The Market Will Crash [Insert Percentage]

Good Morning,
 

U.S. stocks finished slightly higher on Friday to set another round of record closes.

The major averages finished with modest gains for the week, as the strong rally which opened February has now taken a little breather. 

The market ground higher to notch records this month as investors remained hopeful for a smooth economic reopening as well as additional Covid stimulus. The Dow has gained 4.9% in February, while the S&P 500 and the Nasdaq have rallied 5.9% and 7.8%, respectively. The S&P 500 has raked in ten record closes in 2021.

Cyclical sectors, those most sensitive to an economic rebound, led the rally in February. Energy is up more than 13% month to date, with financials and materials also among the leading sectors. Nevertheless, while the "other" segments of this market garner the attention, it is important to acknowledge that this is a very broad based rally. 

Our Take

The medical and economic picture is improving and investors seem to be taking notice. Additionally, fourth-quarter earnings are rolling in well ahead of expectations, and analysts are now adjusting their 2021 earnings estimates upwards. Furthermore, if you take the time to look beyond the headlines - dominated by Reddit speculation stories (many of which have since sold off mercilessly) or “everything is a bubble” stories - investors have appeared to react rationally to underwhelming earnings prints from high-multiple “darling” stocks selling them off aggressively.  

For all the unprecedented events and unforeseen consequences of the past year, all the fear mongering of bubbles and exuberance, market conditions today actually resemble quite closely to those of mid-February 2020, when stocks peaked right before the Covid crash. Interestingly, the S&P 500 (since its pre-Covid peak February 10, 2020) is only about 15% higher one year on. Is that euphoria? 

Much of the discourse around the market is also similar; worries that too much of the market is dominated by a few large growth stocks (the top five S&P stocks were 20% of the index then and are 22% today) and that investor sentiment had grown complacent or even euphoric.  

Back then, and like today, the S&P was at a 20-year high in terms of valuation, the forward price/earnings ratio then just above 19 and now surpassing 22 – yet for those who choose to compare equity earnings yields to Treasury yields, the gap is pretty close: 3.7 percentage points then versus 3.3 now.

Nevertheless, there are some key differences. The economic collapse brought on by government induced lockdowns reset the clock on the economic cycle and accompanying policy stances. 

Michael Santoli reminds us that from 2019 into 2020 Wall Street was caught in a late-cycle set-up, with the economy near peak employment, the Treasury yield curve flat, corporate profit margins near peak, and earnings projected to be flat.

Short rates were higher at 1.5-1.75%, the Fed was on hold indefinitely yet certain Fed officials were projecting a rate hike in 2021.

The flash recession and profit collapse led to one of the greatest deficit-financed fiscal support binges in history ($5 trillion and counting) and turned the Fed maximum accommodative focused on a return to full employment coupled with a lasting rise in inflation before any whisper of normalization. 

So, yes, valuations are higher now and investor expectations could be growing more willy nilly yet corporate America just refinanced itself for years to come at ultra low rates with a Fed and government who have gone all in on the “Wealth Effect”. 

The "Wealth Effect" is the notion that when households become richer as a result of a rise in asset values, such as corporate stock prices or home values, they spend more and stimulate the broader economy. 

Asset Price Increases = Spending Increases = Employment Increases

Now in 2021, earnings will be back above their prior peak, government is eager to run the economy hot and policy makers (arguably) just pulled off a repeatable process for sidestepping a recession. 

For us, we do believe certain themes and stocks are running hot and that the major indexes look tired. As such, we maintain a focus on individual names. We expect divergences to emerge across sectors with higher volatility for the rest of the year. We see opportunities in individual small-caps particularly in names that are under-the-radar and still have long-runways and thus real value. Think bio-tech, health-tech, clean-tech and certain basic materials. We also like smaller emerging markets (Asia) that can benefit from a weaker U.S. dollar and still have upside to historical valuations.
 

Musings

So are we in a "different " investment world today? Have the old rules changed? Or will all the “pundits” pointing to history (South Sea bubble, 1929, and 2000) calling for an epic crash be vindicated? 

The short answer is they might, as the future is unknowable. Yet today we believe that one should be cautious when applying investment history to the present in order to predict the future. 

The further back in investment history you go the more likely you are viewing a world that no longer applies to the present moment. 

As Morgan Housel reminds us in his fabulous book, investment history matters, yet if one relies too heavily on it, one will likely miss the outlier events that have the greatest impact.

It is important to remember that most of what is happening at any given moment in the global economy can be linked to a handful of past events that were nearly impossible to predict.

Think: the invention of the printing press, the first passenger plane, penicillin, the integrated circuit, the internet, the Great Depression, WWII, September 11th and Covid-19 to name a few.

The most common denominator of economic history is the role of surprises. The danger investors face is taking the worst and best events of the past and assuming they will occur again in the future. They make the assumption that a history of unprecedented events doesn’t apply to the future. This isn’t a failure of analysis but a failure of the imagination.

Instead, we believe that the future might not look anything like the past and this need for imagination grounds our approach to investing. We understand that the things that will move the needle the most are the things history gives us no guide to understanding or necessarily predicting.

We also understand that history can be a misleading guide to the future of economies and stock markets as it has difficulty accounting for unique structural changes that are key to today’s world.
 

Historical theories about recessions, interest rates, inflation and purchasing stock often look tired when applied to today’s world. We take cues from the past, but believe in the power of adapting such learnings to the present.

