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2021 Fourth Quarter Commentary

For printable version which includes all graphs and tables, click here.​​​​

On Cycles

“History may not repeat itself, but some of its lessons are inescapable. One is that in the world of high and confident finance little is ever really new. The controlling fact is not the tendency to brilliant invention; the controlling fact is the shortness of the public memory, especially when it contends with a euphoric desire to forget.”

- John Kenneth Galbraith – “The 1929 Parallel.” The Atlantic, January 1987*

Cycles in financial markets are often driven by multiple factors, not least of which is human emotion and behavior. One of the conspicuous things in investing is how these cycles seem to repeat themselves with striking similarities. This fact hasn’t been lost on us as we have written about it extensively over the last several years. We will be making frequent references to these previous commentaries in this issue. While this speculative cycle has been of the longer variety, we believe that it has led to the formation of one of the greatest opportunity sets that value investors have ever seen. Broad market investors have ignored inexpensive value stocks while driving up the valuations of “hyped” growth companies. Each investing generation believes they are more intelligent and better informed than investors in prior generations, who paid too high a price for companies that didn’t deserve them during prior speculative markets.

In our 1st Quarter 2018 Commentary we wrote: “Today’s stock market environment reminds us of other periods when investors ignored risks, chased momentum, and paid little to no attention to valuations. The “Nifty Fifty Era” of the early 1970’s, “The Portfolio Insurance Blow Off ” of 1987,“The Internet Bubble” ending in early 2000, and “The Housing Bubble”, which led to the Great Financial Crisis of 2008-2009 were all periods, like today, of government-induced speculation in the stock market. For investors like FRM who are focused on first preserving, then growing our clients’ capital through fundamental research, investing in an over-valued market is especially challenging. That is, until something changes. And change it will, we just never know when.”

As to the “when” mentioned above, we still DO NOT KNOW. Fundamental value investors like FRM are often early skeptics in a cycle. But we believe such early skepticism is common among investors known for protecting and growing capital over full investing cycles in the past.

• Ben Graham, who literally wrote the book on value investing, has been quoted as saying the following regarding the 1929 crash: “It is worth pointing out that assuredly no more than one out of 100 who stayed in the market after 1925 emerged from it with a net profit and that the speculative losses taken were appalling.”

• In the lead up to the “Nifty Fifty Era” of the early 1970’s, also known as the ‘go-go years’, Warren Buffett saw little further upside because of extended valuations and closed his investment partnership in mid-1969. US stocks didn’t enter a bear market (a market down 20% or more) until 1973.

• Another investor for which we have tremendous respect is Jeremy Grantham of GMO. The firm got out of tech stocks in 1998 after noting in late 1997 that it was the highest-priced market in U.S. history. “The Internet Bubble” did not burst until the spring of 2000. It’s often easier to go with the crowd (we wrote about this “career risk” in our 1st Quarter 2006 Commentary, which we are happy to send to you if you want to read it!). After deciding to sell their tech stocks and subsequently underperforming the market, clients left in droves with GMO’s assets declining almost 45% in the late 1990s.

It is worth noting that none of the investors mentioned above “got out” of the market and held only cash. All three continued to own attractively-priced, publicly-traded businesses throughout the cycle. Each had tremendous subsequent performance, as the speculative fervor left the stock market, and a focus on business fundamentals returned. At the opposite end of the investing spectrum from Graham, Buffett, and Grantham, each of these speculative cycles had a head cheerleader whose optimism toward a new era lead to sharp outperformance as investors piled into aggressive strategies. This set the table for subsequent sharp underperformance as that new era failed to materialize as quickly as the extremely high stock prices suggested it would. You may remember some of them:

• In September 1929, just before Wall Street crashed, the famed economist Irving Fisher stated “Stock prices have reached what looks like a permanently high plateau.”

• During the “Nifty Fifty Era”, Gerald Tsai left Fidelity to start his Manhattan Fund raising $247 million in 1966, the largest amount ever raised by an investment fund to that point. In fact, the funds raised represented 15% of all cash going into equity funds that year. The Manhattan Fund would lose 90% of its assets over the next few years; by 1974, it had the worst eight-year performance in mutual fund history to date.

• Janus Capital Group was the hottest of hot fund companies during “The Internet Bubble”. In early 2000, the height of the bubble, 50% of the funds flowing into mutual funds went to Janus. From the time the bubble burst in the spring of 2000 until 2002, the Janus Global Technology Fund lost 84% of its value.

