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

Market Meltdown: Correction or Destruction?

Good Morning,
 

Oh how fast things can change. After a big January, U.S. equities ended their worst week in two years as rate-hike fears pushed markets into a correction.

The recent turmoil in equities began last Friday, when the Dow fell 666 points after a better-than-expected jobs report ignited inflation fears. That fall was exacerbated Monday after the yield on the benchmark 10-year Treasury note hit a 4-year high, sending the Dow tumbling another 1,175 points as investors grew more nervous about an overheating economy.

Trouble with securities called exchange-traded notes that decline in value when volatility increases likely helped create more turmoil in the markets this week. The Cboe Volatility index (VIX) — the market's best fear gauge — shot above 40 again Friday after jumping as high as 50 earlier in the week. At the end of January, the VIX was below 14.

Traders are now focusing on next week’s U.S. consumer-price data after a week in which the 10-year yield pushed as high as 2.88 percent. Equity investors took the signal to mean interest rates will rise as inflation gathers pace, denting earnings and consumers’ spending power.

In only a week the S&P 500 has tumbled 5.2 percent, its steepest slide since January 2016. At one point yesterday before a furious rally, stocks had fallen as low as 12 percent from their latest highs. The volatility Friday was impressive: the Dow jumped 349 points in morning trading, fell 500 points later in the session, before closing 330 points higher.

Still, the selloff has wiped out gains for the year and signs have mounted which suggest that  jitters have spread to other assets, with measures of market unrest pushing higher in junk bonds, emerging-market equities and Treasuries.
 

Our Take
 

Hindsight being 20/20 it was easy to see this coming: record high valuations, record high returns (the S&P’s risk adjusted return was close to the world’s best in 2017), a strengthening economy, synchronized global growth, signs that inflation is picking up, risk-on behaviour gaining ground, massive equity inflows, monetary policy normalization, the shift from a monetary driven economy to a fiscal driven economy...the list goes on.

U.S. stocks have enjoyed a nearly uninterrupted bull market since late 2009. Two factors have helped create a Goldilocks scenario driving this surge. First, the shock administered by the 2008-2009 financial crisis left stocks significantly undervalued, creating plenty of room for equity prices to recover. Second, U.S. inflation has consistently held below the Federal Reserve’s 2 percent target, leaving the central bank with little reason to tighten monetary policy.

Finally conditions are now changing.

Stocks are richly valued and at the same time, inflation looks set to overshoot the Fed's target in the medium term. The overshoot won't be large, but it could ultimately trigger faster rate hikes than presently are being priced by the market. That could cause the bond market's yield curve to invert, as short-term rates rise above those for longer-term maturities. Fiscal stimulation is hitting the gas, which is driving the economy forward into the capacity constraints, which is triggering interest rate increases that are hitting the brakes, first in the markets and later in the economy.

This confluence of circumstances will make it difficult for the Fed to get monetary policy exactly right. As Ray Dalio has pointed out, this is classic late-cycle behavior (when it’s difficult to get monetary policy exactly right, which leads to recessions), though it is more exaggerated because the durations of assets are uniquely long, which means that when interest rates are low, prices of assets are more sensitive to changes in interest rates than when interest rates are high.

A yield curve inversion is normally a clear signal the economy is heading for a recession. We're not there yet, but the risks are rising.

Caution is warranted and longer term return expectations should be lower. Nevertheless, what so far looks like a purge of sorts, will likely be long-term positive; flushing out the excess and re-calibrating investor psychology. For now we see this pullback a potential opportunity to dollar cost down in existing positions as well as to initiate new positions at more attractive multiples. Nevertheless, a watchful eye should be set on volatility as measured by the VIX. For if the VIX continues to rise sustainably as the stock market rallies and retests its lows, more meaningful trouble may lie ahead.

Some things to consider:

The S&P 500 would have to fall an additional 52 percent to reach its long-term average valuation. Bulls have nothing to panic about yet, and bears have not been vindicated.

The return of major volatility is unpleasant for many, but does give some much-needed negotiating power to investors in IPOs and stock sales. As stock volatility jumps -- as in recent days -- so the risk of loss rises and discounts should widen. The problem is that US startups don’t want to go public anymore and that's bad news for investors.

The current market rout -- which is occurring smack dab in the middle of a nice earnings season -- may put a damper on the recent trend towards record-high takeover valuation.

