The World's Most Valuable Asset

Good Morning,
 

U.S. stocks rebounded on Friday as Wall Street reassessed concerns arising from news that the White House could seek a hike to the capital gains tax.

On Thursday markets had a volatile session after multiple news outlets reported that President Joe Biden is slated to propose much higher capital gains taxes for the rich.

Bloomberg News reported that Biden is planning a capital gains tax hike to as high as 43.4% for wealthy Americans.

The proposal would hike the capital gains rate to 39.6% for those earning $1 million or more, up from 20% currently, according to Bloomberg News, citing people familiar with the matter. Reuters and the New York Times later also reported similar stories.

Still, with Democrats’ narrow majority control in Congress, a tax bill like this could face challenges and many on Wall Street believe a less dramatic increase is more likely.

We expect Congress will pass a scaled back version of this tax increase,” wrote Goldman Sachs economists in a note. “We expect Congress will settle on a more modest increase, potentially around 28%.”

Interestingly, U.S. taxable domestic investors own only about 25% of the U.S. stock market, according to UBS. The rest of the market is owned in accounts that aren’t subject to capital gains taxes such as retirement accounts, endowments and foreign investors, so the impact on overall stock prices should be limited even with a higher tax rate.

As earnings season is well underway, corporations have for the most part managed to beat Wall Street’s expectations. Still, strong first-quarter results have been met with a more tepid response from investors, who have not, to date, snapped up shares of companies with some of the best results. This is especially true of the reflation/cyclicals who continue to be 2021’s market’s darlings. 
 

Our Take

 

What looked like a perfect downside setup last month didn't create anything more than a minor dip. The market certainly seems to have underlying strength to it with many sectors and assets hitting ATHs. 

Nevertheless, the market is showing some signs of exhaustion, and with good reason. Most major parts of the market have run up significantly in the past month and there is a growing chorus warning that we are at “peak everything.” That is, peak earnings growth, peak economic data and peak reopening.

From our perspective, most assets look fully valued offering perhaps the lowest prospective returns we’ve ever seen. The easy money has likely been made. Growth (ISM) typically peaks around a year (10-11 months) after a recession ends, right at the point we would appear to be. A majority of historical peaks in growth (two thirds) were inverted-V shaped, while the rest saw the ISM flatten out at an elevated level. The S&P 500 sold off around growth peaks by a median -8.4%, but even episodes which saw the ISM flatten out rather than fall, saw a median -5.9% selloff.

When the ISM's manufacturing activity reading exceeds 60, the S&P 500 tends to be lower over the next three- and six-month periods. In March, the ISM's manufacturing activity index registered a reading of 64.7 (37-year high). Not to mention that global economic growth accelerated to the fastest in just over six and a half years in March and the IMF is forecasting world economic growth to be the best in forty years.

Everything the market discounted in 2020 is happening now, and so there's no obvious positive catalyst for markets over the next few quarters. Everyone, in other words, already knows what the most bullish story is right now for markets. And additional pieces of good news are unlikely to change the outlook for indexes that have already rallied 80% or more in a year.

Nevertheless, the resilient grind higher (strong market breadth and more than 75% of stocks above 200 SMA) that we've seen over the past couple of weeks is consistent with a bull market, and as long as things stay boring and support continues to hold, we don’t see any compelling reason to be out of the market. Furthermore, many of the “speculative sectors” have taken a beating of late which bodes well for future returns.

The global rollout of Covid-19 vaccines, the persistence of ultralow interest rates, and expectations for torrid economic growth should continue to provide a nice tailwind for the investor who holds a portfolio of “winner take most” businesses in the innovation space. Long-term investing remains a marathon of compounding that consists of countless sprints.  As Morgan Housel has smartly remarked, there are books on economic cycles, trading strategies, sector bets and investment approaches yet the most powerful and important book should simply be called: “Shut Up and Wait.”

Musings

What was particularly exciting about this year's March technology selloff was the opportunity to evaluate smaller capitalization stocks set to benefit from significant structural changes in the economy trading at more reasonable prices. One such stock we purchased in the quarter is DMYI. DMYI is a SPAC launched by dmy Technology Group Inc. (one of the more reputable SPAC sponsors) that will soon merge with IonQ (will trade under the symbol IONQ). This will make IonQ the first ever publicly traded pure-play quantum computing business on the NYSE.

Why quantum computing?

"This is going to be the decade in which quantum really comes of age,” an IBM executive recently told the Wall Street Journal. Quantum computing is to AI what nuclear weapons are to bombs. Corporates, institutions and other entities are thus racing to build such a new type of computer, a quantum computer, that will bring the computational hardware required to match and exceed the human brain. This will require the computation of models 1,000x larger than OpenAI’s massive GPT3, or 100x larger than Google’s recent 1T parameter leviathan.

While quantum technology will take years to scale, the race is on to build the software and hardware infrastructure today. The race to such technology will be a defining theme of the decade to come and the stakes could not be higher. The current CEO of Google, Sundar Pichai, has said that the impact of AI will be more profound than man’s discovery of fire. Palantir’s CEO recently stated that:

“Military AI will determine our lives, the lives of your kids. This is a zero-sum thing. The country with the most important AI, most powerful AI, will determine the rules. That country should be either us or a Western country.

