Footnotes is a monthly publication which summaries our “First Friday” webinar presentations each month. The goal of the Footnotes publication is to capture our “First Friday” presentation’s most important data points, which will make it easier for The Abernathy Group Family Office members to make intelligent decisions based on facts and data – as opposed to potentially conflicted opinions from the mainstream media.
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As a short reminder to each Family Office member, The Abernathy Group Family Office has now sponsored 20+ “First Friday” webinars. All of them are available on our website and “YouTube” Channel if you would like to go back and see how we have interpreted the economic signals, while doing our best to cancel the noise over the last year plus. Our goal: to help you spend less time making intelligent financial decisions, by focusing on causal, predictive data (signals); and ignoring the clamor of biased, irrelevant data (noise).
Commentary from the February “First-Friday” meeting:
Today’s Presentation is titled “Intelligent Investment Themes for 2025.”
In our “First Friday” meeting today, we will discuss the opportunities and risks associated with an “investment themes”-focused approach.
As discussed in previous Family Office meetings, we will emphasize intelligent investment tactics that will allow investors to remain invested while controlling investment risks for our Family Office members who want to make sure they don’t have to go back to work and make it all over again.
As you can see from the start of the year, 2025 promises to be challenging. Most public markets are priced for perfection, speculation is abundant, and policy changes are happening rapidly.
Steven:
Welcome. I am Steven Abernathy, and this is the February 2025 “First Friday” meeting for The Abernathy Group Family Office members.
This is our 26th monthly “First Friday” meeting, and all of the meetings’ recordings are available on our YouTube channel and our website.
And by the way, if you haven’t been to our website lately, please consider visiting.
There is a wealth of information, content is added frequently and there are some clever estate planning ideas you might consider implementing at tax time…
Also, we recently started a new company focused on reducing the costs of offering employees a corporate 401k plan while giving each employee the education they need to make intelligent decisions about their future.
We recently published a study of over 700,000 corporate retirement plans and found that over 80% of those plans had red flags associated with their 401k plan structure. We believe this is unfortunate, as most employees count on their employer to offer a retirement plan structure that allows each employee to invest a portion of their salary in a plan that offers them a solid chance of retiring on time and with the dignity they deserve.
Our goal is to transform the staid and boring 401k plan from a cost center into a beneficial offering that will increase employee retention and help recruit valuable new employees.
If you have a few minutes and if you have a retirement plan, give me a call or stop by our website and read one of our recently published research papers. We are happy to inform you how your plan ranks relative to the firms your company competes against.
Slide 2
As Kim said, this month, we want to discuss intelligent investment themes for 2025, and we want to do this with one eye solidly on the fact that our subset of investment possibilities may be overvalued. So, keep in mind that valuation is always a first principle of investing for us, and it may be that at times, we avoid seemingly promising investments because the overvaluation represents too much risk for us.
As you can see from the slide above, today’s investment environment offers a labyrinth of alternatives. Almost every investor we speak with is wondering which way to lean, and where to take risks – or whether the fixed income return of 4% plus represents an adequate safe harbor until the broad investment environment offers reasonable price levels.
Of course, the economy indeed seems to be on solid footing.
Are assets expensive? Yes.
Are they more risky than they have been over the last 100 years? Again, yes.
So, for us, it is a very tricky balancing act of finding assets that are fairly valued or cheap, AND that have solid balance sheets, with intelligent management that returns shareholder capital over time.
So, before we begin to allocate capital, it’s a very good idea to understand the investment environment in which we are entering.
Slide 3
This is where our “themes-based” investment approach may offer a helping hand.
Today, we are going to cover the investment environment in general and do our best to let you know what the U.S. and global markets are telling us about their expectations for the future.
Next, we will discuss a few intelligent investment themes which have promise. And a few that may be challenged.
Keep in mind – the new administration favors change. It is entirely likely that the economic environment can change rapidly. It is also equally likely that the common-sense changes being implemented today (namely cost-cutting and decreasing government bloat) are as likely to create a slower economy before delivering a more balanced economy.
This means every investor needs to be able to understand the impacts of the changes being made (not just suggested) and to spend some time understanding the second and third-order effects of the changes – as those effects will take time to manifest themselves – thus offering true value for intelligent investors.
Today, we will discuss the Private Equity and Debt markets, as they have become so large today that they must have a seat at the table for every investor’s decision-making.
We will spend a few minutes discussing the U.S. and global economy, with the disclaimer that the new administration offers both the U.S. and the global economy an almost 180-degree change.
Next, we will discuss the stock market with some fairly obvious and welcoming data and then address the world of Artificial Intelligence and how its second and third-order effects might offer investment opportunities which remain underappreciated by the broad market.
Slide 4
All empirical evidence suggests that the broad U.S. and global markets tend to be right more often than wrong. So, what are the markets telling us today?
