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

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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

The Nature Of Long-Term Shareholding

Good Morning,
 

The Dow Jones Industrial Average jumped to another record high on Friday as reopening optimism continued to encourage the rotation into cyclical stocks. Meanwhile, surging bond yields rekindled valuation fears and took the comeback momentum out of high-growth, high multiple names.

The 10-year Treasury yield jumped another 10 basis points to 1.64% at its session high Friday, hitting its highest level since February 2020. The benchmark rate started 2021 at around 0.92%.

The rapid rise in bond yields prompted investors to dump the high-growth, high-multiple long-duration Nasdaq (QQQ) names again after a brief rebound earlier this week. Sharp increases in interest rates can put outsized pressure on such high-growth long-duration stocks as they reduce the relative value of future profits.

February and March saw the biggest market sell-off since September 2020. The recent sell-off predominantly affected the QQQ with a rotation out of high-growth, high-multiple technology companies and into businesses that have taken a beating throughout the pandemic (energy, banks, live events, brick-and-mortar retailers, hotels or travel to name a few). 

For those in more traditional S&P 500 (SPY) components, with little exposure to the high-growth complex, the “sell-off” was barely noticeable. Whereas, for those with significant exposure to such long duration assets, the drawdown was more pronounced than the move in the index would suggest, with many names reaching extremely oversold levels (average drawdowns of 30%-40% across the board):

Many analysts and so-called market pundits have since rushed in and declared that the bubble is popping. That the high-growth technology trade is dead. The refrain is now: 

“I think the story is becoming very, very clear in the tech sector. We have incredibly high valuations and yields that have tripled from the low last year,” said Robert Conzo, CEO of The Wealth Alliance. “You are going to see a lot of volatility in the tech sector. There’s a better trade out there in the cyclicals.”

Or even more bold calls such as:


“2020 marked the secular low point for inflation and interest rates; new central bank mandates, excess fiscal stimulus including UBI, less globalization, fading deflation from disruption, demographics, debt…we believe inflation rises in the 2020s and the 40-year bull market in bonds is over… BofA Global Research’s Inflation Survey shows 61% of analysts saw their companies raise prices in recent months. AA [asset allocation] implications bullish real assets, commodities, volatility, small cap value, and bearish bonds, US$, large cap growth.”

There is no doubt that the rapid sharp increase in U.S. government-bond yields is pressuring certain pockets of the stock market and forcing investors to confront the implications of both rising inflation and interest rates.

Yet the rotation referenced above has been playing out for at least 6 months now as energy, financials, industrials and materials (stocks whose fortunes are closely tied to economic growth) have greatly outperformed technology:

Same goes for growth vs. value with traditional value stocks (those which trade at low multiples of their book value, or net worth) beating growth stocks by the widest margin in TWO DECADES! 

This year, the Russell 1000 Value Index is up 11% and the Russell 1000 Growth Index has edged up 0.2%.

That gap is the largest lead for value stocks at this time of year since 2001, according to Dow Jones Market Data, when the bursting of the tech bubble led to a resurgence in value shares. At this point last year, during the coronavirus-induced downturn, growth stocks held a wide lead.

Oh what a difference a few months can make...

Our Take

So, should one abandon high-growth technology/innovation and chase the hot hand, piling into cyclicals/value names even as they reach new highs? Should one chase the trend and shift to low quality, high volatility, weak balance sheet names with little profitability? 

What should we make of the rotation?

Value investing and growth investing are two different investing styles.Traditionally, value stocks are thought of as an opportunity to buy shares below their actual value (although most investing can be conceptualized this way), and growth stocks exhibit above-average revenue and earnings growth potential.

Wall Street attempts to categorize stocks neatly as either growth or value stocks. The truth is a bit more complicated, as some stocks have elements of both value and growth. Nevertheless, to answer the questions posed above, it is important to step back and think about what’s going on and how investors should approach the current market. 

The pandemic has caused a massive acceleration for digital/innovation businesses. This isn’t likely to be temporary. The pandemic has now lasted long enough for consumers and companies to form new habits and ways of doing business, many of which will last even as the pandemic fades into history.

The digital/innovation acceleration is real. The long-term implications are likely larger than currently envisioned by even the most optimistic forecasters. Yet as we have warned before, many stocks leveraged to these trends, especially those that appear to be pure plays, were likely overvalued coming into 2021 and remain overvalued now. Mistaking such individual investments as a "no-brainer" way to capture long-term mega trends like digital acceleration, AI, solar, cloud, blockchain, EV is fraught with risk as stock price moves in such names can be extreme. 

At a high level, as long-term investors (more on this below), we believe that although the declines discussed above can be painful given their speed and unpredictability, investors must be willing to pay this price in the pursuit of above-average long-term returns. 

Such drawdowns should not be a catalyst for panicked portfolio rebalancing, as well as significant rotations/reallocations towards the “investment theme du jour”. Instead, they should prompt diligent reflection on one’s portfolio:  

1. How do I understand market, sector and company risk? 

2. How much drawdown can I cope with?

3. Do I have the cash I need and a cash deployment strategy?

4. Does my portfolio fit my risk profile?

5. Do I have a list of stocks I want to buy and a strategy for allocating to them?

6. Do I have a strategy that is written down?

In addition to this, the recent drawdowns in high-growth/high-innovation names should remind us that it isn’t enough to recognize a big innovation/investment trend and throw money at it. 

As QQQ names were melting down earlier this month, there was real fear that this could be a Dot Com moment. The knife could continue to fall. 

Intrinsic Investing reminds us that if we look at the Dot Com crash for guidance we can find at least two important lessons: 1) people at the time were too conservative about their big mega trend outlooks and; 2) they were too optimistic in how they expressed those views in individual stock selection. 

Despite the internet being vast, only a handful of the companies capitalized on the mega trends of the times. Some of the biggest winners of the internet age weren’t even public (i.e. Google) or founded yet (i.e. Facebook) until well after the Dot Com bubble crashed.

The Dot Com bubble and crash teaches us not to get out of the market when speculative activity surges as it is today. Rather, the takeaway is to “avoid those specific stocks that are speculatively valued and to be highly skeptical of unproven businesses that claim they are sure to capitalize on exciting new trends.” It is during periods like these - and where we find ourselves today - that stock selection (knowing what you own) becomes extremely important. The last few weeks have been a stark reminder of this principle. 