Constant experimentation, retesting of assumptions and adaptation is crucial for lasting investment success. Tethering to past events, patterns and ideas can bring comfort but it can also lead to destructive blind spots.

Human nature and human behaviours tend to be stable over time, yet specific investment trends, causal relationships and strategies are constantly evolving. 

Regardless of whether the pundits are at some point proven correct, those who can free their minds and evolve their ideas and biases tilt the odds of outperformance in their favour.

Charts of the Month

County-level data on U.S. stock market holdings suggest that rising share prices induce consumer spending, which raises employment and wages.

Cross-border investment fell off a cliff in 2020, dropping 42% to $859 billion from 2019's $1.5 trillion, according to official UN figures.

Logos LP January 2021 Performance

January 2021 Return: 11.71%

2021 YTD (January) Return: 11.71%

Trailing Twelve Month Return: 116.73%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 27.10%
 

Thought of the Month

“In general I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook was first published. But the situation has changed a great deal since then.” -Benjamin Graham

Articles and Ideas of Interest

• Why a dawn of technological optimism is breaking. The 2010s were marked by pessimism about innovation. The Economist suggests that is giving way to hope. For much of the past decade the pace of innovation underwhelmed many people—especially those miserable economists. Productivity growth was lacklustre and the most popular new inventions, the smartphone and social media, did not seem to help much. Their malign side-effects, such as the creation of powerful monopolies and the pollution of the public square, became painfully apparent. Promising technologies stalled, including self-driving cars, making Silicon Valley’s evangelists look naive. Security hawks warned that authoritarian China was racing past the West and some gloomy folk warned that the world was finally running out of useful ideas. Today a dawn of technological optimism is breaking. The speed at which covid-19 vaccines have been produced has made scientists household names. Prominent breakthroughs, a tech investment boom and the adoption of digital technologies during the pandemic are combining to raise hopes of a new era of progress: optimists giddily predict a “roaring Twenties”. Just as the pessimism of the 2010s was overdone—the decade saw many advances, such as in cancer treatment—so predictions of technological Utopia are overblown. But there is a realistic possibility of a new golden era of innovation that could lift living standards, especially if governments help new technologies to flourish. Opportunities abound. The future is bright.

• Canadians’ wealth is tied to their parents’ more than ever, StatCan finds. A new study has found that the likelihood of Canadians staying within the same income and wealth class as their parents has increased significantly. The report, released Wednesday by Statistics Canada, measured the incomes of five different cohorts of children born between the 1960s and 1980s, as well as that of their parents. It found that intergenerational income mobility — the degree to which a person’s income and wealth could move further from that of their parents — had declined across all of the cohorts.

• As Vaccines Raise Hope, Cold Reality Dawns: Covid-19 Is Likely Here to Stay. Governments and businesses are starting to accept that the coronavirus isn’t a temporary problem and instead will lead to long-term changes enabling society to co-exist with Covid-19, as it does with flu, measles and HIV.
  
   

• 'Alarming' numbers show Canadian business investment has plunged to just 58 cents for every dollar spent in the U.S. Canadian business investment numbers out today ‘tell a bleak story’ of a nation that will struggle to compete when it emerges from the COVID-19 pandemic. The pace of business investment’s decline over the past five years has been alarming, says the C.D. Howe Institute report, entitled “From the chronic to the acute: Canada’s investment crisis.” After “slipping badly” since 2015, it has now plunged in 2020 to the lowest since the beginning of the 1990s, widening the gap between us and the United States and other OECD countries.

• While the world is in the midst of a tech revolution, Canadians (as usual) bet on real estate. Now, the addiction is simply embarrassing. The world is in the midst of a transformative shift to a digital and carbon-neutral economy, a once-in-a-lifetime investing opportunity, and where are Canadians placing their bets? Houses, for the most part. We’ve resumed, after a brief cooldown, plowing a ridiculous amount of money into assets that do nothing to improve the country’s ability to generate wealth. Housing accounted for 37 per cent of overall investment, while business spending on machinery and equipment and intellectual property dropped to 28.2 per cent, the highest and lowest levels, respectively, since early 1993.

• GameStop may not have been the retail trader rebellion it was perceived to be. The prevailing narrative of a retail investor revolution or a David vs. Goliath battle seems flawed. Data shows institutional investors as drivers of a large portion of the wild price action in GameStop. GameStop was not even in the 10 most-bought names by retail investors that month, according to JPMorgan.

• Markets that are definitely NOT in a bubble. If it feels like we’ve been debating a stock market bubble in the U.S. for a decade it’s because we have. LOL Ben Carlson suggests that the longer this goes the louder the chorus of bubble-callers will get. And maybe they’ll be right eventually. Bubbles are basically an American past-time. We can debate all we want about whether we’re in a bubble or not and there are compelling arguments on each side. But there are plenty of other markets that are certainly not in a bubble. Ben puts together a compelling list. Emerging markets representing the most interesting opportunity.