That doesn't mean you're anti-our-adversaries. It just means would you rather have them with the equivalent of tech nuclear arms or us?

This program will quite literally determine who is standing here [at Davos] and what they're saying in five years.”

If (in the words of Ray Dalio) the Federal Reserve’s printing press is the world’s most valuable asset, the world’s first scaled-up quantum computer and/or generally intelligent AI would be a close second.

 

Enter IonQ. IonQ started as a research project about 10 years ago (as a business about 6 years ago) by Chris Monroe (head of quantum physics at the University of Maryland, College Park) and Jungsang Kim (Professor of Quantum Physics and Electrical Engineering at Duke University, formerly of Bell Labs) who wanted to build the most powerful quantum computer using trapped ytterbium atoms, a unique method that reduces the overall space required to create a quantum computer without seeing loss in quantum power.


This is an interesting method because unlike other methods (ie. those done by Google, IBM, Rigetti etc.), the trapped-ion method comes from nature and builds quantum qubits on a small chip (Honeywell who also realized the power of quantum is also using an ion method). Despite the other methods of building a quantum computer, there are several unique advantages of the trapped-ion method including low error correction, high gate fidelity, scalability (although scalability overall is still an issue), noise reduction and lower costs to operate (other methods require tremendous electrical and refrigeration costs).

The reason IonQ has gained traction and attracted capital is three-fold: 1. IonQ has the most advanced quantum method on quantum volume alone; 2. They have attracted the best business and technical minds of any quantum computing business to date; and 3. Their long-term business model revolves around Quantum Computing as a Service and managed services (their QCaaS currently charges roughly $10 per compute hour on AWS and Azure). On the talent front, both Mr. Monroe and Mr. Kim are two of the best minds in quantum physics and have both a combined over 51,000 academic citations in the area. In fact, Dave Bacon, who was head of Google’s quantum division and one of the authors of the Bacon-Shor quantum algorithm, left Google to join IonQ. Peter Chapman is the current CEO of IonQ (former MIT grad and son of a NASA astronaut) and is the former head of engineering at Amazon Prime.


From a capitalization perspective, the business raised $650 million (roughly $350 million in a PIPE and $300 million through the SPAC) at an enterprise value of $1.95bn ($10/share for DMYI). Although not an exhaustive list, the PIPE investors include some of the biggest investors in the world: Breakthrough Energy (Bill Gates), TIME Ventures (Marc Benioff), MSD Capital, Silver Lake Partners, Fidelity and Hyundai. Existing investors include but are not limited to Amazon Web Services, Bosch, Samsung Ventures, Tao Capital, Lockheed Martin, Airbus Ventures and HPE Ventures. Currently, the business’s quantum service is the only one available on both AWS and Azure and once merged, they will end up being the most well-funded standalone quantum business. Their investor base will also be the business’s first customers (Samsung, HPE and Airbus have already publicly committed to using their services for real-world applications) and Dow Chemical has recently used their service to recreate the water molecule.

Despite our excitement about IonQ’s prospects, this is a very long-term investment for the LP as there will be multiple phases before we see broad commercial use of quantum computing (early on its S-curve growth runway). There are still significant technical barriers to the technology, the most important being error correction, error modification and scalability. Currently, the ion-trap method uses a significant number of lasers to manipulate the ytterbium atom, which is something that is not sustainable long-term. These technical barriers must be fixed and enhanced over the next few years before they can use their technology for broader commercial applications. From a business perspective, we will need to see the creation of a flywheel over time (acquisition of software, security services, developer portals etc.) to continue to attract talent and provide top notch customer service, just like Amazon has with AWS. 

Charts of the Month

Human innovation always trumps fear.

Private equity (PE) deal valuations by EV/EBITDA are increasingly rich and are hitting higher double-digit figures.

2021 is expected to be another home run year for PE, with 20% of buyouts estimated to be priced above 20x EV/EBITDA.

Logos LP March 2021 Performance

March 2021 Return: -14.71%

2021 YTD (March) Return: -1.96%

Trailing Twelve Month Return: 126.85%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 24.09%

 

Thought of the Month

“Remember to conduct yourself in life as if it was a banquet. As something being passed around comes to you, reach out your hand and take a moderate helping. Does it pass you by? Don’t stop it. It hasn’t yet come? Don’t burn in desire for it, but wait until it arrives in front of you. Act this way with children, a spouse, toward position, with wealth - one day it will make you worthy of a banquet with the gods.” - Epictetus, Enchiridion, 15

Logos LP Services



Looking for portfolio construction support? We would be happy to chat. Please book an intro call here.