So, as we manage our portfolio at a time when speculative activity is rampant, we will do our best to keep an open mind when it comes to the significance of the big fundamental changes at play, while remaining very skeptical about which companies will capture those trends and the valuation of those companies we believe will be the long-term winners. In short, we will not be rotating into low quality, high volatility, weak balance sheet names with little profitability. 

Musings

It’s important to realize that as an investor in an increasingly digital world in which investment information is ubiquitous, no matter what innovations we see in the financial industry, patience will always be the great equalizer in the financial markets. In fact, one of the biggest advantages investors have over the pros and even the machines is the ability to be patient. 

Charlie Munger nailed it when he remarked: 

“We've really made the money out of high quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money's been made in the high quality businesses. And most of the other people who've made a lot of money have done so in high quality businesses.

Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result.”

Individual investors have the luxury of thinking (and hopefully acting) in terms of decades which is virtually impossible on Wall Street. A buy and hold strategy is by no means perfect, yet for it to work, you need to do both the buying and the holding during a drawdown. Of late, it has been much easier to do the buying and holding when markets are rising. Yet we must remember that on the journey to making large returns, there will be detours accompanied by poor returns.  

For example, Morgan Housel looked at one of the best-performing stocks of the last 20 years (Monster Beverage) and found that it spent the majority of that time with returns that would make make most investors hit the sell button. 

Housel looked at the 10 best stocks to own over the past 20 years which were all cherry-picked for their stellar returns, and would represent the stocks you would probably choose to own if you had a time machine. On average they increased more than 28,000%.

But they all spent a majority of the time well below their previous high mark. They all had multiple declines of 50% or more. A few had multiple 70% drops.

Investors underestimate how common and severe volatility is, especially among individual stocks. If stocks with the cherry-picked best returns spend a third of their time down at least 30%, you can imagine what the long-term losers look like. 

In 2009, Charlie Munger was asked how concerned he was that Berkshire Hathaway shares — which made up most of his net worth — dropped more than 50%. He quickly interrupted the interviewer and responded:

“Zero. This is the third time that Warren [Buffett] and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%. I think it's in the nature of long-term shareholding that the normal vicissitudes in markets means that the long-term holder has the quoted value of his stocks go down by, say, 50%.

In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50% two or three times a century you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get compared to the people who can be more philosophical about these market fluctuations.”

Investing is work. Stock picking is work. There are no shortcuts that provide easy money for an extended period of time.
 

For long-term investors like us, there is no scenario where we will be meaningfully selling out of high quality businesses in order to buy and hold low-quality businesses or sit in cash. Why not now?

1. We don’t know how to time the market: We don't know when the market will crash or even correct. It could be next week; it could be a decade from now. Unpredictable geopolitical, environmental, and biological events, coupled with people's emotional response to them, will determine this. 

2. What matters is time in the markets: If you wait for ideal conditions before investing, you never will. Time in the market is what is important. Productively and diligently allocating capital creates far more wealth than timing its allocation perfectly.

3. Stocks are a wonderful hedge against inflation: Since 1928, the U.S. stock market is up 9.8% per year while inflation has averaged 3% per year. So stocks have grown at nearly 7% more than the rate of inflation. One of the reasons for this is the fact that earnings and dividends also grow at a healthy clip above inflation. Over the past 93 years, earnings have grown at roughly 5% per year. Stocks also have perhaps the greatest income stream of any asset. Dividends have grown at roughly 5% per year. So earnings and dividends both have a history of growing above the rate of inflation.

4. Real interest rates are likely to remain negative over the long term: We aren’t economists, yet we believe that the rise in inflation and interest rates will be a temporary diversion from a clear downward trend. The fiscal stimulus is all transitory and the economic effects on demand will be short-lived. Zombie firms (those that cannot cover their fixed expenses with operating income and thus continuously rely on the capital markets to survive) are proliferating all over the developed world causing disinflation. We are also going through a productivity boost (technology) at a time when real wage growth is depressed and that is no prescription for durable inflation from a unit-labour cost perspective. In addition, aging demographics and a catastrophic collapse in birth rate (which no one is talking about) across the developed world are disinflationary, while governments are arguably the most anti free-market and least business friendly ever. How will the investor holding a portfolio of low quality, high volatility, weak balance sheet names with little profitability fare if the reflation thesis flames out? 

There will always be another narrative to worry about. A reason to sell your holdings or rotate into the “investment theme du jour”. A good long-term investment strategy will not produce desired returns year in and year out. 

Rather, it will be tested as it makes progress toward some long-term goal over time as winning years more than offset losing years. Investors who keep their investment strategy consistent regardless of volatility set themselves up for success over the long-term. 

Embrace the grind. How can you know what your investment strategy is made of if its never been tested? 

Charts of the Month


How does the market perform when interest rates rise?

Back drop: Why the big picture is critical – especially now:

(1) Three YEARS of non-stop Stock selling.

(2) All the money went into Bonds.

If the rally continues, where does the money go? Is the current equities market a bubble? This chart offers some perspective. Look at where money has been invested since the March 2009 bottom. The bets on equity funds and ETFs are dwarfed by the inflow for bonds.

Where are the jobs? Where is the growth?

The big boost China experienced post Covid-19 looks like it has already come to an end. China's economy was the first to recover from the Covid-19 collapse due to trillions of credit pumped into the economy at home, as well as Americans rushing out to buy imported goods using stimulus money. With China again showing signs of economic weakness, the story that it takes more and more stimulus to create the same kick each time we play this game is playing out. Will the story somehow be different for America or Canada?

Zombies are taking over the world.

If you think that is a lot, consider the entire globe. An International Monetary Fund report from October 2019, fretted that global zombie debt could soon rise to $19 trillion and amount to 40% of all corporate debt in major economies...

Logos LP February 2021 Performance

February 2021 Return: 2.89%

2021 YTD (February) Return: 14.95%

Trailing Twelve Month Return: 133%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 27.29%

 

Thought of the Month

“I judge you unfortunate because you have never lived through misfortune. You have passed through life without an opponent- no one can ever know what you are capable of, not even you.” -Seneca

Logos LP Services


Looking for help with your investments? Unsure about how to achieve your financial goals? We would be happy to chat. Please book an intro call here.



Articles and Ideas of Interest

• The Gig Economy Is Coming for Millions of American Jobs. California’s vote to classify Uber and Lyft drivers as contractors has emboldened other employers to eliminate salaried positions—and has become a cornerstone of bigger plans to “Uberize” the U.S. workforce. This while Long-term unemployment is close to a Great Recession record and the unemployment rate for the bottom quartile of Americans is 23%.

