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New Year is in just a couple days. We spent Christmas in my house noisily with one of my two granddaughters in attendance, with a prime rib roasting away. As is tradition, my wife had the TV tuned to a station that plays seasonal tones while the screen is filled with a roaring fireplace.

Now we’re heading to Orlando to my son and his wife’s house for Christmas part two, with our youngest granddaughter. To keep our New Year’s tradition alive, we will swap the prime rib for a pork roast and black-eyed peas.

As we ring in 2023, many investors will feel thankful that 2022 is over. Unfortunately, this year has not been much fun for traditional investors.

For less conventional investors, things looked much better…

If you bought into the Wall Street story and used low-cost indexes, or if you formed your portfolio along the suggested 60% stocks and 40% bond allocation, you have gotten waxed.

What worked in 2022 was unconventional thinking:

Those who invested in heavily discounted closed-end funds that own a lot of energy-related assets have done well in 2022.

Buying high-yielding bank stocks during market sell-offs has worked out OK as well.

Ignoring electric vehicles and renewable energy and buying fossil fuel-related stocks has turned out to be a brilliant strategy.

Heeding the late, great Marty Zweig’s old Wall Street adage, choosing not to fight the Fed was just as reliable a piece of advice this year as it always has been.

Buying stocks that trade below liquidation value has always been a winning strategy and is again this year. If you followed this approach, there would have been no wonderful, world-changing technology stories to tell around the water cooler about your 2022 portfolio.

Instead, you would have owned some incredibly boring companies that made hand tools, automobile locks, built ships, canned vegetables, and other mundane businesses.

And you would have had gains of more than 20% for the year.

If you followed Wall Street’s advice, you would have had close to 20% losses this year.

It would have been worse if you followed the growth stock gurus like Cathie Woods at Ark Funds. Her flagship Ark Innovation ETF (ARKK) has a portfolio filled with all the exciting companies that are supposed to be changing the world.

But investing in these stocks is not just about owning the companies that are changing the world: it’s about how they make or lose you money. Your investment portfolio can change your net worth and scheduled retirement date, and investors who owned ARKK this year and bought into the rebound story are down more than 60%.

It’s unlikely to get better. If you think that once inflation is under control, things are going right back to the way they have been the last decade, you are sadly mistaken.

The near-zero interest rates, tightly controlled by monetary policy, that we had for more than a decade are over. The markets will play a much more significant role in setting rates now.

The environment for stocks will be much less favorable. After a decade of above-average returns, we are in for a decade of below-average returns.

The good folks at GMO have forecast negative returns on domestic stocks and bonds for the next ten years or more. And Vanguard is looking for U.S. stock market returns of just 2.3%–4.3% annualized for the next decade.

If you do what everyone else is doing in the financial markets, you are probably about to have a very uncomfortable decade. Even the best-case scenario is that conventional approaches to investing will not provide the returns you need to live the life you have been hoping to achieve.

But there are strategies that have provided market-beating returns regardless of economic and market conditions.

They are not conventional. Most of the time, they are not even exciting. Most of them involve minimal trading, so there is no action to be found with these strategies.

But there are profits.

Chasing exciting dreams has never led to a happy ending in the stock market. Every time we get one of these world-changing stories, we have seen very fast large gains in the markets, followed by an epic collapse.

Everyone believes they are smart enough and quick enough to get out before the collapse. Most of us are not.

The world is changing in many exciting ways over the next few decades. Picking the winning companies in all the risky research and development efforts needed for those changes to occur is a crapshoot at best.

During the California gold rush in the 1840s, some prospectors and miners got rich. But everyone who sold supplies, blue jeans, picks, and shovels made a fortune.

The same approach to the next big thing will work for us in the markets for the next big thing: we can be the bankers and landlords to everyone working to make the future brighter. We can build their homes, sell them tools and supplies, and meet their everyday needs.

Investing at bargain basement prices in the companies that provide these services will consistently be a profitable approach capable of delivering the returns you need to make your goals a reality.

Have a fantastic New Year. I will be back in January to show you more ways to uncover the hidden profits in the unexplored corners of the financial markets.

Until then!
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Howard Marks, the billionaire founder and chairman of Oaktree Capital, sends out his “Memos” several times a year. His December issue, titled Sea Change, offers food for thought about successful investment strategies to use in the new year.

Let’s take a look, and see how we can earn some nice cash returns next year with less risk…

Marks’ December memo opens with this:

sea change (idiom): a complete transformation, a radical change of direction in attitude, goals…(Grammarist)

In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes. I think we may be in the midst of a third one today.”

The first sea change Marks is referring to occurred in the mid-1970s when it became acceptable for corporations to issue non-investment grade bonds as a way to raise capital. Prior to that, there was no market for bonds that didn’t have an investment-grade credit rating. Non-investment grade or high-yield bonds opened up the potential for companies to issue this type of debt to fund growth or make acquisitions.

Marks, who made his fortune investing in high-yield securities, explains:

…The most important aspect of this change didn’t relate to high yield bonds, or to private equity, but rather to the adoption of a new investor mentality. Now risk wasn’t necessarily avoided, but rather considered relative to return and hopefully borne intelligently. This new risk/return mindset was critical in the development of many new types of investment, such as distressed debt, mortgage-backed securities, structured credit, and private lending.

The second sea change started when, in 1980, Fed Chairman Paul Volker ratcheted the federal funds rate up to 20% to kill the high inflation that had persisted since 1974. The move succeeded and ushered in four decades of falling interest rates, which were tremendously positive for investing and the economy. Bond prices go up when interest rates fall. As a result, bond funds posted year after year of positive returns.

Falling rates also fueled corporate investments that led to massive economic growth. Low interest rates reduce the cost of capital for businesses and increase the fair value of assets.

Per Marks:

It seems to me that a significant portion of all the money investors made over this period resulted from the tailwind generated by the massive drop in interest rates. I consider it nearly impossible to overstate the influence of declining rates over the last four decades.

The third sea change, now underway, is that inflation and high interest rates have produced investor uncertainty and pessimism. These are valid concerns, as growth-focused companies can no longer count on cheap money to fund their growth.

Marks closes the memo with this:

We’ve gone from the low-return world of 2009-21 to a full-return world, and it may become more so in the near term. Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets. Lenders and bargain hunters face much better prospects in this changed environment than they did in 2009-21… if you grant that the environment is and may continue to be very different from what it was over the last 13 years—and most of the last 40 years—it should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.I have already started making changes to my Dividend Hunter recommendations that should let subscribers earn attractive cash returns with less risk. Now in its ninth year, my strategy has continuously evolved, and the recommended strategy and investments will do very well in the new “sea-changed” world.
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