everyone wins except for those speculating on a further spike in oil prices. As intimated above, Fort Street’s investment in oil is not tied to politics but to longer-term supply/demand considerations.

Nuclear Energy Update: The US could be on the cusp of a nuclear renaissance. The federal government will provide a $1.5 billion loan to restart a nuclear power plant in Covert, Michigan, following support from the state of Michigan and the Biden administration. It would be the first nuclear power plant to be reopened in the U.S. However, it still needs to obtain the blessing of the US Nuclear Regulatory Commission (NRC), which is anything but guaranteed. It’s instructive to note that President Biden, California Governor Newsom, and Michigan Governor Whitmer are throwing their political weight behind nuclear as part of their energy transition strategies. Perhaps this is a testament to the utter unworkability and unpopularity of a renewables-only approach.

Palisades Nuclear Power Plant in Michigan – restart your engines?

GOLD – SHINING BRIGHTER

The argument for owning gold has become more compelling. At Fort Street, we are neither gold bugs nor doomsayers, but we have held an average 5% position since our inception and will probably add more going forward.

Misconceptions about Performance: Gold has actually performed significantly better than popular belief. From 1971 to today, the dollar gold price has returned 7.98% annually. Yes, gold massively underperformed over the last 100 years, but that is simply because it was pegged at $35 before Nixon took the US off the gold standard in 1971.

Gold tends to get a bad rap, which we think is mostly unjustified. Admittedly, it is an unproductive asset that generates no income and, by default, is hard to value using conventional metrics. However, gold has played an essential part in our economies for thousands of years, a track record unrivaled by just about every other asset.

Inflation Hedge: Gold has shown its greatest effectiveness in preserving purchasing power when price inflation runs above 3% a year. During such times, the price of gold has increased by an average annual rate of 15.05%.

Capital Preservation:

Uncorrelated to stocks and bonds, gold is an effective way to preserve capital and limit portfolio drawdowns to capital during market dislocations. As a safe haven in times of crisis, Gold has a track record of holding its value or even rising when many other assets are falling. Gold was up 7.2% when the S&P 500 fell 23.5%. 

Fiat Currency Risk: While fiat currencies have helped facilitate the biggest economic expansion in history, they are neither bulletproof nor irreplaceable. Just about anything can qualify as a means of exchange and a store of value. Personally, I’d argue for mint chip ice cream. All kidding aside, this is partly why we shouldn’t reflexively dismiss the concept of cryptocurrencies. And why we have recently invested in Room40 Capital.

Many of us were either too young or not yet born when Nixon took the US off the gold standard in the summer of 1971. I’m sure a few of you out there remember the exact day (August 15). I was seven and blissfully unaware. My point is that the vast majority of us have become accustomed to our paper money being backed by the credit of the US government. What happens if that credit falters? I’m not saying that will happen; I’m just asking the question.

Rising Demand: Demand for gold is likely to increase in an increasingly bifurcated and unstable political world. China and Russian central banks have dominated fund flows over the last year or so, sending the price of gold to an all-time high of $2,315. As a percentage of individual savings in the US, gold accounts for approximately 0.5%. The forty-year average is 2%. A reversion to the mean would quadruple demand.

IN CONCLUSION

On a lighter note, here are the top 5 regrets of the dying from a book I recently read with the same title. Ok, I think I need to get out more. Nothing like a dose of reality to keep things in perspective and remind us to take the good wherever and whenever we can find it.

1. I wish I’d had the courage to live a life true to myself, not the life others expected of me.
2. I wish I hadn’t worked so hard
3. I wish I’d had the courage to express my feelings
4. I wish I had stayed in touch with my friends
5. I wish I had let myself be happier

I think I would add a few of the following to my list:

• I wish I stayed more active and healthy, exercising my body and mind.
• I wish I surfed more often – this one is debatable.
• I wish I listened to more live music and went dancing more often.
• I wish I had traveled more, learned more languages, and met more fun and interesting people.
• I wish I gave more money to those nice people at Fort Street Asset Management.
• I wish I was more present and spent less time worrying about small and inconsequential stuff.

Link to PDF here. 

