Greetings from the Northwest!

As we welcome the new year, let’s briefly consider how exceptional 2023 has been. Thanks to strong El Niño conditions in the Pacific, the drought in California has been quenched, Washington has a state new record Mahimahi (a tropical fish often associated with Hawaii), and at this point no snow so far in the western Oregon or Washington valleys. It’s been warm and wet. 

Things were equally warm with securities markets, leaving many well-known economists, fund managers, and writers trying to dissect exactly why the year ended so much better than most predicted. Remember that the bank crisis (yes, that was in 2023), rapidly rising rates, high security valuations, inflation, global tensions, and a slowing world economy would combine to pummel stock prices? It didn’t happen; instead, we finished a year that provided solid gains in many asset classes. Some of the showy numbers, like the NASDAQ’s 54% gain, or the S&P’s 26%, were somewhat deceptive, in that they were driven to a huge extent by a very small number of headline stocks, and the NASDAQ’s eye-popping gains came on the heels of an equally bad selloff in 2022, so it’s pretty much where it was two years ago.

Can it continue? Sure, but many of the concerns about overvaluation, a slowing economy, higher rates, etc., are still valid, even more so now. Much of this stock price enthusiasm was encouraged by the belief that the Fed will begin easing rates soon. They may not. I don’t think they should. The Fed has managed to take us from zero rates to something more in line with historical averages, and in so doing regained a useful tool to help us through times of crisis. We are not in crisis and haven’t been for a couple of years, yet governments at all levels have been spending like the end was nigh: another possible cause of the flourishing markets, and something that is unlikely to continue. The world’s supply chains are mostly back up to speed and shouldn’t be a significant driver of inflation going forward. When the seemingly endless flow of unfunded government payouts and backdoor bailouts ends, things are likely to become more challenging for consumers and smaller businesses. I look forward to Patrick’s more nuanced take on some of these topics.  

Here at home, we were honored by a long-time client and his daughter, to be presented with a digital rendition of a cairn photo that we now have hanging in our Vancouver office. Sarah Haftorson is the amazing, upcoming, digital artist who created the picture you see below. You can find out more about her and the process she employs at sarahhaftorson.com.

The 4th quarter of the year topped off a solid 2023 for broader equity markets with the S&P 500 rising over 11% for the quarter and over 26% for the year. Small Cap and International stocks also returned a respectable 16% and 18%, respectively. Bonds started the year poorly, with interest rates continuing to rise for the majority of the year, but the drop in rates that took place in the final two months saw their return move into positive territory at 5.5%. Up until the end of October, equity market performance could be characterized by the “Magnificent 7 (Apple, Microsoft, Meta, Alphabet, Tesla, Nvidia, and Amazon)” and then everyone else. The chart on the right shows the performance of the Mag 7 versus other broad indices. We have talked a lot about the lack of participation during this bear market rally that started at the end of 2022 and how unhealthy such an environment is for markets. So, if there is one silver lining to the recent rally that started on 10.27.23, it is that it has been very broad across numerous asset classes and sectors. The reason I say “one silver lining” is that the recent exuberance in equities is being driven mostly by investors’ hope that the Fed will return to a time of extremely low interest rates and that the inflation war has been won. That exuberance is not driven by drastically improving fundamentals. When you look at the data, the S&P 500 rose 16.21% from 10.27.23-12.31.23, while the S&P 500’s Price / Sales valuation multiple rose 20.19%. Euphoria is indeed alive and well, thanks to the Fed signaling a pivot in monetary policy.

To end the year, the futures market is pricing in almost seven rate cuts in 2024. As you can see in the chart below, there are only eight Fed meetings during the year, so the market is assuming one rate cut starting in March and for every meeting that follows during a time when Core CPI is double the Fed’s long term 2.0% target. Not to say that cannot happen, but equity markets had better be careful what they wish for. If the Fed is cutting rates seven times in 2024, then my bet is that something alarming happened in the economy, causing the need to stimulate growth, which would not be a good thing for equity markets. This makes the biggest risks heading into this year – outside of extremely high valuations (touched on next) – that interest rates and inflation will stay HIGHER than the market is anticipating.

