Paying The Piper

Good Morning,
 

Stocks slumped on Friday as increased tensions between Ukraine and Russia sent oil spiking and led investors to dump risky assets like equities. Shares were mostly flat on the day until Ukraine-related headlines in afternoon trading caused traders to dump stocks and buy Treasuries.

With about 2 hours left in the trading day, U.S. National Security Advisor Jake Sullivan said at a White House briefing that there were signs of Russian escalation at the Ukraine border and that it was possible that an invasion could take place during the Olympics, despite speculation to the contrary.

Both the U.S. and U.K. have called for their citizens to leave Ukraine as soon as possible. Sullivan noted that the U.S. is not certain that Russian President Vladimir Putin has made a final decision to invade Ukraine. But “it may well happen soon,” 

This week’s volatility in the bond market started after a hotter-than-expected inflation reading on Thursday, which prompted St. Louis Fed President James Bullard to call for accelerating rate hikes — a full percentage point increase by the start of July.

Goldman Sachs shifted its expectations for the Fed this year, calling for seven rate hikes in an effort to cool an economy that has generated inflation far more persistent than policymakers had anticipated.

Our Take 

What a difficult environment. It’s as if with every passing day the macro environment deteriorates and the outlook for 2022 grows more fragile. 

We believe that investors should avoid wasting time on things that are unknowable and unimportant and focus primarily on things that are knowable and important. Nevertheless, some unknowable questions such as the direction of interest rates, how high inflation will go and where the economy is headed are important.

Yet how do we confront their importance if they are unknowable? To study such questions, we practice looking at facts and deriving probabilistic statements. Not whether we will be right or wrong but rather: “What is the probability of this scenario versus another, and how does this information affect my assessment of value?”

When it comes to the unknowable yet important macro questions above, we believe as we stated back in November, that governments and central banks are caught between a rock and a hard place. They face persistent above trend inflation that is poorly understood while their economies’ fundamentals weaken, dependence on loose monetary policy becomes entrenched, debt burdens continue to rise, and politicians have gone all in on anti-growth/anti-business populism.

We still maintain this view, yet even after the historic selling which kicked off 2022, we see the potential for more downside as the piper collects his due. Both the Fed and Joe Biden’s credibility are now on the line as too many people are suffering from the effects of stubbornly “non-transitory” inflation. The issue is now political and with 40% of American voters holding no stake in asset markets, the Fed will find it very hard to pivot away from established tightening expectations.
 

The Fed will be tightening into fading cyclical growth momentum at peak valuations, significantly raising the probability of additional drawdowns. 

Core to the slowing growth view are peak/declining readings on various well-known inputs like ISM New Orders, US Consumer Confidence, trade weighted US$, US BBB credit spreads, and Global Manufacturing PMIs. Bond markets seem to agree as the gap between the 2-year and 10-year Treasury yields has sunk to its lowest since late 2020.

Unfortunately, the Fed looks poised to tighten for the wrong reasons (slowing runaway inflation in an economy with a backdrop of weak fundamentals) rather than for the right reasons (slowing runaway inflation in an economy with a backdrop of strong fundamentals). It should also be noted that investors underestimated how much the Fed would raise rates in the last three tightening cycles, so there is a risk that the Fed may tighten more than expected this time around.

Bottom line, the probability of profit growth momentum peaking and slowing through 2022 and even into 2023 is high. With 4Q earnings underway, the slowdown is already apparent. The pace of positive surprise has slowed meaningfully in 4Q21 with fewer positive revisions to subsequent quarter forecasts and corporate guidance has returned to its mildly negative average. The slowing rate of change is how weakness begins…

China is also an important leading indicator (typically as goes China, goes the West) and their central bank has already begun an easing blitz with fresh rate cuts. A serious Chinese economic downturn would endanger growth everywhere.

Despite the above, we must stress that this environment is fluid. As a result, we will remain defensive yet will not hesitate to shift to offense if the pendulum swings too far towards extreme fear.

This is a challenging environment with the worst start to the year since January 2009, but for the long-term investor, there is always opportunity amidst volatility. The long-term investor’s portfolio is not, nor should it be, immune to rough patches. After all, to enjoy the benefits of compounding, such patches must be endured.

The long-term investor should remain focused on allocating capital to assets based on well-reasoned estimates of their potential and remain confident that with patience, the storm will pass as it always does.

“To make money in stocks, you need to have vision to see them, courage to buy them and patience to hold them. Patience is the rarest of the three.” -Thomas Phelps

Musings

 

Looking back on 2021 at Logos LP with an eye to 2022 we’ve put most of our energy into honing the definition of our “circle of competence”.

“I’m no genius, but I’m smart in spots, and I stay around those spots.” -Tom Watson Sr.

As liquidity is drained and capital becomes more discerning, the ability to correctly evaluate “select” businesses is paramount. As opportunity sets improve, the importance of knowing our sweet spots increases.

At its core, our circle of competence includes durable, high-quality (growth security and deliverability) businesses that are trading at reasonable (or cheap) valuations relative to their long-term earnings power. If we are able to develop a deep understanding of these businesses and establish confidence in their long-term business results, we will build meaningful stakes.

No single strategy works in every kind of market yet we believe that long term, having a concentrated portfolio composed of such businesses will offer the best odds of outperformance.

As the Fed moves down a tightening path and elevated market volatility compresses multiples, dislocations are beginning to create attractive opportunity sets in our sphere of competence. One sector in which we are seeing the most attractive opportunity set of relative value per unit of fundamentals is healthcare/life sciences.

At present, the healthcare sector typifies the “quality value” factor trading at a roughly double discount relative to the broader market. This sector offers well above market FCF yield, double digit sales growth and low volatility of sales. Relative earnings for the sector (vs. other sectors) also appear to be poised for improvement which can support outperformance. This is before considering the secular forces of aging populations, growing demand for health and wellness as well as treatments for complex and chronic diseases. Such factors also underpin the secular trends currently fueling investment in healthcare sub-sectors including healthcare services, infrastructure, and research globally.

We believe these sub-sectors hold some of the most important innovations of our lifetime, in addition to possessing some of the most durable tailwinds we have seen in a post-Covid world. According to EvaluatePharma, by 2026, global pharmaceutical R&D spend is expected to reach $233 billion coinciding with US national healthcare expenditures increasing at a 5.5% CAGR between 2019 and 2028. These secular tailwinds should continue to drive greater demand for diagnostics and novel therapeutics, addressing the world's most complex and onerous disease threats, such as cancer, Alzheimer’s, and other life-altering diseases.

There are currently more compounds in Phases 1-3 of clinical trials than in any other period in history (Figure 1). Additionally, the number of biotech formations and catalysts (these are measured by FDA approvals, audits, readings, or patient output) has declined to 9-year lows due to: 1. Covid delays; 2. No FDA head for the 9 months prior to October 2021; 3. Fluctuating lockdowns impacting clinical trials (Figure 2). This has led to one of the lowest valuation troughs for the small-to-mid cap biotech sector over the past 20 years (Figure 3) and the longest (and largest) drawdowns for the XBI vs. the SPY in history (Figure 4).

