Blue Chip Stocks Crash as the Stock Market Gets More Expensive

Joshua,

I've been a reader for over a decade now and am glad to see you writing more again. One of my favorite things to do in winter is light up the fireplace and re-read some of your older case studies and blog posts. You have had a huge influence on my life.

Is the image at the top AI-generated?

thanks again,
Andrew

Thank you for the kind words - I'm glad my writing has been helpful to you!

Yeah, on this particular post all of the images were generated de novo with A.I. rather than licensing them from Adobe or another one of our subscriptions. It was faster and I could do it while I was writing rather than try to search for something that worked perfectly and had been used on countless other sites.

It's been quite wild watching the tools evolve. My primary interest came before they had entered the public imagination because I was concerned about how they could help, or hurt, Adobe Systems. As such, back in those days, I had one of the earliest enterprise subscriptions to Midjourney for research purposes and I remember having a meeting at Kennon-Green & Co. walking through how it was going to change everything. Here we are, everyone and their brother knows about them, and they've taken the public by storm.

I'm now convinced that Stable Diffusion, due to companies being able to load their own completely private checkpoints and LORAs, will be seen as little more than a tool for creative studios including large companies such as Disney. You'll have artists use models entirely trained on their own work or intellectual property - no third-party images used, or at least none that aren't in the public domain, thus removing all reasonable objection - for purposes such as the rapid storyboarding of ideas. It will be thought of as little more than Photoshop; a massive distinction between it and other tools using image training that includes artists who otherwise did not consent to the use of their work. I suspect that this development will lead to Congress modifying copyright law to permit copyright on certain A.I. generated images, if used with some proprietary inputs, as I don't think Hollywood will let it go.

Generative text A.I., in contrast, is still just mostly smoke and mirrors. Any expert in their field knows that once you dig in below the surface, some of the responses it provides are not just outright wrong, but dangerous. Here, I think you'll have companies license the base technology and enterprises such as Thomson Reuters will develop specific software-as-a-service packages that will dramatically improve the end result. For example, imagine a tax package for, I don't know, $25,000 per annum as a license that can answer almost all partnership tax questions. That's where the real money is going to be made, I think. There is a lot of industry-specific low-hanging fruit out there right now.

A major concern is the use of wide-scale A.I. spying and interconnectivity that could pose a system-wide cyber threat. I think any reasonable person should probably be looking into having local redundancy with a completely offline system containing their most important data. It is insane to trust everything to the cloud or even a connected operating system. I mean, Microsoft's Recall tool is something so absolutely insane it poses a literal national security threat and should be outlawed by regulators. Sure, there are some things you can do to mitigate it - e.g., physical security keys for multi-factor authentication - but it's imperfect. I've made peace with the fact I'm probably going to have to learn Linux at some point, which I would have been perfectly happy to do at any other point in my life. Right now, it just seems like a time commitment I don't have with the kids and the firm. But, we do what we must.

Yes. Precisely for the three reasons you mentioned.

For at least a couple of decades now, we've watched as the number of publicly traded companies decreases. I think it's generally bad for society from a psychological standpoint as there was something important to being able to purchase part of local businesses where you knew the people running it and could see the facilities every day as you drove to work. Now, technological scalability has made it so the company raises capital from a few well-connected, already-rich investors, it stays private for as long as possible, then goes public. Many regulatory proposals, in effect, have the consequence of concentrating opportunity and advantage in the hands of the already-successful as they are the only ones capable of dealing with the burden.

It's also important to point out that the near zero-rate environment also played a role as did the transition to a knowledge-based economy where capital expenditures were an increasingly smaller portion of revenue for the biggest winners. It takes a company like Microsoft a lot less property, plant, and equipment to produce $1 than it did General Motors in its heyday.

As things stand now, for the reason you mention, I am not convinced the small cap long-term compounding advantage remains true. That's one of the reasons I'm market cap agnostic when deploying capital. I want value where I can find it, regardless of company size.

Joshua, is there a way to subscribe to the blog so I get an email notification when you make a post? I hadn't checked for awhile, and had a lot of reading to catch up to!

At present, I don't have anything built into the site but I can look into a solution when I have time if it's something you'd be interested in / it would be helpful.

