The following is an excerpt from Eagle Point Capital’s Spring 2024 letter to clients. Every six months, EPC writes to clients to explain what we own and why we own it. The portfolio-specific portion of each letter is for clients only. Please contact us to learn more about investing with EPC.
“Bull markets climb a wall of worry; bear markets slide down a river of hope.”
– Wall Street proverb, Anonymous, 1950s
In investing, as in life, the coast is never clear. Certainty only exists in hindsight. Hindsight makes outcomes seem obvious and inevitable, so it’s easy to forget how murky the future always appears. The best time to buy is always when the news looks ugliest.
Do you remember October 12th, 2022? We sure don’t. The S&P is up 44% since then. Here were the Wall Street Journal’s headlines that morning:
“Stocks Slip After Fed Minutes, Inflation Data”
“The Federal Reserve Slams the Brakes and Risks Spinning Out”
“Stocks Move in Lockstep as Fed’s Rate Increases Show No Mercy”
How about March 23rd, 2020? The S&P is up 130% since that day. Again, the WSJ headlines:
“Senate Fails to Advance Coronavirus Rescue Package for Second Day”
“Mortgage Firm Struggles to Meet Margin Calls as Market Turmoil Continues”
“Stock Market Meltdown’s Historic Velocity Bruises Investors”
“U.S. Stocks Drop Despite Fed’s Latest Stimulus Move”
“The Fed Steps Up but Can’t Save Economy on Its Own”
Here’s March 9, 2009. The S&P is up about 600% since then.
“Tech Drop Takes Down Stocks”
“Nikkei at 26-Year Low”
“Unemployment of 8% is highest in 26 years”
“New Fears as Credit Markets Tighten Up”
Let’s end with something more recent: October 27th, 2023 – not even six months ago. The market has rallied over 25% since then.
“Stocks Log Another Weekly Loss as Market Mood Darkens”
“Inflation Trends Keep Fed Rate Hikes on Pause”
“‘Disappointed Again’: Ad Companies Suffer as Tech Firms Clip Spending”
How many people felt, on any of these days, that the coast was clear and it was THE time to pile into the stock market? Was it obvious at the time that generational returns lay ahead?
The WSJ’s headlines sure didn’t give investors the green light to invest. It would have been much easier to sell on these headlines. But selling at any of these junctures would have been a costly mistake.
To avoid cherry picking, let’s look at headlines during a year where nothing noteworthy happened – the good old days of 2019. Pundits refer to 2019 as the last “normal year,” but people were worrying incessantly in 2019, too.
Here is how Barron’s opened their January 2019 cover story:
“It was a dark and stormy day. No, we’re not referring to the weather, which was perfectly chill for early January, but to the tenor of the conversation at this year’s Barron’s Roundtable, our annual investment talkfest and stockpickathon, featuring 10 of Wall Street’s smartest investors.
Consider the panoply of problems on which our panelists dwelled: a rising ocean of corporate and government debt, a debilitating trade conflict, fake earnings, tech disruption, political paralysis, the withering of the middle class. Might as well cue the demise of the Western world, which, by the way, also came up for discussion.”
That sounds rather bleak. Barron’s “experts” were girding for a tough year. In 2019 the S&P 500 returned a little over 31%.
Of course there was something big to worry about in 2019: the global pandemic approaching our doorstop. No one was talking about that, though. The biggest, most impactful risks are always the ones that no one sees coming.
There Is Always A Reason To Sell Stocks
In 2016 Morgan Housel published a chart, reproduced below, outlining all of the “smart” reasons to sell stocks during a period where stocks returned 100x after inflation.
All of the events Housel highlighted were objectively bad. Selling stocks and waiting for the storm to pass would have sounded smart at each juncture, but would have turned out to be dumb. Markets tend to rise over time despite dreary headlines, negative events, and doom and gloom prophecies. Why? People, companies (especially high-quality ones), and nations adapt and evolve.
Case in point: COVID-19.
On March 11, 2020 the WHO declares COVID-19 a pandemic.
250 days later, on November 16, 2020, the FDA found that Moderna’s vaccine was 95% effective.
28 days later, on December 14, 2020 Sandra Lindsay, a nurse in New York, became the first American outside of clinical trials to receive a COVID-19 vaccine.
89 days later, on March 13, 2021, over 100 million COVID-19 vaccines had been administered in the US (in no small part thanks to McKesson).
In almost exactly a year the US solved what initially appeared a hopeless situation. Vaccines typically take 10-15 years to develop, but when the stakes are high people find a way to cut through red tape and get things done. It’s a miracle that has happened again and again in America, from the colonists defeating the British to American factories retooling seemingly overnight to build weapons for World War 2.