Aside from basic common sense, how does an investor determine whether the macroeconomic investment framework is attractive or overvalued?
There are several time-tested methods that are easy to use and tend to offer reliable insights into the expectations for future returns.
However, it is important to note that these reliable and time-tested indications of expected returns are NOT timing indicators.
One of the best predictors of future returns is defined by the current price of assets relative to their current earnings.
The current value of the stock and bond markets tells us a lot about what investors should expect for future returns. Unfortunately, empirical evidence tells us that most investors ignore this data and instead follow the talking heads and the press.
In 2013 Robert Shiller received the Nobel Prize in economics for the data displayed in the slide below.
In short, the data say the market’s current valuation tells the investment public little about the expected returns over the next 12 months.
Slide 5
Here is how you read the chart on the left above.
Each diagonal represents the 12-month return from the closing price 12 months ago. On the vertical axis (the “Y” axis) you will see the return achieved after the 12-month holding period; the horizontal axis (the “X” axis) represents the Price Earnings multiple at the start of the 12-month period. Shiller included all monthly returns, since 1968.
The green-shaded vertical bar tells you where our current markets are valued today.
As you can see, there is no rhyme or reason to the returns above (in the left chart above), meaning there is little to no correlation between the current valuation based on expected or predicted earnings and the stock market’s value 12 months from now.
Slide 6
Having most of the diagonals on the positive side of the horizontal axis after 12 months offers a realistic hope—as markets tend to grow over time, asset values will follow the growth.
However, given that there is little to no correlation between current values and future returns 12 months from now, the current value of our stock market (represented by the green, vertical bar) should give most observers little confidence that positive returns are ahead in the next 12 months.
Look at the graph on the right-hand side of this chart for a better indication of what lies ahead.
Here is how to read the chart.
This chart has the same structure as the left chart. On the vertical axis, you will see the market’s return over the following 10 years; this calculation has been performed (again) each month since 1968.
On the horizontal axis, each diagonal represents the market’s valuation relative to its earnings at the starting point (ten years ago), which is described as the Price-Earnings ratio.
This chart shows a high correlation between today’s prices and investors’ expectations in ten years. Lower market prices today will likely lead to higher prices over the next decade, and higher prices today produce lower or negative prices 10 years from now.
As you can see, the lower the price paid for the assets, the higher the returns received over the next 10 years. The correlation is undeniable, and it is for this reason that we have been outspoken about the need for intelligent investors to notice this and expect little to no appreciation from current valuation levels. Remember, the green vertical bar shows us where we are valued today.
Slide 7
Investors should expect returns in the low single digits or negative returns from current valuation levels over the next 10 years.
This is why we shifted portfolios to higher-quality companies with high dividends and a history of growing dividends. This tactical shift in strategy allows investors to avoid relying on appreciation and instead, focus on the more reliable and increasing generation of 5% – 7% coming from dividends (and if appreciation occurs on top of the dividends – great!).
In short, the market can continue increasing in value, yet it would certainly defy the odds.
On the other hand, owning a portfolio of high-quality companies with a dividend income of 5% plus provides a highly reliable and growing return that meets most investors’ needs while out-earning inflation, which protects purchasing power. It also allows intelligent cost-sensitive investors to have cash to invest in quality companies if/when the market corrects and offers attractive valuations.
Let’s check with Kim, and Matt to see if there are any comments or questions.
Slide 8
Here are some themes we listed as worthy of consideration over the next year.
Let’s tackle private markets first.
Slide 9
The private equity market is priced so highly that it would be difficult or impossible to determine future expectations.
As many of you know, when investing in the private equity market, 5-6 out of 10 companies either blow up or lose value over the next 10 years; 2-3 of the companies return the investment made and stay in business; and 1 or 2 companies deliver a 10X or more return.
It is almost impossible to know which companies are which before the investment is made and the 10-year holding period ends.
Slide 10
What we do know is that the period of 2009-2021 offered an interest rate environment of nearly 0%, and the private equity market and the private debt market benefited greatly from this by increasing valuations. Unfortunately, this provided investors with expectations that were unlikely to be met with a comfortable outcome.
In short – the higher prices of 2009-2021 will likely deliver lower future returns – as logic and data would predict.
Slide 11
What can we count on? We can almost guarantee that the fees charged by the private equity firms will decrease the returns received even further.
And for those who are largely fee insensitive, we would offer the following pedestrian math.
In 2009 – 2021 it was common for PE firms to charge 1.5% to 2.5% or more in management fees. It became so commonplace that most investors ignored the math surrounding these fees.
However, let me take a moment to remind each of us that these funds lock up your money for 10-plus years.