Articles and Ideas of Interest

• There’s a name for the Blah you’re feeling: It’s called Languishing. Colleagues reported that even with vaccines on the horizon, they weren’t excited about 2021. A family member was staying up late to watch “National Treasure” again even though she knows the movie by heart. And instead of bouncing out of bed at 6 a.m., I was lying there until 7, playing Words with Friends. It wasn’t burnout — we still had energy. It wasn’t depression — we didn’t feel hopeless. We just felt somewhat joyless and aimless. It turns out there’s a name for that: languishing. Languishing is a sense of stagnation and emptiness. It feels as if you’re muddling through your days, looking at your life through a foggy windshield. And it might be the dominant emotion of 2021.

• Welcome to the YOLO economy. Burned out and flush with savings, some workers are quitting stable jobs in search of postpandemic adventure. The NYT reports that some are abandoning cushy and stable jobs to start a new business, turn a side hustle into a full-time gig or finally work on that screenplay. Others are scoffing at their bosses’ return-to-office mandates and threatening to quit unless they’re allowed to work wherever and whenever they want. If “languishing” is 2021’s dominant emotion, YOLOing may be the year’s defining work force trend. A recent Microsoft survey found that more than 40 percent of workers globally were considering leaving their jobs this year. Blind, an anonymous social network that is popular with tech workers, recently found that 49 percent of its users planned to get a new job this year.

• WOKEISM – The New Religion of the West. There is a new religion. It is moving like a tidal wave through every facet of western culture, shaping and redefining society as it goes. This religion masquerades under the guise of compassion and justice, but underneath is an evil ideology that is incompatible with western values and incongruent with the Christian worldview. This movement did not start in Minneapolis on May 25th, when George Floyd was murdered. That event acted as a watershed moment for an ideology that has been growing for decades. If left unchecked, this new religion could lead to a complete unravelling of western culture. There are many names for what we currently find ourselves in; wokeness, political correctness, and cancel culture are some of them, but these only encapsulate a portion of the phenomenon. Cultural Marxism, neo-marxism, social justice, identity politics, and Critical Theory are broader descriptors. We would like to use a term that adequately captures the religiosity of the movement: wokeism.

• The economics of falling populations. The Economist explores how a shrinking global population could slow technological progress. While Joel Kotkin reminds us to be careful for what we wish for as declining fertility rates may deliver us into oblivion. We could choose to create a kind of woke utopia, where children and families are rare, upward mobility is constrained, and society ruled by a kind of collective welfare system that rewards inactivity and stagnation. But to those who value the permanence of our society, and the remarkable importance of children, this is something close to a dystopia. To be sure, a smaller, older society may emit fewer greenhouse gasses per capita, but at the end we confront a society that will be less innovative, less dynamic and, in the most profound sense, distinctly less human.
  
   

• Neurotechnology could one day shape our thoughts and behaviors. Scientists have discovered how to use technology to put an artificial image inside a mouse's brain so that it behaves as if it actually sees it. This will be possible to do with humans in the future — potentially shaping our thoughts and behaviors.

• Millions are tumbling out of the global middle class in historic setback. An estimated 150 million slipped down the economic ladder in 2020, the first pullback in almost three decades.

• Europe is heading toward a new financial crisis. Europe faces a predicament. Even as it struggles to contain the Covid-19 pandemic, it’s setting itself up for another crisis — this one financial. To ensure the viability of the common currency at the heart of the European project, the EU’s leaders will have to cooperate in ways they’ve so far resisted. 
  
   

• Turkey’s crypto pain grows with second exchange collapse. Turkey’s cryptocurrency investors were dealt another blow at the end of a dismal week after a second big exchange collapsed in as many days and its chief executive was reportedly detained. We expect regulators to increase their scrutiny of this asset class. Betting on Bitcoin? You should know the story of the Hunt brothers and the silver market. It was arguably the biggest business story of 1980. Two of the world’s richest men, Texans Bunker and Herbert Hunt––along with Saudi partners––had bought or amassed contracts to purchase over three-quarters of the world’s silver in private hands. Speculators jumped on the news, driving the price to never-before-seen peaks. Then the commodities exchanges panicked and banned selling, the Fed pushed the banks to call the Hunts’ gigantic loans, and strip mall storefronts lured folks to sell their bracelets and silverware to be melted into bullion, flooding the market with the precious metal. In just five months, silver’s price cratered 80%, scorching the billionaire brothers’ fortunes. Seldom in financial history has America witnessed a craze where so much wealth mushroomed then disappeared in such a brief span, or one featuring a cast of such colorful, damn-the-establishment mavericks.

• Microsoft’s $20 billion AI deal will shake up how we work. The technology giant’s purchase of voice-recognition and AI specialist Nuance Communications puts it at the forefront of the next big wave of workplace innovation. Imagine the workplace of the future, where computers powered by artificial intelligence take care of the most tedious administrative tasks, making employees happier and more productive. Microsoft Corp. wants to be at the forefront of that future — and its deal for voice-recognition and AI specialist Nuance Communications Inc. shows it’s willing to spend a lot of money to do it.

Our best wishes for a month filled with joy and contentment,

Logos LP

Get Out or Go All In?