• Canada's balance sheet is deteriorating and the consequences could be significant for investors. Canada is spending in places that may not directly repair the damage that has been done by the virus. No wonder a job in the public sector has never looked better. The long-running rivalry between the two services — public versus private — has been settled by COVID-19. Why would anyone risk the dangers and uncertainty of free enterprise when they could have the safety and security of a large and ever-expanding government? The bottom line is that the cachet that once went with private employment has gone the way of the Dodo bird, which coincidentally never had a government to protect it either. Public pay is better, the benefits top-of-line, it’s almost impossible to be fired, you know the date you can retire, and the amount you’ll be paid. If you don’t get along with your manager you can call the union and grieve 13 ways from Sunday. You don’t have to worry about the business going under, and can live in confidence that terror-stricken politicians will opt to buy peace at contract time, rather than challenge the latest set of demands. This reality is a major problem for the future of Canada’s economy.

• Move over GameStop, hockey cards are emerging as the hottest bull market on the planet: Blame it on the pandemic, but cards are seeing a 'parabolic boom' with values up 300% to 400%. All this while people are paying millions for video clips that can be viewed for free. Welcome to the world of ‘NFTs’.
  
   

• Microdosing study shows placebo effect of taking psychedelics. UK research into LSD consumption reveals expectation of improved wellbeing drives transformation rather than the drug itself. The mind is more powerful than the sword. 
  
   

• YOLO investing still appears healthy. 37% of Americans in a recent online survey say they've made trades based on an Elon Musk tweet and half of respondents in a recent survey between 25 and 34 years old plan to spend 50% of their stimulus payments on stocks. Bless their hearts.

• The long-term economic costs of lost schooling. Students who are falling behind now because of Covid restrictions may never catch up in their skills, job prospects and income.
  
   

• SPACs are becoming less of a sure thing as the deals get stranger, shares roll over. Faced with intense competition, deadline pressure and a volatile market, some SPACs had to settle for less ideal targets, and in some cases, throw their entire blueprint out the window.The proprietary CNBC SPAC 50 index, which tracks the 50 largest U.S.-based pre-merger blank-check deals by market cap, dropped more than 15% in the past two weeks, giving up all of its 2021 gains. Most are problematic, but there is one we find attractive: IonQ (DMYI) which promises to be the leader in quantum computing. 

• What happened to gold? If you went into a laboratory to build a gold price optimizer, you would want a couple of things: A falling dollar, Rising inflation expectations, Money printing, Central bank balance sheets expanding, Fiscal deficits increasing and Political turmoil. All of these things were in place over the last few months, and yet gold has done the opposite of what you expected it to do. It’s down 9% over the last 6 months, and it’s 15% below its highs in August. Gold could rally on any one of the items I mentioned. All six were in place at the same time, and it couldn’t get out of its own way. Michael Batnick digs in.  
  
   

• How Much Longer Can This Era Of Political Gridlock Last? Democrats may have a narrow majority in both the House and the Senate for the next two years, but it’s nothing near the margin they hoped for. And the likelihood that Democrats keep both the House and the Senate in 2022 are low, as the president’s party almost always loses seats in the midterm elections. That means more divided government is probably imminent, and the electoral pattern we’ve become all too familiar with — a pendulum swinging back and forth between unified control of government and divided government — is doomed to repeat, with increasingly dangerous consequences for our democracy.

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

Logos LP

The Myth of Icarus

Good Morning,
 

Stocks rose to record levels on Friday, notching another weekly advance, as investors shook off a disappointing U.S. jobs report.

Friday’s jump led major averages to their fourth weekly gain in five weeks. The Dow rose 1% this week. The S&P 500 gained 1.7% over that time period. The Nasdaq Composite rallied 2.2% this week.

The U.S. economy added 245,000 jobs in November. That’s well below a Dow Jones consensus estimate of 440,000. The unemployment rate, however, matched expectations by falling to 6.7% from 6.9%.

However, investors took the “bad news is good news” approach viewing the weaker-than-expected number as a positive as it could pressure lawmakers to move forward with additional fiscal stimulus.

Our Take
 

November is in the books, recording one of the best months in market history. That makes it six out of the last eight months where the S&P has recorded gains since the March lows. More importantly, all of the major indices showed strength reaching new all-time highs in unison. Based on historical patterns, while there is usually a period of "'give back" following such an event, this kind of market breadth typically foreshadows continued equity market gains…

Although there were some concerning data points in Friday’s jobs report data, Chris Williamson, Chief Business Economist at IHS Markit noted that:
 

"November saw US business activity surge higher at a rate not seen since early-2015 as companies enjoyed sharply rising demand for goods and services. Confidence has picked up considerably, with encouraging news on vaccines coinciding with reduced political uncertainty following the presidential election, hopes of greater stimulus spending, and fresh stock market highs. Optimism about the future is running at its highest since early 2014.The recent improvement in demand and the brightening outlook encouraged firms to take on extra staff at a rate not previously seen since the survey began in 2009, underscoring how increased optimism is fuelling investment and expansion. Pricing power is also being regained, with firms pushing up average charges for goods and services at a rate not seen for at least a decade, boding well for stronger profits growth."

Furthermore, despite the continued negativity regarding how the U.S. is responding to the virus, it finds itself leading the global recovery. In aggregate, Markit data show the U.S. economy accelerating rapidly, with November being the best month since September of 2014 for manufacturing's growth rate, the best month since March of 2015 for services' growth rate, and the best month since March of 2015 for the output-weighted composite of these two indicators.

Globally, Europe appears to be flirting with a double dip recession yet China and Japan as the world’s second and third largest economies, are currently helping keep the global expansion on track. Asian strength bodes well for a global recovery to take shape once COVID is less of an issue. Price action is confirming that view. Asia-Pacific equity markets have broken out to the upside. Japan, Korea, Taiwan, and India are all at decade-plus or all-time highs, while other markets have participated as well. A synchronized global recovery is underway.

South Korea now leads this part of the globe in gains for Industrial production, a 10-year yield of 0.24%, and their Stock Market (KOSPI) is nearing an all-time high.

In aggregate, these economies are growing faster with lower rates than the rest of the world average, a positive backdrop for further equity market gains.

But what of the growing bullishness among individual investors with sentiment reaching highs? 
 

