Crystal Balls and Bottom Calling

Good Morning,
 

Stocks surged on Friday after a report said a Gilead Sciences drug showed some effectiveness in treating the coronavirus, giving investors some hope there could be a treatment solution that helps the country reopen faster from the widespread shutdowns that have plunged the economy into a recession.

Stocks tumbled from record highs in February into a bear market a month later as the spread of the coronavirus roiled market sentiment and the economic outlook.  More than 2 million cases have been confirmed worldwide, including over 650,000 in the U.S., according to Johns Hopkins University. Governments urged people to stay home, effectively shutting down the global economy.

But the stock market has rallied since March 23 as new coronavirus cases in the U.S. and globally showed signs of plateauing. President Donald Trump said Thursday that “our experts say the curve has flattened and the peak … is behind us.”

He also issued guidelines to open up parts of the U.S. Thursday night, which identify the circumstances necessary for areas of the country to allow employees to start returning to work. The decision to lift restrictions will ultimately be made by state governors.

To be sure, the outbreak has already dealt a huge blow to the economy. In four weeks, about 22 million Americans have lost their jobs as the US economy has erased nearly all the job gains since the Great Recession (a 35 sigma event). The human suffering (physical, psychological, economic)  brought on by the outbreak is tragic. 

Our Take

It is no secret that markets rolled over this past quarter with the outbreak creating what looks to be the deepest recession since 2008-09. As a result, Q1 was by far the most active period in the history of our fund as we experienced what we believe to be one of the greatest buying opportunities for the patient long-term investor since the Great Recession of 2008-2009 and perhaps one of the greatest buying opportunities in the history of the capital markets. 

Although it is an impossible task to time markets, understanding the temperature of the market and thereby making informed inferences as to the market’s probability of swinging from one extreme of the pendulum to the other is possible. It is during these times of great short-term pricing dislocations brought on by sudden economic shocks that high quality stocks trading at what we believe to be below their intrinsic value can be identified. While we have found several data points suggesting a possible near-term bottom, the following represent a list of those we found of most interest (courtesy of our friends at Sentiment Trader and Tom Lee from Fundstrat) during the Q1 selloff:

 
1. Over 23 days in the past 7 weeks we have seen the S&P 500 move more than +/- 3%. The previous records were Oct. 1932 and Nov. 2008. In those 2 cases, the S&P 500 staged rallies of +40% and +27%, respectively, over the next 12 months.

2. MSCI Emerging Market Index price-to-book ratio hit under 1 on April 2nd, 2020. The only other times the index hit those levels were bottoms in 2002 and 2008.

3. March 2020 saw the 2nd largest one month change in aggregate cash holdings in AAII survey history.

4. On March 31st, 89% of S&P 500 stocks have triggered a MACD buy signal, which at the time was the highest in recorded history. This has only occurred 10 times in the last 30 years and every time this happened, the Nasdaq Composite has rallied 6 months later by a median of +18%.

5. As of March 20th, the average 5-week percentage change of 21 developed markets was -31.3%. This was the worst 5 weeks ever for global stock investors, beating 2008-09 Great Recession.

6. On March 25th, more than 90% of NYSE issues were positive. The S&P 500 is up 100% of the time over the next year by a median of +29% every time this happened.

7. The S&P 500 is at 2,845 (which is well above 50% retracement loss level). In the 1987, 2003 and 2008 crashes, “bear market rallies” fail at 33% retracement decline. For all three previous bear markets, the bottom was confirmed with a 50% retracement.

Does this mean that we have hit a bottom and things go straight up from here? Unlikely, as we have to consider the current situation in the context of unprecedented uncertainty and the weakness of analogies to the past.

Furthermore, the answer to this question of whether we have hit a bottom should not overly pre-occupy the patient long-term investor. Why?

We never know when we have hit a bottom as a bottom can only be recognized in retrospect. As Howard Marks has recently written:

“The old saying goes, “The perfect is the enemy of the good.” Likewise, waiting for the bottom can keep investors from making good purchases. The investor’s goal should be to make a large number of good buys, not just a few perfect ones.”