I know RSS is getting more obscure by the year, but you can subscribe to this blog through something like Feedly or another free or paid service, which helps with notification. Email alerts might be possible through these tools, but I haven't looked into them myself

With RSS pretty much dead, email subscriptions would probably be the easiest way for most people. Oaktree allows you to do just that and get an email every time they publish is a new Howard Marks Memo. Would be nice to get that notification for Joshua Kennon blog posts. I believe I saw something mentioned on the Kennon-Green website that you may consider publishing a few select private client letter normally reserved for your client, but the page doesn't seem to have been updated after 2022. Speaking of Kennon-Green - are you accepting international clients yet?

"...[e]njoys adding cash-rich money printing machines to their collection of enterprises." I'm sure more than a few of us here struggle with that sort of shortcoming.

Such a great question!

Always love to hear your thoughts on the market and your data driven approach. Only wished we hear from you more often.

I do, too. I mentioned it elsewhere, but between parenthood and the firm, the past few years have been a lot. I'm slowly getting more and more time for myself, though, which means more blog posts.

It would take a book, but just a few ...

Issue #1 - The Federal Government

U.S. Constitution Article I, Section 8, Clause 5:

[The Congress shall have Power . . . ] To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures; . . .

If there is ever a national crypto-currency to replace paper fiat, it will be issued, and controlled, by the Federal government as this was one of the first powers reserved to itself under our constitutional system when it was established in the late 18th century. There is no scenario in which the largest, strongest economy in the world cedes any meaningful control of its economic apparatus, especially when that replacement suffers from all of the materially catastrophic drawbacks as the gold standard. People think inflation is bad - and it is - but unless you get into Weimar Republic territory, it is nothing compared to the destruction of prolonged, deep, and seemingly unstoppable liquidation cycles like what happened in the 1870s and the early 1930s.

Issue #2 - It Suffers the Same Drawbacks as the Gold Standard

Look at what happened with Covid. You can find the old posts on this blog, but I warned that we had to engage in mass stimulus and the cost would be substantial inflation for at least a couple of years; that the general population was so economically illiterate (forgive the directness) they would blame whomever was in the White House. (We didn't know at the time Joe Biden was going to become the next President of the United States, but sure enough, it played out precisely as I said and plenty of folks somehow think it's his fault prices increased, which is total nonsense. In one letter I sent to clients of the firm, I think I said something along the lines that we could elect a ham sandwich and prices were going to spike, so don't believe whomever gets blamed for this, it's a necessary cost of saving us from destruction and it is better than all the alternatives.) Now, here we are with economic growth that is obliterating the entirety of the rest of the world. The U.S. economy just keeps driving forward. Bitcoin can never respond to crises such as the pandemic. Had something like Bitcoin been the foundation, or even a notable part of, the money supply, the pandemic could have sent us into a Great Depression. It limits the regulatory response tools in a way that is self-defeating and, frankly, unwise.

Issue #3 - It Has No Intrinsic Value Backing It

Unlike the U.S. dollar, as fiat, which is backed by the full military and economic taxing power of the United States, the sole source of market value for cryptocurrency as presently structured is what other people think it's worth. This is more akin to art or collectibles. With a business, even if everyone thinks its worth nothing and won't buy it from you, you can still generate huge cash flows that you go out and spend (that's the source of intrinsic value). The same for farmland - if you can't find anyone to buy it from you, you can grow your own food and consume it, possibly sell some (the source of intrinsic value). This means it is de facto a speculation. It can never not be a speculation. It is definitionally impossible.

Note, for those who absolutely accept this is pure, unbridled gambling with no investment case, I have no objection as long as they are keeping it modest relative to their net worth and income, treating it like buying a lottery ticket. That's not what a lot of folks are doing, though. It certainly should never be permitted in a retirement account.

Issue #4 - It's Not a Currency

The most important functions of a currency are that it 1.) maintains its relative value over days, weeks, months, and at least a year or so, 2.) it can be exchanged for goods and services nearly anywhere and at any time, and 3.) such exchanges cost next to nothing with no "frictional" expenses.

Bitcoin fails every definition. This is why I think regulators should not permit it to be referred to as a crypto "currency". There is no currency there. Again, it is definitionally impossible.

