Good Morning,

U.S. stocks closed mostly flat on Friday, with financials falling around 1 percent, as investors braced themselves for a key constitutional referendum in Italy while digesting a stronger-than-expected jobs report. In economic news, the U.S. economy added 178,000 jobs last month, the Labor Department said, with the unemployment rate falling to 4.6 percent. Economists polled by Reuters expected a gain of 175,000 with the unemployment rate holding steady at 4.9 percent. Wages, however, slumped to 2.5 percent.

While Friday's jobs data will not deter the central bank from raising rates, it was not a good report as record numbers of workers are no longer looking for work and part-time job creation is far outpacing full-time.

Our Take

It is always best not to be caught in the crowd. Take the temperature of the market. This violent Trump rally may not be all that it is perceived to be. Commentators such as Bill Gross warned this week that the Trump rally is built on a false promise of growth. Some of his points are worth considering.

Specifically his concerns about US productivity. Gross pointed out that future growth is primarily a function of productivity, which has flat lined for the last several years and shows little promise of accelerating. Gross wrote that “A strong dollar and continuing structural headwinds including aging demographics, de-globalization trade policies, and accelerating debt-to-GDP in almost all countries at now higher interest rates, promise to contain productivity at perhaps 1 percent annual growth rates and therefore real GDP growth at 2 percent.”

In addition, analysts at Bank of America Corp. suggested this week that we may be approaching the market’s last hurrah. The crux of the argument is that the firm’s contrarian sell side indicator, which measures Wall Street’s bullishness on equities, jumped to a six-month high in November, its biggest gain in more than a year. Right now, the index is pointing toward a rally of almost 20 percent for U.S. stocks over the next 12-months, but the analysts believe that a rally of that magnitude could mark the end of the bull run. Remember that market euphoria is typically what we see at the end of bull markets and that has been glaringly absent so far in the cycle.

Musings

Recently, we have been looking at companies with explosive book value that have been selling off in this market. After careful analysis, we have noticed that significant book value growth over the last 10 years (over 2.5x), coupled with sustained high returns on capital over the past 5 years, can provide a glimpse into up-and-coming quality enterprises that may propel higher over the medium term.

Some picks of interest:

CGI (TSE: GIB.A): Book value per share nearly quadrupled since 2007 as revenue tripled. Average ROE is above 14% over the last ten years. Company has strong tailwinds going forward and stock is below 200 MA and is down 4% last 3 months. Look for the stock to dip below its 50 MA.

Luxoft (NYSE:LXFT): Roaring book value per share growth, more than doubling over past 2 years. Return on Invested Capital has averaged over 35% since 2011. Price to sales is at 2.5, which lower than some consumer non-cyclicals growing at less than inflation, and revenue is expected to hit $1 billion by end 2018 (TTM at $716MM). Stock is down 33% YTD despite record growth and no debt.

Thought of the Week

"The herd instinct among forecasters makes sheep look like independent thinkers." - Edgar Fieldler

Stories and Ideas of Interest

Silicon Valley has an empathy vacuum. The New Yorker suggests that Silicon Valley’s biggest failing is not poor marketing of its products, or follow-through on promises, but, rather, the distinct lack of empathy for those whose lives are disturbed by its technological wizardry. Living in a bubble can mean different things to different people.

Tech was supposed to crash in 2016. It got real instead. Sure money isn’t as easy to get as it used to be but the unicorn reckoning expected in 2016 was nigh. Wired magazine looks into a year in tech which looked more like air leaving a balloon rather than a sudden pop.

An incubator for (former) drug dealers. Amid calls for more job training, less automatic background searching, and other changes that would make it easier for ex-felons to become employees, an alternative idea has slowly taken hold: Encourage them to start their own businesses. Bloomberg takes a look at the largest nonprofit pushing entrepreneurism of this kind: Defy Ventures, based in New York. Over the past six years it has trained more than 500 formerly incarcerated people and incubated more than 150 successful startups.

Corporate executives have opinions about Donald Trump. Bloomberg has a look at what they’ve been saying. On balance it is safe to say that they are optimistic but most believe that it is too early to speculate about what changes in Washington are going to mean for business. We tend to agree, despite the incredible rotation we have been witnessing in the markets into financials, basic materials and industrials. Be weary of premature herd following. Nevertheless, here’s an interesting look at how the new president might change rules that have made the financial system safer since the 2008 crisis, from most likely to least.

Harvard research suggests that an entire generation has lost faith in democracy. And it’s among millennials that this “crisis of democratic legitimacy” is starkest. Young people today are more into political radicalism and exhibit less support for freedom of speech than previous generations. So rampant is democratic indifference and disengagement among millennials that a shocking share of them are open to trying something new—like, say, government by military coup.

All the best for a productive week,

Logos LP