“So it’s my view that waiting for the bottom is folly. What, then, should be the investor’s criteria? The answer is simple: if something’s cheap – based on the relationship between price and intrinsic value – you should buy, and if it cheapens further, you should buy more.”

Successful long-term investing isn’t about buying only at bottoms and selling only at tops. It is instead about the gradual re-adjustment of one’s portfolio as a function of the significant price movements of individual stocks.

This is precisely the approach we have tried our best to stick with during these unprecedented times. We were able to re-position the fund into stocks that we have been monitoring for some time at what we believe to be good prices. The future is uncertain, the economic shutdown remains a very fluid situation and the amount of unprecedented fiscal and monetary action that has occurred in such a short period of time is unlike anything we have ever seen in human history (balance sheets of G4 central banks – the Bank of England (BOE), the Bank of Japan (BOJ), the Federal Reserve (FED), and the European Central Bank (ECB) – have expanded to 40% of gross domestic product). We don’t know what the precise long-term implications of this shutdown will be past 2020, but one thing we can predict with a degree of certainty is that certain businesses will continue to thrive long after the dust has settled. Ultimately investors who stay with their plan will be rewarded. 

Stock Ideas
 

Currently, there are 22 names in the portfolio with our top 10 making up 65.17% of the fund’s net asset value and software now makes up over 85% of the fund’s industry exposure. Our portfolio has become more concentrated and we have now been able to take a shot at some of the highest potential growth stocks that have been on our watchlist for over 2 years. Below you will find the top 5 names in the portfolio:

1. ALTERYX INC. (AYX)

2. SERVICENOW INC. (NOW)

3. TRADE DESK INC. (TTD)

4. JOYY INC. (YY)

5. ZSCALER INC. (ZS)

Musings

Over the past few weeks we have seen the typical torrent of crystal ball forecasting with predictions flying around on just about everything from personal consumption habits to global supply chains. It reminded us of a great quote:

“He who lives by the crystal ball will eat shattered glass.” –Ray Dalio.

Looking back at all the predictions that were made during and after the crisis of 2008 that things would “never be the same” and that “things would change forever” it is important to recall one of the great lessons of this current crisis: humility has been in short supply for a while now.

Who could have predicted much of what has occurred? Just like who can predict much of what will occur?

Instead, we will be modest with our outlook and focus only on one high-conviction trend we believe will have a large impact on the post COVID business climate: the accelerated adoption of new technologies. The planet is currently having a crash course in remote working, digital productivity and automation, e-commerce, digital payments and online social interaction. Technological adoption in such areas is still quite low and thus the growth in these areas which were fueling the bull market pre COVID still has plenty of room to run.

As mentioned in our COVID-19 update on March 19th, 2020 we are thinking of this accelerated technological adoption through the following 3 key themes:

1. The rise of the emerging market Millenial/Gen Z -- ie. Joyy Inc, Baozun, MasterCard, Baidu etc.;

2. The continued expansion of the ‘virtual’ economy as certain transformative digital workflows are likely to stick (fintech, video, e-commerce, virtual purchasing, cloud networking, IT management) – ie. Atlassian, Adobe, Paycom, Zscaler, Trade Desk etc.;

3. Mission critical cloud computing and related applications as well as advanced artificial intelligence (and quantum computing) for the enterprise – ie. Alteryx, Anaplan, ServiceNow, F5 Networks etc.

After this period of “forced” adoption or large-scale “testing” of such technologies, individuals from managers, shareholders, employees to citizens will realize that they had much more to offer than previously thought. Restrictions put in place during the SARS outbreak of 2003 helped accelerate China’s embrace of e-commerce and COVID is having a similar effect globally. The pandemic will highlight the convenience and ease of online life and will expose opportunities for cost savings through increased technological adoption that will be too difficult for managers and shareholders to ignore.

 

Charts of the Month

Jobless claims have been a 35 sigma event.