During times of excitement and euphoria, investors tend to forget that valuations and the price you pay for the value of an investment are the main determiners of your long-term return, not the story being pitched at the time. We wrote about Cisco Systems last quarter, as many investors remember the Tech Wreck in the late 90’s, but this type of behavior has been happening for decades. In the 1970’s a story was being told about the Nifty Fifty stocks that is quite like the story being told about the Mag 7 now. It didn’t matter what price you paid for these darlings because they were innovators and would be around for many years to come. IBM is a perfect example of the narrative being presented. Yes, IBM was changing the computing world with growth rates that would match their innovation and impact on technology. In fact, IBM’s revenues grew from $6.88 billion in 1968 to over $34 billion in 1982 (close to 500%). In 1968 Business Week wrote about the exciting growth of IBM and how it compared to other companies:

From the start of 1968, shareholders were rewarded with a price decline over 5% during the coming fourteen-year period, right in line with the S&P 500. Whether it is a company or an asset class, negative returns can be realized over a long-term investment horizon if you pay too dear a price.As Mark Twain is said to have opined, “History doesn’t repeat itself, but it often rhymes.”

Currently, equity valuations are high, with the S&P 500 index price-to-revenue multiple higher than at any point in history outside of late 2021 and 70% above its long-term median.

With high valuations and euphoric expectations about future growth and interest rates, risk of loss is higher than normal. A disciplined investment process with a focus on risk management will be paramount in navigating the years ahead.
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This is not to say there are not opportunities. Today, we still own high-quality companies that are trading at reasonable valuations; we combine those investments with asset classes we feel offer attractive valuations over the intermediate term. Fixed income is much more compelling than it was a few years ago, but we are still holding most of our allocation in short maturity debt based on the risks we discussed above. We also hold a large portion of the portfolio in cash via money markets, since the interest rate is high and it provides us with the optionality to invest in other long-term investments when prices are attractive. Our conservative positioning will not last forever. Market environments will change, and we will be ready to deploy our higher cash balances when valuations are lower or euphoria in the market has dissipated. Thank you for your continued trust and please do not hesitate to contact me directly if you have any questions or want to discuss any topics in more detail. —Patrick Mason

​Thanks, Patrick. As always, we’re open to discussing any and all of these topics, and would enjoy having you in the office to discuss your investments and plans. The coffee is always hot and free.

Happy Trails,

Tim Mosier, President
​Cairn Investment Group, Inc.

Greetings from the Northwest!

How quickly things get back to normal; the weather, I mean, not the economy. As I begin writing this it’s a blustery and wet fall day that serves to remind me that all things, good or bad, must eventually come to an end. Of interest to us all is where our economy is headed, something that will be determined by our collective adaptations to the higher interest rates and just how badly the embedded cost increases of the past years will affect the spending power of the middle class. 

While employment seems to be hanging on, many effects of the higher rates are just now being felt and are already sending out warning signals. Credit card delinquencies and defaults have risen to levels not seen since the “Great Recession,” and that can only be interpreted as a sign of consumer stress. If employment weakens, expect things to get even worse. Much of this stress is the result of the sticky inflation that has already happened. According to Mark Zandi, Chief Economist at Moody’s Analytics: “To be sure, the high inflation of the past 2+ years has done lots of economic damage. Due to the high inflation, the typical household spent $202 more in a July than they did a year ago to buy the same goods and services. And they spent $709 more than they did 2 years ago.” As employers are forced to increase wages, it’s likely that earnings will suffer.
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Another effect of the higher rates, not well understood by the general public, is the relationship between interest rates and growth expectations of stocks. Patrick has hit on this in the past, and it’s now being manifested in the price of the high growth stocks that drive the Nasdaq. I’ll leave it to Patrick to take a deeper dive into some of these topics.

​Let’s see what Patrick has to say:

The third quarter saw the return of volatility across capital markets, with most asset classes posting negative returns. Large cap stocks, measured by the S&P 500, were down 3.7%, with bonds not fairing much better, falling 1.99%. The first half of the year, investor enthusiasm was rivaling periods we saw during market highs of 2021, as pundits pushed the narrative that inflation was being controlled and the Fed could soon start cutting interest rates. Growth and big cap tech stocks were the biggest beneficiaries of this, since the artificial intelligence (AI) story has become a popular investment theme. The excitement surrounding AI is reminiscent of the 1999-2000 time frame when any company attached to the internet was being awarded a very lofty multiple. I have written about the disconnect between a good story and a good investment, most recently in March of 2021. As with any good story, there are some partial truths that make the excitement surrounding the growth in a new technology sound compelling, which then awards select companies lofty valuations. In 1999, the partial truth and narrative focused on how impactful and beneficial the internet would be to society, and to company profits. Companies like Cisco were set to profit greatly from the internet’s increasing importance since they developed networking hardware and software. In fact, from fiscal years 1999-2001, Cisco’s revenue grew at a very impressive 83%. Now, one might think that the high growth in revenue would have equated to a soaring stock price to match that growth. In truth, during that same period, Cisco’s stock went on to lose over 80% of its value as even the company’s high growth rate could not match the even higher expectations that investors had placed on the company. Witnessing investors bid up a company like Nvidia to over 30x revenues shows that investors have very short memories about market history and the effects that high valuations can have on future returns. In fact, looking at Cisco’s share price movement during the last 10 months of 1999 is very similar to what we have seen with the share price of Nvidia over the previous 10 months.

