A Crisis Of Intelligence

Good Morning,
 

Stocks fell on Friday, led by major tech shares, as Wall Street wrapped up a difficult week in which coronavirus cases rose, U.S. fiscal stimulus talks broke down and traders braced for next week’s presidential election.

The Dow and S&P 500 fell 6.5% and 5.6%, respectively, and posted their biggest weekly losses since March. The Nasdaq lost more than 5% over that time period and also had its worst one-week performance since March.

Those weekly losses came as the seven-day average of new coronavirus cases in the U.S. hit an all-time high this week, according to data from Johns Hopkins University. In Europe, Germany, France and the UK announced new lockdown measures to curb the virus’ spread.

Our Take

Massive policy stimulus, positive medical developments, a belief that lockdowns were discredited and high hopes for a return to pre-pandemic economic activity levels have provided solid support for equity markets yet with each passing day, they each seem to be on increasingly shaky ground. Stimulus is now likely stalled until the new year, new economic restrictions in the form of lockdowns, particularly in Europe, in response to the re-acceleration in COVID-19 infections, are now catching investors attention triggering a re-evaluation of downside risk. 

Investors had been betting on both sides reaching a stimulus deal before Tuesday’s vote and now recent data is suggesting that the recovery may continue to lose momentum without new aid just as governments face pressure to re-lockdown. 

On a more positive note, we are now halfway through a spectacular third-quarter earnings season. So far, 85% of companies have beat expectations by an astounding 19% on average, well above the historic average of 3% to 5%, according to The Earnings Scout.

But the market has shrugged. The S&P 500 is 8% below where it started on the day earnings season began Oct. 13.
 

Why? It’s simple: markets don’t live on past earnings reports, however good they may be. They live on future earnings projections, and they are now in danger of plummeting. Markets are being hit with a quadruple whammy: The reopening narrative is in trouble, with politicians opting for fresh lockdowns despite clear evidence of their disastrous economic effects; stocks are richly priced, even for an economic recovery; strong earnings reports are not moving stocks up; and some CEOs are again, declining to provide guidance, leaving analysts to themselves.

The reopening story is in jeopardy. Investors were betting that the reopening would continue to proceed without lockdowns, and that additional stimulus would be coming to bridge the gap to a vaccine that would be widely available sometime in the second quarter. In other words, investors priced in rational political leadership that was data driven and awake to the long term economic and social health of their nations. 

Then Europe happened. Germany, France and the UK decided to re-lockdown, closing bars and restaurants for at least a month. More lockdowns, more of the same failed policies, instead of learning from our failures and the successes of other eastern nations. The strategies pursued by South Korea, Vietnam, China and others do still seem to be paying off. While the total Covid-19 death toll is between 500-700 per million people in France, the U.K., Spain and the U.S., in China and South Korea it is below 10 per million. 

If the key to avoiding more lockdowns is finding a way to “live with the virus” — through widespread testing, investment in health infrastructure, protecting the vulnerable, tracing of contacts and isolating positive cases to slow transmission — Western countries have made structural, not cultural, errors.


The problem is that even if outright lockdowns do not happen in the U.S., a widespread slowdown in economic activity — with many simply refusing to go out regardless of whether stores and restaurants are open or not — is increasingly likely given the following reality:

Third-quarter numbers have been great, but Wall Street had been betting that the following three quarters (Q4, Q1, and Q2) will also see sequential improvement as the reopening story proceeds. The lockdown story likely kills all of this and companies know it as many have declined to provide guidance to analysts. 

The prospects of renewed economic slowing, if not the outright onset of a new recessionary phase in 2020 Q4 and 2021 Q1, due to lockdowns would also likely result in meaningful downward revisions to corporate earnings forecasts that were until recently getting revised marginally higher but remain depressed below pre-COVID levels.

If politicians choose to go down this road, U.S. stocks are likely set up for meaningful disappointment as these earnings forecasts increasingly fall apart. Will investors want to own stocks at 60 times or 80 times earnings, if not more?

Put this ugly package together, and you have a high degree of macro uncertainty, with stimulus doubts, lockdown threats, uncertainty on the timing of the vaccine, and the election.

It’s a potentially explosive combination that on its face, appears to be a nightmare for investors. On top of such worries you have hedge fund gurus lining up to call a top as well as calling for “a lost decade” for stocks. 
 

So what to do in the face of the above? 

Musings

We do believe that the current climate does represent accumulating potential downside risk, yet we prefer to remain cautiously optimistic and focus on “what is” rather than “what if”. 

Leadership in the west is abysmal yet we are not surprised. Leadership is simply a reflection of those who elect such leaders and studies show that people in the West are getting “dumber” by the year. 

A recent study found that 19 percent of young New Yorkers — millennials and Gen Z — believe Jews caused the Holocaust. A shocking 58 percent of New York state adults between 18 and 39 could not cite the name of any concentration camp, death camp or ghetto. 

A survey in 2013 by the Public Religion Research Institute found that 27 percent of Americans think God helps determine the outcome of football games. A 2012 survey by the National Science Foundation found that 26 percent of Americans believe the sun goes around the Earth instead of the other way around, which indicates people haven’t been keeping up with the newspapers since about 1532. As for Democrats, 67 percent of them said (in a 2018 YouGov poll) that Russia “tampered with vote tallies in order to get Donald Trump elected.” There is no more evidence for this than there is for the existence of vampires. A survey last year found that the majority of residents in every state except Vermont would have failed a citizenship test. 

In another recent study it was found that the IQ scores of young men have plunged below previous generations for the first time in nearly a century. For the past 90 years, the IQ levels of young people were believed to have steadily increased by about three points per generation in a phenomenon dubbed the Flynn effect. But the selfie generation’s empty-headedness may be linked to the way math and language are now taught — along with more time spent on TV and cell phones/computers researchers said. This is the most convincing evidence yet of a reversal of the Flynn effect. 

Given the above, should we really be surprised by the intellectually vacuous debates we’ve witnessed in the run up to November 4? Should it shock us that politicians aren't learning and improving their responses to the pandemic? 

We are facing nothing short of an intelligence crisis in the West from the bottom right up to the top, which is undermining our problem-solving capacities and leaving us ill-equipped to tackle the complex challenges posed by pandemics, AI, global warming and developments we have yet to imagine.

Investors should be aware of these shortcomings (think of it as a cognitive decline risk or ignorance risk) and take them into consideration as they price risk and make decisions as to where and with whom they will allocate capital. 

So what to do? If technology and complex challenges are on the rise while IQ is on the decline, we believe that the best opportunities for long-term growth and capital appreciation will be found in disruptive innovation. We believe such opportunities have the ability over time to transcend cognitive decline risk/ignorance risk. 

And they have. In a recent piece in Bloomberg, Sarah Ponczek found that if you took all the physical assets owned by all the companies in the S&P 500, all the cars and office buildings and factories and merchandise, then sold them all at cost in one giant sale, and they would generate a net sum that doesn’t even come out to 20% of the index’s $28 trillion value. Much of what’s left comes from things you can’t see or count: algorithms and brands and lists. This is, in the broadest sense, a new phenomenon. Intangible assets make up more than 84% of S&P 500 firm value. 

So, for all the stress and worry about how the pandemic run-up in tech stocks bespeaks a bubble that’s bound to burst, what if the bigger concern is that it doesn’t?

If you work at a company riding this wave or better yet own one, you’re doing well. For everyone else, the news is less good. One loose way of thinking of the impact is that while intellectual property tends to create a small set of well-to-do workers and investors, it often displaces a larger set of non-innovation focused ones. 

This helps explain why many American workers have recently had it so rough, with wages stagnating and benefits disappearing. Demand for certain intangible linked skills is rising while it is dropping for almost every other skill set. 

The market’s appetite for earnings based not on plants and machinery, but ideas -- feeds itself. The share of business investment targeted at intangible assets is now rising 1 1/2-times faster than it did during the financial crisis, itself a record period of hyper-investment in intangibles, estimates Jason Thomas, the head of global research at Carlyle Group.

Such spending tends to be motivated by a desire to do more with less. Our bet is that this continues. Unfortunately, if it does, it implies an uncomfortable projection for a labor market still destroyed from the shutdowns, with close to 8% of people in the U.S. unemployed and the prospect of further shutdowns looming. 

In fact, the Covid-19 induced economic shutdowns should be thought of as the worst assault on the working class in half a century. Economic recoveries that focus more on intangible investments have increasingly been met with slower labor market bounce-backs and this rebound will be no different. 

Innovative ideas are becoming more hard to come by and thus, we believe that big idea-based companies - those who are the leaders, enablers, and beneficiaries of disruptive innovation - will be the epicentre of attractive future returns. 