Musings

After a year of abnormally low volatility, this past week has been particularly gut wrenching. But these types of selloffs should be expected in the stock market from time to time. Let's remember that although the raging bull of the 1980s and 1990s which is likely the greatest of all time in U.S. stocks, investors were forced to deal with the 1987 crash, when stocks fell more than 33 percent in the span of a week. In addition, most investors forget there was an emerging-markets crisis in 1997 and 1998 that caused the S&P 500 to fall just shy of 20 percent. Stocks still charged afterward, reaching highs in 1999 and early 2000 before crashing after the tech bubble popped.

The stock market should not be mistaken for the economy. Fundamentals are still solid and while double-digit losses should be expected when investing in equities, investors must also realize that human beings tend to panic more often when money evaporates before their eyes. In the short-term, emotion rules. In the long-term, fundamentals prevail.

Bull markets end when economies go into recession, not because of high valuations or old-age. At present, there appears to be little on the horizon to suggest the economy is on anything but stable ground as the best-known recession triggers -- asset bubbles, oil-price spikes and interest-rate hikes -- all look reasonably unlikely.

Continue to buy and hold quality at a discount, shut off the screens, get some air and be grateful.

Logos LP January 2018 Performance

January 2018 Return: 1.57%

2018 YTD (January) Return: +1.57%

Trailing Twelve Month Return: +39.19%

CAGR since inception March 26, 2014: +21.33%

Thought of the Month


 

"Then the flood came upon the earth for forty days, and the water increased and lifted up the ark, so that it rose above the earth.” -Genesis 7:17-20

Articles and Ideas of Interest

• Investors may want to calm down since history shows rising rates have been good for stocks. Using Kensho, a hedge fund analytics tool, CNBC looked at what happens during major periods of rising interest rates. The findings show there were six periods with major rises in interest rates in the last three decades. The market rose big during five of those instances and only fell slightly during the one lagging period.

• 35 steps to a market bottom by Michael Batnick. Where are we and where are you?

  -1% Mock the permabears

  -2% Meh

  -3% Yawn

  -4% Off the highs

  -5% Pullback

  -6% Healthy correction

  -7% Buying opportunity

  -8% Stay the course

  -9% This too shall pass

  -10% Correction territory

  -11% I’m a long-term investor

  -12% Stocks always come back

  -13% Don’t panic

  -14% Draw lines on a chart

  -15% Look for attractive valuations

  -16% I knew this was coming

  -17% Blame Cramer

  -18% This sucks

  -19% I should buy some downside protection

  -20% Bear market

  -21% I should have listened to my gut

  -22% Buy when there’s blood in the streets

  -23% I was early

  -24% Is this the bottom?

  -25% This sucks

  -26% Uggggh

  -27% I can’t take this much longer

  -28% I sold my stocks

  -29% I’m never buying stocks again

  -30% Good thing I sold

  -31% I should buy gold

  -32% And silver

  -33% I don’t even care anymore

  -34% Glad I stopped looking

  -35% Bottom

  
   

• President Trump’s first year in 14 metrics. A year ago, we chose benchmarks for his administration's progress. The results are in.

• Gene editing - and what it really means to rewrite the code of life. We now have a precise way to correct, replace or even delete faulty DNA. Ian Sample explains the science, the risks and what the future may hold.

• Post-work: the radical idea of a world without jobs. Work has ruled our lives for centuries, and it does so today more than ever. But a new generation of thinkers insists there is an alternative.

• It’s the (democracy-poisoning) golden age of free speech. Here’s how this golden age of speech actually works: In the 21st century, the capacity to spread ideas and reach an audience is no longer limited by access to expensive, centralized broadcasting infrastructure. It’s limited instead by one’s ability to garner and distribute attention. And right now, the flow of the world’s attention is structured, to a vast and overwhelming degree, by just a few digital platforms: Facebook, Google (which owns YouTube), and, to a lesser extent, Twitter. Yes, mass discourse has become far easier for everyone to participate in—but it has simultaneously become a set of private conversations happening behind your back. Behind everyone’s backs. Not to put too fine a point on it, but all of this invalidates much of what we think about free speech—conceptually, legally, and ethically. The most effective forms of censorship today involve meddling with trust and attention, not muzzling speech itself. As a result, they don’t look much like the old forms of censorship at all. No wonder our political future is hackable.