How Eagle Point Manages Uncertainty
Trying to predict unknowable events and assess when the coast is clear is a fool’s errand. It’s akin to market timing. We don’t try.
We manage uncertainty by owning businesses that can survive and thrive during virtually any environment. We prefer what Allan Mecham calls “cockroach-like businesses”: very hardy and almost impossible to kill. They may not be pretty, but they have stood the test of time and will likely be here long after we’re gone.
We own businesses with strong competitive positions that can confront uncertainty from a position of strength. For example, businesses with pricing power – those that can raise prices without losing volume, like AutoZone – can navigate a variety of stressors relatively pain free. Labor costs rising? Raise prices. Raw material prices rising? Raise prices. Taxes going up? Raise prices. Pricing power is a great lever to be able to pull and makes being a business owner much more comfortable.
Rather than fearing uncertainty, we embrace it. Uncertainty can create low valuations and low valuations can create asymmetric investment opportunities. Ben Graham taught that “the purpose of a margin of safety is to render the forecast unnecessary.” When pessimism is so rampant that valuations already reflect the worst-case scenario, stocks can become a “heads I win, tails I don’t lose much” investment.
The next time alarming headlines or “high” stock prices (whatever that even means) give you the urge to sell, think like a business owner. This is, after all, what investing in common stocks makes you.
If you owned a collection of 10 local businesses, all with sound economics and durable cash flow, would you be on the edge of your seat waiting for the latest Federal Reserve policy statement to decide whether or not to sell your businesses? Would you sell your town’s pharmacy, or local Domino’s Pizza franchise, or corner convenience store, because Israel is at war with Hamas or because a strong jobs report could lead to higher interest rates? We sure wouldn’t, so why do so many people consider selling their minority interest in these same businesses via the stock market?
We like Housel’s advice for dealing with a perpetually gloomy outlook where there is always something to worry about: if something is unlikely to matter five years from now, do not spend five minutes worrying about it today. Very little ends up passing this test, as the WSJ headlines we shared show.
One of our favorite investment scenarios is to buy when a wonderful company encounters a significant but temporary one-time problem. Uncertainty and fear can quickly drive the stock’s price down 50% or more. The price may be attractive, but prices never fall in a vacuum. The attractive price always comes paired with a high dose of uncertainty.
When this happens we ask: was it really a one-off event, or is the business model broken? If the business has a strong and strengthening competitive position, we will typically buy. That’s what we did when Dollar General tumbled in 2023. Though margins had fallen, the company’s long-term competitive position was, as far as we could tell, as strong as ever. If that was the case, its margins were not structurally impaired and would eventually recover, even if that meant waiting several years.
There’s a natural tendency to want to wait to buy until the coast is clear. Lots of investors wanted to wait to see DG’s margins normalizing before buying. But by the time that happens, prices are almost always dramatically higher. Indeed, Dollar General’s stock is up 50% off its lows now that margins are beginning to perk up.
We’ve had countless investments play out like this, including McKesson, DaVita, and Meta, to name a few. Often there will be no debate among knowledgeable investors that the stock is undervalued. Yet, they won’t buy. Many investors refuse to purchase what they admit are clearly undervalued stocks because they are afraid the stock price might decline further over the next few quarters and they will look foolish. Fortunately, thanks in large part to our investor base, Eagle Point Capital has not and will not suffer from this phenomenon.
As Seth Klarman has reminded investors, when presented with an attractive price, the correct course is to act, even if it means accepting the chances that the stock will become even cheaper after you’ve purchased it. In other words, don’t wait until the coast is clear.
"Sometimes buying early on the way down looks like being wrong, but it isn't. You must buy on the way down. There is far more volume on the way down than on the way back up, and far less competition among buyers. It is almost always better to be too early than too late, but you must be prepared for price markdowns on what you buy."
– Seth Klarman, Margin Of Safety
There is no more clarity today than there was a year ago. There will be no more clarity at this time next year, either. If today’s worries clear up they’ll be supplanted by the worries of tomorrow. This worrying whack-a-mole reminds us of a cartoon that Howard Mark frequently references.
The coast is never clear, which is why we like to buy cockroach-like businesses selling for a price that does not require the coast to be clear, now or in the future.
Do you have a “stranded” 401k from a past job that is neglected and unmanaged? These accounts are often an excellent fit for Eagle Point Capital’s long-term investment approach. Eagle Point manages separately managed accounts for retail investors. If you would like to invest with Eagle Point Capital or connect with us, please email info@eaglepointcap.com.
Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.
Love the chart from Morgan Housel. Sometimes you just need to look at those charts over an extended period of time. I've made the mistake of selling too quickly and you never forget it when the stock you sold ends up continuing to run upwards.