Figure 1:

Source: Pharmaprojects 2020

Figure 2:

Source: Evaluate Pharma; Bloomberg; Wedbush Securities, Inc. Research

Figure 3:

Source: Wells Fargo Securities

Figure 4:

Source: Wells Fargo Securities

Additionally, the biotech sector is well capitalized with high quality assets during a period in which cash rich big pharma will likely look to M&A as they face imminent patent cliffs.

Within the complex described above, we believe the optimal approach is to look at the ‘compounder’ businesses that are less cyclical, possess oligopolistic characteristics, very strong pricing power and are comfortable with share buybacks. 

We are currently focusing on a few businesses that meet these criteria including:

1. Charles Rivers Laboratories (CRL) – Provides CRO services to roughly 80% of all FDA approved compounds.

2. West Pharmaceuticals (WST) – Holds 70% market share in drug packaging and has been involved in 90% of all biologics delivery since 2019.

3. Repligen (RGEN) – Has a virtual monopoly on ligand A proteins, a key ingredient for any FDA approved vaccine or therapeutic.

Given the make-up of the economy in a post-Covid world, we believe this rare breed of business is well positioned to take advantage of certain secular tailwinds that will likely be present over the next decade and will provide attractive long-term IRRs. Furthermore, this view is supported by peaking cyclical growth as well as a slowing pace of earnings growth as 2022 progresses (see above). Slowing growth elsewhere will favor the growth security and deliverability of such businesses in the healthcare/life sciences sector.

Charts of the Month

The gap between 5- and 30-year yields narrowed to less than 40 basis points, the smallest since the Fed was at the end of its last rate-hike campaign in 2018. That signals speculation that economic growth will slow as the Fed tightens monetary policy.

History doesn't repeat but it sure does rhyme. Tightening tantrum followed by growth correction…

Earnings revisions and outlook views tend to begin with a trickle and then the downward revisions lead to a change in the consensus outlook…

Historical look at core goods minus core services inflation with recessions … spread is more negative now than at any point going back to late-1950s.

The S&P 500’s real earnings yield continues to plunge; now at -3.2% (an all-time low). We are living in the upside down…

When if ever will China take the number one spot? Maybe never..

Mid term years can be ugly…

Logos LP December 2021 Performance

December 2021 Return: -9.46%

2021 YTD (December) Return: 4.82%

Trailing Twelve Month Return: 4.82%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 22.58%

 

Thought of the Month


“People who arbitrage time will almost always outperform. The first order thought of instant gratification is a crowded path, ensuring mediocre results at best. Delayed gratification, which requires second order thinking, is less crowded and more likely to get results.” — Shane Parrish

Articles and Ideas of Interest

• Does the national debt matter? For decades now, there have been many over-simplistic views on government debt. Some people were acting as though it would be a near-term catastrophe thirty years ago, and it never was. On the other hand, there are people who say it barely matters at all, ironically when it’s probably starting to actually matter. As with most things in life, the truth is somewhat more nuanced. This article by Lyn Alden dives into some of the details as far as the available data are concerned.
  
   

• The great climate backslide: How governments are regressing worldwide. From the U.S. to China, harsh economic realities mean the political will for painful choices is evaporating fast. In 2022, a toxic combination of political intransigence, an energy crisis and pandemic-driven economic realities has cast doubt on the progress made. If 2021 was marked by optimism that the biggest polluters were finally willing to set ambitious net-zero targets, 2022 already threatens to be the year of global backsliding. 

• When will China be the world’s biggest economy? Maybe never. When will China outstrip the U.S. to claim the top spot in the world economic rankings? For Beijing, it would be convenient if everyone viewed that transition as inevitable and imminent. The reality is as Bloomberg outlines, it’s anything but. A debt crisis, demographic drag, and international isolation could all keep China stuck in perpetual second place.

• Are we cultivating a generation of failed startup founders? Are we driving innovation, or instilling false hope in wannabe entrepreneurs? Medium’s largest publication is The Startup, with more than 700,000 followers. Hundreds of thousands of people who are curious about startups, have created one themselves or plan to build one in the future. More and more people are joining the conversation. More and more people are starting their own side hustles or full-time ventures because they’re hoping that it will lead them to success. Can all these people make it? Can so many people change the world in a million different ways? Or might we be better off encouraging these people to search for secure jobs, so they contribute to the economy in a safe and predictable way? Very interesting article examining the implications of the cult of the “startup”.

• The big question: how long can private market multiples stay elevated while young public companies compress? The median ARKK holding traded for 33x sales in early ’21. Today it’s 9x and going lower by the day. There is almost certainly a tipping point, but Michael Batnick thinks this dichotomy can last longer than most people think. There’s too much money chasing too few deals in private markets, and an interest rate hike or two may not change that.
  
   

• The lockdown catastrophe. Where are the public health benefits to justify Covid-era shutdowns and spending? Government disease doctors and politicians around the world panicked in the face of Covid and began shutting down societies in early 2020. The accounting has hardly begun on the impact of isolating human beings, denying them opportunities, education and experiences—not to mention disrupting non-Covid medical treatments and myriad other valuable services—and then attempting to simulate the benefits of a functioning society by printing fiat money. It will take years to understand the full cost of this man-made catastrophe, But emerging research suggests that on the other side of the ledger, public health benefits were extremely small, if they can be verified at all. The WSJ digs into the results of a new study on the effects of lockdowns by Johns Hopkins economist Steve Hanke and colleagues from Denmark and Sweden.
  
   

• Some good observations from Michael Batnick about 2021. What makes this game fun and exciting is that there is no handbook where we can observe the rule changes. All we have are numbers on a screen. When something that worked for 30 years stops working, how long before we pick up on the shift? My favourite: avoid extremes.

• The capital sponge. Why have US stock outperformed for so long? Lyn Alden suggests that the US put in place a set of policies over the past four decades that pulled a lot of domestic and global capital into its stock market. This naturally had some pros and cons associated with it. Each country generally has a set of political priorities, and those priorities can change over time. Compared to other developed nations, the US has favored its corporate sector above most else since the early 1980s, which made the US stock market an attractive sponge to absorb capital from everywhere. As a result, the US stock market capitalization currently represents 61% of the global stock market capitalization, despite the fact that US GDP is only 23% of global GDP. Are the factors behind this trend running out of steam?
   

Our best wishes for a year filled with discovery and contentment,

Logos LP

When Winning Is Not Losing

Good Morning,
 

Stocks rallied Friday, but still posted their first losing week in six amid heightened inflation fears. The major averages closed the week lower after the hottest inflation report in 30 years. The Dow fell 0.6%, the S&P 500 dipped 0.3% and the Nasdaq Composite inched down about 0.7% on the week.

Consumer sentiment in early November dropped to its lowest level in a decade, the University of Michigan reported Friday. Plunging consumer sentiment prompted hope among traders that the Federal Reserve would delay any interest rate hikes. Many survey respondents cited inflation concerns, according to the report.