This is not a prediction of what is going to happen with the share price of Nvidia. They could very well grow into the high valuation the market has placed on them. However, a good company or story does not always equal a good investment, as Cisco and many other wonderful technology companies showed investors during the tech bubble.

The last three months have seen investor sentiment shift from euphoric levels to a more cautious outlook for capital markets. The primary drivers of the market’s performance over the last three months have been the bond market and monetary policy. Market participants are coming to the realization that interest rates are more than likely to remain higher for a prolonged period, which can affect many different asset classes and investments. The chart below shows as recently as May 3rd, futures markets were pricing in rate cuts for the September Fed meeting that just took place, with rate cuts continuing until the Fed Funds rate was at 4.25% in January.

Fast forward to September 21st: the futures market is now pricing in an additional rate hike this year with rate cuts not taking place until June of 2024.

This has also corresponded with the rate on the 10-year treasury jumping to 4.49%, a level not seen since 2007 before the financial crisis.

What I find interesting about the positive performance in stocks for this year is that many pundits were justifying rising stock prices on the belief that the Fed will change course and start to cut interest rates during the year. With the market now anticipating higher interest rates for longer, and rates might not be lowered until the middle of next year, the types of equities and bonds that will generate attractive risk adjusted returns could shift.

The effects of higher interest rates on fixed income instruments, all things being equal, is straightforward. As interest rates rise, the value of a bond goes down to compensate for the new higher level of interest rates. To combat that interest rate risk in fixed income portfolios, we focus on short maturity, high quality bonds which exhibit less price movement during rising interest rate environments.

The effects on equities are not as intuitive. In our March 2021 letter, I wrote about how different companies can be affected by higher inflation which generally leads to higher interest rates:

If inflationary pressures and concerns become a reality, the tool kit used over that last cycle (investing in high revenue growth, low current earnings U.S. companies, combined with long dated bonds), will not have the same level of success that investors have become accustomed to. The bullet points below explain the intuition:
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• High revenue / low earnings = earnings are realized further in the future (think of Tesla)
• High inflation = earnings realized in the future are worth a lot less today
• Earnings worth less today = lower share price and price-to-earnings ratio to compensate for lower real value of future earnings (higher inflation)

One could almost replace the word inflation with interest rates, and come to the same conclusion, so the bullet points above hold up well during the environment we find ourselves in now – of high interest rates and sticky inflation – for the simple reason of how to value a future stream of earnings. So, the one bullet point I would add now is:
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• All things being equal, the HIGHER the discount rate used to value a stream of earnings, the LOWER a company should be worth, leading to lower multiples investors are willing to pay for earnings.

Our approach has always been to buy companies and asset classes that are being offered at a low valuation, which helps combat the risk that higher interest rates can have on the present value of a company. Most equity markets remain quite expensive historically, so building a portfolio that can weather higher interest rates and valuation risk is paramount to being successful in the years ahead. The benefit of managing risk in the current environment, versus environments during the last 16 years, is that cash rates remain high. This allows us to earn a competitive return in money markets and treasury bills while we patiently wait for a more compelling investment environment that properly compensates investors for taking an elevated level of equity risk. As always, we will change our outlook and positioning, based on what the data and facts tell us. Thank you for your continued trust and support, and please don’t hesitate to reach out to me with any questions.

—Patrick Mason

Hoping everyone is well, and that this new season brings new and exciting adventures.

​Tim Mosier, President,
Cairn Investment Group, Inc.

Greetings from the Northwest!

What a difference 12 weeks makes in the weather! We’ve got a great start to the summer this year, not having to suffer through the typical June downpours before a sudden seasonal shift to dry and hot; we’re already there and my lawn is suffering. Sometimes it’s nice to have simple problems like that. Our friends in California are getting some great weather, too, but still dealing with an immense amount of water leaking out of the mountains. On a recent drive down the back side of the Sierra Nevada, I was delayed several times by flooding over US 395, and those mountains were still covered in snow.

Every quarter I like to give a few thoughts on what I see as big picture issues that escape the casual viewer due to the “forest for the trees” effect, before handing things over to Patrick for his deeper dive into the current market conditions. Frankly, I’m having a tough time finding something to discuss this quarter, mainly because so much has not changed, and you deserve not to read my opinion for the third time on a topic! There are many macro issues in play, yet resolution for most has been slow.

