Skating on Thin Ice, Part 1: Discipline, Doubt, & the Long Game

We’ve received a lot of interest from prospects inquiring about our services recently. Our message is the same — we want folks to become our clients not because we had a great year (or even the last ten years), but because they buy into our process-driven value investment philosophy.

There are three things we ask from our clients:

1. Buy into our philosophy: We are the “getting rich slowly” people.
2. Have a long-term time horizon: When we analyze stocks, we’re looking five to ten years out.
3. Do your homework: Read my letters. If you don’t, your portfolio will be just a collection of random tickers that go up and down every day.

Without these three things, this relationship is not going to work.

We are not just managing money. We are improving the quality of our clients’ lives by growing their wealth and removing the stress that comes with the stock market. Our approach of buying high-quality undervalued companies is common-sensical, yet somehow unique (perhaps because common sense is rare today).

Skating on Thinning Ice

This has been a somewhat surreal six months for our portfolios. Although defense stocks have led the gains, they were not the only source of returns. Other companies, which were punished by the market last year, were revalued this year.

As I mentioned in my earlier letter, we did not suddenly get smarter in 2025. The results you see are a manifestation of many small decisions we made over previous years. As I was writing this letter, I reviewed the many new positions we have added to the portfolio.

Most of them were relatively small (1% or 2%), and their relatively minor size was a result of many factors.

Some are in sectors like energy, where we already have a significant stake, hitting against our total exposure ceiling; others were not cheap enough to deserve a larger position (though we’d be delighted to buy more at lower prices).

A third group falls under the category of what I call “venture” stocks (a notion I’ll discuss in Part 2), and finally some were in industries that are new to us, where we decided to “buy and keep learning.”

This disciplined and somewhat cautious posture reflects the uncertainties of the current geopolitical and macroeconomic environment. We are in a normal economic expansion, but our government is running a budget deficit (6.2%) that exceeds those seen during past severe recessions. We have the highest debt-to-GDP ratio since World War II.

At the same time, rulemaking in DC is erratic and unpredictable. The truth is that DOGE has failed to significantly cut government spending, and the “Big Beautiful Bill” will add to the mountain of debt. As a result, inflation or 1970s-era stagflation (inflation with lower economic production) is likely the scenario we’re facing.

Although everyone’s attention is focused on the stock market, where daily volatility is most evident, the real risk lies in the bond market. At some point, bond investors looking at the pile of old debt and our issuances of new debt (to finance budget deficits) will realize that future principal will be repaid with dollars that are cheapened by inflation. They’ll say “pay up,” and interest rates will go up correspondingly. Higher interest rates will lead to higher interest costs, resulting in larger budget deficits, and the vicious circle will continue.

Every day we are getting closer to a “Liz Truss moment.” If you don’t recognize the name, that’s because she was the shortest-tenured U.K. prime minister in history, serving for only 44 days. In 2022, she announced a highly inflationary “pro-growth” budget. The U.K. bond market responded with a “mini-crash,” while the stock market experienced a much bigger decline, and Truss lost her job. The U.S. is a stronger and broader economy than the U.K., but it is not immune from the laws of economics.

It is also worth noting that foreigners have been incrementally pulling their investments from the U.S. — this is evident in the decline of the US dollar. The administration’s unpredictable and transactional behavior is the primary cause of this, but our past and present fiscal irresponsibility doesn’t help either (I wrote about this in my last letter). That said, a weaker dollar was a nice tailwind for our non-U.S. stocks in 2025.

Our goal as always is to survive the marathon, not to finish the sprint first. Being methodical and process-driven will pay off in the long term, like it has this year. We’ll continue to proceed with the temperament of someone skating on a giant lake as the weather gets warmer and the ice becomes thinner and thinner.

Battle Between IQ and EQ

Many clients have asked me about what will happen to defense stocks when the war in Ukraine ends. Despite owning numerous defense companies, I want to make it clear that I am not a warmonger. I want the war in Ukraine to end yesterday. Aside from all the obvious reasons, I have a very personal one — our analyst Max lives in Kyiv with his family, and my heart skips a beat every time I learn there is a drone attack on Kyiv.