• SPACs are red-hot—but they’ve been a lousy deal for investors. For the dealmakers who put SPACs together, the upsides are obvious. For investors, not so much. For the dealmakers who put SPACs together, the upsides are obvious. They can skip the headache of a road show—in which a company’s top executives make the same pre-IPO presentation over and over to would-be investors—as well as avoid the customary 7% fee normally paid to underwriters. Meanwhile, the organizers typically pocket 20% of the SPACs, a reward known as the “sponsor promote” for their trouble. In other words, the SPAC has plenty of upside and almost no downside. Well, no downside for the SPAC organizers that is. For ordinary investors, though, SPACs have often proved to be a rotten deal. For 107 SPACs that have purchased companies since 2015, the average return on common stock has been a putrid negative 1.4%. That compares with a 49% return for companies that went public via the traditional IPO route during the same period, according to data cited by the Wall Street Journal.

• Tom Lee says rising retail interest won’t mark a market top, could be the start of a long-term trend. The previous decade has been characterized by large inflows in bonds despite the bull market in stocks. This could be the first year out of ten years where there’s real inflows into stocks.

• Social-Media algorithms rule how we see the world. Good luck trying to stop them. What you see in your feeds isn’t up to you. What’s at stake is no longer just missing a birthday. It’s your sanity—and world peace. Fascinating article in the WSJ outlining how computers are in charge of what we see and they’re operating without transparency.

• The battery is ready to power the world. After a decade of rapidly falling costs, the rechargeable lithium-ion battery is poised to disrupt industries. The WSJ digs in. We like MP Materials as a long term benefactor of this disruption.

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

Logos LP

Amor Fati

Good Morning,
 

Stocks closed at record highs on Friday to end the first trading week of the year as traders weighed the prospects of new fiscal aid as well as disappointing U.S. jobs data.

Stocks started off the new year with a slump on Monday, but the market churned higher as expectations of more government aid increased with Democrats winning two key Senate races in Georgia, according to NBC News projections.

The U.S. economy lost 140,000 jobs in December, the Labor Department said. Economists polled by Dow Jones expected a gain of 50,000.

The unexpected drop in employment came as the recent surge in COVID-19 cases across the country has forced state and local governments to re-take stricter measures to mitigate the outbreak. More than 21.5 million coronavirus cases have now been confirmed in the U.S., according to data from Johns Hopkins University. The U.S. reported more than 4,000 COVID-19 deaths Thursday -- the most virus-related deaths the country has reported in one day since the pandemic's start.

It's the third day in a row of record daily deaths from the disease, according to data from Johns Hopkins University. 

Still markets surged higher the weaker-than-expected employment print raised the possibility of more government aid from the incoming Biden administration.

Our Take
 

What a year: a global pandemic, continuous shutdowns, unparalleled government and central bank intervention, the fastest 30% drop in market history, the shortest bear market ever, followed by the quickest recovery on record!

Reflecting back on 2020, the qualities of water go far to describe what surprisingly turned out to be a great year for the bullish investor who was able to stay disciplined despite the chaos. 

Why did the markets end the year in a resounding crescendo of all-time record highs? The primary reason the rebound was so swift was due to overwhelming government and central bank intervention which allowed most business entities to keep the lights on during even the darkest of COVID-19 days. Many vulnerable “old economy” businesses were never forced to close their doors while COVID-19 made it apparent to investors that “disruptive innovation” based businesses (such as DNA sequencing, robotics, energy storage, artificial intelligence, digitization and blockchain technology) form the backbone of economies all around the globe.

The message from the stock market was clear. It saw and continues to see an economy that is fundamentally changed due to technology and is resilient enough to recover. Both the investor who was positioned in “disruptive innovation” before COVID-19 struck, and the investor who quickly recognized this theme and repositioned their portfolio, did extraordinarily well in 2020.

When it came to our portfolio at Logos LP, coming into 2020, its composition reflected an early recognition of how fundamental the above theme of “disruptive innovation” and technological change was becoming, but in the depths of March as markets plunged “limit down” and lockdowns began to grip the globe, we felt that the global economy had likely entered a period of convulsive changes, some positive and others devastating, that would shape financial markets for years to come.

As such, our portfolio’s composition has shifted to reflect our core belief that revolutionary technological changes are creating not only exponential growth opportunities but also black holes in global economies and financial markets.

Contrary to the popular discourse which pits “growth against value”, we believe that 2020 has shown us a way to synthesize the two seemingly opposite investment approaches.

In modesty, just as in the 1930s and 1940s when Benjamin Graham argued that the old investing framework which was dominated by railway bonds and insider dealing had become obsolete, we believe that the classical “value investing” doctrine can be updated.

Just as Graham provided a much-needed overhaul of investment doctrine, we believe that value investors today can improve their frameworks by incorporating into their analyses the rise of intangible assets and the importance of externalities ie. costs that firms are responsible for but avoid paying. 

From 2020 on, it has become apparent that innovation is evolving at such an accelerated pace that traditional equity and fixed-income benchmarks are being populated increasingly by so-called value traps, stocks and bonds that are "cheap" for a reason. As such, we believe that future investment success will require a certain amount of “adapting to the course of the river” in order to find oneself on the right side of disruptive change and innovation.

In John Templeton’s timeless 16 rules for Investment Success (published in 1933) he states:

“The investor who says, ‘This time is different,’ when in fact it’s virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing.”

For those who may suggest that all this talk about “disruptive innovation” amounts to the same old “This time is different” story, it is important to remember a quote by Blogger Jesse Livermore at Philosophical Economics: 

“Not only is this time different, every time is different.  That’s why so many investors are able to outperform the market looking backwards, using curve-fitted rules and strategies. But when you take them out of their familiar historical data sets, and into the messiness of reality, where conditions change over time, the outperformance evaporates.”