10+ years – at 1.5%/year means the investor is going to lose 15% of their investment. And of course, a 2.5% management fee means that regardless of the returns you will receive in the next 10 years, you are guaranteed to lose 25% of your investment.
Slide 12
And don’t forget about the liquidity of the PE investment. When was the last time that you could see into the future with a reliable 10-year outlook?
This does not mean the investing public should not invest in private equity or private debt. Private equity and private debt investments do act as diversifiers relative to most traditional public investments… Yet all investors should be careful not to over-allocate to any investment category with fee levels equal to or exceeding those detailed above.
We will leave you with one thought culminating into one question.
Slide 13
Both PE and PD are incredibly highly-priced.
Both have high fees associated with their investment terms.
Both have illiquidity measured in decades, not months or years… and without dividends or current cash flow…
What could go wrong?
Slide 14
Let’s move on to the economy and the new administration.
The theme all investors must embrace, is that change is taking place.
The new administration is determined to reduce thoughtless spending and return to what many believe to be common-sense policy.
As said, the relevant theme to embrace is that change will be constant over the next 12 months or more.
Intelligent investors must expect good and bad disruption as nothing is perfect.
Matt, I believe you had some relevant commentary on this matter – so I will turn it over to you.
Matt Daley:
One of the first things on everyone’s mind is the new federal administration and the breakneck speed with which it is implementing its agenda.
The media focuses on the speed at which this is taking place. I think it’s fair to say that the strategy seems to be move quickly and break things. The number of new ideas flowing out of the federal government is difficult to keep up with. Let me pause, as I am pretty sure I have never used “new ideas” and “federal government” in the same sentence.
The takeaway should be a continuation of our cautionary sentiment from last month’s “First Friday” presentation, which is to say these changes could have positive or negative short- and long-term effects. Until we see some results, the overarching theme will be uncertainty.
So, how do we manage the uncertainty? We stick with our core principles of investing in value-based assets with a lens offering a long-term view.
Tariffs are also a headline grabber. Tariffs continue to be one of the fixations of both supporters and skeptics of the tactic along with the mainstream media. We mentioned last month that tariffs should be largely seen as a tool for negotiation leverage. Many tariff threats are unlikely to ever be implemented. The United States is Walmart and 95% of the countries in the world are Randall’s Country Market in Biloxi, Mississippi. That is to say we have all the power and all the leverage. Just because we have been reluctant to use it for the past 15-20 years, does not mean we don’t have that position. Tariff threats on Mexico, Canada, and Columbia have already yielded concessions; China is a different story. Concessions will have to be made on both sides. Tariffs may be used less as a tactic to bend the other side’s will, and more as an invitation to the negotiating table between adversaries who are trade partners.
The primary risk to remember is that when you use the threat of tariffs as leverage, you must be prepared to implement them. The possibility that they will go into effect is always nonzero, and we must measure our risk accordingly.
Thanks, Matt. Those are excellent thoughts, and each is worthy of consideration when determining how to defend our assets and potentially implement an offensive strategy if the probability of success warrants it.
Slide 15
Let’s discuss the stock market and a theme likely to offer investors slightly more return and fewer risks as the markets are severely overvalued.
When markets are overvalued, euphoria is high, speculative juices are flowing, it almost always makes sense to move toward value-based investing.
We are value investors—all of you know this—so it may seem like we are just talking about our preferred type of investing. You might say Incentive Dictates Behavior™ is driving our narrative, yet statistics strongly support this thesis, as value investing tends to outperform growth investing; and we believe it does so with less risk.
Slide 16
Here is a chart that takes us back to 1927 and clearly shows that value investing has outperformed growth by about 4% per year over the last nearly 100 years. What it doesn’t show is that value outperforms with a bit less risk, as you are most often buying companies with solid balance sheets and closer to their actual book value.
You may also notice that value investing has been underperforming for the last few years, and these periods of underperformance tend to be followed by periods of value investing outperformance.
Slide 17
Here is a slide that supports those comments.
This slide compares current valuations to the last 15 years’ valuation levels.
As you can see, almost every valuation category, from price to book to the pricing of junk bonds to equity prices, is at or near historical highs.
This chart above clearly shows that speculation is high, expectations are incredibly high, and current pricing leaves little room for disappointment.
Slide 18
The theme which has dominated every topic related to economics over the last year has been Artificial Intelligence.
While the moniker of Artificial Intelligence has been misnamed, overused, and applied to anything and everything digital, there is some truth and a lot of goodness that could and will likely come from machine learning applied to a large language model, which is really what most are calling Artificial Intelligence.
Our point here is that, as you probably know, everything associated with the first-order effect of Artificial Intelligence is priced to perfection—and many intelligent observers would support the statement that it is priced significantly above perfection.