• Most unhappy people are unhappy for the exact same reason. In other words, every activity that didn’t involve a screen was linked to more happiness, and every activity that involved a screen was linked to less happiness. Perhaps the formula for phone addiction might double as a cure. Happiness is a skill you can build with consistent practice.

• The driverless revolution isn’t coming anytime soon. Self-driving cars have come a long way, but still have a long way to go. We’ve all heard the story at some point in the past few years. The tech and auto industries are on the cusp of rolling out vehicles that can drive themselves and will forever transform the way we move. We’ll be able to summon driverless pods that will whisk us to our destinations, making personal vehicles unnecessary and freeing up all the space wasted on parking to be used for parks and public gathering spaces — or so they tell us.

Our best wishes for a fulfilling month, 

Logos LP

Temperament Determines Outcomes

Good Morning,
 

This week U.S. stocks climbed to record highs and Treasuries rallied after a core inflation reading slowed, adding to evidence that economic growth continues apace without stoking price increases. The dollar pared losses.

The three major indexes posted slight weekly gains. The S&P 500 and the Dow recorded their fifth consecutive weekly gains, while the Nasdaq has completed three.

Bonds in Europe gained after a report that the European Central Bank may continue asset purchases for at least nine months after it starts tapering in January. The Stoxx Europe 600 Index climbed, led by steelmakers and miners as most industrial metals gained and crude oil rose back above $51 a barrel.

Excluding food and energy, so-called core prices rose 0.5 percent in September, below an estimate of 0.6 percent. At the same time, a Commerce Department report also released Friday showed U.S. retail sales rose in September by the most in more than two years, as Americans replaced storm-damaged cars and paid higher prices at the gasoline pump. Excluding autos and gas, sales still increased at the second-fastest pace since January.

The inflation data bolstered the view that U.S. inflation below the Federal Reserve’s target may be structural rather than transitory, prompting traders to slightly reduce the odds of another rate increase in December. Could the Fed be ignoring actual inflation data?

Our Take
 

As we’ve suggested in the past, inflation is simply not cooperating but the fundamentals continue to look good. The never-ending crazy going on in Washington simply hasn’t stopped the economic expansion.

The International Monetary Fund, echoing increasingly gloomy sentiment in Washington, has concluded that the Donald Trump administration and Congress probably won't succeed in enacting tax reform or even significant tax cuts. The Republican chairman of the Senate Foreign Relations Committee calls the White House "an adult day care center" and says he fears that the president's reckless bluster may lead us into World War III. The president, meanwhile, says he wants to compare IQ test scores with his secretary of state.

No worries. Investors do not appear to be concerned about any of these things. Earnings season has also gotten off to a good start, with 87 percent of the companies that have reported topping bottom-line expectations. The number of companies currently beating estimates, and the margin by which they are doing so, is running at a clip well above what these same 31 companies have recorded, on average, over the past three years.

Even Buffett thinks that stock valuations make sense with interest rates where they are. You measure laying out money for an asset in relation for what you are going to get back. You get 2.30% on the ten year. Seems fair to say that stocks will do better over the long term. In case you missed it Warren Buffett’s full interview on CNBC.

But what of the concept of Ben Graham's “margin of safety” in this "bull market in everything" environment? The idea that the price paid for an asset (stock, bond, real estate etc.) should allow for human error, bad luck or, indeed, many things going wrong at once.

In a problematic world of trade tariffs, nuclear braggadocio, nationalism and inequality such a concept is more prescient than ever. Rarely have so many asset classes -from stocks, to bonds, to gold, to real estate to bitcoins, to wine, to classic cars- exhibited such a sense of invulnerability. And all at the same time to boot! Listen to the temperature of this market. Listen for the all too familiar refrains of “this time it’s different” as they roll in. Timing markets is a fool’s game, but remaining alert to the concept of “margin of safety” is not. It may ensure survival.  

Musings
 

Many great investors suggest that generating above average investment results necessitates above average temperament.

As warren Buffett has stated: “Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

Over the last few weeks in particular I’ve observed this on numerous occasions. Individuals with seemingly above average intelligence making poor decision after poor decision, blinded by ego and jealousy. Weakened by insecurity and contempt. Burdened by an inability to move forward after failure. Influenced by “opinions” when they reach “decisions”. Led astray by their own faulty temperaments.

