Taking guessing out of the ”risk up” or ”risk down” decision


The most consistent investment firms are not adept at pricing assets perfectly, this is impossible. What makes them exceptional is having a framework for understanding when assets are cheap or expensive and making the right directional bets over time. This is the focus of our latest Big Picture Article.

Good aviators will tell you that their recipe for survival is remarkably unsophisticated – aviate (fly the aircraft), navigate (don’t hit any unintended objects ) and communicate (make a point of telling others where you are), in that order of preference.

In contrast, many in the investment industry portray deep complexity and the need for more than a single prescriptive recipe for success.

We believe otherwise, the best have one key distinguishing trait, being able to buy great assets when they are cheap, and do the opposite when they are not!

What differs to aviation is that “being right” in investing is usually noticeable after the passing of some time, whereas aviation decisions and their consequences are of course immediate!

It is time to moderate the throttle

We have been reducing exposure to increasingly expensive riskier assets, over the past number of weeks, for two primary reasons.

  • Firstly, our own bottom up investment infrastructure designed to identify and own undervalued assets whilst shunning those that are not, is guiding us towards caution.
  • Secondly, it is evident that certain idiosyncratic macroeconomic factors unique to this cycle could overide our bottom up asset valuations.

The uniqueness of this cycle

During the onset of Covid, households (using US households as a strong proxy) started to save furiously. Initially they hoarded and their savings rates rose to over 30% of their disposable incomes. However, midway through the crisis, the excess savings, ballasted further by government grants, converted thrift into raging expenditure.

Chart 1: US savings rate

Source: Bloomberg (31 December 2022)

As we all know, this heightened consumption fuelled inflation and central banks were forced to raise interest rates. The US Federal Reserve started raising rates from 0.25% in March 2022, to the current level of 4.75%. What is unique about this cycle is that despite its (interest rate adjustments) speed and size, pooled savings have, so far, largely neutered their impact.

Chart 2: US consumption expenditures

Source: Bloomberg (31 December 2022)

The economic consequences being

Firstly, (see chart below) the global economy continues to power ahead with unemployment at historically low levels.

Chart 3: US unemployment rate

Source: Bloomberg (31 December 2022)

Of course, employees are hardly in a generous mood when they know that there are more job vacancies than applicants and this fuels even more inflation.

Secondly, corporate profitability is unnaturally resilient considering how late we are into this economic cycle. Both US and European corporate profit margins are at their highest levels seen since 2004. S&P 500 earnings are down only 3% so far in this cycle, versus past cycles where the drop has averaged 25%.

Sticky profits and company ratings

Fortunately, the P/E multiple on the S&P has contracted by over 20% from its highs of 18 months ago, but has not deflated to the same degree as previous investment cycles, which was circa 33%.

We struggle to buy the idea that this cycle should be vastly different from all those that preceded it. In fact, as the Fed pushes ever higher interest rates to overcome a wall of money, the end result might be tumbling corporate profits.

Northstar buy lists have been indicating diminished discounts

Our primary reason for caution on markets has its source in our own investment process, which guides our market exposure. We operate three “buy lists’’. These contain only those assets that we have understood deeply and in turn believe to be high enough in the quality spectrum to invest in. In order to determine buy and sell points for each security, we rigorously maintain a current price valuation (bear, base and bull) for each investment.

  1. Fixed income,
  2. domestic, and
  3. global equities.

We apply a deeply structured approach to and spend a lot of time understanding each company at a fundamental level and this provides us insight as to the discount or premium that each stock trades at against its share price. In other words, we know how “cheap” or “expensive” our entire buy list is against its true value at any point in time. This we call the discount to intrinsic value, and we monitor and record the value daily.

Portfolio activity

With the benefit of many years of monitoring how cheap or expensive our buy lists are against their own histories, we are confident in the efficacy of this work. This means that when our buy lists indicate that assets are cheap, the subsequent returns are excellent for clients, and equally when the buy list warns that stock are expensive, future returns tend to be poor.

In the past few months, after the significant run up in stocks, both our domestic and global equity buy lists spoke to lower future stock returns. Consequently, we de-risked our Northstar funds. Since doing so, markets have pulled back and are already offering slightly better returns, albeit not mouth wateringly so.


Successful investing is never about pin-point accuracy. No investor has 20/20 vision as to what any asset is worth. But our processes and systems must ensure that we make value adding directional calls – a richness of information that creates clarity as to whether we are entering green (cheap), amber (no man’s land) or red (expensive) territory.