2000, Zero, Zero

Please find Running Oak's most recent performance and letter below. Running Oak's Efficient Growth strategy is an excellent complement to the most popular, most overcrowded, most over-owned, high-flying holdings: S&P 500, QQQ, Mag7, unprofitable/innovative Tech, AI companies that burn cash with no path to profitability, Large Cap Growth, etc. It can be a thankless job, but we welcome the opportunity to be your clients' portfolio designated driver.

"The ride is so smooth. You must be a limousine.” - Prince

Efficient Growth appears imminently likely to provide more value than any time since 1999, BECAUSE it's built for the rain - purple rain!. By value, I don’t mean absolute return but outperformance and, most importantly, lower downside. If so, here is what that looked like over the 3-year period following 2000:

"You need a love, you need a love that's, uh, that's gonna last." - The Purple One

The chart that arguably made Vanguard..., except it conveniently didn't include Efficient Growth.

If you're wondering how Efficient Growth has outperformed the S&P 500 to that degree, how it has delivered 50% of the average drawdown of the S&P 500 over 36 years, and why I am so confident about relative performance over the next decade, here's a snapshot*:

*Expected growth column is derived by the difference in Current PE and Forward PE.

Several key takeaways:

• The Best of Both Worlds: The forward PE of Efficient Growth is lower than the S&P 500 AND the implied growth rate is over 50% higher.
• NOT What Clients Need: RSP, the S&P 500 Equal Weight, has a beta of 0.97. That isn't diversification; it's just more of the same - same companies, same price behavior.

“So tonight I'm gonna party like it's 1999” - His Royal Badness

Today’s parallels to 1999 are too many to ignore. While AI will be transformative, will create incredible change, and this time IS different (it always is), the last thing we need as fiduciaries is more hype, more AI cheerleaders…

Sooooo... you're saying the equity market has pretty much NEVER been more expensive, regardless of the metric?

Ready? OK!

What’s a "job"? I don't know!

I’ve got an AI to make the dough!

I’m a VIP! I’m a CEO!

Of doing ABSOLUTELY NOTHING, yo!

Automation! High-five!

It’s a miracle we’re still alive!

We don't produce! We don't compete!

We just sit in the stands and TWEET! TWEET! TWEET!

9 to 5? No, thank you, sir!

Everything’s a total blur!

My boss is a server! My desk is a bed!

I’ve got zero thoughts inside of my head!

Gooooooooo pile in!

“I guess I should've known by the way you parked your car sideways that it wouldn't last.” - Alexander Nevermind

I have opined in the past that the forward PE of the 10 largest holdings is 55 to 60% higher than that of the 10 largest at the very peak of the Tech Bubble. The forward PE is being generous; it incorporates AI optimism. But it's nowhere near as optimistic as - per Michael Burry - several of the largest companies extending the depreciation cycle (useful life) of their AI infrastructure investments. The Wall Street Journal provides more color in a recent article. Here is where current capex stands at the current, highly questionable useful life stands (as a percentage of total revenue - not profit - revenue):

BUT... the world is changing faster than ever before. Technology, in particular, is changing faster than ever before. Nvidia's chips are changing faster than ever before. In fact, Nvidia has gone from a chip cycle of 2 years to under 1 year. That doesn't seem like an environment for extending depreciation cycles. That seems like the opposite.

To illustrate the degree to which this matters, consider the difference between a 2.5 year cycle (what Burry feels is accurate and, frankly, makes sense) versus the 5-year cycle several companies are currently using (some have gone as high as 6). On a 2.5-year cycle, depreciation expense is 2x (100% higher) that which companies are currently claiming.

Here is what their current claims look like:

Now, imagine that cliff above being twice as steep, a free fall. THAT is the difference between a 5-year cycle (that doesn't make sense) and a 2.5-year cycle (that makes sense).

"Babe, you got to slow down." - TAFKAP

That free fall in cash flow, combined with significant uncertainty around when AI investment will actually pay off, is making many nervous.

Brakes are likely to be pumped. But the problem is that they have already bet huge. In poker, what happens if you bet huge... then fold? You lose the hand, and you lose much of your money. Equity investors won't like that. That said, historically, equity investors haven't liked massive capital investment, in general. Maybe this time is different?

The poker example is a little extreme, because the historic capital investment these firms are making likely has value post folding but potentially far less than invested, because it's a race for survival. In fact, at a recent conference, an influential individual in the AI space specifically stated that the Big Tech companies see AI as an "existential threat", meaning they win or they're dead. 

Because poker is such an excellent illustration of companies' current behavior regarding AI, here's a simple poker betting tutorial. Keep in mind that there is a time limit to this investment. At some point, investors revolt, as they did with Meta only a few years ago, resulting in an 85% decline. AI isn't just a race to the finish line; it's also a time trial.

1. Pre-Flop: Setting the Foundation

Before any community cards are dealt, you are fighting for the blinds.

• Standard Move: Raise to 2.5x or 3x the Big Blind.
• Purpose: To thin the field. You want to play against one or two players, not the whole table.

The hyperscalers have invested to a degree that only a tiny number of companies can, thinning the field.

2. The Flop: The Continuation Bet (C-Bet)

The first three community cards are out. The pot is now small-to-medium.

• Standard Move: Bet 33% to 50% of the pot.
• Purpose: Since the pot is still relatively small, a half-pot bet is often enough to force out "air" (hands that missed completely) without risking too many chips if you are bluffed.

Blue Owl seems to have flinched.

3. The Turn: Raising the Stakes

The fourth card is dealt. The pot has likely doubled or tripled in size since the start.

• Standard Move: Bet 65% to 75% of the pot.
• Purpose: This is the "charging" street. If you have a strong hand, you want to make it expensive for opponents to stay in with a drawing hand (like a flush or straight draw).