Issue #5 - Security in an Emergency

Most folks aren't particularly intelligent about how they handle their crypto holdings. I mean, there is a not-insignificant change the world experiences a Carrington Event. How many folks store their hard drives in Faraday cages so they still have it when things get fried? If there is a major emergency, and electricity is out for days, how many folks are truly off-the-grid with sufficient battery power or electrical generation capacity to access their drives? I'm oversimplifying here but there are at least a few dozen scenarios in which it's vastly inferior to other asset forms or gold / silver.

Conclusion

I could go on, but there is no point. As a gambling tool, cyptocurrencies can be magnificent and, again, I take no issue with the people who are fully aware of what they are doing with no delusion this is unbridled speculation. In a broader sense, they serve no meaningful social function, gains are directly extracted from losing parties (rather than a business that employees people, makes products people need and/or want, produces lots of on-going tax revenue, and which benefits owners over time through the profits from said operations).

Of course, none of this applies if you are a criminal. Crypto assets are perfectly tailored to organized crime or terrorism. If you want to move large amounts of money around the world without any oversight or being able to figure out where it originated, be it from the drug trade or human trafficking, you couldn't ask for a better medium. I think that will ultimately be the regulatory downfall. Of course, forensic accountants have gotten good enough that the blockchain isn't truly anonymous anymore.

Again, very very brief summary of my thoughts. I am fully aware I am simplifying. Just responding quickly over a cup of coffee before my lunch break to clear my head prior to my afternoon commitments so please forgive any typos.

I have been upgrading the infrastructure of the site, as well as migrating the email system away from its former provider. The inbox still works but the page has been taken down temporarily. I'll try to check it when I have a moment to see if I can find your message.

Also, I understand completely what you mean about the negatives. On this side of the pond, so to speak, it's working the other way. Buying shares of certain foreign stocks got a nice tailwind for awhile as there was a currency discount baked into them if one was a long-term holder.

I'll always upvote a Peter Lynch video!

I actually don't mind it since I prefer not to sell, generally speaking. I just like finding wonderful businesses and going through life accumulating them. Of course, I'll trim some here and there, but really, I'm in it for the long-haul. My dream scenario is this blue chip decline continues, or at least goes sideways, for a few years so we can keep plowing in fresh deposits, dividends, interest, etc. into growing the share count. I mean ... come on, Nestle slipped below $100 USD equivalent the other day, can you imagine if we could buy huge amounts of it in the $70s or $80s? I think I'd be doing cartwheels to work.

Looks like those days have arrived hope you don't break something doing cartwheels! That is a job for your sons.

It is, indeed, an unique dichotomy in the market currently--I've taken to referring to it as the subatomic economy (for the tech stocks that are driving overall market gains) and the molecular economy (for the blue chips that make actual tangible goods and are currently languishing due to the repricing of goods in this inflationary environment and a stressed consumer who is tightening the proverbial belt).

From a personal investment standpoint, the current environment is a unique chance to apply the Buffett/Munger epigram about going outside with a bucket instead of a thimble when it's raining gold. Unlike previous timeframes (2008-2009, 2018, 2020, 2022) when the overall market corrected and there were more ideas than money and one couldn't build full positions in all the attractively priced wonderful businesses due to limited funds, this environment is offering up a select group of businesses in the "molecular economy" that are attracting all my investment dollars (more money than ideas). A particular personal example (among some of the businesses mentioned in your post) is the Swiss pharmaceutical and diagnostic giant Roche--nearly every time I've had capital to deploy in the last year and I've worked out conservative rates of return over the next few decades for the wonderful businesses on my watchlist, I saw Roche sitting there at <$275 and wondered why I even bothered calculating returns for any other businesses.

That is a great, and very, very complicated question. I'd have to think about it for a long time because it's really worthy of a well-researched book. There are a lot of factors. Some of them are true but vastly overused in terms of explaining long-term consequences (e.g., colonization - look at India versus Africa). There is an element of a so-called "resource curse" in certain countries. Frankly, I think - as I've mentioned a few times in my writing over the years - that a lot of the success of the U.S. historically came down to a couple of factors:

1. Self-selected people who emigrated from their former homes and came to the United States tend to, by definition, be more entrepreneurial and self-determined, creating a selection bias.