He continues:

“Now, in hearing this suggestion, readers will scoff: “So you’re saying this time is different?” Of course I am.  Of course this time is different.  By suppressing this conclusion, even when the data is screaming it in our faces, we hinder our ability to adapt and evolve as investors.  Reality doesn’t care if “this time is different” will upset people’s assumptions and models for how things are supposed to happen. It will do whatever it wants to do.”

This is the problem with many more “traditional” value investors who for years now have found themselves on the wrong side of disruptive change and innovation. The process of learning and growing as an investor is never over. It is a lifelong pursuit.

Alternatively, investors that blindly follow valuation metrics based purely on past averages are falling prey to their own psychological issues even though they think they are acting rationally by following their models.

To simply look back historically at a few classic valuation metrics and say prices are below average, so buy or prices are above average so sell is a recipe at best for mediocrity and at worst for disaster.

It’s never that black and white. If investors would have simply followed those easy models, they would have likely sat on the sidelines for the bulk of this market cycle. It’s far too difficult to use one or even a handful of classic indicators to know exactly when a cycle is at a major inflection point and about to change directions because at the end of the day they are driven by irrational human emotions.

Perhaps our biggest investment takeaways from 2020 is that markets will:

1) always be different in terms of their current state and what factors are contributing to the prices of certain securities. We believe that moving forward, avoiding industries and companies in the clutches of "creative destruction" and embracing those creating "disruptive innovation" will prove lucrative; and

2) never be different when it comes to our inherent irrational human emotions and biases: manias and panics won’t be disappearing any time soon.

Musings

Investors ended one of the market’s wildest years on record by piling into everything from bitcoin to emerging markets, raising expectations that a powerful economic comeback will fuel even more gains.

The breadth of this rally is remarkable. It can be thought of as an “everything rally” which has sent most assets to record highs. It was a good year for those who held assets and a painful year for those with few skills, little education and no assets. The result is a financial chasm between the have and the have-nots which is much deeper than what existed prior to the onslaught of COVID-19.

We expect the chasm to widen even further in the coming years as disruptive innovation wreaks havoc on any individual or company not investing aggressively in innovation. In harm's way are companies that have spent the last 10-20 years engineering their financial results to satisfy the short-term demands of short-sighted investors and individuals who are unwilling to update their playbooks and skillsets. We believe the winners will win big and the losers, particularly those that have levered balance sheets (often companies who employ many low skilled workers) to satisfy certain stakeholders, and those who refuse to upskill will be dislocated leading to even greater levels of permanent unemployment.

Nevertheless, we believe there is reason for optimism.

1) The economy and markets have a history of finding a way through unprecedented challenges. It is important to reflect on the historical ability of humankind to adapt and innovate in the face of hurdles, even those that seemed insurmountable. We created a vaccine in record time, avoided what could have been an economic depression and will continue to push on in 2021.
 

2) There are still compelling reasons to invest in 2021. There's still much work to be done, but the U.S. and global economies are on a trajectory of recovery, which provides a favorable environment for risk assets. On the whole, U.S. economic data is still coming in better than expected, even if momentum has slowed. Manufacturing activity, initial unemployment claims and consumer activity have all rebounded impressively off lows. The Federal Reserve is unlikely to deviate from its accommodative course especially with so many still unemployed. Economies are getting massive liquidity injections, cash in circulation is soaring and annual growth of U.S. cash in circulation typically peaks at the start of economic cycles. The world is positioned for synchronized global growth and companies are positioned for impressive earnings growth. Inflation may ramp up a bit, but we think that the probability that it will upend markets in any meaningful way is low as policy makers and central banks are well aware of the disastrous consequences of any sudden rise in inflation (asset prices at all time highs supporting the “wealth effect” underpinning the recovery, a plethora of overleveraged zombie firms and perhaps most importantly most states’ vastly expanded balance sheets-both governments’ debt and central banks’ liabilities). 
 

3) A business-friendly approach to taxes and regulation has been a key driver of markets over recent years and there is little reason to believe this will change as there is little appetite to derail the fragile recovery and instead, there is appetite for major infrastructure spending. With neither political party having a significant majority in the Senate, this will likely mitigate the scale of fiscal policy shifts.

The real question is how much of the above 3 factors have investors already priced into markets? To what extent have investors pulled forward future returns to the present?

We are certainly flying high yet that doesn’t mean that stocks can’t push higher still. When studying the history of stock market excesses, particularly the excess of the 1999/2000 era what is apparent is that calling the market overextended or spotting a bubble is easy as investors were comparing the internet sector to tulip mania as early as mid-98. What is much more difficult is the ability to time a profitable exit...

As Epictetus in Discourses, 2.5.4-5 reminds us:

“The chief task in life is simply this: to identify and separate matters so that I can say clearly to myself which are externals not under my control, and which have to do with the choices I actually control. Where then do I look for good and evil? Not to uncontrollable externals, but within myself to the choices that are my own…”

2020 so starkly reminded us of the virtues of humility. To be humble in our predictions and forecasts. Humble as to what we believe we can control. Humble as to our talents and abilities. Open to an attitude of “Amor fati” which may be translated as "love of fate" or "love of one's fate".

Willing to embrace an attitude in which one sees everything that happens in one's life, including suffering and loss, as good or, at the very least, necessary.