This week I came across an interesting piece in the Economist that made me think deeply about temperament. Management gurus have poured over a related topic endlessly: is a knack for entrepreneurship something that you are born with, or something that can be taught? In a break with those gurus’ traditions, a group of economists and researchers from the World Bank, the National University of Singapore and Leuphana University in Germany decided that rather than simply concoct a theory, they would conduct a controlled experiment.

Moreover, instead of choosing subjects from the boardrooms of powerful corporations or among the latest crop of young entrepreneurs in Silicon Valley, Francisco Campos and his fellow researchers chose to monitor 1,500 people running small businesses in Togo in West Africa.

As they reported in Science, the researchers split the businesses into three groups of 500. One group served as the control. Another received a conventional business training in subjects such as accounting and financial management, marketing and human resources. They were also given tips on how to formalise a business. The syllabus came from a course called Business Edge, developed by the International Finance Corporation.

The final group was given a course inspired by psychological research, designed to teach personal initiative—things like setting goals, dealing with feedback and persistence in the face of setbacks, all of which are thought to be useful traits in a business owner. The researchers then followed their subjects’ fortunes for the next two-and-a-half years (the experiment began in 2014).

An earlier, smaller trial in Uganda had suggested that the psychological training was likely to work well. It did: monthly sales rose by 17% compared with the control group, while profits were up by 30%. It also boosted innovation: recipients came up with more new products than the control group. That suggests that entrepreneurship, or at least some mental habits useful for it, can indeed be taught. More surprising was how poorly the conventional training performed: as far as the researchers could tell, it had no effect at all. Temperament was the determinate factor. Superior mental habits lead to outperformance.

Focusing on the theme of temperament for our own decision making at Logos LP we’ve made a conscious effort to record instances in which poor temperament has lead to poor outcomes. A record of instances when either we or those around us have let poor temperament wreak havoc upon output. The journal gets re-visited on a monthly basis in order to develop an awareness of trends or patterns. Action items are them developed to alter behaviour.

For the next six months try and keep track of all of your major decisions and thoughts in a journal. This will help to build an awareness of the way your decisions are made and their associated outcomes. What you may find is that you develop more control over yourself and your decision making. Education comes from within; you get it by personal struggle, effort and thought. Live in the process…

Thought of the Week

"If you do not conquer self, you will be conquered by self.” - Napoleon Hill

Articles and Ideas of Interest

• There’s nothing old about this bull market. Claims that it’s the second-longest ever don’t hold up. Barry Ritholtz makes a convincing case that the current bull market is only four and a half years years old. The best starting date of a new bull market is when the prior bull-market highs are eclipsed. That is how we get a date like 1982 as the start of the last secular long-term bull market. And it is also how we get to March 2013 as the start date of this bull market, when the S&P 500 topped the earlier high of 1,565 set in October 2007. Could we just be approaching the middle of the run?

• Debt keeps rising and nothing bad happens. Economists are stumped. As the Republicans prepare for their big tax reform push, the issue of deficits and debt is once more coming to the fore. Many economists realize that tax cuts, especially income tax cuts, tend to increase deficits, which over time lead to increases in the national debt. The GOP plan, if adopted, probably would pump up both deficits and debt. So the question is: Is more debt good, bad or does it even matter? But if it’s bad, how serious a problem is it?

• Ideas aren’t running out, but they are getting more expensive to find. The rate of productivity growth in advanced economies has been falling. Optimists hope for a fourth industrial revolution, while pessimists lament that most potential productivity growth has already occurred. This must read piece argues that data on the research effort across all industries shows the costs of extracting ideas have increased sharply over time. This suggests that unless research inputs are continuously raised, economic growth will continue to slow in advanced nations.

• Bitcoin resumed its climb. After tearing past $5,000 on Thursday, the cryptocurrency soared above $5,800 on Friday. JPMorgan CEO Jamie Dimon, who told investors last month that bitcoin was a bubble “worse than tulip bulbs,” said Thursday he doesn’t want to talk about it anymore.  But on Friday, Dimon responded to a question about bitcoin by saying if people are "stupid enough to buy it," they will pay the price for it in the future. The craze rolls on with hedge funds flipping ICOs and receiving preferential discounts and terms. Here’s the deal with an ICO: You can buy entry in a computer ledger issued by a start-up company on the basis on an unregulated prospectus. It is called an ICO (“Initial Coin Offering”) but though the ledger entry is called a coin, you cannot spend it at any shop. And whereas the use of the term ICO makes it sound like an IPO (initial public offering), the process whereby a firm lists on the stockmarket, coin ownership does not necessarily get you equity in the company concerned. The Economist points out that this is the kind of bargain that would only appeal to people who reply to emails from Nigerian princes offering to transfer millions to their accounts. There is a serious side to the craze as there was with the dotcom boom. The technology that underpins digital currencies- the blockchain- is an important development. The problem is that it is not easy to draw a line between financial innovation and reckless speculation.