Despite lockdowns, the absence of a vaccine, the presence of a Republican or Democrat in the White House, cognitive decline in the West, we are confident that remaining long big ideas will reward the patient long-term investor. 

 
Charts of the Month

The number of business bankruptcies and insolvencies in most countries has declined this year through the coronavirus pandemic as the world is seeing far fewer bankruptcies than it did in 2019. But that is largely thanks to assistance from central banks and government measures restricting things like foreclosures.

What it means: When the smoke clears the world is likely to be looking at a sizable increase in the number of zombie companies — firms that owe more on debt than they generate in profits but are kept alive by relentless borrowing.

Why it matters: "Zombie firms are smaller, less productive, more leveraged and invest less in physical and intangible capital," the Bank for International Settlements concluded in a report last month.

• "Their performance deteriorates several years before zombification and remains significantly poorer than that of non-zombie firms in subsequent years."

In other words: More zombies will lead to a slower, less efficient and less productive global economy.

Logos LP September  2020 Performance

September 2020 Return: 0.76%
 

2020 YTD (September) Return: 51.51%
 

Trailing Twelve Month Return: 67.44%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +21.31%

Thought of the Month

"Where there is no vision, the people perish." —Proverbs 29:18

Articles and Ideas of Interest

• The role of luck in life success is far greater than we realized. Are the most successful people in society just the luckiest people? The importance of the hidden dimension of luck raises an intriguing question: Are the most successful people mostly just the luckiest people in our society? If this were even a little bit true, then this would have some significant implications for how we distribute limited resources, and for the potential for the rich and successful to actually benefit society (versus benefiting themselves by getting even more rich and successful). Fascinating article in the Scientific American. 

• Researchers gave thousands of dollars to homeless people. The results defied stereotypes. Researchers gave 50 recently homeless people a lump sum of 7,500 Canadian dollars (nearly $5,700). They followed the cash recipients' life over 12-18 months and compared their outcomes to that of a control group who didn't receive the payment.

• Trump boasts the economy reached historic heights during his first term. Here are 9 charts showing how it stacks up to the Obama and Bush presidencies.
  
   

• Biden, Democratic victories would be the best outcome for the economy, Moody’s says. Biden would be allowed to enact more wide-sweeping economic policy changes such as spending trillions on infrastructure, education and social safety, while also boosting trade and immigration. “Greater government spending adds directly to [GDP] and jobs,” Zandi said, while also arguing that the higher taxes Biden has proposed to fund some of these plans have an “indirect impact” and would not slow the economy. Moody’s analysis found that a Trump victory would be a worse outcome for the economy because of his smaller proposals for fiscal stimulus and the increased likelihood of deeper trade tensions and cuts to immigration. Trump has proposed “much less expansive support to the economy from tax and spending policies,” Moody’s said, adding that his planned immigration cuts are a “significant impediment to longer-term economic growth” as it slows both the job market growth and labor productivity.

• Either way, on Nov. 3, China wins. Mary Hui and Jane Li explain why Beijing is in an “enviable position” going into this US presidential election. A Joe Biden administration would likely bring some cooperation and less confrontation while a Donald Trump win might mean more short-term pain, but would also reduce America’s ability to overcome internal divisions and forge a global strategy to counter China.

• Shallower pools, emptier pockets. Back in June, Donald Trump temporarily halted the H-1B visa program, which companies use to recruit highly skilled foreign workers, especially in computer science. Ananya Bhattacharya lays out how shutting 200,000 top employees out of the country shaved $100 billion off of Fortune 500 companies’ returns.

• The loneliness of the long-distance employee. It takes effort to maintain camaraderie while working from home. The Great Work From Home Experiment of 2020 has gone on for nearly eight months, and preliminary results are coming in. Overall, surveys suggest that most of us like it most of the time, except for one thing: We feel lonely. “Camaraderie” is the No. 1 thing people look forward to about an eventual return to the office. “Loneliness” is often at the top of the list of downsides to remote work.

• The GOP’s demographic doom. Millennials and Gen Z are only a few years away from dominating the electorate. Given that the younger generations align much more closely with Democratic ideological views on almost all policy questions, this shift underscores the stakes in the generational roulette Trump has played by defining the GOP so narrowly around the priorities and preferences of his core groups: older, nonurban, non-college-educated, and evangelical white people. If Democrats can not only express the values of younger Americans, but also advance their material interests, they will have a substantial advantage in building electoral majorities through the decade ahead, says Ruy Teixeira, a veteran Democratic election analyst and co-founder of the States of Change project, which is a joint research collaboration between three liberal-leaning groups and the centrist Bipartisan Policy Center.

• Stocks typically climb, regardless of who’s in the White House. For investors worried about how the stock market will fare in the event of a divided government or a sweep by either party in next month’s elections, history offers an important lesson.  
  
   

• Machines to 'do half of all work tasks by 2025'. Millions more jobs will be lost to robots with Covid accelerating the trend, says the World Economic Forum.

• How do pandemics end? In different ways, but it’s never quick and never neat. Just like the Black Death, influenza and smallpox, Covid-19 will affect almost every aspect of our of lives – even after a vaccine turns up.

• Psyche, an asteroid believed to be worth $10,000 quadrillion, is observed through Hubble Telescope in new study. The exact composition of Psyche is still unclear, but scientists think it's possible the asteroid is mostly made of iron and nickel. It's been hypothesized that a piece of iron of its size could be worth about $10,000 quadrillion, more than the entire economy on our planet. LOL “Wealth” is such a relative concept...

• Now that more Americans can work from anywhere, many are planning to move away. An astonishing 14 million to 23 million Americans intend to relocate to a different city or region as a result of telework, according to a new study released by Upwork, a freelancing platform. The survey was conducted Oct. 1 to 15 among 20,490 Americans 18 and over. The large migration is motivated by people no longer confined to the city where their job is located. The pandemic has shifted many companies' view on working from home. Facebook announced plans for half of its employees to work from home permanently. The company even hired a director of remote work in September to ease the transition. Big cities will see the largest outmigration, according to the survey. Meanwhile, Bruce Flatt the CEO of Brookfield believes things will go right back to normal. With COVID-19 cases reaching new records in the U.S. and spiking around the world, Flatt’s confidence in a return to pre-pandemic norms stands out, and it may be wishful thinking...

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

  Logos LP

Everything is F*cked But Hope Springs Eternal

Good Morning,
 

U.S. stocks rose on Friday, recovering some of their losses for the week, as tech shares clawed back some of their big September declines. Nevertheless, despite Friday’s rally both the Dow and S&P 500 posted four-week losing streaks, their longest slides since August 2019.

The major averages have had a tough month, with the S&P 500 falling 5.8% in September. The Dow has dropped 4.4% over that time period and the Nasdaq is down 7.3% month to date.

Our Take

It is important to remember that there are always two ways to view the stock market at any given time. From an optimistic perspective, there is the potential for favorable results from the Phase III clinical trials as early as the end of October, the elections could be decided in an orderly manner, large institutions and investors could put their record cash piles to work, earnings growth could take off as governments and central bankers continue to support the economy and holiday shopping could be impressive with limited disruption from COVID-19.

From a pessimistic perspective, one could say that all of those developments above are unlikely. No vaccine at all, the election results could be delayed and contested thus resulting in complete turmoil, as a second wave of COVID-19 prompts further economic shutdowns leading to economic collapse.

Whatever camp you fall into, it is important not to get swallowed by emotion as the reality will likely lay somewhere in between. 

Absent additional full economic shutdowns by governments in response to a second wave of COVID-19 (if this happens again all bets are off as the damage would likely be irreversible) we believe the recovery will continue albeit extraordinarily unevenly across industries and countries.  

The Economist recently revisited their “90% economy” prediction and found that economies certainly have begun to recover, yet the world is still a long way from normal. Governments continue to enforce social-distancing measures to keep the virus at bay. These reduce output—by allowing fewer diners in restaurants at a time, say, or banning spectators from sports arenas. People remain nervous about being infected. Economic uncertainty among both consumers and firms is near record highs—and this very probably explains companies’ reluctance to invest.

Calculations by Goldman Sachs, suggest that social-distancing measures continue to reduce global GDP by 7-8% and such measures are set to continue in most countries. Yet The Economist found that although the global economy is operating at about nine-tenths capacity, there is a lot of variation between industries and countries. Some are doing relatively—and surprisingly—well, others dreadfully.

When considering the respective performance of goods and services, goods have bounced back fast while services activity is a lot further below its pre-pandemic level. This is understandable as services require person to person interaction and thus when confidence is lacking, consumption of services wanes. 