Meanwhile, workers left their jobs in record numbers in September with 4.43 million people quitting, the Labor Department reported Friday. The exodus occurred as the U.S. had 10.44 million employment openings that month, according to the report.


Our Take 

Inflation is looking a lot less "transitory" after CPI numbers for October showed that consumer prices jumped 6.2% from a year ago, while notching the fifth straight month of a figure higher than 5%. It's also the fastest rate since 1990, and while that might cause some worry in the general population, Wall Street appears to be discounting the effects. Many continue to argue that the Fed won't get too aggressive, inflation could moderate next year, while some think stocks could even benefit along with a rise in asset prices.

Politicians are certainly taking notice: "Inflation hurts Americans pocketbooks, and reversing this trend is a top priority for me. With the [infrastructure] bill we passed last week, and the steps we're taking to reduce bottlenecks at home and abroad, we're set to make significant progress," President Biden said in a statement. "Very soon we're gonna see the supply chain start catching up with demand, so not only will we see more record-breaking job growth, we'll see lower prices, faster deliveries as well. This work is going to be critical as we implement the infrastructure bill and as we continue to build the economy from the bottom up and the middle out by passing the Build Back Better plan."

On the other hand, in the face of persistent inflation, central bankers around the world are increasingly looking like they are caught between a rock and a hard place. The only way to keep the economy afloat and the expansion continuing was (and is) to keep rates near zero. 

Yet the medicine used to solve the problem of jumpstarting the economy created two new problems: asset bubbles in just about everything, spiralling cost living and an economy that has become addicted to the stimulus drug. 

As John De Goey has pointed out, stimulus can be conceptualized as a form of economic antibiotics: antibiotics stop infections caused by bacteria; stimulus stops economic illness caused by slow growth. No one would ever recommend staying on antibiotics indefinitely. Yet given that any change to the status quo risks triggering a financial meltdown, central banks are stuck. 

Thus, what appears most likely is that there will be no significant tapering or normalization of any kind until we are faced with the harsh no-win economic ultimatum to do something about inflation that is without a doubt non-transitory. 

We haven’t reached that moment yet and there is a compelling argument that we may never reach it as with each passing day the status quo (and associated addiction) becomes more entrenched.


 Musings

Observing most of the major indexes, asset classes, economic output and inflation hit record highs, while consumer sentiment hits ten year lows, has prompted us to shift focus away from the “build wealth” side of the coin to the “preserve wealth” side. 

Market participants appear to have discarded caution, worry and fear of loss and instead obsess about the risk of missing opportunity. Worry appears to be in short supply as most investors who have stayed the course over the last decade have done exceedingly well. Despite the fact that about half the U.S. population does not have a significant stake in the stock market, U.S. household net worth has hit record highs led by real estate values and stock prices.

Stocks have surged to record highs, and low borrowing costs have supported a flurry of home buying, and ultimately home price appreciation. Massive support provided by the government and the Fed has bolstered Americans’ wealth. 

Gains are so considerable that data suggests they may be fuelling the labor shortage (U.S. workers quitting their jobs just hit record highs) as people exit low-paying work to trade stocks and risky digital assets. Too much money is chasing the risky and the new, driving up asset prices and driving down prospective returns and safety. 

What should we make of all of this? In our view what is occurring today appears to be a modern permutation of a classic behaviour. As Mark Twain famously remarked: “History doesn't repeat itself, but it often rhymes.”

Economies, like life, are sine waves with attitudes and behaviour oscillating between peaks and troughs. When it comes to markets, declines can occur because many people’s goal is to become so successful (wealthy) that they can relax (think top of the sine wave), and relaxing leads to complacency (worry is in short supply) which sows the seeds of future decline (and back to the bottom of the sine wave we go).
 

I’ll always remember a conversation I had with a mentor of mine years ago when he noticed me “over celebrating” a win. He saw celebration as something sloppy, something dangerous, a self-indulgent act that could derail one's focus. He told me “if you have arrived, then what is there left to do?”

Most people’s career goal is to work hard so that one day they can stop working. Our economies are set up around this concept. If we can just get to retirement then we can relax.

The problem is that if enough people adopt this mentality simultaneously and feel that they can“relax”, relaxation is compounded into complacency. Think about the uncertainty and hardship brought on by COVID-19. Perhaps the incredible recent asset price gains and associated investor behaviour can be better understood through this lens. 

Becoming financially successful typically requires years of hard, stressful and unglamorous work. It’s understandable that once a certain level of financial success is achieved some feel justified to slow down, kick back, and let their guard down – especially when their assets are rising in value almost daily. 

People today understandably need a break from what has been an incredibly taxing and uncertain last two years. Desire for comfort and confidence is high. Bandwidth for skepticism, fear of loss and risk aversion is low. 
 

Investors long for the feeling that they are finally “getting ahead” despite the gravitational pull of inequality/class stagnation and spiralling costs of living. Yet as my mentor so aptly pointed out, there is usually a cost to such indulgence. A cost for casting skepticism aside and replacing reticence with eagerness. Success has an odd way of increasing confidence more than ability. The longer it lasts, and the more it was tied to some degree of luck, the truer that becomes. 

Recognizing this pattern and identifying it is key for investment survival as building wealth and preserving it are two different skills. 

On the one hand building wealth requires taking risks, being optimistic and swinging the bat. On the other, preserving wealth requires frugality, humility and a healthy dose of skepticism. It also requires an understanding that what you have can be taken away from you just as fast in addition to an acceptance that at least some of what you have can be attributable to luck. 

For us, the past two years and the current moment of rapid asset appreciation and high risk tolerance have made us think a lot about longevity and survival. Few gains are worth permanent capital loss and to experience the power of compounding in life and in markets, one must survive the unpredictable dips along the way. 

What does thinking about survival and longevity mean for us today in light of the above? 

For us it means increasing room for error by focusing on increasing our “margin of safety”. What measures can be taken to raise the odds of success at a given level of risk by increasing our chances of survival: 

-Reducing financial leverage 

-Flexibility of strategy and worldview

-Increasing willingness to commit capital to investments when risk is obviously being well priced, such as late 2008, 2009 or March 2020 and being less willing when risk is not being as well priced like 1999, 2007 and perhaps today

-Adopting an attitude of patience, humility and skeptical optimism about the future

-Having clarity on one’s investment time horizon

-Focusing on avoidance of accidents and permanent losses - recovering from disaster is difficult if one loses 50% on an ill-considered investment as a 100% gain is needed just to get back to where you started

-Respecting uncertainty by not assuming that the period ahead will resemble the period one most recently experienced 

-Avoiding faddish and vogue investments 

-Avoiding business models that are particularly vulnerable to technological change as well as those with opaque balance sheets or too much financial leverage

-Focusing on businesses that are less vulnerable to competitive forces - think DHR, WST, MSFT, CRL

With a focus on increasing our “margin of safety” we can increase our odds of hitting the ball out of the park without ever swinging for the fences. During “go go” times like these in which investor behaviour evidences a widespread belief that risk is low, winning becomes about not losing...