AAII sentiment survey for this week shows the Bulls in the majority at 49%, a slight increase over last week. Other sentiment surveys are echoing the exuberance among investors. The Investors Intelligence survey of equity newsletter writers likewise saw bullish sentiment rise again this week from what were already strong levels. 64.7% of respondents reported as bullish this week. That is in the top 3% of all readings in the history of the survey. The last time this reading on bullish sentiment was this elevated was in January of 2018.

In addition, CNN’s Fear and Greed Index hit over 90 in November and is hovering above 80. What a contrast to March lows…

Fund managers are the most optimistic on the stock market and economy that they’ve been all year, according to Bank of America’s fund manager survey.

Are prices getting ahead of themselves? Have we entered into another bubble? Is this the top? Equity markets, bitcoin, housing, gold, copper etc. The list of assets at or at least close to all time highs goes on.

I must say that this month we’ve had more people than ever before reach out to us and ask about how to get into the equity markets. The above, in addition to the rising chorus of Twitter investors (Fintwit) becoming more and more vocal about their returns, more brazen in their attitude towards value and price:

Has caused us to yet again dust off and reflect upon one of our favourite myths. The myth of Icarus.
 

Musings

In Greek mythology, Icarus was the son of the master craftsman Daedalus, the creator of the Labyrinth. Icarus and his father attempted to escape from Crete by means of wings that Daedalus constructed from feathers and wax. Icarus' father warns him first of complacency and then of hubris, asking that he fly neither too low nor too high, so the sea's dampness would not clog his wings nor the sun's heat melt them. Icarus ignored his father's instructions not to fly too close to the sun; when the wax in his wings melts he tumbles out of the sky and falls into the sea where he drowns, sparking the idiom "don't fly too close to the sun".

This is a stark illustration of the tragic theme of failure at the hands of hubris. Hubris being a personality quality of extreme or foolish pride or dangerous overconfidence, often in combination with (or synonymous with) arrogance. 

We’ve always liked this story as its imagery is easy to remember as fear turns to greed and begins to cloud the mind and influencing judgement. The story is timeless and so is the outcome. Markets are still at their core a story of human emotion. 

Why does the myth of Icarus matter today? 

Sentiment is no doubt becoming extended. Yet by and large we do not feel it is helpful to think of what is going on as a “bubble”. 

A better way to think about the current environment is in terms of “cycles” rather than “bubbles”. 

In an article written back in 2016 by Morgan Housel, he reminds us “that most of what people call a bubble turns out to be something far less sinister: A regular cycle of capitalism.”

Cycles are one of the most fundamental and normal parts of how markets work and are rooted in human emotion. They look like this:

“This cycle is self-reinforcing, because if assets didn’t get expensive they’d offer big returns, and offering big returns attracts capital, which makes them expensive. That’s why cycles are everywhere and we can never get rid of them.”

“A bubble in contrast is when this cycle breaks. It’s only a bubble if return prospects don’t improve after prices fall. It’s when an asset class offers you no hope of recovery, ever. This only happens when the entire premise of an investment goes up in smoke.”

“That was true of a lot of dot-com stocks, which weren’t bargains after they fell 90% because there was still no tangible company backing them up. It was true of homes in the mid-2000s, because you stood no chance of enjoying a recovery if you were foreclosed on. It was true of Holland’s 1600s tulip bubble, as the entire idea that tulips had any value went up in smoke.

But it wasn’t true of stocks in 2007. Yes, the market fell 50%. But that made it so cheap – particularly compared to the alternative of bonds – that buyers instantly came rushing back in. Prices hit a new all-time high by 2013.”

Fast forward to the COVID-19 induced melt-down in March. Many businesses that have since recovered weren’t broken, and valuations had in many cases never been cheaper after the crash. It should not be surprising then that many have bounced back so aggressively as their low prices offered large returns. 

Bubbles should be avoided, because they present the prospect of permanent capital loss. If on the other hand you find assets that look overbought and expensive (perhaps those hitting ATHs outlined above) the chances that they will fall may be elevated yet you likely haven’t encountered a bubble. You’ve instead found capitalism. Excesses will correct, the business will chug on and the humble investor will patiently make a return. Life goes on in a surprisingly predictable way:

Furthermore, when it comes to the first year of a presidential term, the odds of a rising market are 82%, versus 70% in the other three years of the term. But even this difference is not significant at the 95% confidence level that statisticians typically use to determine if a pattern is genuine.

Despite the above probabilities that the market will end positive at the end of each time period, just about every year since 1926 there have been “experts” predicting market “mayhem”, “collapses” or “crashes”. 

Whether an individual expert is wrong or right in their call isn’t the point. The point is that these cycles are inevitable. 

Just as in our own lives, as we were so brutally reminded over the last 10 months of COVID-19, we can’t spot the end or the beginning of these inevitable ups and downs or cycles with great precision. That’s what we signed up for as a human and as an investor. 

Instead, all we can do is remain alive to their existence and attempt to play the ball as it lies. The story of Icarus, which is also inevitably destined to repeat itself, can help us do so. 

Where are we now? 

Based on the data, there is a greater than average probability that we are transitioning out of the “People rush in to exploit opportunity” phase to the “Prices are bid up” phase. Icarus is likely flying closer and closer to the sun. 

Central banks and governments have succeeded in putting together an extremely favourable backdrop for “risk-taking” and thus “asset price-inflation”. Investors are thus being rewarded for taking on risk. 

When investors take 'a little risk' and get rewarded for it, they are then encouraged to take 'a little more risk.' Investors in the 'crowd' don't appreciate the risks they are taking because they're surrounded by people who believe the market will keep going up.

Such appears to currently be the case. Many are thoroughly convinced that markets cannot go down due to the Federal Reserve and government interventions.

Without arguing for or against the wisdom of this belief, we can instead simply view it as a feature of this current market. While future long-term returns based on today’s prices are obviously lower than if one were first investing capital during the March crash, that does not necessarily mean long-term returns will be negative. 

Just because current opportunities may not be as attractive as 9 months ago does not mean sitting on cash to wait for the next correction is the best decision. While there is risk that the market may decline in the future, historically (as shown by the data above) there is MORE risk that it will go up.

As such, we believe at this point in the cycle caution through active portfolio risk management and a renewed focus on company specific stock selection rather than simply sector/index exposure is warranted. 

Charts of the Month

Cycles in perspective.