Notice the recommended bet is getting significantly larger. Oracle appears to have tried to buy the pot... and were called by investors. Anthropic, OpenAI, and other major players are unprofitable and dependent on constant venture capital money to stay in the game. VC has shown they have deep pockets, but those pockets aren't bottomless.

4. The River: The Commitment

The final card is out. There are no more cards to wait for; you either have the best hand or you don't.

• Standard Move: Bet 75% to 100% of the pot (or go All-In).
• Purpose: To extract maximum value from a worse hand that is "curious" or to force a better hand to fold. At this stage, the pot is at its largest, making the bet size feel significant.

The stakes have now gotten far larger. It's getting more and more difficult to stay in the game, which could explain why Nvidia has been structuring circular deal after circular deal, working to keep the game going and carry someone to the finish line in time. But Nvidia can only do so much. First, they bluffed, announcing a $100B "deal" with OpenAI. Recently, they announced it's actually a 30B deal - "Just kidding!"

The Final Decision: To Fold or Not?

When your opponent bets back at you on the river, you face the ultimate choice. Use this logic to decide:

Again, an individual intimately familiar with AI stated that the largest companies view AI as an "existential threat". When it's a matter of life or death, there is no folding, just all-in. Numerous people have stated this race could be a "one company takes all" situation.

"She walked in through the out door, out door."

Well-run, profitable, growing, reasonably levered - you know, Quality - companies are down. Garbage is up.

"Pills and thrills and daffodils will kill."

We've see this before.

"Let's go crazy.

Let's get nuts."

It has been a wild several weeks with companies swinging all over.

"Maybe I'm just like my father, too bold."

The average household is all-in like never before... at historic valuations for the 10 largest holdings.

"How can you just leave me standing

Alone in a world that's so cold?"

Numbers and all...

Why Invest in Efficient Growth:

• Opportune: A little known - yet very large - hole exists in the typical equity portfolio, precisely where the most attractive risk/reward asymmetry currently lies. Efficient Growth fills that hole - and opportunity - like few portfolios do. Own what others don't.
• 5 Stars: Efficient Growth has a 5-Star Morningstar rating.
• Since inception, Efficient Growth has provided 14% more return than the S&P 500 Equal Weight Index, given the same level of downside risk, gross of fees. (Ulcer Performance Index)*

Differentiated Approach and Construction

• Mid Cap stocks are at their cheapest in 25 years relative to Large. Efficient Growth provides significant Mid Cap exposure.
• Efficient Growth is built upon 3 longstanding, common sense principles: maximize earnings growth, strictly avoid inflated valuations, protect to the downside.
• Running Oak utilizes a highly disciplined, rules-based process, resulting in a portfolio that is reliable, repeatable, and unemotional.

How to Invest

• Efficient Growth is currently available as an SMA and ETF. (ETF specifics and SMA historical performance can't be shared in the same letter - sorry, it's annoying, I know. Please inquire for the ticker or more information.)
• In 2 and a half years, The ETF Which Shall Not Be Named has grown roughly 19,000% since launch - from 2 to 380mm.

Performance Update

• Running Oak’s Efficient Growth portfolio was up 3.68%, gross of fees (3.64%, net), in January.*

Quick hitters:

Consistently Not Stupid - Running Oak in 3 Words

Invest Where Others Aren't (MARGE - Upper Mid/Lower Large Cap)

• Investing where everyone else is investing means higher prices, higher valuations, lower implied returns, higher implied downside.
• Investing where others aren't means lower prices, lower valuations, higher implied returns, lower implied downside and a margin of error.
• Investing where others aren't also provides valuable diversification.
• If the market goes up, others are likely to follow, propelling prices.
• If the market goes down, others can't sell what they don't own, meaning less selling and downside pressure.

It's win/win.

Running Oak's goal is to maximize the exponential growth of clients' portfolios, while subjecting them to far less risk of loss. In other words, we aim to help your clients realize their dreams and avoid their nightmares.

If you appreciate critical thinking, math, common sense, and occasional sarcasm, we would love to speak with you. Please feel free to set up a time here: Schedule a call.

Lastly, some music to liven your day:

Click the above image to play video

Seth L. Cogswell
Founder and Managing Partner

Edina, MN 55424
P +1 919.656.3712
www.runningoak.com

For additional data and context regarding the claims made within this letter, please refer to the Disclosures and Additional Data document located here.

Investment Advisory Services are offered through Running Oak Capital, a registered investment adviser.

The opinions voiced in this material are those of Running Oak Capital’s, do not constitute investment advice, and are not intended as recommendations for any individual. To determine which investments and strategies may be appropriate for you, consult with us at Running Oak Capital or another trusted investment adviser.

*Past performance is no guarantee of future results. Performance expectations are no guarantee of future results; they reflect educated guesses that may or may not come to fruition. All indices are unmanaged and may not be invested into directly.

*Returns prior to September of 2013, while unaudited, were documented and generated on a real-time (not back-tested) basis. Such results are from accounts managed at other entities prior to the formation of Running Oak Capital. It reflects the strategy’s performance since the beginning of 1989. Downside risk is calculated by dividing the average drawdown of the strategy, observed on a quarterly basis, by the average drawdown of the S&P 500 index since 1989.

*Statements regarding the large gap in the middle of the typical equity allocation reflect the opinion of Running Oak Capital This is based on informal feedback and experience from interactions with investors and other financial professionals. Further, statements on where the most attractive risk/reward asymmetry lie, although based on observable data, reflect the opinion of Running Oak Capital.

*Statement regarding Mid Cap stocks outperforming Large is reflective of historical performance of the Russel Midcap Index vs Russell 1000 Index.

*Source of Mid Cap undervaluation & Large Cap overvaluation: Bloomberg