Additionally, the magazine found that the huge gap between countries’ economic recovery can be attributed to: 1) industrial composition (countries which rely on retail and hospitality and laggards) 2) confidence (countries who had good leadership under lockdown) and 3) stimulus (countries that put in place large rescue package ie. America may still not be able to agree on a new one, yet still has ALREADY enacted the world’s largest package relative to the size of its economy). 

In light of the above, and the fact that most developed countries seem to be hovering around a “90% economy”, should we opt for the pessimistic view of markets or the optimistic view? 

In our view, absent further draconian lockdowns, we believe that a 90% economy - one which could trend towards 95% if countries can better calibrate social-distancing measures without jeopardizing output - is certainly not a good enough reason for the patient long-term investor to significantly reduce equity exposure and move to cash or gold.

There will be scars to the economy and the recovery will take time, there will be more short term volatility in markets as political headlines and a record amount of derivatives trading foster instability, yet we remain hopeful and confident that holding quality businesses with unique secular tailwinds for the long-term, remains the right strategy.

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Musings
 

Over the course of the month of September it has struck me how emotional the last 6 months have been for most. How difficult it has been to wake up 6 months into the pandemic and read a variety of news headlines which are basically the same as those featured 5 months ago, 4 months ago 3 months ago etc.: 

-“Terrified’: Bar, restaurant, gym owners say they won’t make it if forced to close again”

-”New-York State Tops 1,000 New Daily Coronavirus Cases for First Time Since Early June”

-”Stock market crash: David Rosenberg warns of a dot-com-bubble, IPO mania”

-”The Death of the American Dream” 

The mood is sombre. Hope appears to be slipping away as pandemic fatigue sets in and this is precisely what we as a society need to combat: hopelessness. 

Flirting which such feelings myself over the last six months, I picked up a book this month with a title that unsurprisingly caught my attention: “Everything is Fucked: A Book About Hope” by Mark Manson (ironically written pre-Covid-19) 

While the book covers a lot of ground, what resonated with me was his explanation that “the human psyche needs hope to survive the way a fish needs water.”

He furthers that: 

“Hope is the fuel for our mental engine. It’s the butter on our biscuit. It’s a lot of cheesy metaphors. Without hope, your whole mental apparatus will stall out or starve. If we don’t believe there’s any hope that the future will be better than the present, that our lives will improve in some way, then we spiritually die. After all, if there’s no hope of things ever being better, then why live- why do anything?” 

Without hope for the future one sinks into indifference and nihilism- the sense that there is no point, no broader “why?”. Without hope for the future, without a hope narrative that gives us a sense of purpose, we pursue the pure indulgence of desire. Success for the sake of success. Pleasure for the sake of pleasure. Power for the sake of power. Protest for the sake of protests. Shut downs for the sake of shut downs. Hysteria for the sake of hysteria. 

Manson reminds us that, hopelessness is the root of anxiety, mental illness and depression. It is the source of all misery and the cause of all addiction. Chronic anxiety is a crisis of hope. It is the fear of a failed future. Depression is a crisis of hope. It is the belief in a meaningless future. Should we be surprised that such mental illnesses are on an eighty year upswing among young people and a twenty year upswing among the adult population? 

The problem with COVID-19 six months in, is that it has exacerbated the crisis of hope which was plaguing the rich developed world well before the pandemic struck. Although a serious public health issue, we now have nothing short of a COVID-19 national hysteria. We’ve allowed the virus to take over our economy, our small businesses, our schools, our social lives, our quality of life and most importantly our hope for the future. 

This irrational sense of hopelessness is growing and those in power should carefully consider its effects when they set out to combat a second wave of COVID-19 and put policies in place to aid in the recovery. 

The human mind/human nature is the most powerful force on earth. Left misunderstood by those in power as well as by those acutely suffering from a lack of hope themselves, any recovery will be challenged. 

The rich developed world has made incredible progress in health, safety, material wealth and quality of life yet those are facts about the past, not the future. Hope doesn’t care about these things. Hope only cares about the problems that still need to be solved. Hope must be found in our visions for the future. 

We as individuals and as a society need to find our “why” again. Our personal hope narratives which give us a reason to believe that our tomorrows will be better than our todays. Our inspirational vision which gives us purpose. Which makes us smile, grounds us, helps us stay on course, joyful in the face of adversity and suffering.  

Somewhere along the way as we argue about whether everything is “rigged”, or whether we will “accept” to leave office, or what we are entitled to by virtue of our birth, or about how much we wish to take from others who have earned it to give to ourselves, or as we continue to surrender our economies and our lives to the virus, we’ve become lost. 

My hope is that we succeed in finding hope again. That will be the true recovery. 

Charts of the Month

Where is hope trending? 

In Canada, the Covid-19 mortality rate is 0.024% and the chance of not dying from Covid-19 is 99.975% yet in a survey conducted on behalf of Global News, Ipsos found that 75% of respondents would approve of quickly shutting down non-essential businesses in the event of a second wave???

Why isn’t the media talking about this? That’s also what TIS Group asks in the USA, citing revised Centers for Disease Control statistics that say Covid-19 is only directly responsible for 6% of the reported Covid deaths in the U.S., or around 10-11,000 people. The rest of deaths reflect Covid as a contributing factor to existing illnesses, particularly among the elderly...

Logos LP August  2020 Performance

August 2020 Return: -0.71%
 

2020 YTD (August) Return: 50.36%
 

Trailing Twelve Month Return: 57.65%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +21.46%

Thought of the Month


 

"Fearlessness is not the absence of fear, but the willingness to walk into it. When I walk into my fear, practice there, sit upright in the middle of it, completely open to the experience, with no expectation of the outcome. Anything is possible. When our circumstances look impossible or terrifying, there is a way.” -Judith Randall

Articles and Ideas of Interest

 

• Interactive Brokers braces for election volatility by telling clients to put up more cash. Market action around the election is expected to be so volatile that Interactive Brokers is forcing clients to put up more money in order to trade using leverage. The retail broker is increasing margin requirements — how much money an investor using leverage and derivatives has in their brokerage account after a stock purchase — heading into the November presidential election, according to a clients letter obtained by CNBC.

• Is Covid to blame for business closures or is it helping new startups? The answer may be both. A report found that more than 100,000 restaurants have closed this year, but another says new business applications are up by 19%. Everyone has their narrative about the plight of small business because it’s a political issue. The right wants to make it out that small businesses are suffering and state governments need to relax the shutdowns. The left says that not only small businesses, but their employees, are feeling pain and therefore significant stimulus is still needed. Both sides agree on some form of a more targeted round of the Paycheck Protection Program. Everyone’s right. Everyone’s wrong. The fact is that no one really knows for sure about the effects Covid has had on small businesses ... yet. We won’t know until this whole thing is over and researchers can comb through the data and that’s going to take a few years. I’m sure they’ll find that many businesses did close permanently because of the pandemic. But then again, how many of these businesses would have closed anyway? And how many were previously buoyed by a strong economy until that facade disappeared?

• America divided by education. The gulf between the party identification of white voters with college degrees and those without is growing rapidly. Trump is widening it. One of the most striking patterns in yesterday’s election was years in the making: a major partisan divide between white voters with a college degree and those without one. According to exit polls, 61 percent of non-college-educated white voters cast their ballots for Republicans while just 45 percent of college-educated white voters did so. Meanwhile 53 percent of college-educated white voters cast their votes for Democrats compared with 37 percent of those without a degree. The diploma divide, as it’s often called, is not occurring across the electorate; it is primarily a phenomenon among white voters. It’s an unprecedented divide, and is in fact a complete departure from the diploma divide of the past. Non-college-educated white voters used to solidly belong to Democrats, and college-educated white voters to Republicans.

• Covid grows less deadly as doctors gain practice, drugs improve. For those who develop dangerous cases of the infection, advances in medical care and the growing experience of doctors are improving the chances of survival. Since the first case arrived in the U.S. at the start of the year, medical professionals have gone from fumbling in the dark to better understanding which drugs work -- such as steroids and blood thinners, and the antiviral medicine remdesivir. Allocation of intensive medical resources have improved. And doctors have learned to hold off on the use of ventilators for some patients, unlike with many other severe respiratory illnesses. Governments are also learning lessons from Europe’s lockdowns and finding that they simply can’t lock down again.