One method of evaluating the S&P 500 (SPX) is to subtract the six-month Treasury yield from the SPX dividend yield to get the "net yield". By this measure, stocks are historically cheap. Further, the profile of the net yield is similar to 1995 and 1998, just before two explosive, multi-year rallies in the SPX. Could a new technological revolution be taking hold which will send the stock market to levels that few people can imagine...just like in the late 1990s?

Reduced deficit spending always precedes recessionary periods (red outlines below). Throughout the 1990s, Clinton reduced the deficit and finally eliminated it, sending the budget into surplus.

Household balance sheets are healthy and swollen…

Logos LP November  2020 Performance

November 2020 Return: 25.71%
 

2020 YTD (November) Return: 89.34%
 

Trailing Twelve Month Return: 89.38%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +24.79%

Thought of the Month

"Amor fati, for Nietzsche, meant the unconditional acceptance of all life and experience: the highs and the lows, the meaning and the meaninglessness. It meant loving one’s pain, embracing one’s suffering.” -Mark Manson


Articles and Ideas of Interest

• How do we prevent the next outbreak? Vaccines are on the way. There appears to be light at the end of the tunnel. But we are still, for the most part, shut down as we wait for vaccines to be rolled out. Our governments have chosen a virus containment approach consisting of rolling draconian lockdowns which have and will continue to cause permanent economic and social damage. This doesn't seem to be a sustainable long-term approach and sets a problematic precedent. What if COVID-19 was not a "black swan" but instead just the first of many in a new era of deadly global pandemics? What if, not long after the vaccine roll out, we are hit with the next global pandemic? Will citizens expect their governments to again attempt to protect every last human life by demanding another round of massive economic and social sacrifices until a vaccine is developed? Are politicians even considering such a new era of frequent deadly pandemics? Coronaviruses, like the novel coronavirus SARS-CoV-2, which causes COVID-19, are not uncommon. The WHO estimates that some 60 percent of all viruses that infect humans come from animals. This phenomenon is termed “zoonosis.” The WHO finds that 75 percent of new infectious diseases in the past decade are zoonotic. Our planning needs to take into account the complex interconnections among species, ecosystems and human society. The Scientific American digs in and explores what we can do to prevent infection by the next emerging virus.

• Blackrock’s Chief Investment Officer says Bitcoin could replace gold to a large extent. The chief decision maker for where BlackRock, the world’s largest asset manager, invests its funds said bitcoin could take the place of gold to a large extent because crypto is “so much more functional than passing a bar of gold around.” What would the implications of this shift be on the roughly $9 trillion dollar market capitalization of gold and those who hold it? In the meantime, US investors who variously view the virtual currency as a “risk-on” asset, a hedge against inflation and a payment method gaining mainstream acceptance are gobbling up the asset.

• Major scientific advance: DeepMind AI AlphaFold solves 50-year-old grand challenge of protein structure prediction. In a major scientific advance, the latest version of DeepMind’s AI system AlphaFold has been recognized as a solution to the 50-year-old grand challenge of protein structure prediction, often referred to as the ‘protein folding problem’, according to a rigorous independent assessment. This breakthrough could significantly accelerate biological research over the long term, unlocking new possibilities in disease understanding and drug discovery among other fields. 
  
   

• Why value stocks won’t necessarily keep outperforming growth. A fading of the economy’s momentum would favor growth stocks over value, contrary to the recent trend. A decline in expectations for inflation would mean a less upbeat outlook for economic growth, and for corporate profits. 

• Boom times have returned for venture-backed start-ups, says co-founder of $3 billion fintech Brex that lends to thousands of other start-ups. Customer spending is now at an all-time high, roughly 5% higher than it was before the pandemic, he said, but companies are transacting differently than they used to, plowing dollars into online advertising and remote work expenses. New companies are being formed at a furious clip, Dubugras says, and many of these firms – retailers, restaurants or professional services— are “looking more and more like tech companies.”

• The new casino. Pandemic-induced options trading craze shows no signs of slowing down. The stay-at-home requirement created by Covid-19 has spawned a huge sub-industry in options trading in tandem with an increase in equities trading that shows no signs of letting up. Trading in equity options hit new highs in November, continuing a trend that began earlier in the year. Equity option trading is 50% above last year’s levels year to date on all the options platforms. Human nature is undefeated…

• Prepare your portfolio for a return of the roaring 20s. Some naysayers point to surveys suggesting that consumers plan to maintain the savings habit once lockdown is over. But after a year of no holidays, no eating out and no high street shopping sprees, how inclined to fiscal prudence will we really feel? We suspect this is one of the few occasions where the phrase “pent-up demand” has genuine meaning. So the stage is set for a short-term boom as all that delayed demand floods out in the early part of next year. But what happens then? Why will this be anything more than a short-term sugar rush? MoneyWeek makes the uber bull case...
  
   

• How Covid-19 will change aging and retirement. As the pandemic wreaks havoc on our mental and physical health, it is also quietly reshaping how Americans will face retirement and old age in the years to come. It will make people rethink retirement altogether as well as fuel a boom in innovation improving life in later years. Interesting piece in the WSJ exploring the themes above.

• After Covid, “Normal” could be profoundly different. Those expecting things to go “back to normal” after ten months of new habit building maybe in for a surprise. Even when lockdowns are a thing of the past, we’ll be spreading out in the suburbs and ordering in. The economy may never be the same. Any of these changes on their own could well have redirected tens or hundreds of billions of dollars in government and consumer spending from one place to another, but they are all happening at the same time. Some of the trillions of dollars’ worth of aircraft, cruise ships, gyms, shopping malls, office buildings, hotels and convention halls have been sitting idle may not be needed even after it is safe to use them. Others like e-commerce infrastructure can’t be built fast enough. The WSJ digs in.

• How companies like Nike and Apple stay cool for decades. Very few brands manage to navigate coolness alongside an extreme rise in popularity, and two have done it more successfully than anyone else: Nike and Apple. Both maintain their credibility by preserving some of what originally earned them acolytes, while constantly tinkering with new ideas to stay relevant. Here’s how these two titans have kept their edge for decades, and what other companies might learn from them.
  
   

• All successful relationships are successful for the same reasons. 1,500 People give all the relationship advice you’ll ever need. Mark Manson reached out to those who have been married for 10+ years, and is still happy in their relationship and asked what lessons would you pass down to others if you could? What is working for you and your partner? Also, to people who are divorced, what didn’t work previously? The response was overwhelming. What he found was incredibly repetitive. The same twelve things are here. 