Our candidate for head cheerleader of this cycle may not surprise many of you. For this cycle we nominate Cathie Wood and her ARK Funds. The ARK Funds have been one of the leading investors in “disruptors” and “leading” innovative and transformational companies, no matter the price paid for the companies’ shares. As with other periods of unbound optimism and speculative fervor, this strategy worked well from 2017 – 2020, as funds flowed into the strategies. It worked particularly well in 2020 as the flagship ARK Fund, the ARK Innovation ETF (NYSE: ARKK), saw massive inflows of $9.5 billion in assets. This coincided with the fund generating tremendous returns of 152.52% in 2020 versus 18.40% for the S&P 500. As with past cycles, investors bought in at the highs and in 2021 ARKK was down -23.59% versus a positive 28.72% return for the S&P 500. ARKK is currently down more than 46% from its record high in February 2021. We are of the view that there is more air to be let out of the ARKK holdings, which currently trade around 12 times price-to-revenues - A VERY RICH PRICE!

As already mentioned, we don’t know when this particular cycle will turn. We suspect that ARKK’s performance is a precursor to what could happen to the six stocks that have contributed most to the S&P 500’s impressive performance over the last five years. As we wrote in our 2nd Quarter 2020 Commentary: “Although the broad market indices have rebounded sharply to near pre-COVID levels, a deeper look into market returns for this and recent years reveals something that most participants probably do not appreciate. We have mentioned before how the S&P 500 has and is being driven by the performance of six large companies. Much like in 1999, the performance of “the market” gets narrower and narrower, driven by the large companies at the top of the index and further fueled by the massive shift to index investing. As more liquidity is funneled into the index, that forces purchases by those funds of the largest components, regardless of valuation. Only a reversal of this process finally burst the bubble of the late ‘90s.” In order to bring this statement up-to-date, we would only need to change “rebounded near” to “rebounded well above” pre-COVID levels.

No Escape From Low Rates?

The one justification that we’ve seen for broad market stock prices trading at the nose-bleed valuations now present (see chart beside) is that extremely low interest rates warrant such valuations, in particular those of large growth stocks that make up a large percentage of current market capitalization. Now, the academics at the National Bureau of Economic Research have caught on, publishing an interesting working paper in October 2021 titled “Falling Rates and Rising Superstars.” The paper finds empirical evidence for the competitive advantage present for large companies in extremely low interest rate environments. A brief summary: “Do low interest rates contribute to the rise in market concentration? Falling rates raise the valuation of industry leaders relative to industry followers and this effect snowballs as the interest rate approaches zero. The findings provide support to the idea that extremely low interest rates and the rise of superstar firms are connected.”

If inflation continues on its recent course, the writing may be on the wall for interest rates to rise. In our second and third quarter of 2019 client presentations, we presented two recent Bloomberg Businessweek covers. The one from April 22, 2019 was titled, “Is Inflation Dead?”. Unlike the deflated dinosaur on the cover, inflation is, in fact, not extinct. The most recent Consumer Price Index (CPI) figure from December 2021 was a 7% increase over the last 12 months (released on January 12), the highest in 40 years. We do not believe this figure is due solely to supply chain issues so we do not expect the inflation to be transitory. The massive amount of money that has been printed over the past decade has finally begun to find its way into categories of goods and services measured by CPI.

The Federal Reserve has recently acknowledged that inflation is NOT transitory and has started talking about an eventual end to Quantitative Easing and a rise in overnight interest rates in 2022. So far, the Fed is only talking tougher today, since money supplies continue to increase and real rates (interest rates minus inflation) remain at deeply negative levels. If inflation does stay elevated, we believe it will force their hand. This leads us to the second Bloomberg Businessweek cover from July 29, 2019 titled, “No Escape From Low Rates.” Will it soon appear to be as wrong as the inflation cover?

Opportunity in Value Stocks!

Share prices for the broad market have grown far in excess of earnings power as we showed you in our 2nd Quarter 2021 Commentary, which is how you end up with valuations in line with levels reached by stock markets in 1929, 1966, and 2000. So, why is FRM so cautiously optimistic?

To put it simply, value stocks remain priced at very attractive valuation levels. AQR, run by well-respected and successful investor Cliff Asness, recently published the chart above. The value versus growth spread is calculated using a composite of five value measures: book-to-price, earnings-to-price, forecast earnings-to-price, sales-to-enterprise value, and cash flow-to-enterprise value. The higher the spread, the more attractive the opportunity in value stocks.

One compelling aspect of this opportunity is that value stocks are priced this attractively, while they are actually expected to generate growth in earnings per share (EPS) that is higher over the next five years than they have achieved historically. And while expensive growth stocks are expected to have EPS growth over the next five years that is higher than cheap value stocks, the difference is expected to be smaller than the historical figure (illustrated by the difference in the gray bars of the AQR chart above). We generally give little weight to analyst predictions of the future, but we agree with the analysts at AQR that most stock investors are missing something, and we are happy to take advantage of it in FRM portfolios.