Good Morning,
 

Stocks fell for a fifth straight day on Friday after the U.S. government released employment data that missed expectations by a large margin, adding to mounting concerns that the global economy may be slowing down.

The indexes posted their biggest weekly declines of the year. The major indexes all dropped more than 2 percent this week. The Nasdaq snapped a 10-week winning streak, while the Dow notched its second weekly decline of the year.

To put things in perspective, while the headline was that the S&P suffered its worst week in 2019, the index gave back 2.5% of the 19+% gain achieved during the recent rally.

The U.S. economy added just 20,000 jobs in last month, marking the weakest month of jobs creation since September 2017. Economists polled by Dow Jones expected a gain of 180,000.

The data come amid growing concerns about the global economy possibly slowing down. Data out of China showed its exports slumped 20.7 percent from a year earlier, far below analyst expectations and wiping out a surprise jump in January.
 

The weak data all come less than 24 hours after the European Central Bank slashed its growth forecasts for the euro zone and announced a new round of policy stimulus.

Our Take
 

The bears came out again this week screaming the usual platitudes they’ve been pushing since 2015: “The bull market is old and tired, the economic recovery has run its course, we are headed for a recession and the market’s best days are behind us.”

This may or may not be true, but it is important to remember that investors as humans have a tendency to think in terms of extremes. Things are “good” or they are “bad”. You should be “in” the market or “out” of the market. Given this tendency, it is no surprise that most pundits will offer an insight that suggests “go all in” or “get out”.

The reality is that much of the market’s activity occupies a middle ground. Things are fine and there is no need for any extreme actions or reactions. Why?

Because there are no immutable rules that explain what is going on in the market. There are no physical laws at work in investing. The future is uncertain, vague, and random. Psychology dominates and therefore there are no laws only tendencies.

As such, instead of thinking in extremes which imply the existence of laws governing the market such as “when the yield curve inverts that means a recession is coming thus get out of equities” it is better to examine certain tendencies which can be associated with the stock market.

What tendencies can we observe? Nick Maggiulli points to several:

1) Stocks will provide long-term positive returns

The historical evidence illustrates that equity markets around the globe have provided long-term positive returns to investors.  

The equity market has been in a bull market:

1. 76% of the time since 1929.

2. 80% of the time since 1940.

3. 84% of the time since 1980.

The majority of the time, stocks mostly go up.

2) Higher returns do not come without volatility

You can put your money in stocks and sleep tight....but the reality is far more punishing. Most developed country stock markets from 1900-2018 experienced at least one an annual decline of at least 37%. Furthermore, in a recent article in Bloomberg which backtested a “God” portfolio (an equal-weight portfolio comprising the best 100 stocks in the Russell 1000 since the bottom of the financial crisis that would have returned nearly 20 times the benchmark) to the bottom of 2009 and found that even this portfolio fell behind the benchmark by as much as 10 percent for part of certain years and also plummeted more than 22 percent at certain points -- six percentage points more than largest drawdown for the S&P 500.

"If God is omnipotent, could he create a long-term active investment strategy fund that was so good that he could never get fired?” The conclusion was no. While long-term returns were obviously astounding, shorter stretches -- the ones by which fund managers are often judged -- were “abysmal.”

Large crashes and volatility help explain why equities have a positive real long-term return. You are being compensated for taking risk. The compensation process simply requires patience.

3) Markets occasionally crash

Markets crash from time to time, but then they recover. Market crashes happen because of a rapid shift in investor psychology.  Sometimes this shift is warranted but other times the market is oversold and a recovery becomes inevitable.

4) Cheap stocks and rising stocks tend to outperform the rest

Though stocks in aggregate tend to do well over the long run, cheap stocks (i.e. value) and rising stocks (i.e. momentum) tend to do even better. Although there is a lot of talk at present surrounding the relative “failure” of “classical” value strategies based on low price-to-book it is best to think of “value” as stocks trading at a discount to their intrinsic value.

Musings
 

This month we wish to highlight two pieces of news:

1. We see a unique opportunity in the markets at present. Please contact us for more information.
    

2. After receiving many requests, we have also decided to launch a 1 on 1 coaching service designed to help investors build their own custom equity portfolios. Please contact us for more information.

Charts of the Month

The majority of the time, stocks mostly go up more than pretty much everything else.

Logos LP February 2019 Performance

February 2019 Return: 3.03%

2019 YTD (February) Return: 8.41%

Trailing Twelve Month Return: -8.32%

CAGR since inception March 26, 2014: +13.46%

Thought of the Month

"There were a lot of questions today — people trying to figure out what the secret to life is, to a long and happy life: You don’t have a lot of envy. You don’t have a lot of resentment. You don’t overspend your income. You stay cheerful in spite of your troubles. You deal with reliable people. And you do what you’re supposed to do. And all these simple rules work so well to make your life better. And they’re so trite."  - Charles Munger

Articles and Ideas of Interest 

 

• Why we fell for clean eating. The oh-so-Instagrammable food movement has been thoroughly debunked – but it shows no signs of going away. The Gaurdian suggests that the real question is why we were so desperate to believe it. In the spring of 2014, Jordan Younger noticed that her hair was falling out in clumps. “Not cool” was her reaction. At the time, Younger, 23, believed herself to be eating the healthiest of all possible diets. She was a “gluten-free, sugar-free, oil-free, grain-free, legume-free, plant-based raw vegan”. As The Blonde Vegan, Younger was a “wellness” blogger in New York City, one of thousands on Instagram (where she had 70,000 followers) rallying under the hashtag #eatclean. Although she had no qualifications as a nutritionist, Younger had sold more than 40,000 copies of her own $25, five-day “cleanse” programme – a formula for an all-raw, plant-based diet majoring on green juice. But the “clean” diet that Younger was selling as the route to health was making its creator sick. Sound familiar?      