2. Protestantism, particularly a strain of Calvinism, created a culture when combined with the American upstart mentality that brought in an element of religious reinforcement to prosperity and hard work; i.e., the idea that God not only exists and wants to bless you but that salvation requires you to work hard and better yourself. Combined with, paradoxically, an atheistic, or at least deistic, worldview of a lot of leading thinkers based upon the European Enlightenment this led to knowledge-based approaches rather than superstition. Outside of poor rural areas, you aren't going to get a lot of folks believing in witchcraft or spirits, for example, it's very Scooby Doo lets-get-to-the-bottom-of-this-mystery-and-logically-figure-out-what-forces-are-causing-it-so-we-can-fix-it thinking. It's hard to overstate how big of an advantage this is compared to certain parts of the world.

3. Free, compulsory education that, yes, has suffered significant drawbacks in recent years as a result of cultural wars and an elevation of ignorance. But, historically, the fact that any child in the United States had a fundamental right to learn to be literate, which was hard-won. (There is a reason that slave-owning societies, including the American South pre-civil war, criminalized teaching black Americans to read. Education is the mechanism that allows someone to bootstrap / jumpstart their own rapid expansion and improvement.)

4. Geographic advantages in terms of not having to worry about neighbors invade, allowing for a greater domestic expansion and focus at critical times.

5. A bent towards free markets that, yes, comes under attack from time to time but which, coupled with intelligent regulation (e.g., consumer disclosure laws, environmental protection laws, etc.), has no competitor in terms of human happiness and elimination of poverty.

6. An emphasis on personal property rights being strongly settled in both case law and statute. This allows people to make long-term plans, which benefits society. If you have to worry about your car being stolen every other day, or someone pickpocketing you, it changes your behavior and your feeling towards the society in which you live.

I could go on and on, but ... oh boy this is a good question and there is no simple answer. It's a case of an emerging property, so to speak. You add certain elements together and you get, as Charlie Munger would have called it, a lalapalooza effect. Other countries, in other periods, have gone through similar things; e.g., a period in Ancient Egypt, a period in Ancient China, a period in Greek history. Advantage compounds upon advantage.

With regard to education, there's a reason that the latin word for "book" and "free" is essentially the same--liber.

It would be so cool if you could embed a real time tracker of these stocks, bought on the day of this post and see 5, 10, 20, 30 years how these stocks have done vs a S&P 500 index fund. Future readers could stumble up on this page 50 years from now and see how your predictions fared.

As a long-time Adobe employee, my strict reading of our public communications policy unfortunately apparently prevents me from saying anything about Adobe on this financially-oriented blog (although I could double check with Adobe PR though if you really care about my opinion). However, (with the same disclaimer as you of this not being investment advice), I am in agreement regarding investments in Google, Meta, and Microsoft, and happy with the performance and positioning of those companies especially within the generative AI market, which I do research science and research engineering in. I feel these other consumer blue chip companies are also nice --- especially Hershey --- but I am super picky about investments in companies that I understand less well than those in the tech sector, so I do not hold them except in index funds. This is mostly due to regrets regarding investment opportunities missed in companies that I thoroughly understood, but I can hardly complain since both my index fund and active investment holdings have performed well. I've enjoyed reading your posts this year off and on.

I'm glad you like the grand piano --- one relative has a Steinway refurbished from the late 1800s and although I do not play much I like its sound, so I assume the Bösendorfer must be a step up from that. Although personally I would be cautious about disclosing such valuable possessions online: maybe this comes from me being a former resident of Seattle and seeing so many crazy crimes on the news. It sounds like your family and business are both doing well, which I'm glad to see.

What do you make of the growing inventory levels at Brown Forman? I was looking at this recently as I was a shareholder in the past, but I couldn't get past this trend.

Josh,

wondering what your thoughts are on the the state of insurance companies in light of the hurricanes this year.

do you think this will materially change anything about how the industry works in hurricane prone areas?

from a personal level, the loss experienced is absolutely tragic, and it reminds me of my own struggles to find flood coverage while not in a flood assessed area. My main concern was even though I wasn't low lying, flash flooding had been known to do quite severe damage in my area. What I found was that it's cheaper to get flood insurance if you live just inside a floodplain assessed area (inside the 1 in 1,000 year flood area) than outside of it due to the bespoke nature of policies outside those zones.

The day will come when insurance and mortgages in certain areas of Florida will be impossible to purchase or attain, fundamentally transforming housing values. People can refuse to recognize the situation as much as they want, but it will be capitalism through the price discovery mechanism that ultimately does the job.

