The December to Remember Sales Event

First, my most recent interview with Lead Lag went somewhat viral on X. (It's all relative.) We cover much of what follows in this letter but more thoroughly.

Click the above image to play video

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

"Investing is the only business I know that when things go on sale, people run out of the store." - Mark Yusko

I often reminisce on the good ol’ days when people invested in strategies. You know… with thought. They invested with intent, aiming to buy low and sell high. Now, almost 60% of the equity market is invested in portfolios with no strategy; there is 0 thought behind the investment decisions. Themes, which can be cool and helpful, round it out. There’s little to no investment in “Buy low. Sell high" - the most self-evident way to make money.

$100,000 invested in Running Oak’s Efficient Growth strategy at the beginning of 1989 would be worth $7,404,114, net of a 58bps fee, while $100,000 invested in the S&P 500 would be worth $5,085,515, gross of fees, or over $2.3mm less.* (Keep in mind you can’t invest in an index for free, so $2.3mm is artificially low.)

The largest driver of the strategy’s significant outperformance is far smaller drawdowns. Since 1989, Efficient Growth has provided roughly 50% of the average drawdown (downside risk) of the S&P 500.* Large drawdowns often occur from high valuations. Speaking of high valuations, the forward PE of the 10 largest holdings of the S&P 500 is currently 39. The forward PE of the 10 largest holdings of the S&P 500 at the peak of the Tech Bubble was 25. The forward PE of the top 10 is currently 55% higher than at the peak of the Tech Bubble AND the percentage of the top 10 is also much higher, currently 41%. (If you're interested in nerding out on how we got here, here's an excellent conversation.)

Far more importantly than the higher return, Efficient Growth has provided almost 130% more risk-adjusted return (more than double) than the S&P 500. Ytd through April, Efficient Growth had outperformed every relevant benchmark and each of the most common peers.*

On Sale Now!

From April 1st through September 30th this year, Efficient Growth was up 5.52%, net, versus 19.94% for the S&P 500. In other words, a portfolio that has outperformed the S&P 500 over a 36-year period with 50% of the downside risk, providing 130% more return given the same level of downside, and that had outperformed every peer and benchmark, ytd, only a few months ago is now at over a 12% discount relative to that time.*

Counter intuitively, lagging over the past 6 months is GOOD. (Note: I would prefer to outperform for our clients every day.) By numerous, clear measures, the last 6 months was THE DUMBEST 6-month period in the history of the stock market. To outperform was to invest in the unintelligent. The opposite, lagging, was a clear sign of investing intelligently; it's been weird. Three traits we intentionally don’t invest in: High Volatility (the riskiest of stocks), Meme stocks (those pumped on message boards to the unsuspecting - a pertinent article), and Momentum were up significantly. A large basket of stocks with a trait proven to destroy value, High Volatility, was up 100% in only 6 months; that was previously unheard of.

Levered idiocy in a picture - We do the opposite.

Our strategy can most simply be described as "Consistently Not Stupid". Three traits we intentionally invest in: Low Volatility (proven to provide value - another excellent article), High Quality (good, well-run companies), and Profitability were some of the worst performing. Companies that make money were never so unwanted as the last 6 months. Outperforming would have required taking significant risk with our clients’ hard-earned money, investing in companies that lose money, and doing the opposite of that which we tell our clients - being inconsistently stupid.

So, for the best of reasons, our portfolio is 12% off versus 6 months ago. It's the December to Remember Sales Event; get a Lexus for the price of a Corolla.

Why this matters NOW

10-year negative expected returns + Financial shenanigans (some say fraud) + Historic downside risk + High odds of a recession = Mandatory evasive action

Like 1999 (the only time Efficient Growth lagged to this degree), it is not a time for status quo and kowtowing to clients who measure performance versus Nvidia and the S&P 500.*

2. Data – Given current valuations, the S&P 500 is expected to have a NEGATIVE return over the next 10 years. Will that be acceptable to clients?

2. Questionable Data (some say fraud)

According to Michael Burry (and common sense), several of the Mag7 appear to be artificially stating higher earnings. This isn’t fancy complicated math.

• The useful life of chips and data centers is rapidly declining. Nvidia’s chip cycle used to be 2 years. It’s now below 1 year. Historic capex is being pumped into technology that rapidly becomes obsolete due to technological advances. Yet…
• These companies are extending the reported useful life of these assets against all that is blatantly obvious.

