4Q 2023 – Be Careful What You Wish For
2023 was one of the most interesting in the history of financial markets. The Federal Reserve war on inflation was center stage, but so was the proliferation of artificial intelligence and we were reminded of the horror that can be created from geopolitical upheaval.
The stock market rallied on both the hope that the Federal Reserve was approaching the end of their rate hiking cycle and the anticipation of higher productivity that would come from artificial intelligence. The ironic thing about both factors is that they directly lead to the title of this quarter’s letter, Be Careful What You Wish For…
On the artificial intelligence (“AI”) front, people are very excited about how productive we will all be with AI. And they are right, but they may not have thought entirely about how much of an impact that will have on jobs … Be Careful What You Wish For … Yes, we want AI to make all our lives and businesses run more efficiently, but we know there will be a tradeoff, which is not likely fully appreciated by investors.
With regards to the rate cycle, the markets are hoping that the Federal Reserve banks around the world have pulled off the “Goldilocks scenario,” where inflation is controlled but the massive hike in interest rates does not cause a recession. Unfortunately, history is not on the side of that optimism. That was the main point of our keynote presentation for the amazing Themes for 2024 event we hosted in Houston on January 18th, with more than 500 people from all over the world in attendance.
This year we started Themes a day early with an artificial intelligence workshop, in addition to a behind the scenes tour and cocktail reception on the field at Minute Maid Park (home of the Astros). The day of Themes consisted of fireside chats with many of the partners for our major Thematic investments, such as GP Stakes, Healthcare, Energy, Disruptive Technology and Professional Sports. We learned much about the geopolitical landscape from the recently retired Chief of Staff of the U.S. Army, General James McConville. The evening session featured an overview of our outlook for 2024 and our keynote fireside chat with the one and only Tony Robbins.
The presentation from our main event is included later in this letter and it will provide you with a bevy of charts and information about where we are in this economic cycle. We discussed in vivid detail why we believe the Federal Reserve is in a box and how we feel the 1980 debacle is haunting the minds of central bankers around the world. Yet, investors are clearly anticipating a sharp and rapid decrease in interest rates … Be Careful What You Wish For … as the only real way the Fed can aggressively cut rates is because of a deep recession or a geo-political event … We also illustrate clearly how valuations are not our friend right now and how history would indicate that traditional stock market investments will have a very difficult time achieving attractive returns over the next decade.
There are four things we believe investors must consider:
1. The reality that we believe the Fed will be forced to keep interest rates higher than people think, for longer than they expect.
2. Definitive uncertainty that is caused by the escalating violence around the globe, including the very real possibility of direct conflict between the United States and Iran.
3. A looming election cycle that is unlikely to go smoothly, regardless of who wins.
4. Valuations that are stretched and vulnerable to repricing from any/all the previous points.
It is for these reasons, and more, that we remain a “1” on the CAZ Scale, and we strongly believe that the risk/reward in traditional risk assets is not favorable. Make no mistake, there are dislocations in the public markets that are very interesting, but we continue to believe that the current opportunities in the private markets are significantly better than what is offered in plain vanilla investments. This is especially true considering how much more attractive the opportunities are in the private markets than we have seen in quite some time.
We are very concerned about stagflation, as we know that is historically the worst possible environment for both stock and bond investors. Thus, we continue to allocate our personal capital to investments we feel will persist in most any economic environment.
To help you efficiently understand precisely how and where we are allocating our personal money, we have also added to the bottom of this letter a summary from the Themes event. This will contain key takeaways from each of our various topics/speakers and covers a broad range of subjects and the economy.
Themes is always designed to be on the 3rd Thursday of each year, so we are scheduled for January 16, 2025, in Houston. Please hold it on your calendar as we would love for you to join us for what is a unique opportunity to hear from some of the greatest living investors, all in one place in one day.
On the housekeeping front, you will notice a few new improvements in your statement and the InvestorFlow portal. To continuously improve the quality and comprehension of our investment reporting, please note the following changes, which begin with this reporting cycle:
1. To reflect the design of the vehicles more accurately, we have updated all references from “Liquid Funds” to “Evergreen Funds” and from “Illiquid Funds” to “Drawdown Funds.”
2. We have also changed our approach to reporting for our “hybrid funds,” which are evergreen funds that invest in underlying drawdown or long-lived private investments. We have historically included those “hybrid funds” within our Drawdown Fund construct and reported performance using Multiple on Invested Capital (“MOIC”). This was not an ideal fit, considering that the vehicles accept new capital quarterly. Therefore, we are including them with the Evergreen Fund construct and reporting performance using the industry standard Rate of Return methodology.
The changes will be visible immediately in your statement and the InvestorFlow portal will reflect the changes over the next few weeks. If you have any questions, please reach out to your primary contact at CAZ and we will answer them immediately.
We look forward to a very productive year and are very grateful for your partnership. Please let us know if there is anything we can do for you. All our very best!
The Team at CAZ Investments