  
   

• Dating apps are reshaping society. There’s been a big uptick in interracial and same-sex partners who find each other online. Interesting research presented in the MIT Tech Review which tends to support that there is some evidence that married couples who meet online have lower rates of marital breakup than those who meet traditionally. That has the potential to significantly benefit society. And it’s exactly what new data models predicts. Perhaps online dating isn’t all bad. Important to think about as Berkshire Hathaway CEO Warren Buffett recently stated that making money means nothing without having another person, such as a spouse, to share the wealth with. Who you marry, which is the ultimate partnership, is enormously important in determining the happiness in your life and your success. A study published by Carnegie Mellon University found that people with supportive spouses are "more likely to give themselves the chance to succeed."

• The loneliness epidemic. This may not surprise you. Chances are, you or someone you know has been struggling with loneliness. And that can be a serious problem. Loneliness and weak social connections are associated with a reduction in lifespan similar to that caused by smoking 15 cigarettes a day and even greater than that associated with obesity. But we haven’t focused nearly as much effort on strengthening connections between people as we have on curbing tobacco use or obesity. Loneliness is also associated with a greater risk of cardiovascular disease, dementia, depression, and anxiety. At work, loneliness reduces task performance, limits creativity, and impairs other aspects of executive function such as reasoning and decision making. For our health and our work, it is imperative that we address the loneliness epidemic quickly.

Our best wishes for a fulfilling week, 
 

Logos LP

• Asset Management 4
• Ideas 19
• Macro 9
• Newsletter 87
• Psychology 4
• Strategy 7

Stealth Bear Markets

Good Morning,
 

U.S. equities managed to stage a comeback from their session lows on Friday after Steve Bannon, one of President Donald Trump's top advisors, left the administration. Traders at the New York Stock Exchange literally cheered the news that Bannon was out of the administration.

The Dow and the S&P fell 0.8 percent and 0.7 percent for the week, respectively, marking their first two-week losing streak since May. The Nasdaq, meanwhile, posted a four-week losing streak, its longest of the year.

In Europe, stocks extended their declines after a horrific terrorist attack in Barcelona added to unease about U.S. policy paralysis and lingering tensions over North Korea.

Tension between Bannon and other top advisors to Trump, including Chief Economic Advisor Gary Cohn and National Security Advisor H.R. McMaster, had been intensifying inside the White House. On Wednesday, Reuters reported that disagreement between Bannon and McMaster is destabilizing Trump's team.

As volatility picked up this week with the VIX rallying roughly 44% from its lows only a month ago, investors grew worried that Trump's economic agenda, which includes tax reform and fiscal stimulus, will not get through Congress. These concerns only grew as backlash multiplied from Trump's remarks following the violent protests in Charlottesville, VA.

This led to Trump dissolving two CEO advisory forums, one of which included JPMorgan Chase's Jamie Dimon. Rumors also started circulating Thursday that Cohn, Trump's top economic advisor, could resign amid the fallout.

Investors pulled $1.3 billion from equity funds in the week ending Aug. 16 as tensions over the Korean peninsula escalated, according to EPFR Global data. Outflows from U.S. stock funds were triple that, suggesting a growing risk off attitude.

Our Take
 

Largely lost in the debate over how much credit President Donald Trump should or should not get for the performance of U.S. stocks this year is that perhaps the biggest reason for the rally is strong earnings. With more than 90 percent of the S&P 500 members having reported second-quarter results, earnings growth is tracking at a 12.2 percent pace year-over-year, much better than the 8.4 percent expected, according to Bloomberg Intelligence.

All sectors of the benchmark are on pace to beat projections, except energy, where less than 40 percent of companies topped earnings forecasts. Technology and healthcare continue to lead upside surprises, with more than 85 percent of tech companies and 75 percent of health companies posting better-than-expected earnings per share.

