December 2023 | Quarterly Letter

Over the course of my career I have had the good fortune to be exposed to a number of professional investors who have helped shape my view of the investment world. None was more important than Peter Bernstein who, as a friend and mentor, was the wisest of them all. Writing his biweekly investment letters, he produced many quotable statements, often pithy, as below.

“Forecasts create the mirage that the future is knowable.”

The truth of this quote underlies what is at the heart of our way of investing at Crawford. It is the assumption that the future, because it is unknown, offers a wide range of potential outcomes for an investment. Thus, we emphasize quality as the characteristic that best narrows the range of outcomes and enhances the possibility of a positive return. The quote also points to the folly of forecasts, which at this time of year we feel duty bound to attempt. So, with trepidation, we will briefly and generally outline what in our opinion is a reasonable expectation for the economic and market environment this year.

The unknowable aspect of the future is validated by the fact that last year the consensus forecast turned out to be very wrong. Most expected it to be a poor year with a recession occurring sometime during the year, as well as rising unemployment, stubborn inflation, and high interest rates. In fact, with the exception of interest rates, the opposite occurred in each of these areas. Short-term interest rates did move higher with Federal Reserve (Fed) tightening. But the economy was surprisingly strong, highlighted by a blowout third quarter Gross Domestic Product (GDP) growth of 4.9%. Most impressive was the fact that inflation declined sharply while unemployment remained near record lows. Although we were on recession watch all year, we did not predict a recession, and we are delighted that one did not occur. The fact that it did not sets up the possibility of a soft landing this year. More on that later.

Against the backdrop of last year’s consensus forecast failure, here is what we are looking for this year.

• Economic growth will be slowing as the lagged effect of tight monetary policy finally reduces overall demand and residual Covid savings are diminished. Whether the slowing growth results in a recession or soft landing is yet to be determined. The Fed is betting on a soft landing.
• Inflation will continue on its downward path toward the 2% target. Its rate of descent will depend on the outcome of the soft landing/recession question, but in either case inflation should end the year at or near target.
• Unemployment will finally begin to rise as the labor market loosens. Again, the extent of increased unemployment will depend on the outcome of the soft landing/recession question.
• Interest rates will decline. This year will mark the beginning of the downward side of the monetary cycle as reductions in the federal funds rate occur under either the soft landing or recession scenarios. Longer-term rates should follow short rates lower, but much of the move downward may have already occurred.

Before discussing the investment implications of our outlook, a word about the soft landing/recession question. We have been, and remain, dubious of the possibility of a soft landing. Looking at the question broadly, we take into account the difficulty of achieving a perfect landing for an economy that is so large, complex, and cumbersome. Small twists of the monetary dial by the Fed create tremendous economic leverage at some later point; therefore, the calibration has to be almost perfect. Furthermore, there are historically reliable indicators pointing in the direction of recession, namely: inverted yield curves and leading economic indicator indexes. For these reasons we remain on recession watch but hope that another year passes without a contraction in our economy. If the Fed pulls off a soft landing, it will be a remarkable achievement.

On the other side of the question, we do believe there is one thing that could make this cycle different and improve the odds of a soft landing. It has to do with the character of the inflation problem that the Fed has been fighting. Because this inflation cycle appeared so suddenly without a long period of rising inflation expectations, it never got deeply embedded in the minds of consumers, businesses, or investors. Since its roots did not run deep, the possibility that it could be effectively curtailed by policy seems plausible. Also, aside from the monetary policy effect, the disappearance of supply disruptions has been a significant factor in the fall of inflation. This line of thinking would support the possibility of a soft landing as inflation drops to 2%, employment remains strong, and the Fed can reduce interest rates back toward a more neutral level. We shall see.

INVESTMENT IMPLICATIONS. We express our opinion of the year to come within a larger context. It is our belief that the economic and investment environment remains one of transition. Covid brought with it a number of economic and financial challenges, the most notable of which were supply disruptions, increased spending power due to immense fiscal and monetary aid, changing consumption patterns, and surging inflation that required a dramatic monetary response to fight it. We can label it as “the Covid cycle,” and the economy has been and continues to be making an effort to transition through this period back to what can be called normal. The normal conditions would be something on the order of 2% sustainable GDP growth, 2% inflation, full employment, and relatively low interest rates. We, like the Fed, believe this set of conditions is achievable. The transition has taken longer than expected, nevertheless, we believe it will be completed. We also believe such an environment can be a constructive one for investing in the capital markets.

The investment question that needs to be answered is, how to invest through the transition period and thereafter? Does one invest differently for a recession or soft landing? In our opinion, not really. We believe, as stated in the opening paragraph of this letter, that the future is unknowable, and therefore, one should invest consistently according to a philosophy that is time tested and which acknowledges the management of risk and return as co-equal parts of the investment challenge.  

We believe we have such an approach. The essential aspects of it are as follows.

• Invest for the long term. This implies a focus on owning the right companies.
• Stay invested. Trying to predict the market over the short term is futile. The markets pay you when it is least expected and the payoff comes quickly. You have to be there to participate.
• Focus on quality above all else, and don’t underestimate the importance of dividends and effective capital allocation.

The most essential of these elements is quality. We have defined it many times, but, simply stated, quality is best represented by companies that consistently perform. Those companies that have a record of increasing earnings and dividends year in and year out, regardless of economic conditions, are the ones that reward investors with returns that are achieved while assuming a lower level of risk. These are the type of companies that narrow the range of potential outcomes and provide a greater probability of a positive return. Companies that prioritize dividends in their capital allocation process by consistently paying and raising their dividend most often enjoy the quality profile. We live comfortably in the dividend community.

These quality comments apply equally to bonds. Last year bonds recorded positive returns, and this year should also be favorable for bondholders in terms of total investment return if, as we expect, both short-term and long-term interest rates decline. Again, the primary focus is on quality, represented by the ability of the underlying entity to weather difficult economic conditions and therefore provide investors with confidence as to interest and principal payments.

This dual approach of incorporating risk and return does not work every year, but it has worked over long periods of time by producing attractive, lower-risk returns. It is a simple approach, but intuitively logical. It has been good for our clients, and we believe it will continue to be.

We approach the New Year with keen anticipation. There will be challenges, as always, but we look forward to meeting them on your behalf. Your continued confidence in our ability to satisfy your investment goals energizes us for the task, and we express our heartfelt appreciation for the opportunity to work with you.

Disclosures:

The opinions expressed are those of Crawford Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.

Crawford is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Crawford’s investment advisory services can be found in its Form ADV Part 2, which is available upon request.

Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed.

Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

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