Charts of the Month


When looking at the sheer volume of money flowing into the market, it's easier to understand today's price action. Whether it's the record flow of speculative options volumes, or the torrential downpour of cash flooding into the broader equity markets, we've simply never seen anything like this:

Traders are nearing the all-time speculative blow-off peak from February, with the smallest of traders spending 53% of their volume on buying calls to open. That ranks as the 4th-most out of the 1,141 weeks since January 2000. It's even more extreme among large traders. 

Among all traders on all U.S. exchanges, net speculative volume is equal to the peak during the week ending February 12. There's no point showing the complete history because extremes over the past year are so far beyond anything seen in the prior 20 years that it completely distorts a chart.

Investing capital when prices are exceedingly above the underlying growth trend repeatedly had poor outcomes. Investing money at peak deviations led to very long periods of ZERO returns on capital.

The S&P 500 ended October with a return greater than 20%, and when that's the case the index has never been lower - neither in the month of November, nor in the months of November and December, combined.

Heading into November with the S&P 500 up 20%+ for the year means that the average returns investors may expect are 3.7% for November and 6.2% until year-end. That's significantly higher than the average year's returns of 1.7% and 3.2%, respectively.

Over the last month, investors pushed the stock market to extremely overbought, extended, and deviated levels. Currently, the deviation from the long-term bullish monthly moving average is at the most extreme since 1997. Furthermore, the stock market is now highly overbought, which has typically preceded more significant market corrections.

For nearly 5 decades, the NFIB Small Business Cost of Labor index has been a good barometer, especially for extended cycles. Based on this gauge, it took 19 months (on average) for the US economy to be in recession once the reading >=8. 

FYI: The most recent reading is 12... (needless to say this is an all-time high and this index has never failed).

The path out of the pandemic continues to defy straight-line forecasts. The hope was that getting the virus under control by vaccinating a large percentage of the population would turbocharge an economic recovery. Now we know it’s not that simple. As the chart below shows, countries with pre-pandemic challenges haven’t escaped them.

Focus on what you can control. There are always reasons to sell.

Time horizon is everything.

Logos LP October 2021 Performance

October 2021 Return: 5.14%

2021 YTD (October) Return: 17.97%

Trailing Twelve Month Return: 56.43%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 25.04%

 

Thought of the Month

“The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future." -Benjamin Graham

Articles and Ideas of Interest

• The best market indicator over the last 34 years. Interesting article by Ralph Wakerly which looks at six major market indicators and their track record in navigating the last seven bull/bear market cycles. Investment advisor sentiment has the best track record. CAPE has little value as a short-term timing tool, but is powerful in forecasting future long-term market returns. CAPE is currently near historical highs, signaling weak returns over the next ten years. Technical analysis is controversial and murky. Contrary to many academic studies and proponents of efficient markets, some technical indicators have proven useful. But their effectiveness varies with time. And most technicians don’t rely on any single indicator.
  
   

• Generation lockdown: Where youth unemployment has surged. Young people around the world have found themselves shut out of the labor market—and the consequences could linger for years to come. Niall O’Higgins, one of the authors of the ILO report, warns of the consequences of being shut out of the labor market for an extended time. “Clearly there is a serious danger that young people being out of work for a long period is likely to damage both the individual’s earnings prospects and the society’s productivity and long-term earnings potential.” The damaging effects go beyond economics. In countries with relatively young populations, having a large number of out-of-work youth can contribute to criminality and political instability.

• There's a massive chasm between government policy and our energy reality. Eric Nuttall suggests that it is epically frustrating that in Canada, a country blessed with some of the most abundant energy resources in the world, the majority of the population suffers from profound energy ignorance: the lack of knowledge of how hydrocarbons are used, how critical they are to our daily lives, and the realistic timeline to replace them with a “renewable” alternative. Without oil and natural gas, we would literally be back in the Stone Age, experiencing a fraction of our current standard of living. So how did we get here, where the average Canadian thinks the end of oil is at hand, politicians contemplate the necessity of limiting production growth, and where we have lost sight of how blessed we are as a nation to be gifted with such valuable energy resources produced in one of the most ethically and cleanest manners anywhere in the world? Joe Oliver also ​​reminds us that although Canada represents only 1.6 per cent of total emissions and cannot make a difference to global climate, we have a moral obligation to do our part in a worldwide effort. A common-sense approach would be to optimize our contribution while limiting damage to the economy. Instead, we seem determined to minimize our effectiveness and maximize self-harm.
  
   

• America needs a new scientific revolution. A repurposed antidepressant might help treat COVID-19, a remarkable study found. The way this research was funded highlights a big problem-and bigger opportunity-in American science. The Atlantic diagnoses several paradoxes in the current U.S. system.
  
  

• The bio revolution: innovations transforming economies, societies, and our lives. Mckinsey suggests that a confluence of advances in biological science and accelerating development of computing, automation, and artificial intelligence fueling a new wave of innovation. This Bio Revolution could have significant impact on economies and our lives, from health and agriculture to consumer goods, and energy and materials. We believe this is one of the best investment themes for the next decade. We like IONQ, KZIA, WST, CRL, RGEN, BDSX.
  
   

• AI is no match for the quirks of human intelligence. We may sometimes behave like computers, but more often, we are creative, irrational, and not always too bright.
  
   

• I’m a life coach, you’re a life coach: the rise of an unregulated industry. Fascinating piece in the Guardian charting the rapid rise of an unregulated industry at a time when the demand for mental health services is outpacing supply. Operating in the murky realm of “empowerment”, where personal development and financial success blur together, Life coaching Schools are having their moment yet are they empowering their largely female client base with the tools and support they need? Or selling them an unattainable fantasy?

• No One Cares! Our fears about what other people think of us are overblown and rarely worth fretting over. Arthur C. Brooks for the Atlantic suggests that we are wired to care about what others think of us. As the Roman Stoic philosopher Marcus Aurelius observed almost 2,000 years ago, “We all love ourselves more than other people, but care more about their opinion than our own,” whether they are friends, strangers, or enemies. This tendency may be natural, but it can drive us around the bend if we let it. If we were perfectly logical beings, we would understand that our fears about what other people think are overblown and rarely worth fretting over. But many of us have been indulging this bad habit for as long as we can remember, so we need to take deliberate steps to change our minds.
  

• The metaverse will mostly be for work. Stanford professor Jeremy Bailenson has been thinking about virtual reality and the metaverse for decades. As of 2020, he even teaches in it (more on that in a moment). For all of the chatter from Facebook/Meta, Nvidia, and other companies about building the metaverse, though, he thinks the metaverse will be mostly empty. That is to say, there won’t necessarily be a lot of things to do in this immersive version of the internet.