Why are they claiming the opposite of what is obvious, using one’s eyes? Because it artificially pushes earnings higher, making valuations appear lower. Again, Burry states that META is likely to overstate earnings by 27%. That’s being generous. He’s granting them a 2-3 year life cycle when it appears to be under 2. This is one of the best articles I have read on the current craziness.

While Burry's analysis doesn't pertain to Nvidia, his claim that Nvidia is Tech Bubble Cisco is worth a read. Here's an excellent synopsis. Nvidia's forward PE isn't especially alarming, by itself. The expectation of roughly 100% earnings growth for a company whose market cap is 16% of US GDP - a company that is handing customers money to buy its products, manufacturing demand with its own cash - THAT is alarming. If 100% earnings growth fails to materialize, the company's forward PE will be higher (potentially far higher), skewing all statistics within this letter, and they're already wildly skewed versus history.

3. Historic room to fall

Not only is the forward PE of the 10 largest holdings in the S&P 500 55% higher than the same measure at the peak of the Tech Bubble, concentration is also 50% higher. And those forward PEs are very like artificially (some say fraudulently) low. Adjusting for Burry's claims (by reducing earnings by 20%), the forward PE of the 10 largest holdings are arguably 94% higher than the peak of the Tech Bubble. Lastly, the average household has 30% more invested in stocks than at the peak of the Tech Bubble. The below chart attempts to illustrate the sheer, insane magnitude of the risk currently being taken in just 10 companies.

4. The yield curve has steepened from the longest inversion ever. Normalization occurred in 2007, 2001, 1989, and 1929. The forward PE analysis above assumes no recession. If earnings decline, the chart above - the one showing people are taking almost 4x the risk of the peak of the Tech Bubble - is overly conservative.

Tech Bubble Refresher

I have referenced the Tech Bubble multiple times throughout this letter. That was 25 years ago. Many either didn't experience the full severity or time has eroded the memory. The Tech Bubble was the largest bubble in US market history. The Nasdaq declined 78%, while the S&P dropped 49%. The magnitude of risk in the 10 largest holdings is arguably 4x that of the Tech Bubble. Those who simply rode it out experienced significant pain. Those who made strategic tweaks performed far better. Value, Small Cap, Quality and our Efficient Growth portfolio were all up in 2000 and 2001.* This isn't a time to do nothing. Maybe the 10 largest companies become 60% of the S&P. Maybe they decline to the long-term average of 20%. Diversification is key, and with an active share of 94%, Efficient Growth provides excellent diversification versus that which most own far too much of.

“When people panic, they make mistakes. They override systems. They disregard procedures, ignore rules. They deviate from the plan.” - The Obstacle Is the Way

Begrudgingly, a financial plan is more important than investments; always begin with the end in mind. Did the financial plan assume almost an 18% return in the S&P 500 since 2019? Or did it assume a typical 10% return? If 10%, what is the plan for the extra 100%? To let it ride, risking it at 4x the risk of peak of the Tech Bubble, or to take it off the table, investing it in a conservative alternative, because the client is far ahead of the plan? If it's still riding at historically obscene risk, don't panic due to FOMO. Don't make mistakes. Don't override the system. Don't disregard procedures, ignore rules. Don't deviate from your well-thought out plan.

Warren Buffett is a smart man. If you can't beat'em, copy'em. Diversify. Reduce Risk.

3x the stock exposure of just 5 years ago

Lastly, I can't recommend this video enough. Ben Hunt is one of the most thoughtful individuals I have ever had the pleasure of meeting. His message is disconcerting but grounded in data and reality.

Click the above image to play video

Why Invest in Efficient Growth:

• Top Decile: Running Oak’s Efficient Growth separate account has performed in the top decile of all Mid Cap Core funds - despite being historically out of favor - in Morningstar's database over the last 10 years and as of Q3, net of fees.1
• 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.
• 5 Stars: Efficient Growth has a 5-Star Morningstar rating.
• Since inception, Efficient Growth has provided 15% 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 just over 2 years, The ETF Which Shall Not Be Named has grown 18,000% since launch - from 2 to 365mm.

Performance Update

• Running Oak’s Efficient Growth portfolio was up 1.16%, gross of fees (1.12%, net), in November.* (preliminary performance, subject to change)

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.

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

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