So, instead, I’ll turn inward a bit. First, I’ll remind everyone of our upcoming move. We’ll be out of the current location at the end of the day on July 13, the end of this week, and up and running on Monday, July 17 at our new headquarter location in Vancouver. Meetings that week can be scheduled at either the Vancouver location, or at our branch office in Portland. Remember that the Portland office is available by appointment only.

Another exciting development is that Cairn can now manage your 401K and other employer sponsored retirement plans. If you have a desire for professional management of your retirement assets, let us know and we can discuss how this works and what advantages this may bring to your financial outlook.

Finally, I’ll mention our expanding focus on financial planning. It’s something we’ve always done on demand but was not originally a core feature of our business. Times change and so have we. We have two Certified Financial Planners (CFP®) on staff, and we utilize the most comprehensive planning software available, allowing us to provide accurate and informative projections that reveal the key decisions that you must make as you make your way through life. This service has no additional cost to you, so if you feel like now is the time, let us know.

With that I’ll hand things over to Patrick:​

With all the noise surrounding the economy, interest rates, and inflation, one could be forgiven for thinking that equity markets would be suffering. Instead, the S&P 500 has experienced a stellar first half. We have written at length regarding valuations, and risks facing current equity markets, and our opinion has not changed as nothing in the data has meaningfully shifted. In fact, today’s environment is similar to the one we wrote about a couple years ago when US equity markets were being driven by a few select companies. The two charts below show 6-month return contributions for the S&P 500 going back to 1991, and the year-to-date returns of some broadly followed indexes. Leadership has never been so narrow as it is right now, which is not the hallmark of a healthy market.

The top 10 stocks in the S&P 500 now make up over 30% of the index compared to 17% in 2015. Investors throwing money into this bloated index are making a huge bet that market dynamics are forever changed. Enthusiasm for the most popular stocks is also evident in sentiment indicators, with both the CNN Fear & Greed Index and Sentimentrader’s Smart Money showing extreme optimism.

This type of frothy sentiment has historically been a contrarian indicator when combined with high valuations. Outside of late 2021 and the tech crisis, valuations have never been higher.

The silver lining in this challenging environment is the fact that we are still finding some attractive companies and asset classes that present compelling long-term value. And as the interest rate environment has shifted over the last 15 months, we are able to earn a return on cash while we patiently wait for a more attractive investment environment. Thank you for your continued trust. Please reach out to me if you have any questions or want to discuss any topic in more detail.
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​—Patrick Mason

Thanks, Patrick! With that, I’ll wish you all a wonderful summer full of family and travel.

​Tim Mosier, President,
Cairn Investment Group, Inc.

Greetings from the Northwest!

I’ve heard that it’s finally Spring. I’d like to see some evidence before I believe it! All of us on the West Coast would welcome a change from the cold and rain. Attempting just that, I recently spent a few days at Disneyland with my granddaughters and rarely have I been so wet, and that’s from the perspective of a Northwesterner. I’m glad to be back in the dry, warm office.

Speaking of the office, Cairn continues to grow! I’m happy to announce that Dan Poe, recently of Ameriprise, has joined us an Investment Advisor in Portland. His bio will be up soon on our website. With Dan, we’ll have four Advisors with the firm, and be better able to serve the diverse needs of our clients. I’m really looking forward to having his help in answering your many questions and making sure that our investment strategy is in sync with your needs. While the world roils around us, we feel that it’s vital to make these investments in people to assure our future.
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It’s been an interesting first quarter for 2023. While much has changed, like finding out that some big banks weren’t really solvent, much has not changed so much. Fundamentally, we’re still in a time of higher inflation, rising interest rates, and resilient employment. The same political and economic issues are being fought about in Washington. The major market indices are near historic highs, measured as either price or valuation. Since we have little exposure to the banking sector, and none at all to the banks considered at risk, our general outlook and plans remain steady. I’m sure that Patrick will expand on this.

The recent bank implosions are worth discussing briefly, because they caused disruption in the financial markets, and many of you have been concerned about the safety of your money. Banks fail when the FDIC says they fail. Sometimes it seems unfair and too preemptive, but everyone in that game knows the rules. Insufficient liquidity, the inability to meet depositors’ withdrawal needs, is the measuring stick. You can get there by facing too many withdrawals too quickly, or by making poor investment choices. They usually find a way of coinciding. The failed banks all played a part in their own demise by poor investment management relative to their obligations to depositors, and also by being a bit too successful at winning jumbo-sized clients who can demand huge withdrawals in a flash, which they did. The vast majority of banks do not have these issues, and the largest, considered too big to fail, get easy liquidity from the US government as they need it. While 90% of bank deposits are FDIC insured across the country, Silicon Valley Bank operated with about 10% of its deposits insured. So hopefully, on that topic, we can relax a bit and realize it’s just part of the process of burning off excesses from our long bull market.