4Q23 INVESTOR LETTER 

Last year clearly demonstrated the futility of predicting what the markets will do over a given period. Most so-called experts and talking heads were flat-out wrong in 2023. Everyone expected a recession, and no one thought the S&P 500 would be up in the mid-double digits. Basing an investment strategy on being able to predict the future is a fool’s game. 

“We’ve long felt that the only value of stock forecasters is to make fortune tellers look good.” Warren Buffett

Even though we were relatively bullish last year, we did not substantially dial up the level of risk in the portfolio, knowing that our views are far from infallible, despite what my mother says. Our investment decisions are made with a sober assessment of risks and opportunities based on the facts and are always subject to change as circumstances evolve. At Fort Street, we don’t swing for the fences, even when potential returns look compelling. Our strategy is not to hit home runs but to consistently get on base. We tend to check our swing even when we see a fat pitch. It is not an exciting or sexy strategy, but it has delivered impressive results over time while minimizing agita. Apologies to our non-American friends for the baseball analogies. 

FIRST BASE

Rising Risks: It seems we live in a riskier world with the status quo challenged at home and abroad. Global conflicts seem to be intensifying, and populism is on the rise. Higher interest rates and inflation could negatively affect the economy and investment returns going forward. Climate change and the potential for new health emergencies could also destabilize the political, economic, and societal landscape. In light of some of these threats and more, we have been spreading our bets across a number of possible outcomes and strategies to reflect the higher level of risks to markets. 

Human Behavior 

The one thing that is constant and predictable is human behavior. We are all driven by the same base-level desires and fears. Our species evolved based on our ability to cooperate as a group. Nothing like a jaunt through the African bush to realize that we humans don’t stand a chance alone. Yours truly experienced this first-hand when an elephant decided to attack during a walking safari in Botswana. Spoiler alert: I survived. 

Crowd Psychology

Millions of years of evolution have conditioned us to make decisions as a group and avoid becoming some animal’s dinner. This is probably one of the reasons why, as investors, we tend to stay bearish or bullish long after the market has turned up or down, respectively—safety in numbers. At Fort Street, we try to use human nature to our advantage, doing our best to resist the pull of the crowd without getting run over or eaten by a lion in the process. The reality is that while there is often safety in numbers, crowds can be dangerous. 

SAFETY IN NUMBERS 

Waiting for a Pullback 

Fortunes have been made (and lost) waiting for the inevitable pullback or market crash. Buying an asset only when it trades well below its intrinsic value is a bona fide investment strategy that tends to yield market-beating results when executed properly. However, it’s not for everyone. It requires having: 1) the ability to calculate fair value estimates; 2) the courage to buy when the bullets are flying and everyone else is running for cover; and 3) not chasing prices or caring about the fear of missing out (FOMO). Fort Street uses elements of this strategy. 

Keeping an Open Mind 

For all you doomsayers out there, we suggest not being too negative. We know it’s tempting to cash it all in, move to a remote island, and live under a rock. In case anyone is looking for a good rock on a remote island, we can help. While it’s understandable to be worried about the future, the end of the world always appears to be nigh. We are not saying that the sun will shine eternally, far from it. We are concerned about the state of affairs in the US and worldwide. We might be entering into an extended period of minimal returns, be on the precipice of a significant global conflagration, or maybe climate change challenges our very existence. The problem is that it’s impossible to predict these possibilities with any certainty. Will there be exogenous events that disrupt the markets and the economy? Absolutely. When and how will they occur? Who knows. Conversely, new technologies like AI could yield advancements that dramatically improve the human condition, the economy, and, hopefully, the planet. The Fort Street Fund portfolio is constructed to consider various risks and opportunities with an emphasis on safety. 

We’ve outlined a brief review of 2023 and our expectations for next year. Please note that the success or failure of the portfolio is not predicated on our 2024 outlook. 

YEAR IN REVIEW 

Alarming Headlines

The lingering effects of 2022’s bear market, war in Ukraine and the Middle East, a record rise in interest rates, a banking crisis, ongoing dysfunction in Washington, and the prospects of an imminent recession kept the vast majority of investors and market pundits in a risk-off mood for most of the year. Hiding all your money in your mattress or leaving it in a money market fund seemed like a good bet, especially with risk-free Treasury Bills yielding 5%. However, things are rarely what they seem or at least what the talking heads would have you believe. 