What surprises me is the speed with which it is happening. Florida is obvious but there are other areas at huge risk. For example, when we did our nationwide search for a relocation, Asheville, North Carolina made the top 15 or so potential cities. We rejected it for three separate reasons, but one of those top three was climate risk. It wasn't well positioned for the next 30 years. We expected it to get wiped out, in whole or part, at some point, but not for a long time. Yet, here we are twelve months later and it's just obliterated. People simply will not accept reality on this topic. It's bizarre.

Climate migration is all but inevitable eventually. For our part, it's been wild getting used to being in an environment where rare tornados and the occasional winter storm are the only climate related things that are a problem. There was one period in California when we dealt with an earthquake, hurricane, tornado, landslide, wildfire, drought, roaming coyotes that were attacking toddlers, and heat dome all in a fairly short period of time. Here it's been ... almost nothing. This thesis is one of the reasons behind our sudden willingness to pile up ownership of real estate. This particular county where we are is expected to grow to a population as large as Orange County, California within the next couple of decades. Right now, it's still fairly inexpensive. I don't think that stays the case long-term.

If I woke up with real estate holdings in coastal areas of Florida tomorrow, I'd have it listed for sale before lunchtime.

Thanks for the kind words - I hope you are doing well, too! Things have been great here; certainly better than 2023, which I felt was like wrestling a polar bear. (It was such a strange year. On paper, we absolutely blew it out of the water and ended up ahead on nearly all of our personal and professional goals but I don't ever want to live through anything like it, again. This year has been a dream in comparison.)

Speaking of restored Steinway & Sons pianos, there was a stunning model at the big local Steinway dealer that I thought about for a long time not just as an instrument but as a piece of furniture. It would have looked so cool in a "Clue" style library or something. They did such a good job on it. I still think if you caught me in the right mood, on the right day, I'd want to buy it for the office or a side room. Probably not everyone's cup of tea but I felt like it was so, so cool.

https://uploads.disquscdn.com/images/f57ac7f9146cee6eb70bec6711fbc60450f3163b7cb6badae42c9374a248b8b8.png

Looks like a great restoration job! It's different than my relative's because I can see the brown wood grain somehow through the finish. I saw Nestle and Hershey hit yearly lows recently, which made me think of your blog.

I bought another 100 shares of Hershey today, as it hit another 52 week low, which too made me think of Joshua. The Nestle ADR is at $87.23 as of this writing but most of my money is in tax-advantaged accounts so it makes more sense for me to buy Hershey. Joshua must be going bananas today.

Yes, his book Stocks for The Long run was the most influential book I read when I began investing (in mutual funds) almost 2 decades ago.

I'm sure you're busy, but if you get a chance, I'm curious about your thoughts on the earnings yield compared to the 10-year treasury yield. I read this article that argues "Bonds Are Still Too Expensive" from Morningstar https://www.morningstar.com/columns/rekenthaler-report/bonds-are-still-too-expensive

I'm not sure younger generations are really that much more focused on health than older generations, think about this for example...

Smoking is down, but the use of nicotine pouches like ZYN and vaping is increasing.
Younger generations seems to like marijuana and its definitely debatable on how healthy that is.
Supposedly younger generations are more focused on healthy food, but is that really the case? Think about how many new locations of Raising Canes, Chick-fil-A, Shake Shack, In-N-Out Burger, etc are currently opening.
Pizza and Wings aren't health foods, but new locations of Dominos and Wingstop are opening non stop.
Younger generations seem to drink less soda, but more energy drinks and its debatable if thats really a healthier option
There is no shortage of new Starbucks and Dutch Bros locations opening up all over the place and they serve lots of drinks that contain an unbelievable amount of sugar.

In my opinion all these things come and go. Just a few years ago microbreweries were all the rage. I believe most people will continue to enjoy caffeine, sugar, fast food, alcohol, etc and for most people if they enjoy these things in moderation while eating a good diet otherwise and get some exercise, will live long and healthy lives.

In fact, I can actually see alcohol making a comeback going forward. Alcohol is a social activity and I can see society getting to a point where people are getting tired of sitting home along on their phones and computers, staring at social media, and want to go back to a more social in person life.

Good point..