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

Logos LP

Do Bull Markets Die Of Old Age?

Good Morning,
 

The S&P 500 and Nasdaq composite closed lower on Friday as tensions between the U.S. and China weighed on investor sentiment while both countries continued negotiations on trade.

On Thursday, the two largest economies in the world began the second round of trade talks. But President Donald Trump told reporters he doubted the negotiations would be successful.

Later, reports emerged saying China would offer the U.S. a $200 billion trade surplus cut. Those reports, however, were quickly denied by a Chinese ministry spokesman on Friday.

Investors are closely watching progress on the latest China-U.S. trade talks for signs of a breakthrough that could reignite a recent rally in global equities, while factoring in oil prices at a four-year high and a 10-year Treasury yield now firmly above 3 percent. Politics in peripheral Europe are also back in the spotlight after Italy’s populist leaders sealed a coalition agreement and a plan for reforms seen as a challenge to the European Union establishment.
 

Our Take

In a bull market pushing through its 10th year, market timing has again become a preoccupation. One week stocks are climbing to reflect fundamentals ie. stellar earnings growth. The next they’re dropping as yields jump, trade talks with China stall and an executive suggests “peak earnings” on a call. The cost is less to the wallet than the psyche, given that we are coming off two years of relatively straight line low volatility gains.

Furthermore, both stock market bulls and bears can marshal data in their favor. Considering the S&P 500’s current forward P/E which runs above its 5 and 10 year averages, as well as its elevated CAPE ratio, the market looks rich. On the other hand, looking at the market’s PEG ratio or a P/E that accounts for earnings growth, stocks appear to be trading at their cheapest level since 2012...

Best to focus on particular businesses rather than on market prices. How could the business create value in the years ahead? As Thomas Phelps reminds us: “When experienced investors frown on gambling with price fluctuations in the stock market, it is not because they don’t like money, but because both experience and history have convinced them that enduring fortunes are not built that way.”


Chart of the Month

Source: More Than Never. Less Than Always


Musings
 

This month, the current U.S. expansion reaches the 107-month mark, making it the second longest business cycle expansion in the post-war period. It’s looking increasingly likely that this expansion will continue for more than a year and will become the longest since World War II. Most economists will tell you that expansions don’t die of old age, but the odds of fatal mistakes and excesses increase the older they get.

The age of this bull market is the elephant in the room for investors who each year get less enthusiastic about increasing long exposure. How worried should we be? What should we make of comments suggesting that things have “peaked”?

What should be remembered is that output growth during this expansion has severely lagged other expansions. There has been no robust recovery. The slow start in this expansion in the wake of the Great Recession was counterintuitive to the thinking of most analysts, who expected a robust recovery following the worst recession in a generation. However, there is evidence indicating that recessions caused by financial crises tend to be deeper and have longer recovery times than normal recessions.

In addition, this expansion has seen comparatively low rates of personal consumption. Personal consumption which comprises nearly 70% of GDP, has been a major contributor to the overall slow economic performance in the current expansion. Real consumption has grown by 23% since the summer of 2009, compared to growth rates of 41% and 50% at the same point in the expansions of 1991-2001 and 1961-1969, respectively.
 

Consumers are not the only group that has shown uncharacteristic restraint during this expansion; investment by the private (non-government) sector has also lagged since the last recession. Real private fixed investment has grown by 50% in this expansion, compared to growth rates of 89% and 76% at comparable points in the 1991-2001 and 1961-1969 expansions, respectively.

Perhaps one of the most interesting aspects of this U.S. expansion is its global ubiquity. The subpar economic growth seen in the U.S. following the global financial crisis has been simultaneously experienced by many other countries. Whatever the causes of mediocre economic growth in the U.S., the same factors have been at work around the world due to the increasing level of global economic interdependence.

So what?

All we can say at this point is that the mediocre growth of the U.S. economy since the Great Recession is likely a contributing factor in this expansion’s length. As such, although there appears to be pockets of excess across the market (see below), there doesn’t seem to be the kind of widespread excess and economic robustness which is typically characteristic of an expansion’s “final inning”. This time may be “different”, yet the faster and higher you climb, the further and faster you fall. Have we climbed high? Have we climbed fast?

Long-term investors should be wary of remaining “underinvested” on the sidelines waiting for the cycle to turn, as the wait may be longer than planned.

Logos LP April 2018 Performance



April 2018 Return: -3.84%

2018 YTD (April) Return: -3.79%


Trailing Twelve Month Return: +8.22%


CAGR since inception March 26, 2014: +18.39%

Thought of the Month


 

“Over all, 76 percent of the companies that went public last year were unprofitable on a per-share basis in the year leading up to their initial offerings, according to data compiled by Jay Ritter, a professor at the University of Florida’s Warrington College of Business. That was the largest number since the peak of the dot-com boom in 2000, when 81 percent of newly public companies were unprofitable. Of the 15 technology companies that have gone public so far in 2018, only three had positive earnings per share in the preceding year, according to Mr. Ritter.” -Kevin Roose

Articles and Ideas of Interest

 

• Hooray for unprofitable companies!  Interesting article in the NYT that discusses an omnipresent characteristic of this cycle: the proliferation of unprofitable companies. The start-up pitch is basically this: “It’s called the 75 Cent Dollar Store. We’re going to sell dollar bills for 75 cents — no service charges, no hidden fees, just crisp $1 bills for the price of three quarters. It’ll be huge. You’re probably thinking: Wait, won’t your store go out of business? Nope. I’ve got that part figured out, too. The plan is to get tons of people addicted to buying 75-cent dollars so that, in a year or two, we can jack up the price to $1.50 or $2 without losing any customers. Or maybe we’ll get so big that the Treasury Department will start selling us dollar bills at a discount. We could also collect data about our customers and sell it to the highest bidder. Honestly, we’ve got plenty of options. If you’re still skeptical, I don’t blame you. It used to be that in order to survive, businesses had to sell goods or services above cost. But that model is so 20th century. The new way to make it in business is to spend big, grow fast and use Kilimanjaro-size piles of investor cash to subsidize your losses, with a plan to become profitable somewhere down the road.” Instead of pointing the finger at Musk and his unprofitable counterparts the author makes an interesting suggestion: For consumers who are willing to do their research, though, this can be a golden age of deals. May you reap the benefits of artificially cheap goods and services while investors soak up the losses. What could go wrong?