Encouraging Data

Conversely, falling inflation, peaking interest rates, strong consumer spending, and a pick-up in productivity kept the economy growing beyond most investors’ expectations. At the same time, investors moved a record amount of stocks and bonds into money markets. These massive outflows dramatically reduced the number of sellers, allowing the market to easily climb the proverbial wall of worry. Fort Street Asset Management

Magnificent Technology 

While a handful of large technology stocks (the Magnificent 7) drove a disproportionate amount of the market’s performance, there were still plenty of other opportunities outside this group. The emergence of AI as an economic and market force surprised everyone. Often, the things we least expect have the most significant impact. 

Pervasive Skepticism 

It’s not unusual for investors to remain skeptical in the first year after a bear market. After being mauled in 2022, investors took a more risk-averse approach in 2023, opting for the safety of calmer waters in high-yielding money market funds. Only in November, as the storm clouds dissipated, did investors dive back into the water, reversing fund flows back into stocks and bonds. 

FORT STREET – 2023 

Moderately Bullish 

While we recognized the various risks of higher rates, recession, geopolitical crises, and rich valuations, we also saw reasons to be optimistic. In particular, we expected inflation to dissipate and saw plenty of evidence that the economy remained resilient, if not robust. Despite the Fed’s efforts to tighten financial conditions, we also felt that money still seemed abundant. The cumulative wealth effect from refinancing during the Pandemic gave us confidence that consumers would continue to spend. 

Portfolio Highlights 

Risk assets exposure ranged from 50 to 65% throughout the year. 

We reduced the number of holdings in the core equity portfolio from 41 to 30. 

Allocation to cash and protection strategies helped minimize losses when the markets hit a rough patch in October. 

The core equity portfolio performed in line with the broader markets. 

Uranium, big tech (MSFT, GOOGL, CSU, AMZN), and the Indus Select (Asian) Fund were the biggest contributors to the portfolio. 

Oil, options, the Ruffer Fund, and cash were the largest detractors. 

Our bond portfolio also made a meaningful contribution this year. 

While we kept plenty of dry powder, we closed out all our protective options after the market bottomed out in October. 

OUTLOOK

Not wizards

We are not in the business of predicting markets, the weather, earthquakes, or who will win the World Series. We don’t pretend to be self-proclaimed truth-sayers, fortunetellers, sorcerers, wizards, feng-shui masters, augurs, or economists. We don’t use magic wands, crystal balls, economic models, tarot cards, price charts, lucky dice, or fancy college degrees; however, there are days when we wish we did. We don’t engage in tasseography (reading patterns in tea leaves, coffee grinds, and even wine sediments), examine the entrails of animals slain for sacrifice, observe the behavior of chickens, or watch for random signs in the creaking of a chair, a sudden gust of wind, randomly spoken words, sneezing, coughing, or falling down to help guide our investment decisions or peer into the future. Nor do we wear fancy outfits to help brandish our credentials, although Clint has been spotted wearing a cape—more of a Superman thing. 

Our Best Guess

As mentioned above, we will not try to impress you with grand proclamations about what will happen in 2024. Our guess (strong emphasis on guess) is that 2024 will be a more challenging year for stocks and bonds but that the S&P 500 could still end the year in positive territory. 

For bonds, the setup looks a bit trickier. Lower inflation is putting pressure on the Fed to cut rates sooner rather than later. It could become a bit more challenging to simply sit in cash as money market yields are likely to fall more than longer-dated bonds. Bonds tend to move in advance of the time the Fed actually starts cutting rates. Statistically, equity markets usually do well in an election year. However, the nature of this year’s election carries a higher-than-usual level of angst, which could lead to an extra dose of fireworks, hopefully only metaphorically. 

“Among all forms of mistake, prophecy is the most gratuitous.” -George Elliot, Middlemarch 

Fund Flows 

Statistically, the stock market usually goes up after the first strong year of a bull market as FOMO entices investors who missed out on last year’s bonanza to chase prices higher. Record fund flows started reversing as the bonds and equities rallied in November 2023. We suspect there are still many more funds to unwind as investors turn from fear to greed over the course of this year. 