But Max would agree with what I am about to say: Peace is not enough. Ukraine wants a sustainable peace. It needs security guarantees that Russia, after it rebuilds its army, won’t invade again.

From an investor perspective, if the war ends tomorrow, defense stocks may initially sell off, but European defense spending will not stop. Russia’s economy is not performing well and peace would give it time to recover. However, Russia has a much stronger defense industry today than it did before the war. From a European perspective, Russia not at war is just Russia preparing for war.

As I mentioned in my last letter, Europe no longer views the U.S. as a reliable partner. Even if Trump were replaced tomorrow by French President Macron, you would still not know who’ll come next. The U.S. political winds change every two years, while it takes a decade (or longer) to build a defense industrial base.

Over the last few months, every single NATO country (with the exception of Spain) committed to spending 5% on defense by mid-2030. The real number is closer to 3.5%, as 1.5% will be spent on infrastructure, which Europe (just like the U.S.) desperately needs. But even 3.5% is double what Europe spent just a few years ago. This doesn’t mean we just let our defense stocks ride; we continually update our models as we receive new data.

One of the most difficult parts of being an investor is not the fluctuation of IQ, but the volatility of your own EQ. Our IQ changes when we suddenly encounter new types of problems and cannot match our knowledge base to these issues. But EQ is the more volatile of the two, and has the greater impact on our decision-making.

One of my favorite books of all time is Edwin Lefèvre’s Reminiscences of a Stock Operator, a fictionalized account of the life of Jesse Livermore, one of the most successful traders of all time.

I read it for the first time a quarter century ago and have reread it several times since. One passage from it that I quoted in my first book, Active Value Investing, describes today’s situation perfectly:

After several months of despair, Livermore finally summoned up the courage to analyze his behavior and to isolate what he’d done wrong. He finally had to confront the human side of his personality, his emotions and his feelings… Why had he thrown all his market principles, his trading theories, his hard-earned laws to the wind? His wild behavior had crashed him financially and spiritually. Why had he done it? He finally realized it was his vanity, his ego… The outstanding success of making more than $1 million in one day had shaken him to his foundations. It was not that he could not deal with failure – he had been dealing with failure all his life – what he could not deal with was success.

Our EQ is usually highest when we are in a state of equanimity. Success and failure take us away from this state. Failure makes you question your ability to walk, but success makes you believe you can walk on water.

Over the last few months, instead of uncorking champagne, we dug into research. The rising valuation of defense companies requires us to be smarter (i.e., have a higher IQ). When we initially bought these stocks, they were so cheap that modeling their fair value could have been done with crayons. But higher prices demand a better understanding of the future.

But we didn’t stop there. We went back and improved our investment process. I’ll discuss it next week in Part 2.

Key takeaways

• Rational, unpopular decisions will sometimes make you look like an idiot during market euphoria, but this guarantee ends when the euphoria turns to tears.
• True client relationships require three non-negotiables: buying into the “getting rich slowly” philosophy, maintaining a long-term horizon of five to ten years, and doing homework by reading letters so portfolios aren’t just random tickers.
• Navigate uncertain times with the temperament of someone skating on thinning ice. Stay methodical and process-driven while facing budget deficits, high debt-to-GDP ratios, and potential “Liz Truss moments” in bond markets.
• Success can be harder to handle than failure because it makes you believe you can walk on water instead of maintaining the equanimity needed for good decision-making, creating a battle between IQ and EQ.
• Investment processes must evolve with circumstances, requiring deeper research as valuations rise and moving from investments so cheap you could model them with crayons to ones demanding better understanding of the future.

Vitaliy Katsenelson is the CEO at IMA, a value investing firm in Denver. He has written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. Soul in the Game: The Art of a Meaningful Life (Harriman House, 2022) is his first non-investing book. You can get unpublished bonus chapters by forwarding your purchase receipt to [email protected].

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