• Unions are on the rise, but so are the robots. U.S. manufacturers hired 60,000 people in October, double economists’ estimates and the most since June of last year. It was a robust showing, led by automakers. But payrolls in the sector are still down by almost 300,000 since the end of 2019, even as many large industrial companies are reporting sales above pre-pandemic levels. Last month’s recruitment success will only make a modest dent in the nearly 900,000 open manufacturing positions as of the end of August. The tight labor market has created a moment for unions: Deere & Co. workers this week felt so confident in their value to the company that they voted down a revised contract proposal that included substantial wage increases and enhanced retirement benefits. It’s also creating a moment for robots.

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

Logos LP

Tilting the Odds in Our Favor

Good Morning,
 

Stocks gyrated between gains and losses Friday to end a volatile week on Wall Street, as investors appeared content to consolidate positions after worries over Evergrande and a slowing global economy prompted traders to pull $28.6 billion from U.S. equity funds over the first three days of the week, the most since February 2018. But stocks then staged a two-day rally after the Federal Reserve signaled no removal of its easy money policy, at least for now. 

Tech stocks trailed Friday after a crackdown on bitcoin by China overnight hurt sentiment in the sector, but financial stocks rose as the 10-year U.S. Treasury yield reached its highest since July. "What is clear is that inflation is likely to be the determining factor for liftoff and the pace of rate hikes," Deutsche Bank Chief U.S. Economist Matthew Luzzetti wrote in a note. "If inflation is at or below the Fed's current forecast next year of 2.3% core PCE, liftoff is likely to come in 2023, consistent with our view. However, if inflation proves to be higher with inflation expectations continuing to rise, the first rate increase could well migrate into 2022."

Meanwhile Nike confirmed investor concerns about the pandemic wreaking havoc with supply chains and raising costs for companies, especially multinationals. Nike shares fell 6.2% after the sneaker giant lowered its fiscal 2022 outlook because of a prolonged production shutdown in Vietnam, labor shortages and lengthy transit times.

Our Take 

Skepticism on Wall Street is widespread with most of the major investment firms calling for a 10-20% market correction. Furthermore, the popular narrative for the rest of the year appears to be falling Covid cases globally and economic acceleration favouring cyclical stocks in the energy, financial, industrial and travel sectors. For us the data is noisy. Economic acceleration could very well occur but we also believe as we have stated in the past, that there are equally compelling reasons to infer significant economic deceleration. 

At present we believe policy error in the form of excessive government intervention in the economy to be the largest risk to growth estimates. Several countries closely regulate industries, labor, and markets, set monetary policy, and provide subsidies to help boost their economies yet many countries are veering towards giving the government a level of control that would allow it to steer the economy and industry along a path of its exact choosing channeling additional private resources into strengthening state power.

The big risk for these countries is that the push winds up suppressing much of the entrepreneurial energy and incentives that have powered their boom, years of innovation and improving standards of living.

From a market standpoint, we continue to believe that as pandemic-era programs to bolster the economy are lifted there will be an easing of market conditions which favor the indexes and tech megacaps. The era of narrow stock leadership -- powered by the explosive growth in passive funds -- may be beginning to unwind. Less aggressive monetary easing ahead should expand the number of market winners favoring active management. PanAgora Asset Management’s research suggests that a cap-weighted strategy thrives as concentration rises, but delivers “significantly” lower returns when the macro climate shifts in favor of higher rates. 

The removal of policy supports could mean the fundamentals of individual companies come to the fore replacing what has been a wall of stimulus money hitting the indexes. We see much opportunity for outperformance ahead...


 Musings
 

Over the past month, as I’ve watched politicians worldwide flounder around on everything from public health, housing, the economy, taxation to capitalism itself I’ve found myself thinking more about my framework for viewing life and investing. The future is becoming more and more uncertain as the world is changing rapidly while those in power appear less and less capable of leading with grace and conviction. It is possible we are at the dawn of the period of greatest change for the past few centuries and the range of potential outcomes when pondering the coming decade or two spans from “dystopia to Renaissance”. 

In Canada and across the border in the USA, our democracies appear to be in the hands of statists who believe that government justifiably holds near-absolute power. During the recent Canadian election and the ongoing Democrat proposed 3.5T spending discussions there is little sense that there are or should be limits on the power of democratically elected governments. Such limits still exist in constitutional form, but they are being overwhelmed in spirit if not in law. A tax on wealth and capital? Previously unimaginable spending and deficits? Restrictions on the right to buy and sell property? Restrictions on speech, employment, movement and association based on “woke” ideological purity? Break up corporations? State led discriminatory attacks on certain corporations and individuals based on their ability to make profits? No worries. Big brother knows best and more government intervention and control is warranted. 

The overall ideological thread today has been that governments have the power and the right to do whatever they want — a trend that COVID-19 appears to have entrenched globally. 

Authoritarianism is on the rise around the world with governments becoming less transparent and losing the people's trust. The latest report 'Freedom in the World 2021' by Freedom House is sobering. The report, which is an annual country-by-country assessment of political rights and civil liberties, downgraded the freedom scores of 73 countries, representing 75 per cent of the global population. Democracy has eroded in the United States as well, the report noted.
 

While still considered 'free', the United States has experienced further democratic decline. The US score in 'Freedom in the World' has dropped by 11 points over the past decade, and fell by three points in 2020 alone. 

How much of the above is in our control? The rules of the game keep shifting as the state increasingly imposes its will on markets, society and culture. Watching this distressing reality unfold, largely out of my control, has prompted me to think more deeply about my framework for viewing life and investing. 

As a starting point, William Green in his fantastic new book suggests that it’s helpful to view investing and life as games in which we must consciously and consistently seek to maximize our odds of success. The rules are slippery and the outcomes unpredictable yet there are intelligent ways to play as well as stupid ones. 

How can we avoid swimming upstream and instead be carried with the current? How do we tilt the odds in our favor regardless of the environment or “playing field”? 

When it comes to investing, much ink has been spilt on this. Without diving too deeply we could distill the common “get an edge” formula into the following principles:

Be patient and selective exploiting neglected and misunderstood market niches. 

Say no to almost everything. 

Exploit the market’s bipolar mood swings. 

Buy companies at a discount to their intrinsic value. 

Stay within your circle of competence. 

Filter out the noise, keep things simple and avoid anything too complex. 

Make a small number of bets with minimal downside and high upside. 

Control your emotions and be patient. 

Simple but not always easy to follow. But my goal here isn’t to review the core principles that most investors likely already know, or should know. 

Instead, faced with the increasingly frustrating and downright depressing global macro political environment I tried to think about the times in my investing career I was best able to follow the above principles. 

What I found was that essentially all of the moments I had achieved some sort of “high performance” or “success” occurred in periods of time in my life in which I was joyous. Periods of time when I was particularly happy.  

Interestingly, perhaps the most consistent way we can maximize our odds of success is adopting an optimistic and positive attitude. Shawn Achor in his fascinating book “The Happiness Advantage” explains that “waiting to be happy limits our brain’s potential for success, whereas cultivating positive brains makes us more motivated, efficient, resilient, creative, and productive, which drives performance upward.”