Thought of the Month

"Nature does not hurry, yet everything is accomplished.” — Lao Tzu

Articles and Ideas of Interest

 

• The Coronavirus in America: The Year Ahead. There will be no quick return to our previous lives, according to nearly two dozen experts. But there is hope for managing the scourge now and in the long term. One of the more interesting predictions is “Goodbye America First” as global collaboration will be more of a must. Seems a bit contrarian… 

• An artificial intelligence arms race is coming. It is unlikely to play out in the way that the mainstream media suggest, however: as a faceoff between the United States and China. That’s because AI differs from the technologies, such as nuclear weapons and battleships, that have been the subject of arms races in the past. After all, AI is software—not hardware. Because AI is a general purpose technology—more like the combustion engine or electricity than a weapon—the competition to develop it will be broad, and the line between its civilian and military uses will be blurry.

• Software stocks emerge as downturn winners. Share in cloud groups prove more resilient then overall market - and some have risen to new records. Investors accustomed to looking to history as a guide have had to think again. In the meltdown that followed the 2008 financial crisis, the revenue multiples on software stocks contracted by 75 per cent. This time, according to Goldman Sachs, they had fallen back only about 30 per cent by the time the market bottomed in the middle of March — before a rebound over the next three weeks that saw them expand again by 18 per cent.

• Once safer than gold, Canadian real estate braces for reckoning. Canadian housing once seemed so infallible that the head of the world’s biggest asset manager in 2015 described Vancouver condos as a better store of wealth than gold. The coronavirus is putting that theory to the test. While lockdowns, job losses and uncertainty are roiling property markets from the U.K. to Australia to Hong Kong, Canada’s situation is more precarious than most. As its oil sector shriveled in recent years, Canada’s economy became ever more driven by real estate, an industry now in a state of paralysis. Nearly one in three workers have applied for income support. What’s more, its households are among the world’s most indebted, poorly placed to weather the storm. Bloomberg digs in with a well researched piece.

• The price of the Coronavirus pandemic. When COVID-19 recedes, it will leave behind a severe economic crisis. But, as always, some people will profit. Interesting piece from the New Yorker outlining the stories of those who are profiting handsomely from the chaos.

• WeWork’s lessons for US real estate in a post-Covid-19 world. The company’s troubles hint of what is to come - a long period of falling property prices in global cities. The Financial Times digs into the broader lessons WeWork’s travails provide — especially for a post-Covid-19 world. Among them: debt matters; corporate valuations were unsustainable even before the crisis; nobody is going to be rushing to lease office space anytime soon; and real estate in many parts of both the residential and commercial sectors has far, far further to fall.
  
   

• Time alone (chosen or not) can be a chance to hit the reset button. Steadily, slowly, research interest in solitude has been increasing. Note, solitude – time alone – is not synonymous with loneliness, which is a subjective sense of unwanted social isolation that’s known to be harmful to mental and physical health. In contrast, in recent years, many observational studies have documented a correlation between greater wellbeing and a healthy motivation for solitude – that is, seeing solitude as something enjoyable and valuable.

• The woman who lives 200,000 years in the past. As we confront the reality of COVID-19, the idea of living self-sufficiently in the woods, far from crowds and grocery stores, doesn't sound so bad. Lynx Vilden has been doing just that for decades, while teaching others how to live primitively, too.

• Cal Newport on surviving screens and social media in isolation. A computer scientist on why the quality of your quarantine may come down to how you use your technology. Right now, for so many people self-isolating in the face of the escalating coronavirus pandemic, technology is the main link to the outside world. It’s allowing us to maintain crucial contact with friends, family, and coworkers, and providing information and much-needed outlets for joy, amusement, and creativity in a rather bleak time. However, it can also be the source of deep anxiety and distraction: never has it been easier to stress-refresh your Twitter timeline looking for the latest Covid-19 numbers, or pick up your phone to text a friend only to fall into a mindless internet black hole.

We hope that you and your families are safe and healthy and that optimism and hope for the future remains strong. On our end this health crisis has reminded us that we all too often try to insulate ourselves against any discomfort before it even arrives. We seek to avoid pain by trying to control our external conditions to suit our comfort zones. This perception of control is alluring yet we risk losing the potential joy of discovery and the freedom of finding that we can learn and even be happy, within a much greater range of experiences than we thought. This period of pain has been challenging for us, but we are confident that we will look back upon it fondly as a period of exceptional personal growth.


All the best for a month filled with resilience, equanimity and gratitude,  

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