• The servant economy. Ten years after Uber inaugurated a new era for Silicon Valley, the Atlantic checked back in on 105 on-demand businesses. The basic economics of moving human beings and stuff around the physical world at the touch of a button is not an obviously profitable enterprise (almost none of this 105 are profitable despite raising over 7.4 billion dollars). Looking at this incredible flurry of funding and activity, it’s worth asking: These companies have done so much—upended labor markets, changed industries, rewritten the definition of a job—and for what, exactly? An unkind summary, then, of the past half decade of the consumer internet: Venture capitalists have subsidized the creation of platforms for low-paying work that deliver on-demand servant services to rich people, while subjecting all parties to increased surveillance. These platforms may unlock new potentials within our cities and lives. They’ve definitely generated huge fortunes for a very small number of people. But mostly, they’ve served to make our lives marginally more convenient than they were before. Like so many other parts of the world tech has built, the societal trade-off, when fully calculated, seems as likely to fall in the red as in the black.

• What would happen if Facebook were turned off? Imagine a world without Facebook. The Economist reviews comprehensive research which suggests that it might be a better place.

• By the Numbers: Toronto Real Estate vs. The Stock Market. I often get questions which pit the supposedly fabulous returns which Toronto real estate has generated against stock market returns and this excellent research by Vestcap does a great job to demonstrate that Toronto home ownership produced a 5.7% compounded return while the TSX and S&P 500 each grew by 7.9% and 11.6%, respectively. I also get questions about investment in rental properties vs. investing in common stock and this article does an excellent job comparing the two. In general, rental property can be an attractive investment, but profitability is highly dependent on local conditions, global REITs offer compelling value that can replicate much of the returns you could achieve by investing in rentals and investors in favorable markets (cheap real estate) can leverage rentals for large returns.

• The greatest investor you’ve never heard of: an optometrist who beat the odds to become a billionaire. Dr. Herbie, as he is known to friends, is a self-made billionaire worth $2.3 billion byForbes’ reckoning—not including the $100 million he has donated to Florida’s public universities. His fortune comes not from some flash of entrepreneurial brilliance or dogged devotion to career, but from a lifetime of prudent do-it-yourself buy-and-hold investing.
  
   

• Where do disruptive ideas happen? Not on a big team. Innovations are more likely to arise from lone researchers or very small groups.

• How AI will rewire us. For better and for worse, robots will alter humans’ capacity for altruism, love, and friendship. As machines are made to look and act like us and to insinuate themselves deeply into our lives, they may change how loving or friendly or kind we are—not just in our direct interactions with the machines in question, but in our interactions with one another. Meanwhile, China has banned 23m people from buying travel tickets as part of their “social credit” system. People accused of social offences blocked from booking flights and train journey.

Our best wishes for a fulfilling March,

Logos LP

Mistakes Happen

Good Morning,
 

Stocks fell on the final day of a busy week that included the U.S.-North Korea summit, major central bank meetings and escalating trade tensions between Washington and Beijing.
 

The S&P 500 Index declined in heavy trading on a quadruple-witching last Friday, a quarterly event when futures and options contracts on indexes and individual stocks expire. The U.S. and China spent the day exchanging tariff threats, which drove down tech and industrial stocks, while a drop in the price of oil hit energy shares. Consumer staples and telecoms advanced, offsetting some of the drop, and the index finished with a weekly gain, if only barely.

Our Take
 

Value strategies continue to underperform while momentum strategies lead the market. In fact, while broad benchmarks sit relatively still, speculative shares are soaring, among them companies that recently went public, stocks favored by short sellers, and firms with weaker balance sheets. A seven-week rally was preserved in the Russell 2000, which was joined in record territory by an index of microcaps.

Gains in the third category, companies with shakier finances, breathed new life into a trade that had prevailed for most of the bull market before deterioratingas investors sought safety. Known as the low-quality rally, its revival may signal indiscriminate buying pressure is building again for equities.

Fundamentals look to be less important right now as high flying IPO’s have been surging. Technology companies that went public recently soared. Dropbox Inc., which began trading on March 23, climbed 32 percent. Cloud-based software company Zuora Inc. surged 18 percent, topping off gains of more than 50 percent since the start of the month. An exchange-traded fund that tracks newly public companies, the Renaissance IPO ETF, posted its second-best weekly gain this year. Avalara Inc., a Seattle-based company that provides sales tax-management solutions, started trading on the NYSE Friday and nearly doubled. There have been 22 technology companies to go public so far this year in the U.S., and they’ve gained an average of 70 percent, weighted by offer size, according to data compiled by Bloomberg.