Wall of Worry

The S&P 500 and Dow Jones Industrial Average just hit new highs, yet investors are clinging to a record $8.8 trillion in money-market funds and CDs. Amid election uncertainty and global tumult, investors remain concerned about elevated valuations, narrow market leadership, possible recession, and the prospect that lofty profit margins may revert to their historical mean. Despite the thunderstorms, the sun keeps peeking through. Bull markets like this are often more sustained and less volatile, given that neither fear nor greed dominates. Because of this uncertainty, they don’t feel like bull markets, underscoring the “worry” in “wall of worry.” In contrast, bull markets born of FOMO tend to soar and flame out faster and more dramatically. Their arc typically begins with nascent greed that cascades into euphoria and unbridled greed before investors capitulate, leaving rubble and tears in their wake. From where we stand, it could go either way. 

Inflation and the Fed

Inflation will likely continue easing over the next few months, exerting more pressure on the Fed to lower interest rates. We sense that the Fed will start cutting rates later than the market anticipates. When the Fed finally cuts, concerns about a possible economic slowdown could spark a selloff in the equity markets. We expect inflation to become more volatile in the year’s second half as year-on-year comparisons become more difficult. 

Labor and Consumers 

Labor markets still appear tight, indicating that the economy remains relatively robust. Unemployment claims are starting to creep up, so we must keep an eye on those figures. We have not seen any significant shift in consumer spending patterns, although there has been a substantial increase in auto payment defaults and credit card delinquencies. 

Elections 

The economy’s performance often determines the outcome of Presidential elections, so we expect to see the Biden administration do everything it can to goose the economy. Statistically, equity markets usually do well in an election year. However, the nature of this year’s election carries a higher-than-usual level of angst, which could lead to an extra dose of fireworks, hopefully only metaphorically. 

Valuations

Valuations for the broader market are certainly not cheap. Wall Street expects corporate earnings to grow 11.6% in 2024 and 12.5% in 2025. We think that might be too optimistic, but note these are only forecasts and are subject to change. We prefer to pay more attention to what companies say, which seems to be a better barometer of earnings growth. 

HK/China

HK/Chinese equities look cheap after recently hitting a five-year low. There is plenty of speculation that the government will take measures to boost the economy and the stock market. When or if that happens is hard to say, but we wouldn’t be surprised to see a rally at some point this year. However, we remain cautious, given the erratic nature of government policy. Just last month, they announced new restrictions on the gaming industry, only to reverse course a day or two later, causing a number of stocks to plummet and then recover. As we write, China finally announced long-awaited stimulus measures, which could spark a rally. 

Japan

In the land of the rising sun, we are encouraged by the pace and scale of corporate reforms. The chart on the right shows a sharp rise in corporate dividends and buybacks, reflecting a desire to boost shareholder value and investment returns, ultimately leading to higher prices. Despite a strong market performance last year, there are still many excellent Japanese companies that trade at reasonable valuations, 

We wanted to give a shout out to John Pinkel and his team at Indus Capital for helping us manage most of our Asian exposure. Indus was up 19.9% last year, outperforming their benchmark by 11.4%. 

Energy

The world’s failure to fully appreciate the ongoing need for oil, gas, coal, and nuclear power presents a compelling investment opportunity. 

Hydrocarbons – separating fantasy from reality

Despite ever-escalating rhetoric, an “energy transition” away from society’s dependence on hydrocarbons is not feasible in any meaningful time frame, and it is a dangerous delusion to base policies on the idea that such a transition is possible. Data, not aspirations, show just how critical hydrocarbons are. The Ukraine invasion was a wake-up call to the consequences of wishful thinking. A different understanding of “transition” is required, one that recognizes that new energy sources should be considered additives, not outright replacements, for oil, natural gas, and coal.

The core challenge for energy transition goals today arises not from policies or political philosophy but from the physics of energy and technology. Hydrocarbon use continues growing because coal, oil, and natural gas can provide the vast amounts of reliable, dispatchable energy that the world demands at prices consumers can afford. And, like it or not, that will continue to be the case for years to come. Intermittent wind and solar cannot replace oil, gas, and coal at scale. 

