By Fabrizio Pierallini, fund and asset manager

To understand why we believe at Nemesis Group that we are well positioned for the reality of the next decade, we must first review the distortions of the past decade. The foundation of this distortion was the artificial suppression of interest rates. Pushing down interest rates became a matter of national policy—first in response to the great financial crisis of 2008–2009 and then the COVID-19 crisis in 2020–2021. Unfortunately, we believe policymakers pushed rates down too low for too long, which created massive distortions in financial markets and the economy. To comprehend just how extreme this period was, think of interest rates as the price charged for using someone else’s money or capital. Throughout all of recorded human history, users of capital—whether individuals, corporations or governments—have always had to pay providers of capital—be they lenders, creditors or investors—for use of their funds. Only twice-in all of history have short-term rates approached zero: the 1930s and the period since 2009; and never have long-term rates been lower than they were in the past decade. Global financial markets have endured some grim news, but have gone on to persevere and prosper.

What happened a short story:
In 1997, there was a meltdown in both currencies and equities in the Asia: Indonesia, South Korea, Malaysia, and Thailand, losing on average roughly 50% of their value. Following that was the Russian bond default and the subsequent failure of Long-Term Capital Management in 1998, which nearly brought the entire market to its knees. In 1999, there was extraordinary fear of a potential massive systems failure resulting from the digital concerns related to the Year 2000 (Y2K). In 2000, there was the burst of the technology bubble and the presidential “hanging chad” election crisis, followed by the terrorist attack in September 2001 on the World Trade Center and the collapse of Enron in 2001 as well. 2003 we had the start of the second Gulf War and 2007 the collapse of Bear Stearns. In 2008, we had the subprime credit crisis, which led to the failure of some of our iconic financial institutions and nearly drove the country into a full-scale depression. Finally, the COVID-19 pandemic was perhaps our most challenging test followed by the geopolitical crises between China and the US and the fallout of a proxy war in the Ukraine.

What were the effects of a loose monetary policy:
By reducing the cost of money almost to zero, these artificially low interest rates fueled high leverage, provided cheap capital for speculative business models, led to absurdly high valuations for remote potential earnings and provided easy funding for companies that promised to disrupt whole sectors of the economy. In short, this environment rewarded just the sort of business models we tend to avoid as too risky or too overvalued. For more than a decade, market returns were driven by market darlings trading at ever-higher valuations. during the recent bubble, a record-breaking 73 companies in the S&P 500 Index traded at more than 10 times sales— an indication of excess never before seen in stock market history.

“HISTORY DOESN’T NECESSARILY REPEAT ITSELF BUT IT OFTEN RHYMES”
The big change to a normalized interest rate environment: Since March 2022, Fed policy has gone from maintaining interest rates at near the zero-bound to increasing the Fed funds rate in a series of hikes from roughly 0.25% as of March 17th to 4.75% as of February 2023 and ending quantitative easing. One market commentator analogized the Fed’s behavior as switching from
being an arsonist to a firefighter virtually overnight. Therefore, 2022 represented a complete change in market fundamentals and sentiment as we moved from a time of record-low interest rates, speculative bubbles and market highs to a period of inflation, recession and a bear market. Although painful, this transformation represents a long overdue return to normalcy after a decade in which suppression of interest rates inflated asset prices, rewarded speculation and devalued economic fundamentals. During that stretch, especially the past five years, our focus on durability, resiliency and valuation left us out of the hottest areas of the market, and though we grew the value of the assets entrusted to our stewardship, we significantly lagged the indices.

So why are we convinced that now is an excellent time to invest: Our focus on durability, resilience and valuation, which has long been out of fashion, has prepared our portfolio to weather the bear market, a recession and the return of inflation.

Summary: A decade of distortions caused by historically low interest rates has definitively ended. Though painful and volatile, we welcome this return to economic reality and a normalized monetary environment. During this decade of free money, speculation was rewarded in the past 15 years. Businesses with characteristics central to our long-term investment discipline – such as conservative balance sheets, proven long-term business models, a return-on-capital mindset and expense discipline-fell dramatically out of fashion. What is happening today is positive for the long run of our economies. Savers are being paid again and speculators have been taken out.