Investors are no doubt chasing returns and to juice performance but this recent “risk-on” trend may also evidence investor belief that the future looks bright. A recent comment sums up the climate: “Why would you invest in a company where the balance sheet is stressed? You would do it if you felt that either the company or because of the economic situation that they’re going to grow into a more satisfactory fundamental balance sheet.”

Chart of the Month


An inverted yield curve as measured by the 10-year yield less than the two-year yield has occurred ahead of every recession in the past 40 years. The time interval between inversion and recession averages 10 months.

The chart above, courtesy of Urban Carmel, suggests we aren’t there yet.

Musings

Great article by Barry Ritholtz exploring the topic of failure and why we all as investors should learn to fail better. We should all cultivate the ability to be self-critical and implement a “standardized review process” when things go wrong.

As Ritholtz reminds us in contrast to equity investors: “Silicon Valley, technology and the venture-capital business model do a better job. Entrepreneurs and venture funders alike wear their failures like a badge of honor. Many venture capitalists even post their biggest misses on their websites. They recognize their model is to make a lot of losing bets in pursuit of finding the next big winner. Equity investors don’t have quite the same model, but they would benefit from a similar approach to recognizing their own limitations.”

The stigma that surrounds failure in asset management needs to be revisited as even juggernauts such a Buffett and Druckenmiller make big mistakes. As always, the way to avoid future failure is to embrace and learn from past failures. This piece hit home as during the month of May we exited our position in Luxoft and realized we had made a mistake. We were reminded of a few things: 1) turnarounds can take much longer than anticipated no matter how bullish one can be about the business’s prospects 2) more time means a larger opportunity cost 3) sometimes being too early is the equivalent to being wrong.

What investment mistakes have you made lately?

Logos LP May 2018 Performance
 

May 2018 Return: 0%

2018 YTD (May) Return: -3.79%

Trailing Twelve Month Return: +4.38%

CAGR since inception March 26, 2014: +17.99%

Thought of the Month


 

"You know what Kipling said? Treat those two impostors just the same — success and failure. Of course, there’s going to be some failure in making the correct decisions. Nobody bats a thousand. I think it’s important to review your past stupidities so you are less likely to repeat them, but I’m not gnashing my teeth over it or suffering or enduring it. I regard it as perfectly normal to fail and make bad decisions. I think the tragedy in life is to be so timid that you don’t play hard enough so you have some reverses.” -Charlie Munger
 

Articles and Ideas of Interest

 

• World Cup players to watch (not named Messi or Ronaldo). The diminutive Argentine and the preening Portuguese are the most recognizable players in the global tournament now under way in Russia. Oliver Staley details why eight other all-stars also deserve your attention over the next month. Apparently machine learning has come to a conclusion about which team will win. Place your bets. Mine is one France.

• We are worrying about the wrong kind of AI. There’s a bigger AI threat than computers achieving consciousness. Rapid progress in lab-grown “mini brains” from human cells brings up huge ethical challenges. Consider that biologists have been learning to grow functioning “mini brains” or “brain organoids” from real human cells, and progress has been so fast that researchers are actually worrying about what to do if a piece of tissue in a lab dish suddenly shows signs of having conscious states or reasoning abilities. While we are busy focusing on computer intelligence, AI may arrive in living form first, and bring with it a host of unprecedented ethical challenges.

• Tudor Jones says his social impact ETF has potential to rival the S&P 500. Paul Tudor Jones said Tuesday that a new exchange-traded fund about investing based on social impact could one day rival the benchmark U.S. stock index. Social impact investing is making a real impact in private markets. Look for it to grow in popularity in public markets.

• Why China 'holds all the aces' in a full-blown US-China trade war. U.S. tariffs on $50 billion of China goods were imposed Friday to protect U.S. intellectual property and technology. It prompted China to retaliate. But before evaluating the policy prescriptions for this problem, we must first consider the starting point, which is flawed. The current $370 billion deficit estimate does not account for value-added. When looking at the value-added content of Chinese exports, the U.S. deficit with China is actually only half of what it seems. And if we then add back the U.S. surplus in "invisibles" and how much money the United States brings back from investments in China, the U.S.–China deficit shrinks from 2 percent of U.S. GDP to 0.8 percent, a report from Oxford Economics revealed. Furthermore, the reality is that many of the Trump administration's articulated demands are things that China is already doing, albeit at a somewhat slower pace. The United States wants China to buy more American goods and services — and so does China. Trump wants to impose stiff tariffs to prevent China from flooding the American market with increasingly less expensive technological products, like smartphones, computers and related accessories, which collectively comprise China's biggest exports to the United States. And China agrees — they want to export higher value-added goods, especially those with a high innovation content. Interests are much more aligned than either country wants to admit.