At the height of the scare, the list of at-risk banks seemed to explode, and even included Schwab for a while. The metrics being cited were very one-dimensional and failed to recognize how well Schwab had consistently met the FDIC’s liquidity requirements, and how many billions of dollars Schwab has in reserve through the totality of its business. The company thought to be somewhat at risk, Schwab Bank, is just part of the overall Charles Schwab & Co., which includes the security broker dealer that custodies your assets. Only your Bank Deposit funds, also known as “sweep” funds, are connected to the Schwab Bank. These are insured up to $250,000 by the FDIC per account beneficiary. Schwab’s typical client has several types of accounts and is focused on overall wealth management much more than on banking. Almost half of these assets are managed by an advisor like Cairn, adding a layer of care and commitment that is unlike a typical bank. There is a nicely written piece on the Schwab website, in case you want to see some greater details on this. If you need to know more about this, just give us a call.

Let’s see what Patrick has to say.

​All the turmoil in the banking sector, to date, has not rattled capital markets, with Large Cap stocks returning 7.50%, small cap 2.74%, international stocks 8.47% and bonds 2.96%. Headlines surrounding what the Fed might or might not do regarding interest rate hikes, combined with cracks materializing across regional banks, made for lots of volatility. At the end of the day, investors’ risk appetites remained strong despite these headwinds. There has been quite a bit written in the financial news about what has unfolded across the regional bank landscape. I won’t bore you with the small details, but the failure of Silicon Valley Bank was a byproduct of the Fed leaving interest rates artificially low for TOO long, not that the Fed started raising interest rates aggressively. Once interest rates, rightfully, started to rise, banks that had taken on too much risk investing in longer dated bonds exposed their balance sheet and solvency to risks most investors didn’t see coming. When deposit rates are close to zero, while T-Bills and money markets yield north of 4%, it can expose risks for banks that had invested customer deposits in long dated bonds.

Technological advances have allowed clients to move cash balances quickly, and at banks that focused their deposit base on large clients with balances above FDIC limits (SVB, First Republic, etc.), a bank run can happen. I applaud the FDIC for how they have handled the situation, to date. Stepping in swiftly and backing all deposits, regardless of FDIC insurance limits, while wiping out equity and debt holders, is how bank failures should work. As Tim mentioned, we have very little exposure to the banking sector, and that is a byproduct of our process and our investment discipline.
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Over the last couple of years, I have mentioned that although valuations have been elevated for US stocks, one of the silver linings has been broad price participation. This means that returns were not being driven by a narrow list of names like markets witnessed from 2017 to early 2020. The chart below measures the S&P 500 equal weight v. the S&P 500.

​We have seen a steep reversal in market participation this year. The reversal has been so sharp, as this chart from Tavi Costa of Crescast Capital shows, the largest 15 stocks in the S&P 500 have generated 100% of the returns to start the year.

​The rebound in stocks to start the year has done nothing to alleviate the issue of lofty valuations for the S&P 500. Even with the index down close to 8% over the last year, valuations still sit at close to all-time highs. As a reminder, long-term returns, generated by stocks, are comprised of three variables: earnings growth, dividend yield, and change in valuation. To get to the 10% historical average return in US stocks that investors are beaten over the head with, you start with: earnings growth of 6% historically, plus a dividend yield of 2%, which puts you at 8%. To make up the 2% difference, multiple expansion needs to take place. Given that we are already sitting at historically high multiples, that seems to be unlikely. I would argue the path of least resistance is to have multiples contract, meaning that valuations will be a drag on returns for US stocks. It is just math.

​The combination of high valuations, poor market participation, and a market that is still in a downtrend does not strike us as an environment where taking excessive risk will be rewarded. The bright side is that our investment universe is not limited to the S&P 500; and, being value managers, we are always focused on the price we are paying for an investment and whether that provides an adequate margin of safety before putting your capital at risk. We are still finding some attractively valued investments in US stocks, though the opportunities are limited. We find international equities to be more attractive and we look for opportunities to continue to add to that asset class when appropriate. Thank you for your continued trust. Please drop me a line if you want to discuss any topic in greater detail. —Patrick Mason