• Why we shouldn’t have unrealistic expectations regarding COVID-19 vaccines. Among pharmaceutical, medicinal and drug products, vaccines are by far the most complex. They are also life-saving. In times of devastating disease outbreaks such as the COVID-19 pandemic, it is not uncommon to foster hopes that an effective vaccine, a magic bullet, could somehow be quickly made and administered to people. Unfortunately, reality can be very different because vaccines can take a long time to be developed (4-5 years typically), longer than most pharmaceutical, medicinal or drug products. Bottom line: there may never be a magic bullet. We need to get better living with the virus. Furthermore trust in Covid-19 vaccines could turn on a knife edge. The race to remove regulatory and legal roadblocks to secure a vaccine could blow the whole vaccine hope wide open. Will you line up to take a vaccine which has been rushed through development without large scale patient trials from a vaccine maker that has been given full legal immunity from personal injury lawsuits?

• 52% of young adults are living with their parents. That's higher than any prior measure on record, even surpassing the Great Depression's peak. Millennials will likely continue to pay the price for their parents’ luck and self-indulgence. According to a new report by Deutsche Bank the consequences of this dynamic will be so severe this widening generational divide should be a key source of alarm for investors, financial markets and society as a whole. “Investors can expect an abrupt, and significant upheaval in housing and asset markets, tax systems, climate policy, and many other areas,” Allen wrote. “This scenario becomes more likely towards the end of this decade as Millennial and younger voters start to exceed those in older generations.” (This year millennials have surpassed baby boomers as the country’s largest adult population.)

• How China is preparing its economy for a future where the U.S. isn’t the center of global demand. In a world rocked by the coronavirus pandemic and tensions with the U.S., the Chinese government is stepping up focus on the domestic market with the pronouncement of a “dual circulation” policy. Increased public discussion in the last few weeks has helped crystallize some of the implications for global trade. “The ‘dual circulation’ policy demonstrates China’s recognition that it won’t be able to rely on trade as much for the next two decades, as it did for the previous two,” Stephen Olson, research fellow at the nonprofit Hinrich Foundation, said in an email this week. China is focused squarely on a post U.S.centric world in which China leads in technology innovation. 

• Remote work is killing the hidden trillion dollar office economy. From airlines to Starbucks, a massive part of our economy hinges on white-collar workers returning to the office. As companies in cities across the U.S. postpone and even scrap plans to reopen their offices, they have transformed once-teeming city business districts into commercial ghost towns comprised of essentially vacant skyscrapers and upscale complexes. A result has been the paralysis of the rarely remarked-upon business ecosystem centering on white-collar workers, who, when you include the enterprises reliant on them, account for a pre-pandemic labor force approaching 100 million workers. 

• Japanese doctor who lived to 105-his spartan diet, views on retirement, and other rare longevity tips. 1) Don’t retire. But if you must, do so a lot later than age 65, 2) Take the stairs (and keep your weight in check). 3) Find a purpose that keeps you busy. 4) Rules are stressful; try to relax them. 5) Remember that doctors can’t cure everything. 6) Find inspiration, joy and peace in art.

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

Logos LP

What Are We Wrong About Today?

Good Morning,
 

Stocks remained in a holding pattern on Friday after China and the U.S. agreed to a phase one trade deal as investors concluded a decent week of gains.

The trade deal will include a rollback of some of the China tariffs and halts additional levies set to take effect on Sunday. China agreed to significant purchases of U.S. agricultural products, but the amount is below what the White House was reportedly pushing to get. On the U.S. side, investors were hoping for more than just a partial rollback of some tariffs.

The US markets sit at record highs and it would appear that the probability of Christmas 2019 being cancelled like Christmas 2018 is low.

Our Take

Although markets both in the US and around the world seemed to rejoice at the progress made on a phase one trade deal upon further inspection this appears to be another baby step. 

As part of the “phase one” deal, the U.S. canceled plans to impose fresh tariffs on $156 billion in annual imports of Chinese made goods-including smartphones, toys and consumer electronics-that were set to go into effect Sunday. The U.S. also slash the tariff rate in half on roughly $120 billion of goods, to 7.5% from 15%. 

Nevertheless, tariffs of 25% would remain on roughly $250 billion in Chinese goods, including machinery, electronics and furniture. 

Chinese officials said the U.S. has agreed to reduce these tariffs in stages, but U.S. Trade Representative Robert Lighthizer said there was no agreement on that, and he suggested China believes such reductions can be negotiated in subsequent phases. 

For its part, China will boost American agricultural purchases by $32 billion over previous levels over the next two years. That would increase total farm-product purchases to $40 billion a year, with China working to raise it to $50 billion a year. 

The agricultural purchases are part of a package designed to raise U.S. exports to China by $200 billion over two years, Mr. Lighthizer siad. 

Mr. Lighthizer said that China made specific commitments on intellectual property but these would be announced in the future. 

Many trade experts expected the U.S. to eliminate the tariffs imposed on retail goods on Sept. 1 or roll back more tranches of tariffs (there are currently 4 tranches in play), rather than merely halving the September tariff rates. 

So to recap we basically have a saving face ceasefire to further tariff escalations with question marks around most of the most important aspects of the dispute. 

Nevertheless, it should be seen as a positive for stocks since it could boost business confidence and that could spill over to more investment spending and higher corporate profits. In our view this confidence will likely depend on being able to tell businesses not only that tariffs are not going up but that they are going down...

Both countries have agreed to stop punching themselves in the face; but how much better if they hadn’t started at all...

From what we can see, there is nothing in this tentative deal that wouldn’t have existed in the absence of the past two years of trash talking. 

Looking at the record highs in global stock markets, it’s tempting to think that none of this really matters. But it’s worth considering how much of these returns are attributable to the global synchronization of dovish monetary policy which has cushioned a deteriorating geopolitical picture in addition to job growth which has remained strong and consumers who have continued to spend.

Although things look better now than they did in the summer, global growth in 2019 will still be the weakest since the financial crisis of 2008 and 2009, according to the International Monetary Fund, and China and the U.S. will both slow next year. With paralysis at the World Trade Organization, we could be closer to the beginning than the end of the troubles in the global trading system.

While times are good a trade fight is all fun and games. Unintended consequences are ignored, swept under the rug and to the victor go the spoils! Yet when times turn bad and the tide rushes out, those not wearing a bathing suit may finally be exposed to the merciless disdain of the crowd... 


Stock Ideas

 

In our last newsletter update we suggested a few companies we are evaluating for addition to our portfolio. We received positive feedback on the inclusion of such picks and thus we thought we would follow things up with a few updates and picks: 

UPLD (Upland Software): We still think Upland is a compelling buy here. With the recent results we saw from Enghouse, we think that fiscal '20 will be a good year for the consolidators. With a plethora of VC investments ending up as zombies (and more to come as capital becomes more disciplined), we think there is a robust pipeline in niche work management cloud companies (think software that tracks consumer sentiment when you call your telco to complain about your bill). At 3.8x sales, 13x forward PE and 4.1x book, the company is not trading at a premium valuation considering it is a consolidator with rapidly growing revenue in a highly fragmented software market. We have initiated a position and will look to add on further weakness. 

BOMN (Boston Omaha): This is another serial acquirer of an asset class that is peculiar: billboards. Billboards provide surprisingly high ROIC (not digital ones but rather regular old fashioned billboards) and have tremendous cash flow conversion. This company utilizes cash flows from billboards and invests them into other high quality companies a la Berkshire (surety insurance, bail bond insurance and municipal bond insurance companies). They also made a significant investment in Dream Homes, a niche home builder, and a regional bank. They are rapidly growing revenue and have a strong management team that has an ROIC-focused culture. Also, board members aren't paid much and all senior execs plus board members are required to purchase company stock. Stock is down over 15% this year, trading at 2017 levels and we think this presents an attractive entry point.

ATRI (Atrion): The small cap maker of fluid pumps and medical devices is having a tough Q4 as the trade deal made for a volatile period of time. The company reported slowing growth last quarter (especially in Asia) which sent the stock tumbling. Currently, the stock is trading below 50, 100 and 200 moving day average and is well off highs. With high ROIC (over 18% 5-year average) and a dividend increase of roughly 15% we think Atrion offers compelling value for the long term given the recent underperformance. We have initiated a position and will look to add on further weakness. 

Musings

Came across an interesting chart this month:

Apparently most people’s reading of the data and thus views on the economic outlook are highly correlated to their political bias. 

Thus, it is no surprise that many democrats I’ve had discussions with have largely sat the rally out since Trump’s inauguration or worse have remained completely on the sidelines assuming the U.S. economy is headed for Armageddon under the current administration. 

This sentiment was recently confirmed by the following data: “Sixty-five percent of Americans say a recession is likely in the next year — 84% of Democrats, 72% of Independents and 46% of Republicans.” 

This kind of decision making based on political bias is dangerous but oh so common. Why? 

Many possible explanations can be found in the realm of behavioural economics, but one I came across recently that is particularly illuminating: “Manson’s Law”.  

The law states that: 

“The more something threatens your identity, the more you will avoid it.” 