Charts of the Month

Financial conditions are also the most loose on record.

While many stocks have delivered other worldly performance.

As mania spread to derivatives.

Amazing comeback story.

Last year 54% of all new cars sold in Norway were battery-powered electric vehicles, making Norway the first country in the world where electric vehicles (EVs) outsell traditional petrol, diesel or hybrid vehicles. With new models from Tesla, BMW, Ford & Volkswagen all due to hit the market next year, Norway seems very much on track to meet their target of ending the sale of diesel and petrol cars by 2025. Perhaps the world is next?

Logos LP December 2020 Performance

December 2020 Return: 5.48%
 

2020 YTD (December) Return: 99.71%
 

Trailing Twelve Month Return: 99.71%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +25.43%

Thought of the Month

"Join with those who are as flexible as the wood of your bow and who understand the signs along the way. They are people who do not hesitate to change direction when they encounter some insuperable barrier, or when they see a better opportunity. They have the qualities of water: flowing around rocks, adapting to the course of the river, sometimes forming into a lake until the hollow fills to overflowing, and they can continue on their way, because water never forgets that the sea is its destiny and that sooner or later it must be reached.” — Paulo Coelho “The Archer”

Articles and Ideas of Interest

• The pro-Trump mob was doing it for the gram. But it was also quickly apparent that this was a very dumb coup. A coup with no plot, no end to achieve, no plan but to pose. Thousands invaded the highest centers of power, and the first thing they did was take selfies and videos. They were making content as spoils to take back to the digital empires where they dwell, where that content is currency.

• What Warren Buffett’s losing battle against the S&P 500 says about this market. In 2020, Berkshire Hathaway shares were up, but not by much (2%), against an S&P 500 that gained over 18%, with dividends reinvested, according to S&P Global. Taken together, the two-year stretch of 2019 and 2020 marked one of the biggest gaps between Berkshire and the broader U.S. stock market in recent history, with the Buffett trailing the index return by a combined 37%. What does it mean?

• Does Joe Biden have too much power as he will undoubtedly face pressure from extremist left to use it? Joe Biden has a problem on his hands, other than the man in the White House who refuses to behave himself or go away. Kelly McParland digs in. How concerned should investors be about Biden’s tax proposals? After the Democratic sweep of both Georgia senate seats this week, Goldman Sachs now expects the Fed to raise interest rates in 2024 instead of 2025.
   

• A majority of investors believe the stock market is in a bubble - and many fear a recession, according to an E*Trade survey. A new E*Trade Financial survey of 904 active investors revealed that 66% of them believe the stock market is either fully or somewhat in a bubble. An additional 26% said the stock market is "approaching a market bubble." The survey also revealed that recession fears linger. 32% of investors listed a recession as their top portfolio risk right now. But they remain fully invested with inflows surging and the consensus long…
  
   

• Canadian expert's research finds lockdown harms are 10 times greater than benefits. Finally an honest analysis of ROI from an early proponent of lockdowns. Emerging data has shown a staggering amount of so-called ‘collateral damage’ due to the lockdowns. This can be predicted to adversely affect many millions of people globally with food insecurity [82-132 million more people], severe poverty [70 million more people], maternal and under age-5 mortality from interrupted healthcare [1.7 million more people], infectious diseases deaths from interrupted services [millions of people with Tuberculosis, Malaria, and HIV], school closures for children [affecting children’s future earning potential and lifespan], interrupted vaccination campaigns for millions of children, and intimate partner violence for millions of women. In high-income countries adverse effects also occur from delayed and interrupted healthcare, unemployment, loneliness, deteriorating mental health, increased opioid crisis deaths, and more.

• After embracing remote work in 2020, companies face conflicts making it permanent. Although the pandemic forced employees around the world to adopt makeshift remote work setups, a growing proportion of the workforce already spent at least part of their week working from home, while some businesses had embraced a “work-from-anywhere” philosophy from their inception. But much as virtual events rapidly gained traction in 2020, the pandemic accelerated a location-agnostic mindset across the corporate world, with tech behemoths like Facebook and Twitter announcing permanent remote working plans. Not everyone was happy about this work-culture shift though, and Netflix cofounder and co-CEO Reed Hastings has emerged as one of the most vocal opponents. “I don’t see any positives,” he said in an interview with the Wall Street Journal. “Not being able to get together in person, particularly internationally, is a pure negative.” Very interesting expose in Venture Beat. 

• The Life in The Simpsons Is No Longer Attainable. The most famous dysfunctional family of 1990s television enjoyed, by today’s standards, an almost dreamily secure existence that now seems out of reach for all too many Americans. I refer, of course, to the Simpsons. Homer, a high-school graduate whose union job at the nuclear-power plant required little technical skill, supported a family of five. A home, a car, food, regular doctor’s appointments, and enough left over for plenty of beer at the local bar were all attainable on a single working-class salary. Bart might have had to find $1,000 for the family to go to England, but he didn’t have to worry that his parents would lose their home.

• mRNA vaccines could vanquish Covid today, cancer tomorrow. The incredible progress made in developing the Covid vaccines should not be understated as we may be on the edge of a scientific revolution in human health. It looks increasingly plausible that the same weapons we’ll use to defeat Covid-19 can also vanquish even grimmer reapers — including cancer, which kills almost 10 million people a year.