One of the ways we try to control risk is by knowing what we own and why and paying attractive prices for each position. Currently, our portfolios look less like the broad market (as measured by the S&P 500) than they have in the entire 31-year track record of FRM. We think the broad market is over-priced and risky and believe our portfolios to be cheaply priced and full of opportunity for good returns. In the chart beside, you can see that the industry exposures of our composite portfolio differs greatly from both the S&P 500 and the Russell 1000 Value indices. We outperformed both of these indices in 2021 despite the Russell 1000 Value and many other value investors underperforming the S&P 500. Our outperformance was in large part due to our holdings in the Energy industry, the best performing sector in the S&P 500.

Waiting for Patience to be Rewarded

We had a recent client inquiry regarding a subject worth addressing in these pages. The investment at hand was Fairfax Financial Holdings (TSX: FFH, OTC: FRFHF), one of your largest equity positions, and the very valid question was, essentially, “Why would you continue to hold Fairfax when the stock has gone nowhere in years!?” We hope our answer to this question will illuminate why we might continue to own a company whose stock has not had strong recent performance.

Hopefully it is evident in our writings every quarter, but our approach to allocating your capital requires a totally different mindset than that presented on CNBC or Squawk Box. We think about investing in public stocks like a business owner would. To illustrate our point, we will ask you to humor us for another “imagine” exercise. Pretend for a minute that you are the fortunate owner of a cash-flowing business with tangible assets. Your neighbor is envious of your company and asks every year if he might buy your business. For the last five years he has been willing to pay you at most $5.3 million and at least $3.4 million for this business. The business has a current book value of $5.6 million, which has grown over 50% in the last five years and by nearly 18% annually since you bought the business in 1985. Similar quality businesses trade in the marketplace at around 1.3x book value, implying your company should be worth $7.28 million today. However, you also know of pending gains in upcoming quarters that will increase the stated book value of the company and bring your estimate of intrinsic value to $10 million! This business generated $553,000 of cash in the past 12 months. You run into your neighbor at a cocktail party and once again he says “Aren’t you ready to sell? I’m willing to pay $4.9 million on the spot today for your company!!” Would any rational person sell their business for such an unreasonably low price?

This is exactly how we think about your ownership in Fairfax Financial. We have spoken at length about Fairfax in prior letters (see section “Good News from Portfolio Companies” in our 3rd Quarter 2021 Commentary or our 2nd Quarter 2017 Commentary in the “Investment Activity” section). We hope a brief revisit illustrates our thinking. The numbers in the illustration above aren’t made up – they are simply Fairfax’s financial results scaled to the size of a mid-sized business. Fairfax has grown its book value by 53% in the last five years, and we believe the company has additional book value growth to come. During the fourth quarter they completed a buyback of $1bn worth of stock. The buyback was nearly entirely funded by the sale of a ~10% stake in Odyssey Group, their second-largest insurance operation by gross premiums written, to two Canadian pension funds. In our 3rd Quarter 2021 Commentary we gave you a brief update regarding another home-run investment of theirs - Digit, an India-based digital insurance company in which Fairfax invested $154 million and is now worth $1.6 billion.

The broader question at hand is why would we be willing to hold stocks that have not yet “worked” after years of ownership? The answer is that we are focused on the businesses that we own. Every week in our research meetings we estimate a reasonable range of what a business is worth, which we call its “Intrinsic Value.” This valuation is determined by many qualitative and quantitative factors, including the quality and durability of earnings, the quality of the balance sheet, management’s alignment with shareholders, the competitive dynamics in the industry and on and on. We buy stocks that trade for less than this estimate of worth because we have a fundamental belief that the market price of a stock ultimately comes to reflect the true value of the business.

The nearby chart illustrates that Fairfax has traded below our estimate of value for much of the past decade. That is despite our opinion that management has been increasing the intrinsic value of their company over the same period thanks to profitable insurance underwriting and well-timed strategic investments. If the business that we own is profitable, earning a sufficient return on invested capital over time and our estimate of intrinsic value is increasing, then we are perfectly comfortable owning that business until the point that someone is willing to pay us more than we think it is worth. We believe this is only a matter of time for Fairfax.

Series I Savings Bond

One of the only attractive opportunities that we have seen in bond markets in recent years has recently presented itself in Series I Savings Bonds issued by the US Treasury. We have discussed these bonds with many of you after the initial interest rate on the new Series I savings bonds increased to 7.12 percent in November 2021. The main aspects that make these bonds attractive are the backing of the US Government and the adjustment of the interest rate for inflation. We are not able to take advantage of this opportunity for you as these bonds are only available to individual US citizens via the TreasuryDirect website ( or an individual tax return. The maximum purchase per calendar year per person for the bonds is $10,000 of the electronic bonds and $5,000 of paper bonds (issued via a tax return).

