Note: All performance calculations are based on AB Invest Capital per share book value. S&P 500 index is based on published Vanguard S&P 500 Index.
Comments on 2018:
2018 was an interesting year where we continue to bet long on Private Equity, reducing our public market exposure, and holding plenty of cash. During the year we took a few selected arbitrage positions, among others related to European currency trades, and held some short positions against index in the US stock market. Although our year started slower than previous years, as the market started to slow down we made up the lost ground and ended the year quite successfully. The misses this year was that we again expected a slowdown earlier than it really happened, and I alone am to blame for this. At that time, we deployed the primary rule of investing - you don’t have to make it back the same way you lost it. With that in mind we worked the market, and albeit some missed opportunities, we ended the year with overall IRR of 26.08%, exceeding our goal of beating the S&P 500 by 10% with a wide margin. Needless to say, we are pleased with our performance.
As I reflect back on 2018 I would like to refer to my article written in March of 2017 called Cycle Analysis. If you are unfamiliar with cycle analysis, you can study this article on my LinkedIn page. Our current development in the cycle stages this year reminds me of Dorothy in the Wizard of Oz then they wander off into new territories: “Toto, I don’t think we are in Kansas anymore”.
Depending in where you look, early in the year, different parts of the market appear to be priced for substantially different parts of the 3 first phases in a cycle-analysis (Early-, Mid- and Late-cycle). It is now clear, however, that we are in the Late-cycle of this market.
To substantiate my argument. Let’s take a closer look at the analysis:
Most all would agree that the foundation for cycle analysis is the bond market, particularly flattening and widening of the yield curve— the gap between long and short-term Treasuries. While writing this report the gap between the 10- year and the 2-year Treasury equaled just 15 basis points. Last time this reported such narrow difference was when the US equity market peaked in October of 2007. Flattening of the yield curve normally suggests the economy’s moving into the Late-cycle nearing the fourth phase, which is Recession.
One explanation is that bonds point to risks ahead. Long-dated bond yields are rising faster than expected which signals that investors are convinced that interest rates will rise and inflation must, in the long run, be defeated in a then overheated economy. Higher bond yields in turn make growth stocks—those with earnings far in the future—less attractive, with value stocks taking the front row, over time, pushing investors toward even more defensive stocks with more reliable short-run earnings—which is typical late-cycle behavior.
As the lead indicator for the Market behavior is the interest rate, currently being low from historical perspectives, at some point interest rates will reach a pain point where investing in bonds is more attractive than the stock market. We believe that this trend has already started. When that becomes the norm among investors, dark clouds will to emerge in the economic skies as they always do from time to time, and it will be the right time to have plenty of cash on hand to do bargain shopping, which we plan to do.
We are pleased to report to our shareholders that in 2018 we beat our benchmark index S&P 500 by +30.46%, much related to gains in Private Equity and a rebound in public securities. With the widest margin yet reported for AB Invest Capital, we surpassed our goal to beat S&P 500 by at least 10%-points, and we feel confident we will continue to beat this benachmark in the long run.
Anders J. Berggren
Chairman, AB Invest Capital
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