All You Need To Know About Markets This Week

Weekly Issue

Editor’s Note: This macro update went out to Tim’s paid Flagship Report subscribers earlier this week in video form. Given how volatile markets are right now, we felt it was important that everyone get a chance to see this. To get access to Tim’s macro updates and investment system that covers every life stage as soon as they’re updated, click here.

The week began with a bang. Markets opened sharply higher in what looks, feels, and smells like a classic risk-on Monday. Whether that momentum holds as the week progresses is another matter entirely.

The president went on record saying that conversations with Iran are underway and progressing well, suggesting a deal is within reach. He indicated that bombing of important infrastructure and energy projects would be halted for the next five days.

Iran responded emphatically, and the word "emphatically" is doing a great deal of work in that sentence. Tehran stated that there are no discussions with the United States, that no deal is being considered, and that full retribution against their enemies remains the order of the day.

Iranian officials dismissed the president's comments as psychological warfare, plain and simple, describing them as an attempt to jawbone the price of oil lower while buying time for further military operations. The president, for his part, clarified that he is not speaking with the Supreme Leader directly, but rather with important people inside Iran whom he believes represent leadership. That clarification did not exactly put minds at ease.

That sequence of events brought to mind a scene from the end of the original Raiders of the Lost Ark. Indiana Jones sits across from a panel of government officials and reports that the Ark of the Covenant is in the hands of "top people." The very next shot shows the Ark being loaded into an unmarked crate and wheeled into some vast, anonymous warehouse in the middle of America.

The market is rallying on the current situation.

Hope that analogy proves wrong.

We have discussed this pattern before. Some of the most violent, face-ripping rallies occur within broader counter-trend moves. The level to watch on the SPY is 662. A close above that level would recapture the 200-day moving average that the index surrendered late last week.

As of this writing, the SPY sits at approximately 658.78, which means there is still some work to be done before that objective is achieved.

The noise surrounding all of this is, to put it charitably, extraordinary. Depending on which screen you are watching or which feed you are scrolling through, this is the end of the world or the greatest, shortest war in history.

It is the best thing that could ever happen to the United States or the worst thing that could happen to the Middle East.

It is great for stocks and terrible for stocks.

It is wonderful for bonds and catastrophic for bonds.

It will lock in the Republican Party for the midterm elections or cost them dearly at the polls.

Everybody has an opinion. Everybody has a coat and tie on television, or a strong internet connection without one, and they are more than happy to explain exactly what is going to happen next.

Last month, the experts were nuclear engineers and global trade specialists. This month they are Middle East analysts. They know Iran's defense capacity in granular detail. They understand precisely what the conflict means for oil and gas fields throughout the region, what that means for your wallet, and how quickly it can be converted into their wallet.

There is a lot of noise out there, and nearly everyone generating it is absolutely certain they know what is going on.

All of this brings to mind Plato's Apology, which recounts the life and trial defense of Socrates in Athens around 399 BC. A friend of Socrates traveled to the Oracle at Delphi, one of the most important religious sites in the ancient world, essentially the artificial intelligence of its day, and posed a direct question: is there anyone wiser than Socrates?

The Oracle answered that no one was wiser.

This confused Socrates considerably, because Socrates was actually smart enough to doubt his own wisdom. Rather than accept the Oracle's verdict and move on with his life, he went out and tested the theory.

He sought out the people of Athens who were considered the brightest and most important: the politicians, the writers, the thinkers, the prominent voices of the day.

The Fox News hosts and the MSNBC anchors of ancient Athens.

The Taylor Swifts of their era.

He engaged them in conversation using his characteristic method, asking questions, then asking why, then asking why again, peeling back layer after layer to find out how much these people actually knew.

What he found was that they knew the surface of things. They believed with great confidence that they understood far more than they did. They spoke with authority about justice, virtue, and truth. About who was going to win the Super Bowl and what the war in the Middle East meant for markets over the next six months.

Not in those exact terms, obviously, but the behavior was identical. Their knowledge did not survive careful questioning. It was shallow, inconsistent, and built on assumptions that had never once been tested.

Socrates concluded that he may not be all that wise in absolute terms, but he is wiser than the leading lights of Athenian society for one reason only: he does not think he knows what he does not know.

That is probably the most important statement in the entire dialogue, excluding perhaps his calm acceptance of the hemlock at the end, which was its own kind of statement.

This dovetails beautifully with Peter Lynch's famous observation that if you are investing in stocks, REITs, small banks, or anything else, and you spend more than thirteen minutes a year thinking about the economy and the macro outlook, you have wasted ten of them.

Three minutes is all it takes. The rest is noise.

Charlie Munger once compared macro analysis and technical analysis to the ancient practice of slicing open a chicken and reading the entrails to predict the outcome of a battle or the direction of the stock market over the next six months.

Munger's comment was simple and devastating: we do not do that, because he knows what he does not know, and he knows that the macro future is simply not knowable with any reliability.

What we can do is pay attention to the two or three things that actually matter: valuation, credit, and fundamental momentum. When we keep those three things front and center, we have the discipline to sit through exactly the kind of madness that has characterized the past month.