This is all great news yet markets are forward looking, so it stands to reason that what happens next in earnings should have a big influence on the direction of stocks.

That’s where things may be looking a bit less tremendous. Despite the positive earnings surprises in second-quarter results, S&P 500 profit estimates for the next four quarters continue to edge lower. Earnings per share forecasts for the index through mid-2018 have been reduced by 0.7 percent since the end of June, with the fourth-quarter bearing the brunt of downward revisions, according to Bloomberg Intelligence. But should this worry the prudent long-term investor?

FactSet this week presented a nice overview of the charts/data that tell the story of 2017 so far. A few interesting trends which we believe are likely to continue through Q3 and Q4 were:

1) Consumer spending is not keeping up with consumer sentiment (not a good thing)

2) Consumer price inflation is slowing even as the Fed is planning to tighten (also not good)

3) Companies in the S&P 500 with more global revenue exposure are projected to report higher earnings and revenue growth in 2017 relative to companies in the index with less global revenue exposure. (perhaps a source of opportunity)
 

At the sector level, the Information Technology sector is expected to be the largest contributor to earnings and revenue growth in 2017. No wonder the Russel 2000 is up a measly 0.05% YTD while the Dow is up 9.67% and the S&P 500 is up 8.33%.

Absent any significant changes in foreign exchange rates and global GDP growth in the second half of 2017 which could alter these expected earnings and revenue growth rates for the full year, it is unlikely that David Tepper’s bold call that technology stocks "look cheaper than any other part of the market even though they moved” will prove foolish.  

So what are the opportunities? Well, we have spotted one such opportunity that recently took a dive after an earnings miss: Priceline Group Inc. (NASDAQ: PCLN).

This online travel reservation business has been growing pre-tax earnings over the last decade at a compound annual rate of 42% per year. That is faster than Apple, Amazon, Netflix, Alphabet and Expedia (Expedia has been growing EBITDA over the last decade at around 7%).

Average ROE is about 28.4% and long-term prospects also look favorable. Last year travel accounted for roughly 10% of global GDP or $7.6 trillion and only about ⅓ of it is booked online. This share is expected to grow by a few percentage points per year and thus although rivals such as AirBnB, Tripadvisor, Expedia, Ctrip and perhaps Google are circling, the future looks bright indeed.

Sitting roughly 12% off its 52 week high Priceline is getting attractive. A move under 1600 or another 12% down from current levels and we would look to initiate a position.

Musings

Came across a pretty interesting chart this week from Michael Batnick which painted a nice picture of how the market has scaled the “wall of worry” in defiance of a plethora of doomsday predictions of an imminent selloff.

As the graph shows, since stocks bottomed in March 2009, the S&P 500 index has soared 271% to multiple records, meandering higher through the European debt crisis, Brexit, and the U.S. presidential election.

Political upheaval certainly does not necessarily translate to market volatility. But more importantly, the chart got me thinking about a common refrain these days: “things can’t keep going up like this”. Is that true? Are “things” bound to collapse? What may be more relevant to consider is what we mean by “things”?

Looking at this current market as a "market of stocks" rather than as a "stock market" it is clear that “things” most certainly cannot keep going up and in fact “things” most certainly are not continuously going up: The average Russell 2000 stock is already in a bear market, falling 22.42% from its 52-week high. The median Russell 2000 stock is 17.38% from its 52-week high. Likewise, the average and median S&P 500 stock are 8.04% and 11.77% from their 52-week highs.

What of this record bull market then? Well it may be that we have experienced several “stealth” bear markets within the current long-term uptrend.

It should be remembered that market crashes of over 30% are incredibly rare events. Could the bear market that so many people are predicting these days have already happened?

I think this an argument worth considering given the fact that research has shown that in 189 years of stock returns only 3 times since 1825 did the market finish a calendar year down 30% or worse. That’s about once every 63 years...recency bias is a hell of a drug...
 