• You should be sleeping more than eight hours a night. Here’s why. To set the record straight about being horizontal, Quartz spoke to one of the world’s most-talked-about sleep scientists. Daniel Gartenberg is currently working on research funded by the National Science Foundation and the National Institute of Aging and is also a TED resident. (Watch his talk on deep sleep here.) He’s also an entrepreneur who has launched several cognitive-behavioral-therapy apps, including the Sonic Sleep Coach alarm clock. All that with 8.5 hours’ of sleep a night. Some topics covered: why 8.5 hours of sleep is the new eight hours, the genes that dictate if you’re a morning person or a night owl, why you should take a nap instead of meditating, how sleep deprivation can be a tool to fight depression, why sleep should be the new worker’s rights and tips on how to get a better night’s rest (hint: it’s not your Fitbit).  

• Here’s Mary Meeker’s essential 2018 Internet Trends report. A few highlights: Ecommerce vs Brick & Mortar: Ecommerce growth quickens as now 13% of all retail purchases happen online and parcel shipments are rising swiftly, signaling big opportunities for new shopping apps.Amazon: More people start product searches on Amazon than search engines now, but Jeff Bezos still relies on other surfaces like Facebook and YouTube to inspire people to want things. Subscription services: They’re seeing massive adoption, with Netflix up 25%, The New York Times up 43%, and Spotify up 48% year-over-year in 2017. A free tier accelerates conversion rates. Privacy: China has a big opportunity as users there are much more willing to trade their personal data for product benefits than U.S. users, and China is claiming more spots on the top 20 internet company list while making big investments in AI.

Our best wishes for a fulfilling month, 

Logos LP

You're Leaving Value On The Table

Good Morning,

U.S. equities closed down on Friday — the last day of the first quarter and of the month — as investors digested a slew of economic data.                                  

The Dow Jones industrial average fell about 65 points, with Goldman Sachs and Exxon Mobil contributing the most losses. The S&P 500 slipped 0.23 percent, with financials lagging.                       

The Nasdaq composite closed just below breakeven.                                                                           

The three major U.S. indexes posted quarterly gains of at least 4.6 percent. The Nasdaq also recorded its best quarterly performance since 2013 as tech stocks rose more than 12 percent in the period.
 

Our Take

Last week there were some jitters about whether or not Trump’s potential pro growth policies would be delayed, but the market has since remained resilient. March marked the 8th anniversary of the bull market and we hold that the show will go on despite Trump’s bumblings.

There are pockets of value despite repeated calls that “stocks are overvalued” and furthermore for the first time in 6 years double digit earnings growth looks real. Focus on the fundamentals. While stocks have been ascending ever since the election, it’s unlikely the rally would’ve gotten this far without the contemporaneous improvement in earnings, which last year ended one of the longest streaks of declines ever in a U.S. bull market.

Despite oil’s slump to skepticism over Trump’s growth agenda, Wall Street analysts have been standing firm on forecasts that represent almost twice the profit growth seen in 2013, a year when the S&P 500 rose 30 percent.

S&P 500 operating income will rise 12 percent to $130.20 a share this year, estimates compiled by Bloomberg show.

For the health of your investments, earnings are what matters. Long-term fundamentals drive stock prices. Short-term the political noise can impact sentiment but time and time again over the last 8 years buying the dips has worked…

Musings

A focus on the long-term matters. It has a determinate impact on our investment outcomes but more importantly on whether our lives will be remarkable or simply average.

More on that later. First I wanted to highlight the incredible outcomes reserved to those who think long-term. This week I read an excellent research report produced by a team from McKinsey Global Institute in cooperation with FCLT Global which found that companies that operate with a true long-term mindset have consistently outperformed their industry peers since 2011 across almost every financial measure that matters.

The differences were dramatic. Among the firms the team identified as focused on the long term, average revenue and earnings growth were 47% and 36% higher, respectively, by 2014, and market capitalization grew faster as well. The returns to society and the overall economy were equally impressive. By their measures, companies that were managed for the long term added nearly 12,000 more jobs on average than their peers from 2001 to 2015.

In addition, they calculated that U.S. GDP over the past decade might well have grown by an additional $1 trillion if the whole economy had performed at the level their long-term stalwarts delivered — and generated more than five million additional jobs over this period.

What indicators were studying? 1) Investment 2) Earnings Quality 3) Margin Growth 4) Earnings Growth 5) Quarterly Targeting

After running the numbers on these indicators, two broad groups emerged among those 615 large and midcap U.S. publicly listed companies: a “long-term” group of 164 companies (about 27% of the sample), which were either long-term relative to their industry peers over the entire sample or clearly became more long-term between the first half of the sample period and the second half, and a baseline group of the 451 remaining companies (about 73% of the sample).

What is clear from the performance gap between these two groups is the massive relative cost of short-termism.

From 2001 to 2014 those managing for the long term cumulatively increased their economic profit by 63% more than the other companies. By 2014 their annual economic profit was 81% larger than their peers, a tribute to superior capital allocation that led to fundamental value creation.