Uranium – the future’s so bright I gotta wear shades 

Uranium prices are up 90% over the last 12 months due to resurging nuclear power demand and years of underinvestment in new mines. After the Fukushima and Chernobyl disasters, uranium supplies were plentiful. A long-term supply overhang kept uranium prices well below the cost of production. Uranium was cheap and easy to buy. That’s no longer the case. 

The era of supply overhang is emphatically behind us. With little investment in new mines, expanding the uranium supply will take a long time. It can take up to a decade to open and restart mines. Inventories at the big producers are at record lows. Just last week, production giant Kazatomprom announced that a shortage of sulphuric acid was causing problems. This could have broad implications as they account for 43% of global production. 

Governments are finally starting to grasp that nuclear is the only cheap and reliable low-carbon power available. They are realizing that they will never get anywhere near net zero with unreliable, expensive, and politically divisive wind turbines and solar panels. 

Prices could stay elevated for a while. At the recent COP28 meeting in Dubai, twenty-two countries committed to trebling their nuclear capacity by 2050. And yet, uranium demand globally is expected to rise by 28% by 2030 and double by 2040. 

There is certainly some risk. Another accident or a technological breakthrough could dramatically change the current outlook and put the kibosh on a uranium bull market. According to a recent Bloomberg report, you are four times as likely to be eaten by a shark than injured in a nuclear accident. I suspect those odds don’t apply to those of us here in Hawaii. 

Argentina and populism

We are intrigued and encouraged by Argentina’s bold attempt to overturn over 50 years of ruinous populist and socialist policies. One hundred years ago, Argentina had one of the world’s highest GDP per capita. Unfortunately, the country embraced collectivism around the turn of the 20th century. It’s an utter shame that a country endowed with an abundance of natural resources and one of the most highly educated populations in Latin America is such a complete mess. The US and the West would do well to note what can happen when institutions and governments embrace populist or socialist/fascist ideologies. 

Unfortunately, it seems the world is heading in that exact direction. The conflicts in Ukraine and the Middle East could lead to an escalation of hostilities that ignites a much broader conflagration. The rise of anti-semitism and the world’s absurd reaction to the massacre on October 7 and Israel’s right to defend itself is an ominous harbinger. As an Israeli comedian recently said, “People hate us again. What happened to never again”? We at Fort Street proudly stand with Israel and applaud leaders such as Argentina’s new President, Javier Milei, for standing up and making their voices heard. We hope you all do the same. 

“The opposite of good is not evil, but indifference” Elie Weisel.

Market Risks

Inflation spikes, causing the Fed to reverse course and raise rates again. 

Escalation of conflicts in the Mideast, Ukraine-Russia, or China-Taiwan. 

Long and variable effects of last year’s rate hikes spark a credit crisis, a rise in unemployment, or a slowdown in consumer spending, triggering an economic downturn. 

The presidential election in the US leads to some unforeseen events. 

A Biden or Trump White House exacerbates profligate fiscal spending. 

The Mets don’t make it into the playoffs. 

Aliens invade Earth again. 

CONCLUSION

We often discuss trying to be prepared for the punch you don’t see coming. The reality is that it’s impossible to be fully protected against whatever challenges the markets or life decides to throw at you. We have to stay alert and be ready to react and adapt. Our philosophy is to strike a reasonable balance between risk and reward, keeping an open mind to the opportunities and the dangers. Eliminating all the risks guarantees no rewards – where is the fun in that? 

“It’s not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.” Charles Darwin

Getting better 

We would like to report that our fund and company continue to grow and improve at what we do and how we can help our clients and friends. We are constantly working to improve the portfolio and provide the best service possible to our investors – adding new strategies, expanding our knowledge network, upgrading our marketing and communications, and ensuring we have the right resources to complete our mission. As we head into 2024, we feel increasingly confident in our ability to protect your assets and ensure they grow at a more than reasonable rate of return. As always, we are grateful for your trust in us and all your support. Please know that we are here for you in any way we can help.