• Who’s winning the self-driving car race? A scorecard breaking down everyone from Alphabet’s Waymo to Zoox. Spoiler alert: Tesla isn’t even top contender.

• Could Argentina’s woes be the tip of the iceberg of an even bigger crisis for the world economy? Tightening U.S. monetary policy could threaten a broad range of emerging markets. Tighter monetary policy will drain liquidity and lift borrowing costs for much of the world economy. Debtors beware.

• You’re not just imagining it. Your job is absolute BS. Anthropologist David Graeber’s new book accuses the global economy of churning out meaningless jobs that are killing the human spirit. There is no doubt that many jobs could be erased from the Earth and no one would be worse off, but this is a tough argument to make as personal fulfillment is relative. Furthermore, in his comfortable seat as a professor at an esteemed institution, musing amusedly about the mind-numbing hours most working people have to put in and put up with—even at jobs that have lively, meaningful moments—appears to fit neatly in his own category of a BS job…

• Bitcoin fans troll Warren Buffett with ‘Rat Posion Squared’ clothing line. Oh it's on! A 10 year wager perhaps between the CCI30(A Crypto Currencies Index) against the SPY (a low cost S&P 500 ETF)? Any takers?  

• Why winners keep winning and why accepting luck as a primary determinant in your life is a freeing worldview. Cumulative advantage goes a long way to explain a moat.  The Matthew effect, and explains how those who start with an advantage relative to others can retain that advantage over long periods of time. This effect has also been shown to describe how music gets popular, but applies to any domain that can result in fame or social status.  As for luck, when you realize the magnitude of happenstance and serendipity in your life, you can stop judging yourself on your outcomes and start focusing on your efforts. It’s the only thing you can control. 

• The epic mistake about manufacturing that’s cost Americans millions of jobs. Quartz suggests that it turns out that Trump’s story of US manufacturing decline was much closer to being right than the story of technological progress being spun in Washington, New York, and Cambridge. Thanks to a painstaking analysis by a handful of economists, it’s become clear that the data that underpin the dominant narrative—or more precisely, the way most economists interpreted the data—were way off-base. Foreign competition, not automation, was behind the stunning loss in factory jobs. And that means America’s manufacturing sector is in far worse shape than the media, politicians, and even most academics realize.

• The burbs are back. Americans are once more fleeing the cities to the suburbs. According to the National Association of Realtors, a trade association for estate agents, more than half of Americans under the age of 37—the majority of home-buyers—are settling in suburban places. In 2017, the Census Bureau released data suggesting that 25- to 29-year-olds are a quarter more likely to move from the city to the suburbs than to go in the opposite direction; older millennials are more than twice as likely. Economic recovery and easier mortgages have helped them on their way. Watch this trend continue as interest rates rise and large mortgages become even more difficult to obtain.

• Biology will be the next great computing platform. Just as the exponential miniaturization of silicon wafers propelled the computing industry forward, so too will the massive parallelization of gene editing push the boundaries of biology into the future.

Our best wishes for a fulfilling month, 

Logos LP

What Is The Purpose Of Tax Reform?

Good Morning,
 

U.S. stocks climbed to records as the latest jobs report boosted optimism in the world’s largest economy, continuing equity rallies that took hold in Asia and Europe. The dollar posted its best week this year.

The S&P 500 Index and Dow Jones Industrial Average closed at all-time highs in light volume after data showed hiring increased by more than forecast in November and the unemployment rate held at a 17-year low of 4.1%. The dollar briefly edged lower as investors assessed tepid wage growth that missed estimates, then resumed its fifth consecutive gain. Average hourly earnings — a closely watched component of the report — rose 0.2 percent for November and 2.5 percent for the year. Economists expected a monthly increase of 0.3 percent or 2.7 percent for the year. Ten-year Treasury yields inched higher.

The jobs data added to a run of recent news that has been contributing to investor confidence after the U.S. government averted a shutdown and tax reform negotiations made progress.

Our Take
 

This melt-up may have legs as forecasts for U.S. growth have been too pessimistic. Nevertheless, despite a mostly solid run of job growth, 2017 ends pretty much where it began — with wage growth stuck and inflation subdued.

This nonfarm payrolls report brought with it news all too familiar to the post-crisis economy. The 228,000 jobs created formed a solid foundation, but the pedestrian 2.5 percent average hourly earnings growth left many scratching their heads wondering how a 4.1 percent unemployment rate, the lowest in 17 years, still wasn't producing fatter paychecks.

The lack of wage growth at the aggregate level despite the declines in the unemployment rate and strong job gains remain a mystery.

Central bankers can control short-term interest rates but as has become glaringly obvious in the post recessionary world, long-term ones are out of their purview.  

Ms. Yellen’s Fed has raised rates twice this year and will likely raise a third time this month. In October the Fed began reversing quantitative easing (QE), purchases of financial assets with newly created money. Despite all this monetary tightening, yields on ten year Treasury bonds have fallen from around 2.5% at the start of 2017 to about 2.3% today. As a result the “yield curve” is flattening. The difference between ten year and two year interest rates is at its lowest since November 2007.

The yield curve matters as it has inverted- ie. long-term rates have dipped below short term ones-just before each of the past seven American recessions.

The yield curve reflects where markets expect Fed Policy to go and what we are seeing is an expectation that rates are not likely to increase.

Why? Falling inflation risk may explain the falling yield curve but as the Economist suggests, what is most likely is that markets are losing confidence in the Fed’s ability to raise rates without inflation sagging. This nonfarm payrolls report will only accelerate this loss of confidence.  

Musings
 

So what of Trump’s new tax reform package? Despite Trump’s approval ratings hitting a new low, the market appears to be applauding it. From our perspective, although this tax package will likely stimulative in the short term, in the long term a fiscal stimulus through generalized tax cuts is unnecessary, and destabilizing, in an economy running substantially above its 1.5 percent potential (and non-inflationary) growth on the steam of exceptionally loose monetary policy.

Furthermore, deep corporate tax-cuts (which have been tried before by Ronald Reagan) don’t seem to work.

The Trump team’s argument goes something like this: Cutting taxes on businesses will free up profits they will invest in new factories, research and development, and new equipment. The resulting investment boom will spur growth, as firms hire and as workers harness new ideas and equipment to produce more than they used to.

If we look at the Reagan years, investment fell—that was the weakest period of investment in the postwar period.

