AIM13 Commentary - 2025 Q1
“If the world were perfect, it wouldn’t be.”
Dear Investor,
The volatility in the public equity markets in April reminded us of one of the most important things for any investor: DO NOT PANIC. Looking back over the period, it is helpful to keep in mind that if you went to sleep after the market closed on April 2nd and woke up after the close on May 2nd, your investment in the S&P 500 Total Return (“S&P 500 TR”) would have shown a modest gain of 0.36%. You would have missed the dizzying 12%+ fall over three trading days in the first week of April or the zig-zag recovery of that loss over the period.
A lot of people, however, were anything but asleep in April and spent the month biting their nails and checking their portfolio on an hourly basis. They were also whining and freaking out about Liberation Day, tariffs, inflation, a possible trade war with China, and where rates might be going, all the time glued to CNBC and wondering at what point to sell (or buy). Wall Street Journal headlines like “Dow Headed for Worst April Since 1932” (on April 22) only added to the alarm.
If you were one of those people and the market volatility in April caused undue stress and anxiety, we have only this to say:
“YOU CAN’T HANDLE THE TRUTH!”
Seasoned investors know that markets are unpredictable and at times irrational, and that unforeseen events can cause wild over-reactions that can dramatically, and even permanently, impair a portfolio, especially one that is not constructed to manage risk. If you cannot handle that truth, then investing is not for you.
Things are never perfect, no one knows what tomorrow will bring, and change and the unexpected create opportunities for patient, long term investors. They are not occasions for panic. Indeed, disruptive periods create the very environment in which active managers, especially those with the flexible toolkit that truly hedged managers possess, thrive. If the world was perfect and nothing unexpected ever happened, then there would be no need for active investment management. That (fortunately) is not the case.
“We know much less today than usual.”
The Difference Between Managing Risk and Panicking
We agree with Howard Marks and most people who think that the markets and the economy today are as unpredictable as ever, and so we are not surprised to see so much alarm among investors. In this environment, every investor has basically two options: (1) throw up your hands and do the equivalent of picking up your ball and going home (where home is cash); or (2) double down, do more work than ever and pivot and adjust as necessary but soldier on with a portfolio designed to weather the bad times and participate in the good times. We choose the latter.
“Just keep swimming.”
We cannot tell you what is going to happen or where the markets will be tomorrow, next month, or next year. Anyone who pretends to know is a fool. What we do know is that there will be smart investors who find opportunity and places to invest, regardless of how choppy things get. That is who we want to invest alongside of, and when we find a good investor to partner with, we try to stay the course through a market cycle. Risk is something to manage; panicking is running the other direction and sometimes that means running off a cliff.
“Time in the market matters, not market timing.”
Unfortunately, most investors are twitchy and get themselves in the way of making good long term returns. A few years ago, Morningstar analyzed mutual fund investor returns over a ten-year period and found that the average dollar invested in funds earned a 6% annual return, while the average fund gained about 7.7% over the same period. This means that investors missed out on about 1.7% annually or one-fifth of their funds’ returns.
The Importance of Staying the Course
To be clear, we are not “set it and forget it” investors. Every day we underwrite our current investments and ask ourselves whether if we were not invested, would we invest. We understand the importance of being nimble, and we make changes, hiring and firing managers, depending on our view of the risk/reward opportunity set. Above all, we stick to our long term plan and do not over-react. That is managing risk and not panicking.
* * *
“The problem with experts is that they do not know what they do not know.”
Market Observations
As we note above, foremost on almost every investor’s mind are Trump’s economic policies, tariffs, trade wars, conflicts in Ukraine and Middle East, and where all of that will take markets. We agree these things are troubling, however we often remind ourselves that the risks we are focusing on are often not the ones that materialize. Some less talked about things that keep us up at night include:
China’s Ownership of U.S. Debt. One aspect of US-China relations that does not get as much attention as it should is the extent of China’s accumulation of U.S. Treasuries which has made it the second biggest foreign owner of U.S. debt after Japan:
Top Ten Foreign Owners of US Debt
If one accepts that China’s intentions in the global markets and in geopolitics are inimical to U.S. interests (as we do), then their significant ownership of our debt should be alarming. Although China has pared back its U.S. Trearsury investments in recent years, holding such a large stake of our debt gives China a powerful tool to destabilize the U.S. bond market, which could lead to higher rates. Another concern is the lack of transparency around Chinese investments in other U.S. assets, including agency debt, equities and other investments. As reported in the Wall Street Journal in March, “China's U.S. portfolio is difficult to track because the government's use of third parties and custodians in places like Belgium obscures its ownership,” according to Brad Setser, a senior fellow at the Council on Foreign Relations.
Teenage Terrorists. According to a report in the Wall Street Journal in early May, terrorists in Europe are getting younger and that makes them much harder to find. Last year, three Taylor Swift concerts in Vienna were canceled after three suspects ages 17 to 19 were arrested for planning a well developed attack that the CIA said could have killed hundreds of people. At the end of the year, a joint report of the Five Eyes nations (U.K., U.S., Canada, Australia, and New Zealand) warned of the growing prevalence of children being drawn into violent extremism. The report identified some cultural developments that facilitate the radicalization of youth including:
Minors are digital natives who are more technically savvy than previous generations.
Online environments, especially encrypted ones, offer access to children and teens by extremists who can exploit them in a variety of ways.
Engaging with children and adolescents and preventing their acts of aggression is more complex than with adults.
Readers of our letters know that we regularly stress the importance of vigilance in the face of terrorist threats here and abroad; the fact that a segment of the population can be so easily radicalized into killers makes us need to be even more careful in our daily lives.
Dutch Government Recommends 72-Hour Emergency Kits. In March, the Dutch government issued a recommendation for all citizens to have a 72-hour emergency kit in case of a natural disaster, cyber attack, or war. This extended the existing advice to have a kit which was to last at least 48 hours and is an indication that the Dutch government may know things that their citizens do not. A recent study by research firm Ipsos I&O shows that a quarter of the Dutch population owns an emergency kit, a significant increase from 2024, when just 15% of Dutch people had one. We have been big proponents of emergency kits for many years, and like fire insurance for your home, when you realize you need it, it is probably too late!
Closing Thought
We suggested above that we are essentially at war with China in ways that defy conventions, especially in the world of cyber espionage, theft, news manipulation, and surveillance. So we are particularly alarmed by the reports over the last few weeks that apparently Chinese-made fighter jets deployed by Pakistan have shot down several Western-made fighters operated by India. Defense industry experts are closely watching the performance of these Chinese-made J-10 fighters using air-to-air missiles also made in China against Rafale fighter jets built by a French consortium led by Dassault for insights into how any showdown over Taiwan or the wider Indo-Pacific might play out. As reported on May 20 by the New York Times, the J-10 jets have often been used in Chinese military exercises to harass Taiwan, but up to now they had not been battle-tested, leaving open the question of how well they would perform in actual combat. We now have that answer, and it does not bode well for the Western military complex. Not surprisingly, the stock of the maker of the J-10, AVIC Chengdu, shot up over 60% in early May.
We thank you for the confidence you have placed in us.
Sincerely,
Alternative Investment Management, LLC (AIM13)