Mark Manson explains: “that means the more something threatens to change how you view yourself, how successful/unsuccessful you believe yourself to be, how well you see yourself living up to your values, the more you will avoid ever getting around to doing it.”

The world is a noisy place. On a daily basis we are bombarded with a plethora or people, activities and data. In light of this noise, we as humans find a certain comfort in knowing how we fit in the world. 

Anything that disturbs that comfort, threatens it or destabilizes it- even if it could potentially make our lives better (ie. learning something new, enriching us, challenges us to grow)- is inherently “scary”. 

What is fascinating about this law is that it applies to both good and bad things. Working hard earning thousands or even millions could threaten your identity as someone with grievances against the wealthy as much as failing in some way, losing all of your hard earned money could threaten your identity as a “successful” person. 

This is why people are often so afraid of success for the same reason they are afraid of failure: “it threatens who they believe themselves to be”. 

A few common examples of this phenomenon: 

You don’t invest in the stock market and ignore a favorable earnings, revenue and macro backdrop because it could threaten your identity as a Trump hater, staunch democrat, civil rights/99% advocate or simply as a bear who keeps trying to call “the top”. Result: you miss out on years of gains and can’t retire because you’ve failed to generate adequate returns. 

You don’t invest in the stock market and ignore the data that stocks outperform real estate over the long term because it could call into question your identity as someone who puts their nest egg in real estate like everyone you know. Result: your retirement is hoo-hum because you’ve failed to generate any significant returns creating cash-flow issues. 

You don’t wind up a failing business venture with obviously bad unit economics because that would call into question your identity as a high-flying “successful” tech entrepreneur. Result: you tax your life by a few years and burn your investor capital in addition to your reputation. 

You avoid telling your significant other that you feel the two of you are not a fit because ending the relationship would threaten your identity as a nice, loyal boyfriend in a “good relationship”. Result: you tax your life, miss out on meeting someone who is a great fit and both you and your significant other become bitter and resentful. 

These are only a few common examples yet they illustrate the point that we consistently pass up important opportunities because they threaten to change how we view and feel about ourselves. They threaten the values that we’ve learned to live up to and which anchor our lives and conceptions of self. 

We protect these values. We avoid opportunities and people that threaten them. We surround ourselves with people and opportunities that will reinforce them. 

I was walking down the street recently and saw a sign on a high school which advertised the school as a place where the students can “find themselves”. This is the zeitgeist of the times. 

The problem with this tired trope is that most people find themselves and never let go…

In a way, what we should consider is never finding ourselves. This is what keeps us learning and growing. Seeing ourselves as a canvas that is never really complete can keep us humble and open to new places, opportunities and people. 

Instead of anchoring to our existing beliefs and then trying to prove them right, we should consider chipping away at the ways in which we are wrong one day so that we will be a little less wrong the next…

What are we wrong about today that can lead to our improvement tomorrow?

Charts of the Month

Maybe things aren't so bad? 

Does the future belong to Millennials? 

Stock picking can be rewarding...

Logos LP November 2019 Performance
 

November 2019 Return: 9.63%
 

2019 YTD (November) Return: 37.70%
 

Trailing Twelve Month Return: 28.16%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +16.04%

Thought of the Month


 

"Everything is passing. Enjoy its momentariness.” – Mooji

Articles and Ideas of Interest

 

• Kids are expensive. How expensive? Forget retiring any time soon—or maybe ever—if you’re considering raising multiple children. According to Investopedia: Parents tend to underestimate the cost, even of that first year, as a recent survey by personal finance website NerdWallet points out. The actual cost of raising a baby in its first year is around $21,000 (for a household earning $40,000) and $52,000 (for one bringing home $200,000). According to the poll, 18% of parents thought it would cost $1,000 or less and another 36% put the price tag at between $1,001 and $5,000. You’re going to pay a lot of money for that cute little bundle – somewhere around $233,610 by the time the baby turns 18, according to a 2017 Department of Agriculture (USDA) study.

• Hippie Inc: How the counterculture went corporate. The Economist explores how half a century on from the summer of love, marijuana is big business and mindfulness a workplace routine. Nat Segnit asks how the movement found itself at the heart of capitalism. 

• The bad news about women on boards. Research suggests investor bias penalises companies when they make diverse appointments. As reported in the Financial Times: “When Isabelle Solal and Kaisa Snellman looked at 14 years’ worth of data from more than 1,600 US public companies, they made a disturbing discovery: businesses that put a woman on the board then suffered a two-year decline in their market value. Worse, the penalty was greater for companies that had splashed out on measures to boost diversity, such as better work-life balance policies. Their market value fell by nearly 6 per cent after a woman joined the board.” Why? The researchers found that investors think boosting board diversity is a sign that a company is more interested in social goals than maximising shareholder value...

• The most dangerous of all people is the fool who thinks he is brilliant. We all suffer from overconfidence at times (some with more frequency than others) yet Jason Zweig does an excellent job in this piece of reminding us of the blunders that can stem from presuming we know more than we do, more than the people around us, more than the people who came before us, more than the people who have spent decades studying a topic or working in a field. The dangers of underestimating the difficulty of problems and overestimating the ease of solutions.

• How much runway should a founder target between financing rounds? According to CBInsights, running out of cash is the second leading cause of startup failure. Needless to say—it’s an important question to get right. Is it possible that the startup failure rate is so high partially because conventional wisdom tells founders to prepare for 12-to-18 months between financing events when in reality they should be preparing for longer as the experienced VCs suggest? Sebastian Quintero ingests all of Crunchbase’s data to find out. His team finds that it possible that the conventional wisdom of 12 to 18 months between financing events is an influential factor leading to high startup failure rates as the hard data says entrepreneurs should plan for at least 18–21 months of runway, and as much as ~35 months if they want to play it safe and stay within one standard deviation from the mean. 

• OK Boomer, Who’s Going to Buy Your 21 Million Homes? Baby boomers are getting ready to sell one quarter of America’s homes over the next two decades. The WSJ reports that the problem is many of these properties are in places where younger people no longer want to live. If demand the demand isn’t what everyone said it would be, what happens to prices? Think steep discounts — sometimes almost 50%, and many owners end up selling for less than they paid to build their homes. What then happens to retirement?
  

• The American Dream is killing us. Mark Manson puts together an interesting review of American history suggesting that from a unique intersection of good fortune, plentiful resources, massive amounts of land, and creative ingenuity drawn from around the world that the idea of the American Dream was born. He holds that the American Dream is simple: “it’s the unwavering belief that anybody — you, me, your friends, your neighbors, grandma Verna — can become exceedingly successful, and all it takes is the right amount of work, ingenuity, and determination. Nothing else matters. No external force. No bout of bad luck. All one needs is a steady dosage of grit and ass-grinding hard work. And you too can own a McMansion with a three-car garage… you lazy sack of shit.” And in a country with constantly increasing customers, endlessly expanding land ownership, endlessly expanding labor pool, endlessly expanding innovation, this was true. Until recently…
  

• If you can manage a waffle house you can manage anything. A day doesn’t go by without us hearing about some “high-flying”/”high-tech” company raising capital. The founders are excited (yet have no experience in the space), everyone is excited and the space is “ripe” for disruption (yet no one has done a proper analysis of the business’s unit economics). What most don’t hear about or conveniently forget is that a year of two later the founders are looking to wind the thing up. The WSJ pens a refreshing article suggesting that running a 24-hour budget diner isn’t glamorous, but it forces leaders to serve others with speed, stamina and zero entitlement. What if all founders operated with zero entitlement? Now that would be an exciting “disruption”...

• What powered such a great decade for stocks? This formula explains it all. This is a nice follow up to our last newsletter entitled “Haters Gonna Hate”. Market Returns = Dividend Yield + Earnings Growth +/- Changes in the P/E Ratio. Contrary to popular belief, Ben Carlson demonstrates that a vast majority of the gains over the past decade can be explained almost exclusively by improving fundamentals. Yes that's right the market isn’t a ponzi scheme a product of financial engineering, stock buybacks and central bank money printing! Earnings growth and dividends explain nearly 97% of the annual returns for the 2010s. Many would argue the only reason earnings growth has been so strong is because of the massive stimulus we’ve received from low interest rates. Ben isn’t saying valuations haven’t risen in this time (they have). It’s just that they’ve risen in concert with corporate profits.

