Robotti & Company Advisors Q3 2022 Letter
Robotti & Company is a New York deep-value boutique founded by Bob Robotti in 1983, specializing in left-for-dead cyclical industries — energy services, building products, shipping — with multi-year holding periods and occasional activist letters. It manages about $650m; Bob is regarded as one of the most steadfast Graham-tradition cyclical value hunters.
In plain words
This report argues the global economy is leaving the 2010s era of low growth, low inflation, and central-bank life support, and entering a new age of higher government spending, structurally higher inflation, and more market chaos. For ordinary investors, that means: don't rely on the old playbook where central banks always save the day; watch out for hidden risks in non-bank finance (like pension funds using obscure derivatives, which nearly blew up the UK bond market); and if central banks give up on their 2% inflation target and aim for 4% instead, long-term bonds will suffer while real assets may hold up better. Worth reading because it explains why this market rout might be more than just a typical bear market.
Robotti Research report points out that the world is entering a completely new macroeconomic era, whose impact may be comparable to the rise of Keynesianism after World War II and the shift toward free-market globalization in the 1990s. The core argument is that this new era could help developed eco
Theme & Background
This chapter is a special report published by The Economist on October 8, 2022. Its core argument is that the global economy is undergoing a fundamental macro regime shift comparable to the post-WWII rise of Keynesianism and the 1990s turn toward free-market globalization. The report argues that current market turmoil is not a typical bear market or recession signal, but rather the end of the old era (the 2010s' low growth, low inflation, low interest rates) and the beginning of a new era filled with "promise and peril."
Core Thesis
The author's core investment thesis is that the world is entering a new macro era characterized by a structural rise in government spending and investment, with a potentially higher inflation floor. This could help advanced economies escape the low-growth trap of the 2010s, but it also brings serious risks such as financial turmoil, damaged central bank credibility, and uncontrolled public spending.
Counter-intuitive / Contrarian Judgments:
1. Current Turmoil is a "Regime Shift," Not a Normal Cycle: The scale of market turmoil (global equity declines, bond performance) is unprecedented in a generation, marking a "clear end" to the stable economic period of the 2010s.
2. Inflation May Not Easily Return to the 2% Target: While short-term inflation may recede, long-term factors like increased government spending, aging populations, and geopolitics will challenge the inflation target. Central banks may be forced to abandon the 2% target in favor of a higher one, such as 4%.
3. Financial Risk Lies Not in Banks, but in the "New Financial System": Unlike 2008, the current risk primarily comes from the non-bank system (e.g., pensions, leveraged loan markets) that relies on liquid markets and technology. This system is opaque and highly sensitive to losses.
Key Arguments & Data
1. Scale of Market Turmoil:
- Global inflation has reached double digits for the first time in nearly 40 years.
- The Fed is raising rates at the fastest pace since the 1980s (from 0.25% to 3.25%, projected to reach 4.5% by early 2023).
- The US dollar has hit a 20-year high.
- Global stock markets have fallen 25% in dollar terms, on track for the worst year since at least the 1980s.
- Government bonds are facing their worst performance since 1949.
- Global losses amount to approximately $40 trillion.
2. Characteristics of the Old Era (2010s):
- Low private investment; the public capital stock (as a % of GDP) actually shrank in the decade following Lehman Brothers' collapse.
- Slow economic growth and low inflation.
- Central banks became the "only game in town," holding massive assets: the Fed, ECB, and BOJ held up to $15 trillion in financial assets on the eve of the pandemic.
The five companies that dragged down Q3 performance had an average P/E of 7.8x and P/B of 1.9x, significantly below the S&P 500's 18.1x and 3.6x
3. Drivers of the New Era:
- Structural Rise in Spending: Aging (healthcare), defense (responding to Russian/Chinese threats), climate change & energy security (renewables, LNG terminals), industrial policy.
- Demographics: Aging leads to excess savings, persistently depressing real interest rates.
- Inflationary Pressures: Pandemic stimulus, supply chain disruptions, the energy crisis from the Russia-Ukraine conflict (Russia, one of the largest fossil fuel exporters, decoupling from Western markets).
4. Key Comparison Data:
| Indicator | Old Era (2010s) | New Era (2020s & Beyond) |
|---|---|---|
| Economic Growth | Slow | Potential to escape low-growth trap |
| Inflation | Low | Structurally higher; target may be raised from 2% to 4% |
| Government Role | Public capital shrinking | Structural rise in government spending & investment |
| Central Bank Role | Sole stimulus engine, holding $15T in assets | Facing credibility crisis, constrained policy tools |
| Interest Rates | Zero/negative | Rapidly rising, but long-term real rates may still be suppressed by excess savings |
| Financial Risk | Banking system (2008) | Non-bank system (liquidity markets, pensions, leveraged loans) |
Companies/Assets Mentioned
- Credit Suisse: Mentioned as a "mid-sized bank" under pressure, but the author believes banks overall will not be a major problem because their safety buffers are larger than in the past.
- Elon Musk / Twitter: Used as a case study of a frozen "leveraged loan" market, noting that if Musk acquires Twitter, the resulting debt could become a major problem.
- UK Pensions: Their use of "obscure derivatives bets" caused chaos in the UK bond market, serving as an example of risk in the new financial system.
- Federal Reserve, Bank of England: Cited as examples of central banks facing a dilemma. The BOE has already executed a policy U-turn (pledging to raise rates while simultaneously starting to buy bonds).
Investment Implications
1. Abandon the "Old Era" Investment Framework: Investors can no longer rely on the 2010s' investment logic of low growth, low inflation, and unlimited central bank backstops. Market volatility and systemic risk will increase significantly.
2. Beware the Fragility of the "New Financial System": Focus on liquidity risks and contagion effects within non-bank financial institutions (e.g., pensions, hedge funds, private equity) in a rapidly rising rate environment. A freeze in credit markets (especially leveraged loans and high-yield bonds) is a key warning signal.
3. Prepare for "Higher Inflation": If central banks ultimately abandon the 2% inflation target for 4%, it will upend traditional valuation models for bonds and equities. Long-term bonds may face persistent pressure, while real assets, inflation-linked bonds, and certain commodities could benefit.
4. Follow Government Spending Directions: In the new era, government investment will concentrate on defense, healthcare, energy infrastructure, and industrial policy. These areas may generate new investment opportunities, but one must also be wary of the risk of declining productivity from "white elephant" projects.