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

Logos LP

The Myth of Icarus

Good Morning,
 

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

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

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

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

Our Take
 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Musings

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

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

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

Why does the myth of Icarus matter today? 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Where are we now? 

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

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

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

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

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

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

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

Charts of the Month

Cycles in perspective.

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

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

Household balance sheets are healthy and swollen…

Logos LP November  2020 Performance

November 2020 Return: 25.71%
 

2020 YTD (November) Return: 89.34%
 

Trailing Twelve Month Return: 89.38%
 

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

Thought of the Month

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


Articles and Ideas of Interest

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

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

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

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

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

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

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

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

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

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

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

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

Logos LP

Market Cycles

Good Morning,
 

Bit behind on this July update but better late than never!
 

Stocks fell on Friday for the fourth straight day, capping off a volatile week for investors as rising trade fears and a tech sell-off led to broad weekly losses. The Nasdaq Composite fell 0.3 percent to 7,902.54, led by declines in Apple, Amazon and Alphabet. The tech-heavy index posted its fourth straight loss — its first since April — and is worst start to September since 2008.

The S&P 500 pulled back 0.2 percent to close at 2,871.68 as utilities and real estate both dropped more than 1 percent.

President Donald Trump, speaking from Air Force One, said Friday the U.S. is ready to slap tariffs on an additional $267 billion worth in Chinese goods. His remarks come after a deadline for comments regarding tariffs on another $200 billion in Chinese goods had passed last night.

"The $200 billion we're talking about could take place very soon, depending on what happens with them," Trump said. "I hate to say this, but behind that, there's another $267 billion ready to go on short notice if I want." (targeting a sum of goods equal to virtually all imports from China)
 

The selloff pummeling emerging market currencies shifted to stocks as contagion concerns weighed on risk assets. MSCI Inc.’s EM equities gauge entered a bear market on Sept. 6 and had its worst week since mid-August.

The fear also comes after the Wall Street Journal reported, citing U.S. officials, that the possibility of the U.S. and China reaching a trade deal are fading as the Trump administration tries to revamp the North America Free Trade Agreement (NAFTA). Meanwhile, Bloomberg News reports that the U.S. and Canada will likely end the week with no trade deal in place.

Wall Street was also under pressure after strong wage data stoked fears of tighter monetary policy in the U.S. Average hourly earnings rose 2.9 percent for the month on an annualized basis, marking the largest jump since 2009. The U.S. economy added 201,000 jobs in August, more than the expected increase of 191,000.

Treasury yields jumped to their highs of the session following the jobs report release, while the dollar also rose. The Fed has already raised rates twice this year and is largely expected to hike two more times before year-end.

Our Take
 

There is little doubt that the U.S. economy is in a boom. The Conference Board is reporting the highest levels of job satisfaction in more than a decade given a tight labor market — the ratio between the unemployment level and the number of job vacancies is at its lowest level in a half-century. A broader measure, the prime-age employment-to-population ratio, is back to 2006 levels. Meanwhile, real gross domestic product growth for the second quarter was just revised up to 4.2 percent. Corporate profits are rising strongly. And investment as a percentage of the economy is at about the level of the mid-2000s boom.

Wages are still lagging. But all other indicators show the U.S. economy performing as strongly as at any time since the mid-2000s — and possibly even since the late 1990s.

Why? A few reasons present themselves as outlined recently by Noah Smith:

1. Demand Side Explanations:

   1. Low interest rates: lowered borrowing rates for corporations and mortgage borrowers, which tends to juice investment. Fiscal deficits provide an added boost to demand, and deficits have been rising as a result of President Donald Trump’s tax cuts. Typically pumping demand will eventually lead to rising inflation but this hasn’t happened yet.

   2. “Animal spirits” or “sentiment” as small business confidence is at record highs, and consumer/investor confidence also is very strong.

   3. Tail end of the long recovery from the Great Recession — consumers and businesses might finally be purchasing the houses and cars that they waited to buy when the recovery was still in doubt. Housing, traditionally the most important piece of business-cycle investment and consumption, is still looking weak, with housing starts below their 50-year average. But business investment might be experiencing the positive effects of stored-up demand.

2. Supply Side Explanations:

   1. The Trump tax cuts removed distortions that held back business investment, and that fast growth — and the attendant low unemployment — is the result of the economy’s rapid shift to a higher level of efficiency.

   2. Technology: Information technology advances such as machine learning and cloud computing might be driving the investment boom — perhaps also spurring companies to invest in intangible assets such as brands and workers’ skills.

Which one is responsible? It is difficult to say but determining which are responsible matters as it can give insight into how the boom will end and how it can be prolonged. In our view all these factors have played a role, albeit certain ones have played a more crucial role during different stages in the bull market.  

At the current stage of the bull market we see evidence that the demand-side “animal spirits” or “sentiment” factor is doing a lot of the heavy lifting.

It should be remembered that although of late there has been a minor repricing of high multiple/risk assets, the trend is still firmly in place: investors are not put off by unprofitable companies. In fact, the proportion of companies reporting losses before going public in the United States is at its highest since the dotcom boom in 2000.

Last year, 76 percent of the companies that listed were unprofitable in the year before their initial public offerings, according to data compiled by Jay Ritter, a professor at the University of Florida's Warrington College of Business.

That's lower than the 81 percent recorded in 2000, but still far higher than the four-decade average of 38 percent.