When the market sold off, we did not panic. We did not liquidate positions. We went line by line through the Small-Cap Momentum portfolio and asked the only question that matters: are the fundamentals still strong? Is the fundamental momentum still intact? The answer was yes across the board. We kept every position.

We took a beating. This week we are reaping the rewards, with many of those holdings posting double-digit recoveries.

The Small-Cap Deep Value review asked a different but equally straightforward set of questions. Has the credit outlook changed for any of these holdings?

Are people going to drink less coffee? Use less lumber? Buy fewer toys for their children? Will there be materially larger losses on insurance policies?

Are people going to stop riding motorcycles because there is a war in the Middle East? Will people in the United Kingdom and Europe eat less food?

The answer to all of those questions was no. The credit profiles were unchanged. Every holding retained the ability to pay its bills. No contracts were lost. Nothing dramatic or irreversible occurred.

There were not many new bargains created in the chaos, but there were a few, and we moved in and purchased them. That is how this works: when bargains appear, we buy them. When they do not appear, we hold what we own.

The REIT portfolio received the same treatment. Did anyone move out because of war in the Middle East?

Are higher oil prices going to reduce demand for refrigerated warehouse space?

Will this keep people from visiting the grocery store or the barber shop in their local community?

Are residents going to vacate their apartments in favor of tents?

The answers were uniformly no. The ability of our REIT holdings to pay their bills was not impaired. No refinancing situations arose that would force management to pay excessively punishing rates.

As long as those answers remained no, we held the positions.

We also added some positions last month that simply became too cheap to ignore. These are companies operating in excellent segments of the real estate market: refrigerated warehouse space, industrial properties.

Management teams with exceptional track records..

Every one of them was trading well below net asset value.

The decision was easy because the framework made it easy.

The Fixed Income portfolio did experience a sharp little sell-off in bonds, but nothing reached the threshold where we felt compelled to act.

Several positions got close. Had there been another significant down day in the bond market, buyers would have likely been a buyer. We are keeping close watch and actively looking for an opportunity to add to that portfolio when the market provides it.

We do not force things here. We have rules. We have checklists. We apply them to every situation, every week.

The featured topic of this week's full edition is a deep review of the REIT portfolio, and we will also examine the macro backdrop for real estate, which may well represent the early stages of another golden dawn for the sector. That phrase circulated a couple of years ago and it is worth revisiting, because we believe we are in the bottoming process for real estate investment trusts.

Worst case, we are far closer to the bottom than the top.

Predictions about the precise timing of the turn or the magnitude and smoothness of the recovery are not on offer here. What is on offer is the observation that we can buy excellent office properties, quality apartment complexes, full warehouses, well-run hotel chains, and medical office buildings where patients keep showing up with admirable consistency, all of it throwing off substantial cash that flows into accounts every single month.

That is the story. The full analysis will be in this week's edition.

On the macro backdrop, here is the honest summary: we know that inflation was elevated before this began. We are fairly confident, based on the math, that the Federal Reserve cut interest rates more aggressively than current economic conditions warranted.

We know that valuations for the broader market remain quite high by historical standards. None of that has changed. When it does change, we will take whatever actions the new situation calls for.

Predictions about what the economy will do next are not available here, because honest predictions on that topic are not available anywhere. The outcome of the trade policy negotiations is genuinely unknown.

How the situation in Iran resolves itself is genuinely unknown.

What is knowable is valuation. What is calculable is the credit condition of the things we buy. What is observable is momentum, both in the fundamentals and in the price of the securities we own. What is trackable is the general trend of stocks and bonds.

Get those four things mostly right and the results follow.

Get two of them right and we will beat the market by a meaningful margin.

Get one right and we will probably be at or slightly above the market. Get three right consistently and the returns become genuinely extraordinary, but the ride will be bumpy.

That is the bargain we have accepted by operating out on the extremes: Small-Cap Deep Value, Small-Cap Momentum, Real Estate, and Alternative Income.

These are not mainstream strategies because they are not smooth strategies. The mainstream loves low volatility. The mainstream loves being in the middle of the pack, right where a gazelle positions itself to avoid getting picked off.

More importantly for the professionals on Wall Street, being in the middle of the pack means nobody gets fired. When everyone owns the same things and they all decline together, careers survive.

Career risk has always been, in this observer's view, the single largest force shaping behavior on Wall Street.

When surveying all of this madness, the most important discipline is the Socratic one: know what you do not know. Invest accordingly, anchored to valuation, credit, fundamentals, and trend.

Everything else is noise, and there is more noise right now than usual.

Take a close look at the real estate section of this week's full edition. The setup in REITs right now represents one of the more compelling long-term opportunities we have identified in years.

Patient, aggressive investors who are willing to sit through some turbulence to get where they are going have an excellent chance to make an enormous amount of money in this portfolio. The cash flow is already arriving. The discount to net asset value is already in place.

The rest requires only discipline and time.

Thank you, as always, for being part of the adventure. We will talk again very soon.