• A mysterious voice took over investing. I know what it is. The Institutional Investor examines the link behind the decline of value, hedge funds and alpha everywhere. Since the 2008 crisis, the Standard & Poor’s 500 Growth Total Return Index has beaten its Value Total Return counterpart in eight of 11 years, including 2019 for the year to date. Growth has put up average annualized returns of 9.4 percent in the decade since the crisis, versus just 5.6 percent for value. Worse, value has suffered through three negative years during that span, whereas the growth index has not experienced a single one. Spoiler: data and the rise of the machines. We simply cannot compete with this computational supremacy. Our human brains, about 1,260 cubic centimeters on average, have been essentially unchanged for nearly 200,000 years.

Our best wishes for the happiest of Holidays filled with joy and gratitude, 

Logos LP

Haters Gonna Hate

Good Morning,
 

The Dow Jones Industrial Average fell sharply on Friday, weighed down by steep losses in Boeing and Johnson & Johnson. The broader market was also pressured by a decline in Netflix shares that led other Big Tech stocks lower.

The 30-stock index ended the day down 255.68 points, or 0.95% to close at 26,770.20. Boeing dropped 6.8% — its biggest one-day drop since February 2016 — on news that company instant messages suggest the aerospace giant misled regulators over the safety systems of the 737 Max. Johnson & Johnson slid 6.2% after the company recalled some baby powder upon finding traces of asbestos.

Friday’s losses wiped out the Dow’s gains for the week. The index closed down 0.2% week to date. 

Meanwhile, S&P 500 pulled back 0.4% to end the day at 2,986.20 while the Nasdaq Composite slid 0.8% to 8,089.54. Netflix shares dropped more than 6%. Facebook, meanwhile, slid 2.2% while Amazon fell 1.6%. Alphabet shares pulled back 0.4%.

Both indexes were able to post solid gains for the week despite Friday’s decline. The S&P 500 rose 0.5% week to date while the Nasdaq gained 0.4% as enthusiasm around the first batch of corporate earnings lifted market sentiment.

More than 70 S&P 500 companies reported calendar third-quarter earnings this week. Of those companies, 81% posted better-than-expected results, FactSet data shows.

It was also a brutal week for the software/cloud technology sector. The worst in recent memory. 

Our Take

We are currently in the middle of deflationary period for many once popular software stocks which began in late July/early August and certain names have dropped anywhere from 40-60% in a matter of months. Investing can be a popularity contest and the most dangerous thing is to buy something at the peak of its popularity. As such, we are now evaluating this group as the safest and most potentially profitable thing is to buy something no one likes.

What can be made of this selloff? There are likely a variety of reasons for this repricing tied to the overall pessimistic “macro” narrative that continues to dominate “popular” discourse (more on this below) yet a more simple explanation is that their valuations have gotten ahead of themselves in a market that is maturing.  

A quick review of the charts of several cloud computing and software focused ETFs suggest incredible outperformance vs. the S&P 500 since around 2016 until about August of this year with many popular software names (Okta (OKTA), Veeva (VEEV), ServiceNow (NOW), Twilio (TWLO), Coupa (COUP)) still up between 20-100% for the year. To boot, most of the cloud computing and software focused ETFs are still up between 15-25% for the year despite the selloff.

Not exactly a “blood bath”. Instead, we see this repricing as perhaps a welcome reversion to the mean as well as a maturation of the sector. A swinging of the pendulum back to reality as all new great growth stories tend to do. The reality is that many of these businesses are more economically sensitive than once thought and many are running out of runway. Competition is now fierce and so the multiples must come down. Look at history and this is nothing new.

Many of these names continue to generate impressive amounts of recurring revenue, maintaining breathtaking rates of growth while solving real problems for customers.  All things considered, the weakness in the space along with the weakness in demand for such issue in the IPO market (think WeWork, AirBnB, Uber, Lyft, SmileDirect, Slack etc.) all point to the other side of the “can’t lose investment idea” coin.

This is healthy and rational. The greater fool theory works only until it doesn’t (think WeWork). Valuation eventually comes into play, and those who are holding the bag when it does have to face the music.

"Attractive at any price” in relation to the sector is steadily morphing into simply “attractive” on a more company specific basis. This is why we are beginning to get excited about opportunities in the space and have begun considering increasing our portfolio weighting in software and technology related services. Our focus has been on companies in the sector in the small to mid-cap arena with strong secular growth stories with real free cash flow. As such, we have started to initiate positions in companies like the following:

1. New Relic (NEWR): Company provides analytic and data monitoring software for DevOps teams. Company is trading a little over 6x sales with ~80% gross margin. Stock is down 47% from 2018 and FCF has nearly quintupled since then. New Relic has more FCF than companies like Zscaler with a similar growth profile is trading at nearly half the market cap.

2. Zuora (ZUO): Company provides software to utilities, industrials and other technology firms that are developing subscription services. Trading under 5.99x sales with growth in enterprise accounts over 100k at 20% and overall growth at over 40% since 2018, the company blew past quarterly earnings and raised guidance last quarter. Stock is down 61% since 2018.

3. Upland Software (UPLD): Marked as the U.S. version of Constellation Software, the company trades at 14x next year’s earnings, a little over 4x sales with FCF quadrupling since 2016. Company has been on an acquisition spree and has raised full year guidance. This is a name that may become a core.

Not all technology stocks or software stocks are created equal. We believe the market has unfairly treated many SaaS providers with strong growth and cash flows by lumping in real software companies at reasonable valuations with companies that are either tremendously overvalued or that are not even technology focused to begin with. Why should Okta, which is an Oauth replacement trading at over 24x sales, be in the same conversation with some of these other high growth sticky software companies trading below 15x sales? Why is Slack, which seems to have its hands full with MSFT Teams, trading at 26x sales? 

While some professional investors may have an answer to these questions, we prefer to wait for compelling valuations to match compelling growth stories. In the meantime, we welcome further multiple compression among highly recurring software businesses as they will provide for interesting upside in the future. Let the baby get thrown out with the bathwater…

Musings

Pessimism and frustration are the words that best describe the popular sentiment at present. It has become necessary for the majority (the "Haters Gonna Hate" crowd) to portray every data point and every headline as negative, in the hopes of confirming their views. The facts are that we are roughly 2% off of record highs YTD for the S&P 500. These majority views thus haven’t proven to be particularly profitable.

It has been said that there are four phases in every bull market: 1) Despair 2) Disbelief (of initial rally) 3) Acceptance 4) Euphoria. We think it is safe to say that we have been through the despair phase. Next we have the disbelief phase in which a few begin to believe that things will get better but most question everything and maintain a pessimistic view holding large swathes of their portfolio in bonds, gold, utilities, non-cyclicals and even cash. Have we really moved out of this phase to acceptance?

What pundit can you think of that is optimistic? There isn’t a day that goes by without David Rosenberg at Gluskin Sheff calling for a recession. Don’t forget Ray Dalio at Bridgewater suggesting that we are headed for the 1930s all over again. What person do you know who loves stocks right now and is suggesting that you buy? At a recent Thanksgiving celebration we were informed by most at the party that they had completely exited the markets as a recession was “right around the corner”.  We couldn't help but think that at least if these views prove to be incorrect one wouldn’t be lonely... 

This is not indicative of acceptance or euphoria. Instead, we believe the door to the acceptance phase began to open in 2017. For some, there was renewed optimism with a pro-business agenda in play. That crack in the door has been abruptly shut. Negativism is back en vogue and is pervasive anywhere you look.

Just last week The American Association of Individual Investors who runs a weekly sentiment poll where participants express their view on which direction the U.S. stock market will be headed over the next six months reported that 20.3% were bullish, 35.7% were neutral and 44% were bearish. Roughly 80% of market participants are not bullish…This is a huge number. 

In other news, investors are flocking to the relative safety of money market funds at the highest level since the financial crisis-era collapse of Lehman Brothers in 2008. The industry has pulled in $322 billion over the past six months, the fastest pace since the second half of 2008, bringing assets to nearly $3.5 trillion, according to data from FactSet and Bank of America Merrill Lynch. Total money market assets are now at their highest level since September 2009! 

Today, it’s all about what is going wrong, and the positives are nowhere to be found. The negative rhetoric coming from ALL political candidates across the spectrum is shocking. Watching the Democratic primary debates on TV, listening to Trump at his rallies or on Twitter or watching the Canadian Federal election debates is enough to make you lose hope for the future. Any positive data is being thrown under the rug and the person/party that can say the most shocking and negative thing appears to be the one that gets the most attention. 

Quite frankly the political discourse is so uninspirational that we feel confident in saying that the disbelief phase is still in progress today, and the “haters gonna hate” sentiment presented week after week confirms that. The fearful have been joined by the frustrated, and that angry mob has grown to proportions seen during times of crisis. 