Investors are currently keen on “new business models” and are willing to overlook losses. In fact, many are questioning whether “value investing” and classic investing principles even makes sense anymore. The market's euphoria for so-called "growth companies" has even made billionaire hedge fund manager David Einhorn question if classic investing principles that worked for him still make sense today.

As Howard Marks reminds us, in investing as in life, there are very few sure things. Very few things move in a straight line. There’s prograss and then there’s deterioration. We must remain attentive to cycles.

The process/cycle is typically the same: 1) the economy moves into a period of prosperity 2) providers of capital thrive, increasing their capital base 3) because bad news is scarce, the risks entailed in lending and investing seem to have shrunk 4) risk aversion disappears 5) financial institutions and investors move to expand their businesses - that is, to provide more capital 6) they compete for market share by lowering demanded returns (e.g. cutting interest rates), lowering credit standards, lowering prudence, disregarding the linkage between price and value, paying less attention to profits or disregarding them all together and providing more capital for a given transaction.

At the extreme, providers of capital finance borrowers and businesses (investments) that aren’t worthy of being financed. This leads to capital destruction -that is, to investment of capital in projects where the cost of capital exceeds the return on capital, and eventually to cases where there is no return of capital.

Is this time any different?

Chart(s) of the Month

JP Morgan shows us that holding cash for too long can be a dangerous proposition. 

Are overall tech valuations overstretched or only certain segments?  Notice the absence of earnings in the dot com bubble years. Valuations do not appear stretched when put into perspective, prices appear to be in line with the underlying earnings picture. The NASDAQ-100’s price to forward earnings ratio is still a little below its longer run average of about 23x. 
 

Musings
 

What of valuation? What of the relationship between price and value? For an investor (whether a “value” investor or not) price has to be the starting point regardless of where we are in the cycle and especially in the last innings. No asset is so good that it can’t become a bad investment if bought at too high a price.

As an example of the current “animal spirits” climate we should consider the following:

Cannabis : the thesis or “story” here is that cannabis, like alcohol, tobacco and other hedonistic instruments, has now achieved positive momentum with policymakers across the world. As such the fragmented industry will consolidate and a few early movers will reap the profits of this new multi-billion dollar industry. But just like investing in the nascent stages of many industries that in essence were revolutions from a status quo, speculation will initially replace prudent financial analysis of price relative to value.

As Easterly points out in a recent article Cronos' (CRON) current valuation is an outright manifestation of "extraordinary delusions" stemming from the madness of crowds.

Cronos trades at about 17.25 forward price to sales (TTM price to sales of 332.97 and TTM price to earnings of 874.69) compared to its peers. For some further clarity, highly valued SaaS stocks prized for their recurrent revenue stream and high gross margins seldom trade at 17.25 forward P/S ratio. The average P/S ratio for stocks in the software application industry is around 6.8, compared to 2.16 for the S&P 500.

Hence, why does an agricultural commodity producer trade at a higher valuation than Shopify and other?

In Deloitte's "A society in transition, an industry ready to bloom" 2018 cannabis report, they expect legal cannabis sales during 2019, the first full year post-legalization to be [CAD]$4.34 billion. This figure is likely inflated when compared against the results of other markets. Further, the study only surveyed a sample size of 1,500 adult Canadians, which is not significant enough to estimate the Cannabis purchase habit of millions of Canadians.

For some perspective, California, which is regarded as the most important Cannabis market on Earth realized sales of [USD]$339 million or [CAD]$444 million (at current spot USD/CAD) during the first two months post-legalization. Extrapolating this across a full year would infer total sales of [USD]$2.01 billion or [CAD]$2.7 billion. Sure there are other factors to consider like a larger Californian black market and a different set of regulations and taxes. However, the Californian market has also not been as stringent on marketing as Canada will be.

Assuming the Canadian market is at least on par with California, the author models the potential market using an optimistic CAGR of 23.54% from 2019 - 2023 which is more optimistic than some market reports. The author also models Cronos' revenue for the years from 2018 - 2022.

Cronos' current market valuation of [USD]$1.75 billion or [CAD]$2.29 billion is around 84.81% of the total Canadian legal cannabis market in FY2019. (And this does not take into account the fact that the total estimated legal cannabis sales [CAD] $4.34 billion number mentioned above represents a total retail sales projection and that will likely be shared between grower, distributor, retailer, and the government through taxes. Taxes will be large, perhaps even 30%. Retail will be handled by government in a few big provinces like BC -- yet the government will still take a retail margin cut. What will be left for growers could be as low as sub $4 CAD / gram.. half or less of that total [CAD] $4.34 billion number…

At a current market valuation of [CAD]$2.29 billion ($2.79 billion at time of writing) which is around 84.81% of the total estimated Canadian legal cannabis market in FY2019, has the fairness of Cronos’ price been considered? Or have people without disciplined consideration of valuation simply decided that they want to own something because the story is good, risk aversion is low and the future looks bright?

Overall, we see current valuation trends in certain growth stocks (cannabis, select tech.) (not to mention that the ratio of bearish option bets to bullish ones is waning as the S&P 500 keeps churning out records. That implies investors may be loading up on derivatives as way to make up for lost ground should 2018 deliver a year-end rally similar to last year’s, when stocks closed with a 6.1 percent fourth-quarter surge) to be evidence that the demand-side “animal spirits”/“sentiment” factor is doing a large portion of the heavy lifting to prolong the current bull market.