New research in psychology and neuroscience demonstrates that we become more successful when we are happier and more positive. In his book, Achor outlines that: “doctors put in a positive mood before making a diagnosis show almost three times more intelligence and creativity than doctors in a neutral state, and they make accurate diagnoses 19 percent faster. Optimistic salespeople outsell their pessimistic counterparts by 56 percent. Students primed to feel happy before taking math achievement tests far outperform their neutral peers.” 

Unfortunately, for most of us, we are conditioned from birth to believe that once we become successful then we will be happy. Success is conceptualized as a necessary condition for happiness. If we get the promotion/raise/car/return [insert success/external validation], we will be happy. But with each victory the goals shift and the happiness gets pushed further out. 

Instead, in the face of an increasingly precarious future including its associated “FUD: Fear, Uncertainty and Doubt” I think that focusing on happiness as a precursor to success rather than simply its result is game changing. This kind of relationship with happiness is the ultimate way we can tilt the odds in our favor in investing and perhaps more importantly in life. 

Anytime you get a truth that much of humanity doesn’t understand, that’s a large competitive advantage. Intelligent people are easily seduced by complexity while underestimating the importance of simple ideas that carry enormous weight. When you consistently apply a powerful idea such as the happiness advantage with thoughtful diligence, the effects may astonish you...

Charts of the Month

According to the Fed's Z.1 report, U.S. Household net worth rose at a solid 18.4% rate in Q2 to $142 Trillion, after gains of 16.7% in Q1 and 28.5% in Q4 '20. The "Wealth Effect" is one of the most important statistics we can use to measure how American households are faring. This measurement leads to the "feel good" effect that adds to the confidence to go out and spend. It is comical that this report never makes a headline. Then again the popular rhetoric is still concentrating on how BAD things are out there. The data on consumers doesn’t seem to support that outlook...

Men are falling behind remarkably fast, abandoning higher education in such numbers that they now trail female college students by record numbers. No one is talking about it.

Logos LP August 2021 Performance

August 2021 Return: 10.23%

2021 YTD (August) Return: 18.26%

Trailing Twelve Month Return: 57.07%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 25.71%

 
Thought of the Month

“The very purpose of religion is to control yourself, not to criticize others. Rather, we must criticize ourselves. How much am I doing about my anger? About my attachment, about my hatred, about my pride, my jealousy? These are the things that we must check in daily life.” -Dalai Lama.

Articles and Ideas of Interest

• ESG is inflationary. As the global economy rebounds, the likelihood of inflation has become the dominant economic story. You can’t watch the financial news for long without hearing about inflation. At the same time, environmental, social, and governance (ESG) initiatives continue on an inexorable march to greater public perception. However, despite both issues occupying ever more column inches, one consideration has been underexplored; ESG will add to inflationary pressures. TwentyFour Asset Management suggests that yes, ESG is a new source of inflation that was not so present in the previous cycle and cannot be overlooked when forming a view on this cycle’s inflation outlook. How willing will consumers be to shoulder such rapidly increasing costs? There's arguably a point at which a preponderance of inflationary pressures may backfire, with people suddenly demanding governments do something (anything!) to ensure access to cheaper energy (never mind whether it's dirty or not)...Britain looks set to bump up against this reality as some customers are facing a 50% increase in their energy bills…
   

• Replicating private equity with liquid public securities. According to a Harvard Business School study, it is possible to replicate private equity returns with liquid public securities. “A passive portfolio of small, low EBITDA (earnings before interest, taxes, depreciation, and amortization – a commonly used measure of cash flow) multiple stocks with modest amounts of leverage and hold-to-maturity accounting of net asset value produces an unconditional return distribution that is highly consistent with that of the pre-fee aggregate private equity index.” Accelerate in a fascinating report believes that Harvard has it right, despite claims from private equity executives insisting otherwise.

• Lie Flat’ if you want, but be ready to pay the price. ​​The new “lie flat” social protest movement seems to be catching on. It started among overworked Chinese factory workers burned out from grueling 12-hour, six-day work weeks, and the unrelenting pressure from the government and society to climb the economic ladder. So some Chinese millennials formed an underground movement to opt out of work and the pressures of society. Never ones to miss a chance to cry “hardship,” upper-middle-class, well-educated young Americans are also getting in on the action, claiming they, too, are burned out and quitting their jobs to do nothing. What this trend will mean for China is unclear, but Allison Schrager suggests that Americans who choose to lay down in lieu of work may end up worse off than they think.
  
   

• The ‘melancholic joy’ of living in our brutal, beautiful world. Brian Treanor writes that it’s a challenging time to be an optimist. Climate change is widespread, rapid and intensifying. The threat of nuclear war is more complex and unpredictable than ever. Authoritarianism is resurgent. And these dangers were present even before we were beset by a historic pandemic. The data clearly show that based on certain objective measures of wellbeing we are living in the best of times – yet many people feel dissatisfied. In some places, including the US, self-reported happiness has actually been on the decline. So how should we view the state of the world: with optimism or pessimism? In answering, Treanor suggests that we must contemplate the broad sweep of both the world’s goodness and its evils.
  
   

• The everything bubble and TINA 2.0. FTX research does an fantastic job of exploring that common statement that “We are in an everything bubble” reviewing the data and going asset by asset. Worth the read. Spoiler: There’s most certainly pockets of excess in nearly every corner of the financial markets, but there’s also ample opportunity.
   

• Why is gold not rising? Interesting take on the shiny metal (albeit from a gold bug) via GoldSwitzerland.
  
   

• Silicon Valley is searching for the fountain of youth in a bill. Human aging is the latest and greatest field being disrupted by technology. The big picture: Work on therapeutics that could slow or even prevent the aging process is moving out of the fringes and into the mainstream, fueled by funding from tech billionaires who have one thing left to conquer: death.

• What if people don’t want a career? Charlie Warzel, a reporter on the future of work has found an interesting and potentially profound trend: the growing skepticism around ‘careers.’ ‘Careerist’ has long been a dirty word in the working world — usually it’s meant to signify a cynical, ladder climbing mentality. A careerist isn’t a team player. They care more about the job title and advancement than the work. The current brand of career skepticism he is talking about is different, more absolute. It’s not a rejection of how somebody navigates the game, it’s a rejection of the game itself. The idea isn’t limited to a specific age group, but the best articulation of it comes from younger Millennials and working age Gen Zers. Many of them are fed up with their jobs and they’re quitting in droves. Even those with jobs are reevaluating their options. What comes next?
   

• You are living in the Golden Age of stupidity. The convergence of many seemingly unrelated elements has produced an explosion of brainlessness. Interesting take by Lance Morrow suggesting that stupidity dominates in our time because of a convergence of seemingly unrelated elements (the death of manners and privacy) that - mixed together at one moment, in our cultural beaker - have produced a fatal explosion.