What to do? We have chosen to accept this market for what it is: it hasn’t gone anywhere for almost 2 years, “safety assets” are leading the market, US household financial burdens today are lower than at any time since the early 1980s, US household leverage (total liabilities as a % of total assets) has declined almost 35% since the mid 1980s, the five largest money center banks in the USA have beaten earnings estimates this quarter, the commentary from just about every Bank CEO was that: "The consumer is ''strong”, the S&P 500 earnings yield stands at +5.90%, growth remains at a moderate pace, inflation is tame, the Fed is dovish and so we will stay the course looking out for opportunities during the acceptance and euphoria phases.

At the end of the day, if this cycle is anything like the others, the currently hyper-valued defensive stalwarts like consumer staples, interest rate sensitive investments, including REITs and utilities, and the heavily embraced bond market, are all poised to underperform dramatically, as a historic capital rotation occurs. As such, looking out into the final 2 phases of the bull market, embracing shunned economically-sensitive assets, when almost all market participants are bidding up the price of “quality”/“safe” assets preparing for a downturn, is perhaps the perfect storm of a contrarian opportunity. As history has taught us, there is no such thing as a good investment regardless of price…

Charts of the Month

Apparently many think we have another 2008 situation brewing as cash has become king now.

Logos LP September 2019 Performance

September 2019 Return: -5.13%
 

2019 YTD (September) Return: 24.62%
 

Trailing Twelve Month Return: 4.67%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014:+14.48%

Thought of the Month

"When the thumb of fear lifts we are so alive.” – Mary Oliver

Articles and Ideas of Interest

• Why many smart women support president Trump. Interesting piece in the WSJ. "I, too, am a college-educated, suburban woman. I am retired, and during President Trump’s term my retirement fund has increased. I live in a heavily populated border state and am happy to see he is addressing the overabundance of people living here illegally. He has reduced my taxes, reduced government regulations thereby improving the business environment and giving my children and grandchildren more access to better, high-paying jobs, and he is protecting my health plan from a government takeover."

• The 'Glass Floor' is keeping America's richest idiots at the top. Elites are finding more ways to ensure that their children never run out of chances to fail. In 2014, Zach Dell launched a dating app called Thread. It was nearly identical to Tinder: Users created a profile, uploaded photos and swiped through potential matches. The only twist on the formula was that Thread was restricted to university students and explicitly designed to produce relationships rather than hookups. The app’s tagline was “Stay Classy.” Zach Dell is the son of billionaire tech magnate Michael Dell. Though he told reporters that he wasn’t relying on family money, Thread’s early investors included a number of his father’s friends, including Salesforce CEO Marc Benioff. The app failed almost instantly. Perhaps the number of monogamy-seeking students just wasn’t large enough, or capping users at 10 matches per day limited the app’s addictiveness. It could also have been the mismatch between Thread’s chaste motto and its user experience. Users got just 70 characters to describe themselves on their profiles. Most of them resorted to catchphrases like “Hook ’em” and “Netflix is life.” After Thread went bust, Dell moved into philanthropy with a startup called Sqwatt, which promised to deliver “low-cost sanitation solutions for the developing world.” Aside from an empty website and a promotional video with fewer than 100 views, the effort seems to have disappeared.And yet, despite helming two failed ventures and having little work experience beyond an internship at a financial services company created to manage his father’s fortune, things seem to be working out for Zach Dell. According to his LinkedIn profile, he is now an analyst for the private equity firm Blackstone. He is 22.

• Why are rich people so mean? Call it Rich Asshole Syndrome—the tendency to distance yourself from people with whom you have a large wealth differential.

• Not all millennials are woke. In Europe, young people’s political views have shifted right rather than left. Under-30s in Europe are more disposed than their parents are to view poverty as a result of an individual’s choice.

• Australia’s three rate cuts are making consumers even gloomier. Australian consumers are feeling their gloomiest in more than four years, signaling that the Reserve Bank’s three recent interest-rate cuts are having the reverse intended effect. Consumer confidence dropped 5.5% to 92.8 in October, with pessimists again outweighing optimists in the monthly Westpac Banking Corp. survey. The index sunk to its lowest level since July 2015 and is down 8.4% since the central bank started cutting rates in June. “This result will be of some concern to the monetary authorities,” said Westpac Chief Economist Bill Evans. “Typically, an interest-rate cut boosts confidence, particularly around consumers’ expectations for and assessments of their own finances. In this survey, these components of the index fell by 3.7% and 4.9% respectively.” Maybe politicians will eventually realize that they will have to make some hard decisions as monetary policy has run its course and fiscal policy will need to be relied upon.
   

• You now need to make $350,000 a year to live a middle-class lifestyle in a big city. Here’s a sad breakdown of why. 
  
   

• Empty hair salons can’t be saved by a central bank. Struggling businesses in rural Japan show the limits of the BOJ’s massive easing. There’s a lesson for other economies facing demographic decline.

• Time can make you happier than money. It’s true for all ages and stages - even for recent college grads according to a new study. “People who value time make decisions based on meaning versus money,” says study leader Ashley Whillans, an assistant professor of business administration at Harvard Business School. “They choose to do things because they want to, not because they have to.”

• VC Withering? Aggregate valuations of venture-backed companies are still at an all-time high.  But CB insights quarterly deep dive MoneyTree report — created in partnership with PwC — shows deals and funding down almost across the board (in the geographical and industry-specific sense). Looks like the money and dealmaking is pulling back. What does it mean? 

  Our best wishes for a fulfilling October,

  Logos LP
  

2018 Meltdown and What to Think of 2019?

Good Morning,
 

Santa Claus rally? No Santa Claus rally? Naughty or nice? One thing is for sure the last two weeks on Wall Street have been gut wrenching. Not for the faint of heart. During that time, the major U.S. stock indexes have suffered losses that put them on track for their worst December performance since the Great Depression. Investors have also been gripped by volatile swings in the market as they grapple with a host of issues.
 

The S&P 500 has logged six moves of more than 1 percent over the period, three of which were of more than 2 percent. For context, the broad index posted just eight 1 percent moves in all of 2017.
 

The Dow Jones Industrial Average, meanwhile, has seen seven days of moves greater than 1 percent. Its intraday points ranges also widely expanded. The 30-stock index has swung at least 548 points in eight of its past nine sessions, and also posted its first single-day 1,000-point gain ever on Wednesday. The index ended down 76 points Friday after vacillating throughout the session.
 

These moves are remarkable and what has been equally remarkable has been the fact that many pundits and astute market veterans haven’t had much of a satisfying explanation; fears of the Fed after Chairman Jerome Powell said he did not anticipate the central bank changing its strategy for trimming its massive balance sheet, a U.S. federal government shutdown, disfunction in Washington (almost every part of Trump's life is now under investigation), slowing global growth, weaker data coming out of the U.S., “end of cycle”, and thus fears of a recession. All of which seem convincing as a root cause of this vicious selling. Watching CNBC has been almost comical with pundits like Jim Cramer recommending gold one day only to recommend nibbling on stock as markets move higher the next.
 

2018 was the year nothing worked: In fact, in 2018, just about every single asset class one can invest in — from stocks around the globe to government debt to corporate bonds to commodities — have posted negative returns or unchanged performance year to date.
 

Even during the financial crisis in 2008, government bonds and gold worked...
 

What gives?

Our Take

While any 20 percent sell-off hurts (both the Russell 2000 and Nasdaq led the way into bear market territory. The S&P 500 (-19.8%) and the Dow 30 (-18.8%) did manage to fall just short of the 20% threshold yet the average stock is down far more than that) the one happening now is far from unheard of in terms of depth or velocity. Over the past 100 years, there are almost too many examples to count of stocks tumbling with comparable force.
 

THIS IS INEVITABLE AND NORMAL. WELCOME TO THE STOCK MARKET.

Investors over the Holidays have time to reflect on history, now that stocks have avoided a fourth straight down week via the biggest one-day rally since 2009. After coming within a few points of a bear market on Wednesday, the damage in the S&P 500 stands at 15 percent since Sept. 20.
 

This is normal but seems abnormal because we are all talking about it from morning to night.
 

As we are reminded by a recent article in Bloomberg: “A fair amount of complaining has gone on in recent months about the role of high-frequency traders and quantitative funds in the drubbing that reached its peak around Christmas. Perhaps. Those groups are big, and in the search for villains, they make easy targets. Treasury Secretary Steven Mnuchin is among the people who have made the connection.
 

One thing that makes it tough to lay blame for the meltdown on machine-based traders is the many past instances when markets fell just as hard without their help. The Crash of 1929 is one big example. However bad this market is, it’s a walk in the park compared with then.”
 

