Animals hibernate for self preservation—to conserve energy during adverse conditions. But then they emerge, ready for the more bountiful period that awaits.

While we still see an economic setback ahead, and a commensurate market reaction, we expect markets to discount the pending recession, and then once again focus on recovery. In the meantime, we are hibernating—hedging portfolios (afraid of market declines) and buying undervalued, high-quality, recession-resistant companies below our estimated FMVs.

Most don’t practice value investing—instead relying on buy and hold, momentum, or index strategies, all much easier on the psyche in the short term. To us, it’s simple common sense to embrace mean-reversion strategies—those offering better upside potential, especially during a period when most securities have downside risk since they are already at or above FMVs.

The rise in interest rates has been felt across the U.S. economy. Commercial and Industrial loan growth is declining, for the first time since 2020. And it began declining before the recent U.S. bank failures, which were 3 of the 4 largest of its kind. We will continue to hone our short game—hedging portfolios—while playing the long game—owning high-quality companies we expect to grow their earnings and underlying valuations.

Globally, growth is waning, though at a tepid pace because of the prior avalanche of government stimulus, rebuilding of supplies, and extremely low unemployment. Will central bank restraint lead to a mere petering out of growth, if inflation is quickly perceived to have been ameliorated, or is recession inevitable from one of the fastest tightening responses on record?

And up and down. Like a toilet seat, yo-yo, a game of Snakes & Ladders, not straight up and down like an elevator, but more like the ups and downs of a rollercoaster—that’s how the financial markets have felt lately. Unusually volatile, reacting to headlines related to inflation, rising interest rates, declining corporate earnings, layoffs, Ukraine, and covid-shutdowns in China. Emotions have been pushing markets up and down, while underlying fundamentals worsen.

Our glass is typically half full. Lately, the contents have been evaporating. What would fill it again? Either a substantial market decline lowering valuations, or a sudden reduction in core inflation levels along with a commensurate decline in interest rates. Neither are likely to occur in the short term. Though valuations have compressed from their highs, further deterioration is expected as the economic backdrop worsens.

Most believe we are destined for a recession, if not already in one. Between the negative sentiment and the stock price valuation reset that needed to take place, it’s not surprising that the markets have meaningfully softened. While the economy is clearly slowing, we do not foresee an imminent recession.

Our recent mantra has been “Sell the rallies” not “Buy the dips” because we’ve been expecting much more than a dip. That’s not to say that we’ve been expecting a recessionary-based bear market—prolonged and pronounced negative returns while underlying values are falling. We’ve been anticipating a correction, albeit maybe a substantial one, since prices started falling from levels that were above our estimate of fair market value (FMV).

We sleep well at night knowing that we are partially hedged and that our holdings are growing, high-quality companies that, unlike the overall market, trade at substantial discounts to our estimates of FMV. We remain concerned about several factors, primarily high market valuations, which could trigger a market decline and reestablish a wall of worry.

On rare occasions the market takes on a speculative bent as animal spirits run amok. For us value investors, during these periods, it’s always hard to believe that the others, whose behaviour is so odd to us, are competing in the same field. Why would anyone ignore fundamentals, buy purely on price, chase what’s already gone way up, use highly-speculative instruments, assume extreme leverage, or worst of all, purchase something that’s hugely popular—gone viral—a ‘meme’ stock?