Now this makes me think of the countless examples I encounter on an almost daily basis of short-termism. It is not simply corporations that favor these costly short-termist agendas. It is the average human or at least 73% of the population…..that chooses the easy money vs. the long money. The easy choice or the choice that seemingly brings the most juice today. Nevertheless, real change is possible. This is one of the key messages from the research.

The proof lies in a small but significant subset of the long-term outperformers identified in the study — 14%, to be precise — that didn’t start out in that category. Initially, these companies scored on the short-term end of the index. But over the course of the 15-year period they measured, leaders at the companies in this cohort managed to shift their corporations’ behavior sufficiently to move into the long-term category.

As an investor it is best to develop the ability to identify such long-term value creators, as well as those companies who are shifting their behavior.

As a human it is best to look at ourselves in the mirror and ask what short-termist behaviors we are exhibiting and how we can change such habits. Upon honest reflection, what we will undoubtedly find is that we are leaving a considerable amount of “value” and long-term “fulfillment” on the table….

Thought of the Week
 

"The most important quality for an investor is temperament, not intellect.” -Warren Buffett
 

Stories and Ideas of Interest

• A world without retirement. The population is getting older and the welfare state can no longer keep up. After two months of talking to people in Britain about retirement, it’s clear that old age is an increasingly scary prospect. The Guardian digs in.  
   

• Compelling new evidence that robots are taking jobs and cutting wages. In a recent study (pdf), economists Daren Acemoglu of MIT and Pascual Restrepo of Boston University try to quantify how worried we should be about robots. They examine the impact of industrial automation on the US labor market from 1990 to 2007. They conclude that each additional robot reduced employment in a given commuting area by 3-6 workers, and lowered overall wages by 0.25-0.5%. A central question about robots is whether they replace human workers or augment them by boosting productivity. Acemoglu and Restrepo’s research is a powerful piece of evidence on the side of replacement. Furthermore, automation is set to hit workers in developing countries even harder. The fourth industrial revolution looks set to cause global mass unemployment. Could we tax robots as Bill Gates has proposed? The Economist suggests that this idea is misguided.

• Silicon Valley’s quest to live forever. Can billions of dollars of high-tech research succeed in making death optional? Forget retirement. Some are actively working on finding a cure for death. The New Yorker digs in and considers the incredible amount of money and effort being deployed towards achieving eternal life. I’ve always looked at this through the following prism: does the present moment really have any significance if it isn’t fleeting or precious?

• Your animal life is over. Machine life has begun. The road to immortality. In California, radical scientists and billionaire backers think the technology to extend life - by uploading minds to exist separately from the body is only a few years away. Yes that’s right. Forget the problems with robots replacing humans, when we will be able to achieve “morphological freedom” – the liberty to take any bodily form technology permits. “You can be anything you like,” as an article about uploading in Extropy magazine put it in the mid-90s. “You can be big or small; you can be lighter than air and fly; you can teleport and walk through walls. You can be a lion or an antelope, a frog or a fly, a tree, a pool, the coat of paint on a ceiling.” No wonder Elon Musk is founding another company called Neuralink which will focus on merging man and machine through the “neural lace”...talk about thinking long-term...

• Given the circumstances our existence, shouldn’t we just kill ourselves? French philosopher Albert Camus did an excellent job describing those moments in our lives when our ideas about the world suddenly don’t work anymore, when every daily routine — going to work and back — and all our efforts seem pointless and misdirected. When one suddenly feels foreign and divorced from this world. In these frightening moments of clarity we feel the absurdity of life. Luckily, his interpretation of the myth of Sisyphus offers us salvation. Sisyphus was sentenced to push a boulder up a hill, just to see it roll down again, and keep doing so forever and ever and ever. Camus offers a bold statement: “One must imagine Sisyphus happy.” He says, Sisyphus is the perfect model for us, since he has no illusions about his pointless situation and yet revolts against the circumstances. With every descent of the rock he makes a conscious decision to give it another go. He keeps pushing that rock and recognises that this is what his existence is all about: to be truly alive, to keep pushing.

• A dearth of I.P.O.s but it’s not the fault of red tape. Nice piece in the NY Times exploring possible explanations yet finding that while there might be rational reasons to reduce regulation on capital raising — to make it easier and less expensive — we are kidding ourselves if we think that simply deregulating will bring back initial public offerings.

• Not leadership material? Good. The world needs followers. The NYT suggests that the glorification of leadership skills, especially in college admissions, has emptied leadership of its meaning. I love this. Very contrarian. “Perhaps the biggest disservice done by the outsize glorification of “leadership skills” is to the practice of leadership itself — it hollows it out, it empties it of meaning. It attracts those who are motivated by the spotlight rather than by the ideas and people they serve. It teaches students to be a leader for the sake of being in charge, rather than in the name of a cause or idea they care about deeply. The difference between the two states of mind is profound. The latter belongs to transformative leaders like the Rev. Dr. Martin Luther King Jr. and Gandhi; the former to — well, we’ve all seen examples of this kind of leadership lately.”

All the best for a productive week,

Logos LP