This pattern holds for the Dot-com Bust (S&P 500 lost 35 percent over the course of two months), Black Monday of 1987 (S&P 500 rose 36 percent between January and August 1987 in what was set to be the best year in almost three decades. Then the October sell-off pushed the S&P into a 31 percent correction over just 15 days), 1974 Sell-Off (the S&P 500 saw the index fall 33 percent in 115 days as a weakening economy, rising unemployment and spiking inflation pushed investors to head for the exits. Stocks subsequently rebounded, surging more than 50 percent between October 1974 and July 1975), 1962 Rout (S&P 500 Index lost a quarter of its value between March and June 1962), Not so Fat ‘57 (20 percent correction over 99 days in 1957).
 

Last I checked there were no high frequency traders then BUT there were equally dysfunctional administrations and equally irrational humans…
 

The selling is likely overdone. When the SP 500 peaked in late September '18, the forward 4 quarter estimate was $168.72; today, that same estimate is $169.58. The point is with the S&P 500 index falling some 15%, the forward estimate on which it's valued is actually slightly higher. The question is will these estimates hold. Clearly the stock market is not so sure despite the fact that the U.S. economy is in a good position to sustain a 2.5-3 percent growth rate in 2019.
 

With the selling frenzy pushing stock prices lower, investors are now pricing in zero growth in earnings for 2019. Is this reasonable? 2018 earnings will come in at around $162 for the year. Clearly, the market has lost a lot of confidence in the staying power of earnings and the health of the economy. If we apply a conservative 14-15 multiple to that, it yields a range for the S&P at 2,268-2,430. So with the index closing at 2,488 Friday, we are just above that range. The issue is that the stock market generally overshoots in either direction when it sees change. Emotion takes over and causes the rapid move.
 

Despite existing negativity, the market’s valuation has changed for the better. The S&P 500 is actually heading into 2019 with a P/E ratio right in line with its historical average going back to 1929. And if you look just at the last 30 years going back to 1990, it is actually undervalued.
 

Unless one sees another financial crisis upon us (which at this time we do not), the probability is high that this could also mark a near term low.
 

As for investor sentiment, bearishness sits at record highs. In fact, half of individual investors now describe themselves as “bearish” for the first time since 2013. The latest AAII Sentiment Survey shows greater polarization, with neutral sentiment falling to an eight-year low.
 

On December 24 73% of financial stocks hit 52-week lows. That exceeds all days from the worldwide financial crisis…
 

In the past 28 years, there have been 2 times when every stock in the 2&P 500 Energy sector was below their 10-, 50-, and 200 day average and more than half were trading at 52 week lows.
1) During the depths of the 2008 financial crisis
2) Now

The pendulum of the market may be set for a swing in the other direction.


A Few Things We Like for 2019 That We Have Been Nibbling On During The 2018 Rout

Cerner Corp. (CERN:NASDAQ): major player in the healthcare IT industry as its software is highly integrated into the operations of several large provider networks. The firm has internally developed much of its software, which makes its product lineup close to seamless and effective within the healthcare IT sector. The secular demand tailwinds for Cerner’s products are robust given ACA mandates that require providers to upgrade their health records management systems. This highly positive trend will be enhanced over the next several years by changing payer reimbursement structures. Trading at a roughly 30% discount to intrinsic value (earnings based DCF), 10 year low P/E, P/S and P/FCF.

CGI Group Inc. (GIB.A:TSX): deeply embedded in government agencies across North America and Europe. Gained greater scale with its acquisition of Logica in 2012. This scale will allow the firm to better meet the needs of global clients. The firm has a backlog of signed contracts of more than CAD 21 billion, with an average duration of approximately five to seven years. Growing IT complexity is expected to support long-term demand for IT services as companies look to simplify and streamline their IT landscape. Trading at a roughly 20% discount to intrinsic value (earnings based DCF), attractive 10 year low P/E, PEG ratio and EV/EBIT.


Chart(s) of the Month 


“Equity prices are said to have far outpaced earnings during this bull market. In fact, better profits accounts for about 70% of the appreciation in the S&P over the past 8 years. Of course valuations have also risen, that is a feature of every bull market, as investors transition from pessimism to optimism. But this has been a much smaller contributor. In comparison, 75% of the gain in the S&P between 1982-2000 was derived from a valuation increase (that data from Barry Ritholtz).”
 

Musings

I began reading a fantastic book over the break which I highly recommend entitled “The Laws of Human Nature” by Robert Greene. The book takes as its fundamental premise that we humans tend to think of our behaviour as largely conscious and willed. To imagine that we are not always in control of what we do is a frightening thought, but in fact is the reality. We live on the surface, reacting emotionally to what people say and do. We settle for the easiest and most convenient story to tell ourselves.
 

Greene writes: “Human nature is stronger than any individual, than any institution or technological invention. It ends up shaping what we create to reflect itself and its primitive roots. It moves us like pawns. Ignore the laws at your own peril. Refusing to come to terms with human nature means that you are dooming yourself to patterns beyond your control and to feelings of confusion and helplessness.”
 

These principles are all the more relevant in light of 2018’s market action. What is interesting is that like this sell off (including the cryptocurrencies sell off), when we look back at other selloffs like that of 2008, most explanations emphasize our helplessness. We were tricked by greedy banking insiders, mortgage lenders, poor government oversight, computer models and algorithmic traders etc.
 

What is often not acknowledged is the basic irrationality that drove these millions of buyers and sellers up and down the line.
 

They became infected with the lure of easy money. The taste of wealth and the envy of their fellow market participants appearing to make effortless gains.
 

This made even the most rational, experienced and educated investor emotional. Hungry for his own slice of the action. Ideas were rounded up to fortify such behaviour such as “this is game changing technology, this time it is different and housing prices never go down”. A wave of unbridled optimism takes hold of the mind and panic sets in as reality clashes with the story most people have accepted.
 

Once “smart people” start looking like idiots, fingers begin to get pointed at outside forces to deflect the real sources of the madness. THIS IS NOTHING NEW. IT IS AS OLD AS THE HUMAN RACE.
 

Understand: Bubbles/corrections/bear markets “occur because of the intense emotional pull they have on people, which overwhelm any reasoning powers an individual mind might possess. They stimulate our natural tendencies toward greed, easy money, quick results and loss aversion."
 

It is hard to see other people making money and not want to join in. It is also equally hard to watch one’s assets drop in value day after day. THERE IS NO REGULATORY FORCE ON THE PLANET THAT CAN CONTROL HUMAN NATURE.
 

As demonstrated above, the occurrence of these selloffs will continue as they have until our fundamental human nature is altered or managed.
 

As such, it is important during these periods that we look inward to acknowledge and understand the true causes of these phenomenon and even take advantage of them as they occur. The most common emotion of all being the desire for pleasure and the avoidance of pain. The most meaningful experiences of pleasure typically follow the most most meaningful experiences of pain…

Logos LP November 2018 Performance

November 2018 Return: 0.15%

2018 YTD (November) Return: -11.06%

Trailing Twelve Month Return: -7.60%

CAGR since inception March 26, 2014: +14.06%

Thought of the Month

"If you have trouble imagining a 20% loss in the stock market, you shouldn't be in stocks."

-- John Bogle

Articles and Ideas of Interest

• 2018: The Year of the Woeful World Leader. Trump, May, Macron, Merkel. Italy, Spain, Sweden, Latvia. Even the dictators stumbled. So much bad governing, so little time.   

• What the Fall of the Roman Republic can teach us about America. The bad news is that the coming decades are unlikely to afford us many moments of calm and tranquillity. For though four generations stand between Tiberius Gracchus’ violent death and Augustus’ rapid ascent to plenipotentiary power, the intervening century was one of virtually incessant fear and chaos. If the central analogy that animates “Mortal Republic” is correct, the current challenge to America’s political system is likely to persist long after its present occupant has left the White House. 

• Low fertility rates aren’t a cause for worry. AI, migration, and being healthier in old age mean that countries don’t need to rely on new births to keep growing economically.  

• Start-Ups aren’t cool anymore. A lack of personal savings, competition from abroad, and the threat of another economic downturn make it harder for Millennials to thrive as entrepreneurs.

• This McKinsey study of 300 companies reveals what every business needs to know about design for 2019. In a sweeping study of 2 million pieces of financial data and 100,000 design actions over five years, McKinsey finds that design-led companies had 32% more revenue and 56% higher total returns to shareholders compared with other companies.
   

• What do we actually know about the risks of screen time and digital social media? Some tentative links are in place, but many crucial details are fuzzy.

• Start-up economy is a 'Ponzi scheme,' says Chamath Palihapitiya. Tech investor Chamath Palihapitiya addressed concerns about his investment firm, Social Capital, while also calling the start-up economy "a multivariate kind of Ponzi scheme.”

Our best wishes for a fulfilling 2019, 

Logos LP