I Savings Bonds have an annual interest rate derived from a fixed rate and a semiannual inflation rate. The inflation rate can, and usually does, change every six months. Interest is added to the bond monthly and is paid when you redeem the bond for cash. The minimum ownership term is one year and they will earn interest for 30 years or until you redeem them for cash. There is an early redemption penalty if you redeem the bonds before five years.

The U.S. Treasury has experienced unprecedented demand for these bonds since the increase of the inflation adjustment. We understand why as these bonds make sense for many investors to own. We are happy to discuss them with you in the context of your overall investments, even though we cannot purchase them for you. Please let us know if you would like to have that conversation.

2021 Milestones

FRM experienced a very gratifying year in 2021.

We finished the year with the third best equity performance in the 31-year history of our performance composite. The FRM investment team saw some bounce-back in some of your traditional holdings while capitalizing on some new investments that not only added to performance but further diversified your portfolio. We believe we are in the early stages of seeing our long-term discipline rewarded. Inflation, regardless of how it is measured, is now undeniable and recognized beyond the asset inflation we have seen for the last 10 years. Many of your positions have thus far provided the inflation hedge we expected. While we outperformed both the S&P 500 and the Russell 1000 Value, value investing in general continued to lag last year. Thus, the Federal Reserve’s zero bound interest policy is still favoring the most speculatively priced stocks.

We are very proud of our 31-year track record. Unfortunately, in today’s short-term focused world of investing, that longevity carries very little weight, especially in what has become of the institutional investing world. The primary focus in that arena tends to be anywhere from three months to three years. We believe that short-termism actually provides opportunity for those that have the discipline, patience, and courage to be apart from the crowd, more-so during the current mania than ever before. As we mentioned to you last year, FRM claims compliance with the CFA Institute’s Global Investment Performance Standards and has received verification from an independent third-party firm. We are happy to share any information regarding our historical composite upon request.

On a personal level, the greater FRM family saw three of our offspring graduate from high school and move on to college. Tia Boyd graduated from Bryant High School and is enrolled at the University of Arkansas Pine Bluff. Tia is interested in pursuing a career in teaching math. Blake Fleischmann graduated from Catholic High in Little Rock. He is attending Arkansas State University and is majoring in Jazz Studies. He plays the drums in the Red Wolf band. His dad, Chris, is a singer/songwriter in his spare time, so Blake comes by his love for music naturally. Maddy McKelvy graduated from Mount St. Mary Academy in Little Rock. She is attending the University of Arkansas at Fayetteville. She got covid out of the way early on, and she is still deciding on a major. Abby reports that she is having a darn good time!

There are no new family additions to report, however Gray and Mallory Millsap are expecting a little girl in May. That will be their first child. We are setting an over/under on how many trips Mark and Mary take to Dallas this year.

One bit of bad news blindsided us this year. Our partner and long-time colleague, Tom Hill, learned in the spring that a lump on the side of his neck was malignant. Tom had neck and throat surgery and soon began a rigorous radiation and chemotherapy treatment at M.D. Anderson Cancer Center in Houston. Following that round of treatment, a scan showed some malignant spots in the lymph nodes of his chest. Tom’s team then started a series of immunotherapy and chemotherapy treatments. Last week Tom and Debbie went to Houston for follow-up scans and consultations. We were elated to hear that there were no signs of cancer in Tom’s head and neck area and no new signs of spots in his thoracic area. The spots that are there were either smaller or unchanged. We humbly ask that you keep Tom, Debbie, and their wonderful family in your prayers.

October marked the 20-year anniversary of Mark joining Greg at FRM to form one of the most “meant to be” partnerships in history. Abby McKelvy joined them almost immediately, so she received the customary FRM recognition for her 20 years, a hearty handshake and congratulations! Greg and Mark did break down and take their spouses, Janet and Mary, to lunch to celebrate and acknowledge their behind-the-scenes contributions to the company.

Over the years we have shared tremendous joys, tears, successes, and disappointments as a true team does…together. You have been the key to all of this. Without your trust, confidence, and patience, none of our success would have been possible. We never forget that around here. Thank you for being part of our team. May 2022 bring you and yours good health and much joy and prosperity.


Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Foundation Resource Management, Inc. (“FRM”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from FRM. Please remember to contact FRM if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services or if you would like to impose, add, or modify any reasonable restrictions to our investment advisory services. FRM is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice. FRM claims compliance with the Global Investment Performance Standards (GIPS®). GIPS® is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. A copy of FRM’s current disclosure Brochure (Form ADV Part 2A) discussing our advisory services and fees or our GIPS-compliant performance information is available by emailing Abby McKelvy at

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