The Power of Habituation: A Looming Threat to Financial Markets
As the old adage goes, “Habit is a cable; we weave a thread of it each day, and at last, we cannot break it.” This concept of habituation is particularly relevant in today’s financial markets, where investors have become accustomed to low interest rates and high returns. However, this complacency may be setting us up for a rude awakening.
The Black Bear Value Fund, LP returned 0.9% in September and 5.5% YTD, lagging behind the S&P 500’s 2.1% return in September and 22.1% YTD. While we don’t aim to mirror the S&P 500’s performance, we recognize the importance of being vigilant in today’s market environment.
Habituation is a psychological phenomenon where we become desensitized to stimuli after repeated exposure. In the context of finance, this means that investors may be underestimating the risks associated with high asset prices and low interest rates. The prolonged period of cheap debt has led to a buildup of vulnerabilities in corporate balance sheets, which could be exposed when interest rates rise.
We’ve taken a more cautious approach, increasing our credit shorts and adding junk bonds to our portfolio. We’re also short long-term interest rate/credit instruments, which could benefit from a widening of credit spreads. Our option volatility strategy has been reinstated, providing an asymmetric profile in case of a market downturn.
The Federal Reserve’s ability to control interest rates is often misunderstood. While the Fed sets short-term rates, the market dictates long-term rates. The current 10Y interest rate assumes success in bringing inflation down to the low-mid 2’s, but this could be challenged if companies struggle to refinance their debt.
We’re bullish on certain sectors, such as metallurgical coal, which is expected to experience growing demand driven by urbanization in Asia. Our investments in ARCH Resources, CONSOL Energy, and Warrior Met Coal position us to benefit from this trend.
In the building materials sector, we like BLDR, which has shifted its focus to value-add products and boasts a strong balance sheet. Paramount, an exploration and production company, offers an attractive free cash flow yield and a management team aligned with our interests.
As we navigate these uncertain times, it’s essential to remain vigilant and avoid complacency. We’re prepared for increased volatility and will continue to act decisively to protect our investors’ capital.
On a personal note, I’d like to express my concerns about the rising tide of antisemitism and the importance of speaking out against unacceptable behavior. We must use our platforms to promote unity and condemn hate in all its forms.
In conclusion, habituation is a powerful force that can lead to complacency and poor decision-making. As investors, it’s crucial to stay alert and adapt to changing market conditions. We’ll continue to monitor the situation closely and make adjustments to our strategy as needed.
Leave a Reply