Logos LP July Performance

 

July 2017 Return: -1.16%

2017 YTD (July) Return: +18.67%

Trailing Twelve Month Return: +21.59%

3-Year Annualized Return: +22.55%

Thought of the Week

"After seeing a movie that dramatizes nuclear war, they worried more about nuclear war; indeed, they felt that it was more likely to happen. The sheer volatility of people's judgement of the odds--their sense of the odds could be changed by two hours in a movie theater--told you something about the reliability of the mechanism that judged those odds.” -Michael Lewis

Articles and Ideas of Interest

• Ten years ago from August 9, people weren’t that worried about impending financial doom. Ten years ago August 9, all was not well with the global financial system. On Aug. 9, 2007 BNP Paribas froze more than $2 billion in funds, barring investors from withdrawing their money due to a “complete evaporation of liquidity in certain market segments.” This marked the beginning of a dangerous new phase in what eventually developed into the worst economic downturn since the Great Depression. What did we learn? Reuters puts together a decade in charts. Financial Times suggests that there were clear warnings that Wall Street ignored.

• Time to focus on return of capital strategies? Is there anybody left recommending risk assets? It sure seems like if there are, they are few and far between. The number of influential pundits warning about the risk of investing in assets such as corporate bonds and equities is growing exponentially. Recently it was Oaktree Capital Group co-Chairman Howard Marks and former Federal Reserve Chairman Alan Greenspan. Last week, it was the likes of DoubleLine Capital Chief Executive Officer Jeffrey Gundlach, HSBC Holdings’ head of fixed-income research Steven Major and Pantheon Macroeconomics Chief Economist Ian Shepherdson. Have we reached the point in the investment cycle where you’ve got to start thinking the return on capital is rather less important than the return of capital…Luckily for doomsday preppers, the end of the world is good for business.

• Is passive investing “devouring capitalism”? Billionaire Paul Singer is warning of a growing and menacing threat: passive investing.“Passive investing is in danger of devouring capitalism,” Singer wrote in his firm’s second-quarter letter dated July 27. “What may have been a clever idea in its infancy has grown into a blob which is destructive to the growth-creating and consensus-building prospects of free market capitalism.” Almost $500 billion flowed from active to passive funds in the first half of 2017. The founder of Elliott Management Corp. contends that passive strategies, which buy a variety of securities to match the overall performance of an index, aren’t truly "investing" and that index fund providers don’t have incentive to push companies to change for the better and create shareholder value. Cranky underperforming manager (Singer’s Elliott Associates fund rose 0.4 percent in the second quarter, bringing gains for the first half to 3.5 percent) or luminary? The Atlantic explores the growing chorus of experts that argue that index funds are strangling the economy. I would agree. Diversification has brought undeniable benefits to large numbers of Americans. If recent scholarship is right, it has brought hidden costs to many more. For the opposing view see Gadfly.

• Forget robots — “super-workers” may be coming for your job. According to a report from PwC, one outcome of technology and automation could be the rise of the medically-enhanced “super-worker” by 2030. These workers will combine man, machine, and medical enhancements (like pharmaceuticals to boost cognition) to secure employment and guarantee performance in an increasingly competitive labor market. 70% of those surveyed by PwC said they’d undergo treatments to improve their bodies and minds if it would help their job chances. On a small scale, some of this is already happening: A Wisconsin firm recently made headlines for microchipping employees.

• Lego-Like brain balls could build a living replica of your brain. The human brain is routinely described as the most complex object in the known universe. It might therefore seem unlikely that pea-size blobs of brain cells growing in laboratory dishes could be more than fleetingly useful to neuroscientists. Nevertheless, many investigators are now excitedly cultivating these curious biological systems, formally called cerebral organoids and less formally known as mini-brains. With organoids, researchers can run experiments on how living human brains develop—experiments that would be impossible (or unthinkable) with the real thing.

• Digging for digital gold in Inner Mongolia. The crypto currency mania shows no sign of abating. Consider the case for $5000 bitcoin (why not $10000?). Yet also consider that at the heart of bitcoin are miners running massive computing operations to earn the $7 million up for grabs each day for solving complex mathematical equations. Zheping Huang and Joon Ian Wong got access to one of the world’s largest bitcoin mines, Bitmain, and offer a rare look at the lives of its workers, as does a photo essay for Quartz by Aurelien Foucault. I see bitcoin as here to stay. Perhaps grandpa had a pension and this generation has cryptocurrency. Great piece in the New York Times suggesting that “as traditional paths to upper-middle-class stability are being blocked by debt, exorbitant housing costs and a shaky job market, these investors view cryptocurrency not only as a hedge against another Dow Jones crash, but also as the most rational — and even utopian — means of investing their money."

Our best wishes for a fulfilling week, 
 

Logos LP