• Why you need to protect your sense of wonder - especially now. As the pandemic era goes on, more than ever we need ways to refresh our energies, calm our anxieties, and nurse our well-being. The cultivation of experiences of awe can bring these benefits and has been attracting increased attention due to more rigorous research. At its core, awe has an element of vastness that makes us feel small; this tends to decrease our mental chatter and worries and helps us think about ideas, issues, and people outside of ourselves, improving creativity and collaboration as well as energy. David Fessell and Karen Reivich, a physician and a psychologist, have facilitated hundreds of resilience and well-being workshops; they suggest for HBR a number of awe interventions for individual professionals as well as groups. 

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

Logos LP

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

All These Worries

Good Morning,
 

Stocks rose Friday as news about a potential coronavirus treatment increased hope for an economic recovery following the outbreak. Tech stocks also continued their hot streak.

Gilead Sciences said its coronavirus treatment candidate, Remdesivir, showed an improvement in clinical recovery and a 62% reduction in the risk of mortality compared with standard care. The news sent Gilead shares up more than 2%. BioNTech’s CEO also told The Wall Street Journal the company’s coronavirus vaccine candidate could be ready for approval by December.

Shares of companies that would benefit from the economy reopening outperformed, especially the Russel 2000.

Our Take

In the short term, several of our proprietary technical indicators suggest that the market has become over-extended (especially sentiment in the NASDAQ) and thus we would not be surprised if markets pulled back as earnings season kicks off next week. However, if history is any guide, we do think that any selloff or pullback would likely be an opportunity to increase equity exposure. 

Looking at the second half of 2020, we won’t regurgitate the popular suggestions that the market has run too far, too fast, or that too many people own too few of the same “darling” technology stocks which COVID-19 has exposed as defensive investments/the new utilities (more on this below). These points are becoming so frequently argued that they could be considered to be the “consensus” view.

The same can be said for all the gloom and doom reasons which were presented in March and continue to be presented as arguments in favor of why one should be underweight equities or out of the market altogether. There are plenty of things to worry about, but these worries may be priced in as it should be stressed that in general, investors, large and small, are still in a high state of anxiety significantly underweight equities as sentiment levels remain at or near historic lows.

Alternatively, the more interesting story in our opinion is that interest rates are incredibly low and likely to remain so for a very long time in our low productivity/low growth world. This environment creates challenges for the trillions of dollars, institutional and otherwise, that have to be invested for one reason or another.

As such, if the economy continues to recover, COVID-19 cases and deaths trend in the right direction, and we get more positive vaccine/treatment news, the market is likely to continue its hot streak as cash comes off the sidelines and large institutions attempt to reach their historical median equity exposure.

Despite such predictions, as we hit the midpoint of 2020, we can notice that the cost of bad market timing decisions this year has been annihilation. As Vildana Hajric for Bloomberg so eloquently reminds us: 

"But for all the dizzying turbulence, it’s worth noting that the S&P 500 is nearly flat for anyone who sat tight and held through the chaos. Mistakes stand out in an environment like that -- the back-breaking costs of even a few wrong moves in a market as turbulent as this one. Maybe volatility is the time for active managers to shine, but the downside of getting it wrong has rarely been greater.

One stark statistic highlighting the risk focuses on the penalty an investor incurs by sitting out the biggest single-day gains. Without the best five, for instance, a tepid 2020 becomes a horrendous one: a loss of 30%."

Another gem from Aswath Damodaran, an expert on valuation at New York University’s Stern School of Business:

"The people who hate the rally are the people who are market gurus, because it makes it seem like their expertise is useless. And guess what? It is useless,” says Aswath Damodaran, an expert on valuation at New York University’s Stern School of Business. “Those people exist to make soothsayers look good.”

Such statistics remind us of the danger of trying to call the market’s peak, something that investors are feeling tempted to do again now with the S&P 500, DOW and NASDAQ fresh off significant rebounds, coronavirus infections rising and the worst earnings season in a decade about to kick off. Bearishness and general market timing as a strategy has a cost and 2020 is no exception to such a rule as over the long run stocks tend to go up. 

In a recent survey conducted by Citigroup, more than two-thirds of investors see a 20% decline in the market as more likely than a gain of a similar amount. Is the consensus view really destined to get it right as the second half of 2020 begins? Or will “staying the course” again deliver the best investment outcomes? 

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Musings
 

When thinking about the real economy and the stock market of late - whether reading about them, observing them, or listening to friends and clients talk about their experiences - it becomes clear that there is still a lot of uncertainty and anxiety surrounding what the future holds. 

Will the recovery be a V, an L, a W or perhaps some other letter? Will certain industries be forever impaired or worse, collapse? What will all of these newly unemployed people do if their old jobs never come back? 

I read a few paragraphs on these topics in the Washington Post the other day. The author was skeptical of the V shaped narrative:

“United airlines announced plans to lay off more than one-third of its 95,000 workers. Brooks Brothers, which first opened for business in 1818, filed for bankruptcy. And Bed Bath and Beyond said it will close 200 stores. 

Welcome to the recovery. 
 

If there were still hopes of a “V-shaped” comeback from the novel coronavirus shutdown, this past week should have put an end to them. The pandemic shock, which economists once assumed would only be a temporary business interruption, appears instead to be settling into a traditional, self-perpetuating recession.” 

One thing we can say with relative confidence as penned in the New York Times by David Leonhardt is that: 

“the course of the virus itself will play the biggest role in the medium term. If scientific breakthroughs come quickly and the virus is largely defeated this year, there may not be many permanent changes to everyday life. On the other hand, if a vaccine remains out of reach for years, the long-term changes could be truly profound. Any industry that depends on close human contact would be at risk.

Large swaths of the cruise-ship and theme-park industries might go away. So could many movie theaters and minor-league baseball teams. The long-predicted demise of the traditional department store would finally come to pass. Thousands of restaurants would be wiped out (even if they would eventually be replaced by different restaurants).”

What is lost in much of the commentary about the recovery’s shape/trajectory is that when the economy weakens, poor companies with flawed business models and/or products/services that consumers and businesses can live without and/or easily replicate, are always those that will suffer the most, if not die. 

Downturns are opportunities to revisit inefficiencies and can be healthy as they are part of the “creative destruction” process that economist Joseph Schumpeter famously described, allowing more efficient and innovative companies to rise. 

What is also lost in the commentary is that although we find ourselves in the middle of this process of creative destruction, the novel coronavirus shutdown induced recession did not begin the forces of change. It merely accelerated trends that had been blessed by the capital markets long before the pain began. 

In a fascinating article in a recent issue of the Economist the author cites research that the risk-adjusted returns of a high-resilience portfolio of stocks (mostly technology companies offering highly differentiated products and services that consumers and businesses simply can’t live without) were roughly 25% higher than a low-resilience portfolio of stocks (mostly cyclical companies offering non-differentiated products and services that consumers and businesses can live without and/or easily replicate) during the same period this year. 