However, we want to encourage each of you to consider diving a bit deeper into the value chain. One or two levels below the surface, companies that are using Artificial Intelligence to help make intelligent and more well-informed decisions are starting to produce incredible results.
Here are some thoughts:
Slide 19
Education: let’s think about every young person having a tutor with the intellect of a Ph.D. level teacher today. Let’s think about having all available information with the only limit being curiosity. This empowers civilization and is limited only by curiosity. However, what effects does this have on our brick-and-mortar educational system?
What will happen to the trillions of dollars in college, university, and K-12 educational institutions and facilities when they are no longer needed?
Robotics: There is much conjecture that we will be employee-constrained over the next decade due to falling demographics in the U.S. and many other countries. This may be true; however, we are likely to be 3-5 years away from robotics engaging in a significant amount of manual labor, which lessens the demand for human labor. If true, robotic technology will counter-balance the demographic shrinkage in our country, leaving creative new business categories to be discovered and promulgated by our citizenry.
Healthcare: Let’s consider healthcare and add any similar industry tasked with a decision-making process described as a “one-to-many” decision process.
For instance, when biotechnology finds a molecule with confirmed activity within human physiology, the next step is often to find the receptor site able to accept the molecule and produce the desired outcome. Equally often, there are over 100 different receptors to choose from. Clinical trials must be performed to determine which site offers the best outcome with the least toxicity. Each clinical trial is expensive, with many costing billions of dollars, and a time span defined in years rather than days. Some disease states are critical and if clinical trials take years to provide the needed information required for approval, lives will be lost. Artificial Intelligence may help shorten this decision process from years to days of combinatorial processing, by targeting the receptors most likely to accept the molecule without toxicity.
Another easy example of “one-to-many” decision-making is the energy market. All exploration and production companies have 10-50 drill sites. Which site will likely give exploration companies the highest return on their investment? Which can be drilled least expensively? Which can be drilled most quickly? Which drill-site produces the least amount of waste?
Without Artificial Intelligence, the decision may take months of calculations mixed with trial and error. Yet, it may take a day or less in the future, with higher success rates and less pollution.
And think of what will come from our next clean energy production generation. Is it to be the domain of fusion or fission?
Fusion involves the combination of two relatively light atomic nuclei into one, usually involving hydrogen. It tends to produce more energy than nuclear fission. Yet nuclear fission (on a large scale) is probably 5+ years away, while productive and cost-efficient fusion is probably more than 10 years away.
Of course, we don’t know, yet we all have a high level of confidence that Artificial Intelligence will help us make intelligent decisions – destined to make our future brighter.
Slide 20
Let’s turn this over to Matt for comments on our geopolitical future.
Matt:
We have spent a decent amount of time over the past months discussing the possibility of geopolitical conflict.
Briefly touching on that, it is fair to say that temperatures seem to be cooling, and if World War 3 was a 50/50 toss-up a month ago, it’s reasonable to say the dial has shifted slightly in favor of avoidance. This is incredibly positive, as any event or series of events and activities which lowers the probability of a WWIII is, by definition, infinitely valuable. However, with international relations and conflict, these events can always turn on a dime.
It may be prudent to offer some advice on international markets, which could provide the framework for investors to lower their probabilities of future risk.
We have an administration that was previously in office 4 years ago, so we know who the friends and non-friends are. Western Europe does not like Trump, but they are America’s bear cubs, and they would perish without mama bear to provide and protect them. Therefore, they have no choice but to remain our friends and allies regardless of who is in office.
On the other hand, several countries that were at odds with the previous administration are great friends with the current administration: Hungary, Poland, Israel, Saudi Arabia, and India.
India in 2025 is generally where China was in 2005, so that is one relationship to watch closely. India’s growth potential and proximity to China are incredibly valuable to the U.S. The strategic nature of that relationship will be crucial in the decades to come.
Saudi Arabia is going through an economic revolution, as it is already a very rich country. It is also the linchpin that will make or break our relations in the Middle East. Overall, these countries are more likely than many others to have safer investment environments over the next four years.
I’ll finish by saying that overall, there is a higher risk of short-term volatility due to rash action, threats, and leveraged negotiating tactics. However, in taking the long-term view, there is a possibility that government spending and regulatory cuts, an emphasis on utilizing American strength globally, and a proactive approach to strategic global relationships, could put the economy on a long-term track for greater stability in a rapidly changing world.
Over the short term, the U.S. will most likely experience good and bad days. We believe the road will be bumpy, so consider the risks and maintain liquidity. However, understand that negotiations are difficult. They often include bluffs, criticisms, and condemnations. They are often hard to watch, creating a frightening framework in which we view the future. Yet, it may help to remember the U.S. remains in a position of strength; and we have been here before many times – we have seen this movie before.
Investors should expect volatility; remain cautious, invest in quality, value with dividends, and maintain a long-term investment horizon.