Below is Tom Bradley's letter to clients from our Quarterly Report.

The stock market had a pullback at the end of September. The turbulence, which has continued into October, is being blamed on all kinds of things: rising inflation, a real estate meltdown in China, and disappointing corporate profits related to supply chain disruptions and higher commodity prices. The fact is, we never really know why markets rise or fall in the short term.

The current volatility should come as no surprise. After strong markets over the last 18 months, let alone 13 years, we were due for a reset. Rather, the real surprise is how smooth the market’s rise has been since last April. Stocks have powered through COVID concerns and resisted emerging inflationary pressures.

Why has this happened? Well, it comes down to two factors: teamwork and interest rates.

First, stocks have been playing a team game, with different sectors and themes taking turns leading the way. In a golf match, it’s called ‘ham and egging’. Growth stocks (read: technology) have been the most dominant players, but when needed, the cyclicals (economic recovery) have stepped up.

The second factor is far more important. Low interest rates encourage risk taking and inflate asset values. The effect on long-term investments like real estate, long bonds and stocks is profound. In the case of stocks, which are valued on their future profits and dividends, the lower the discount rate, the more valuable the future is.

Unfortunately, declining interest rates have a one-time effect. It’s wonderful owing an asset that is being revalued higher for reasons unrelated to its utility, but once the adjustment has been made, future growth falls back on the productivity of that asset. In other words, when rates stop going down, companies will need to rely on increasing revenues and profitability to move their stock price.

For most of our investing lives, it has been a series of one-time effects, starting in the early 1980’s when interest rates were in the high teens and price-to-earnings (PE) multiples were barely double digit. For 40 years, rates have followed a declining step function to almost zero and PE’s have moved up, albeit haltingly, to the low 20’s.

This year, stock valuations have taken another step up even though interest rates have reversed course. The expansion in multiples has not been fueled by even lower rates but rather a growing acceptance that rates will stay near zero.

Our clients, and other investors holding long-term assets, have benefited tremendously from declining interest rates. Stock market corrections have been short-lived and returns well above inflation, but we should be prepared for tougher sledding ahead. Ham and egging is not a sustainable strategy and interest rates have limited room to go lower.

At Steadyhand, we’re well positioned to slug it out in a tougher investment environment. We’ve never tried to get ahead of macro themes that might lead to multiple expansion (it’s impossible to do consistently) but rather let our fund managers focus on finding reasonably priced companies that are growing their bottom lines. What has been a headwind for us in recent years, namely not having enough exposure to companies that are highly sensitive to interest rates, such as ‘profits-in-the-distant-future’ growth companies and real estate, could become a performance tailwind.

We encourage you to read the rest of our Q3 Report, where we provide more details on our specific strategies and what we've been doing in each of our funds.