“The authors of the above research extend their analysis back in time and come to the rather striking conclusion that the outperformance of less vulnerable firms predates the pandemic. They detect that returns began steadily diverging in 2014, before widening further in the second half of 2019, and then exploding early this year.

This does not imply that markets foresaw the pandemic. It is owed, in part, to a boom in the price of technology stocks. Yet it helps illustrate why much of the reallocation now under way is very likely to stick- because it represents a continuation of trends that were long blessed by capital markets.” 

As such, there will likely be no turning back. No return to the pre-covid economy. Research has shown that roughly 42% of lay-offs linked to the pandemic are likely to prove permanent while options prices imply that over the next two years investors require a far higher expected return in order to accept exposure to vulnerable firms than more resilient ones. 

As such firms, investors, workers and perhaps most of all, politicians will have hard choices to make of whether or not to keep struggling companies, jobs and skill sets afloat. 

Each stakeholder above will need to rethink their operations, trim fat that was accumulated while the economy was growing and reallocate resources more nimbly and creatively towards skills, pursuits and innovation more suited to the future. 

Politicians should be more honest with their citizens about the power of these structural economic changes as they try and strike a delicate balance between generous support (which can discourage workers and firms from seeking new jobs and opportunities in expanding sectors) vs. too little support for those workers and firms dislocated by these changes (which can cause greater inequality and thus even greater social unrest and a prolonged slump). 

In this new paradigm, humility, flexibility and a growth mindset will separate those who thrive from those that merely survive. 

“The future rewards those who press on. I don’t have time to feel sorry for myself. I don’t have time to complain. I’m going to press on.” -Barack Obama 

Charts of the Month

Chart courtesy of Worldometer - Coronavirus

Logos LP June 2020 Performance
 

June 2020 Return: 11.78%
 

2020 YTD (June) Return: 44.54%
 

Trailing Twelve Month Return: 58.81%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +21.34%

Thought of the Month


 

"“When I look back on all these worries, I remember the story of the old man who said on his deathbed that he had had a lot of trouble in his life, most of which had never happened.” – Winston Churchill

Articles and Ideas of Interest

 

• Are tech stocks the new utilities for investors? Tech stocks weren’t considered defensive investments in the past. But as the coronavirus crisis reinforces technology’s fundamental role in our lives, investors can find sources of risk reduction and growth potential in companies that have become digital utilities enabling global networks.

• Over the past 60 years, more spending on police hasn’t necessarily meant less crime. If we look at how spending has changed relative to crime in each year since 1960, comparing spending in 2018 dollars per person to crime rates, we see that there is no correlation between the two. More spending in a year hasn’t significantly correlated to less crime or to more crime. For violent crime, in fact, the correlation between changes in crime rates and spending per person in 2018 dollars is almost zero.

• A mathematician calculated how to keep fans safe at Yankee Stadium. Based on social distancing guidelines, only 11% of seats should be filled.

• We’ve reached peak wellness. Most of it is nonsense. In Silicon Valley, techies are swooning over tarot-card readers. In New York, you can hook up to a “detox” IV at a lounge. In the Midwest, the Neurocore Brain Performance Center markets brain training for everything from ADHD, anxiety, and depression to migraines, stress, autism-spectrum disorder, athletic performance, memory, and cognition. And online, companies like Goop promote “8 Crystals For Better Energy” and a detox-delivery meal kit, complete with “nutritional supplements, probiotics, detox and beauty tinctures, and beauty and detox teas.” Across the country, everyone is looking for a cure for what ails them, which has led to a booming billion-dollar industry—what I’ve come to call the Wellness Industrial Complex. The problem is that so much of what’s sold in the name of modern-day wellness has little to no evidence of working. Brad Stulberg for Outside magazine provides an excellent list of what actually works.
  
   

• 2020's top 15 market moments according to Business Insider, from COVID-19 crashes to huge rallies. At the start of 2020, the killing of Qassam Soleimani, and the Iranian-US tensions that followed, was the biggest story in town for markets. But COVID-19 soon began to spread across the world, causing markets to tank. It's been a rollercoaster ride ever since. From oil prices turning negative in April to famed investor Warren Buffett selling his airline stocks in May, here are the top 15 market events of 2020 so far.  

• Active fund managers trail the S&P 500 for the ninth year in a row. After 10 years, 85 percent of large cap funds underperformed the S&P 500, and after 15 years, nearly 92 percent are trailing the index.
  
  

• We’re not likely to have a Covid-19 vaccine anytime soon. In the meantime, two scientists have developed an antibody-based shot that provides a similar level of protection. A growing number of doctors, including Anthony Fauci, think the approach is promising and readily scalable. So why do US officials and pharmaceutical companies keep refusing to mass-produce it? Emily Baumgaertner takes a look in the Los Angeles Times.
  
   

• A buy everything rally beckons in a world of yield curve control. Should yield curve control go global, it would cement markets’ perception of central banks as the buyers of last resort, boosting risk appetite, lowering volatility and intensifying a broader hunt for yield. While money managers caution that such an environment could fuel reckless investment already stoked by a flood of fiscal and monetary stimulus, they nonetheless see benefits rippling across credit, equities, gold and emerging markets. 

• Like a ton of bricks - Is investors’ love affair with commercial property ending? Covid-19 has upended the impression of solidity. Most immediately, it has severely impaired tenants’ ability to pay rent. It also raises questions about where shopping, work or leisure will happen once the crisis abates. Both are likely to prompt investors to become more discriminating. Some institutions may shift funds away from riskier properties; other investors, meanwhile will hunt for bargains, or seek to repurpose unfashionable stock. As it turns out, more and more people think we can work from home, and should continue to do so. For a nation long frustrated with offices, the coronavirus offers an excellent excuse to avoid them. According to McKinsey, 69% of people who now work from home are equally or more productive than they were at the office. 60% — three in five — say they would prefer to stay home — even after the pandemic is over. Guy Vardi digs into the future of work.

• Where did my ambition go? A drive to succeed has become a drive to just get by. Why workplace ambition is flickering out in this endless limbo. Maris Kreizman writes that the tectonic shift currently shaking our culture/society feels profound. In a time when the pandemic has caused so much uncertainty about the future of so many industries, professional ambition begins to feel like misplaced energy, as helpful to achieving success as chronic anxiety. This is fascinating in light of Robert Shiller’s recent suggestion that the psychological toll from the coronavirus pandemic could completely reshape our societies. He warns that the big risk is people start thinking the setback will last forever and it impacts their willingness to take risks. That mindset could turn into a self-fulfilling prophecy, dramatically hurt demand and push more businesses to the brink. “We don’t have to keep up with the Joneses anymore,” said Shiller. “That might create a different kind of culture that would last for years that you don’t have to show the latest fashions and drive a spanking new car. We just learn that you can relax. But that is bad for the economy.”

• The end of tourism? The pandemic has devastated global tourism, and many will say ‘good riddance’ to overcrowded cities and rubbish-strewn natural wonders. Christopher de Bellaigue asks if there is any way to reinvent an industry that does so much damage?

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

Logos LP