The same is likely to occur today. Firms aren’t cashed constrained. They aren’t asking for more money then and they certainly aren’t asking for more now. In fact, companies don’t even know what to do with their money. Companies today are sitting on record cash piles (roughly $1.84 trillion).

When asking the question of what companies will do with a windfall of after tax-profits,  Quartz points out that the odds that it will flow back into the real economy (investment) aren’t looking good. Many major companies are planning to hand that money to their investors through dividends and share buybacks. In fact, when Gary Cohn, Trump’s economic guru, asked a gathering of corporate leaders who was planning to reinvest their tax cuts, few raised their hands, Bloomberg recently reported. What these cuts will likely do is inflate asset prices even further as the bill directs the largest tax cuts as a share of income to the top 5 percent of taxpayers and by 2027, taxes on the lowest earners would go up.

This at a time when we find ourselves in what could be argued is an “everything bubble”. At a time when a cool $1 million which has long been considered the gold standard of retirement savings, has become only a fraction of what you will really need.A time when 44 percent of millennials would prefer to live in a socialist country, compared with 42 percent who want to live under capitalism. A time when 41 million Americans officially live in poverty. A time when  bitcoin is the most popular search on Google as well as the most popular news story on virtually every news outlet….

What goes up must come down….In this environment, where the balance of risk is likely to the downside, buying EXTRA thoughtfully is warranted.

Logos LP November Performance

November 2017 Return: +7.33%

2017 YTD (November) Return: +28.83%

Trailing Twelve Month Return: +35.67%

CAGR since inception March 26, 2014: +20.65%


 

Thought of the Week 

 

"Do you wish to rise? Begin by descending. You plan a tower that will pierce the clouds? Lay first the foundation of humility.” -Saint Augustine

Articles and Ideas of Interest
 

• Collective intelligence can change the world. Combining the minds of humans and machines to avoid confirmation bias. A group with a more autonomous intelligence will fare better than one with less autonomy. It will fall victim less often to the vices of confirmation bias or functional fixedness. It is more likely to see facts for what they are, interpret accurately, create usefully or remember sharply. Knowledge will always be skewed by power and status as well as our pre-existing beliefs. We seek confirmation. But these are matters of degree. We can all try to struggle with our own nature and cultivate this autonomy along with the humility to respond to intelligence. Or we can spend our lives seeking confirmation. Over the Holidays -- give yourself the freedom to explore, think and imagine without constraint.

• There’s an implosion of early-stage VC funding, and no one’s talking about it. Amid record amounts of capital raised by VCs worldwide, and a sharp rise in the number of private “unicorns” valued at $1 billion-plus, therehas been a quiet, barely noticed implosion in early-stage VC activity worldwide. This is now a three-year trend, so cannot be “blamed” on macro or short-term factors. More worryingly, it comes at a time of unprecedented stock market valuations worldwide. Whether the early-stage VC implosion is healthy or disastrous for the tech ecosystem remains to be seen. This is likely healthy over the long run in order to break Silicon Valley’s never-ending startup cycle: Startup employees get rich quick and quit to become venture capitalists.

• Mysterious object confirmed to be from another solar system.Astronomers have named interstellar object ’Oumuamua and its red colour suggests it carries organic molecules that are building blocks of life. Interestingly, NASA has also found another 20 promising planets for humans to colonize.

• Net neutrality: catastrophe or a non-event?  Some suggest that the internet is dying and that repealing net neutrality hastens that death. Others suggestthat concerns over net neutrality are overblown as public blowback in past cases of service providers blocking sites that are competitive has been fierce, scaring other providers from following suit. Second, blocking competitors to protect your own services is anticompetitive conduct that might well be stopped by antitrust laws without any need for network neutrality regulations.
  
   

• Will BlackRock and Vanguard own everything by 2028? Imagine a world in which two asset managers call the shots, in which their wealth exceedscurrent U.S. GDP and where almost every hedge fund, government and retiree is a customer. It’s closer than you think. BlackRock Inc. and Vanguard Group  — already the world’s largest money managers — are less than a decade from managing a total of $20 trillion, according to Bloomberg News calculations. Amassing that sum will likely upend the asset management industry, intensify their ownership of the largest U.S. companies and test the twin pillars of market efficiency and corporate governance.

• Robots aren’t killing jobs fast enough-and we should be worried.Interesting perspective on this. In fact, data show that the US labor market is the calmest it has been in more than 160 years. The problem is there is not enough disruption. If anything, we need more jobs destroyed. That argument, made by Robert Atkinson and John Wu of the Information Technology and Innovation Foundation, a think tank promoting policies that spur innovation, is a novel one. Their belief that we are in an age of stagnation, not disruption, is based on a decade-by-decade analysis of how quickly occupations have been appearing and disappearing since 1850. No wonder Google, Amazon have found that not everyone is ready for AI.

• How high will bitcoin go? Should you buy in? What is next for cryptocurrencies? Well ladies and gents even the most staunch haters arethrowing in the towel with Jamie Dimon recently suggesting a reversal of his position stating that “I'm open-minded to uses of cryptocurrencies if properly controlled and regulated." Make no mistake this is a frenzy much like the dot-com bubble in 1995. Perhaps even larger as bitcoins appear to be at least 4 times as expensive as dot-com stocks were at their height. Interestingly, few are talking about its energy use implications: By July 2019, the bitcoin network will require more electricity than the entire United States currently uses. By February 2020, it will use as much electricity as the entire world does today. Is this sustainable? The cryptocurrency’s price is completely unreal. Then again so is money...The problem is that it is clear that this is not a currency. Most are buying and holding in hopes of future gains. This is an asset class and as seen many times before, when lots of investors buy an illiquid asset, the price can rise exponentially yet at some point the urge to turn all those digital zeros into cars and iPhones will prove too great. Getting out of an illiquid asset can be much harder than getting in. When that rush inevitably happens, people are going to get hurt. Rule number 1: don’t lose money. Rule number 2: don’t forget rule number 1.

• Me, myself and iPhone. Fascinating research presented in the Economistsuggesting what we already know (subconsciously): the many hours young people spend staring at their phones is having serious effects. Adolescents who spent more time on new media-using Snapchat, Facebook or Instagram on a smartphone were more likely to agree with remarks such as: “The future often seems hopeless” or “I feel like I can’t do anything right.” Those who used screens less, spending time playing sport, doing homework, or socialising with friends in person, were less likely to report mental troubles.

Our best wishes for a fulfilling week,  
 

Logos LP