As such, we would advise caution before increasing exposure to these “loved” and therefore richly valued businesses. Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. For our portfolio, given where we are in the present cycle and overall market conditions we are abiding by the following maxim:
 

“The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price can only go one way: up.” -Howard Marks

Logos LP July 2018 Performance

 

July 2018 Return: -0.34%

2018 YTD (July) Return: 0.00%

Trailing Twelve Month Return: +12.79%

CAGR since inception March 26, 2014: +18.29%

Thought of the Month

 

"The polar opposite of conscientious value investing is mindlessly chasing bubbles, in which the relationship between price and value is totally ignored. All bubbles start with some nugget of truth: 1) Tulips are beautiful and rare 2) The internet is going to change the world 3) Real estate can keep up with inflation, and you can always live in a house.” -Howard Marks

Articles and Ideas of Interest

 

• After Coltrane, there is nothing left to say. The saxophone virtuoso pushed jazz as far as it could go, and it’s been downhill ever since.            

• These Fake Islands Could Spell Real Economic Trouble. Glitzy property projects and financial crises tend to go hand-in-hand.

• U.S. Household wealth is experiencing an unsustainable bubble. Jesse Colombo suggests that Since the dark days of the Great Recession in 2009, America has experienced one of the most powerful household wealth booms in its history. Household wealth has ballooned by approximately $46 trillion or 83% to an all-time high of $100.8 trillion. While most people welcome and applaud a wealth boom like this, research suggests that it is actually another dangerous bubble that is similar to the U.S. housing bubble of the mid-2000s. In this piece, he explains why America's wealth boom is artificial and heading for a devastating bust.

• Who needs democracy when you have data? Here’s how China rules using data, AI and internet surveillance.

• How tourists are destroying the places they love. Travel is no longer a luxury good. Airlines like Ryanair and EasyJet have contributed to a form of mass tourism that has made local residents feel like foreigners in cities like Barcelona and Rome. The infrastructure is buckling under the pressure. Great 2 part expose suggesting that travel has almost become a human right yet it has become predatory - devouring all the beautiful places which drive it. Has nature itself come to be viewed as merely one more good to be consumed? ; Have we developed a shallow, modern need to present a life free from the tyranny of a nine-to-five office job in the tight frame of Instagram? No wonder you are not original or creative on instagram. Everyone on Instagram is living the same life.  
  
   

• Peak Valley. The Bay Area’s primacy as a technology hub is on the wane. Don’t celebrate. Although capital is becoming more widely available to bright sparks everywhere yet unfortunately the Valley’s peak looks more like a warning that innovation everywhere is becoming harder.  

• Americans live in the ruins of the 2008 financial crisis. Prosperity is undercut by broken institutions, from health care to law enforcement. NYT presents some astonishing facts. Is the American dream dead?

Our best wishes for a fulfilling month, 

Logos LP

Where Is "The Crowd"?

Good Morning,
 

U.S. equities rose on Friday on better-than-expected employment data. The Dow Jones industrial average hit a record high and closed 66.71 points at 22,092.81. Goldman Sachs contributed the most gains. The index also posted its eighth straight record close.

Banks, including Goldman Sachs, outperformed the market, with the SPDR S&P Bank exchange-traded fund (KBE) advancing 0.81 percent. The space received a boost from a jump in interest rates, which followed strong U.S. employment data. The U.S. economy added 209,000 jobs last month, according to the Labor Department, well above the expected gain of 183,000.

On the Canadian side, Canada’s labor market continued its stellar performance in July, with the jobless rate falling to the lowest since before the financial crisis. The unemployment rate fell to 6.3 percent, the lowest since October 2008, as the labor market added another 10,900 jobs during the month, Statistics Canada reported from Ottawa. The total increase over the past year of 387,600 is the biggest 12-month gain since 2007. These jobs figures will likely bolster confidence that the country is quickly running out of economic slack and higher Bank of Canada interest rates may be needed to cool off growth...

Our Take
 

The US report was very strong. Timing couldn’t be better as we are moving into the tail end of Q2 earnings as well as into August and September which are typically weak months for the market. This was a beat and raise guidance jobs number and the second month in a row the U.S. has come in above 200,000 and above expectations.

Furthermore, although lower wage Americans are still reeling from the great recession, they are finally getting some relief in the jobs market. Underneath a 209,000 gain in July payrolls, significant shares of job growth were in lower-wage industries such as restaurants and home health-care services. As the overall labor-force participation rate ticked up 0.1 percentage point, the level for people age 25 or older without a high school degree surged to the highest since 2011. In leisure and hospitality, which typically carries lower pay, annual wage gains of 3.8 percent outpaced the average. (For a breakdown of who is hiring see here)

Other indicators suggest that even with the tightening job market, some slack still remains. That leaves room for additional gains that would back up President Donald Trump’s drive to bring people back into the workforce as well as support the Federal Reserve’s go-slow approach to tightening credit. This is good news and suggests that perhaps we haven’t yet reached the peak of this economic cycle.

U.S. equity indexes have been on a roll lately with the Dow notching eight straight record closes.

Nevertheless, all is not rosy. Amid the talk of new highs and record levels, one section of the equity market is having trouble keeping up. Small-cap stocks, on track for their second weekly decline with a loss of 1.7 percent, are falling further behind benchmark equity gauges.

In addition, underneath what was another up week for the S&P 500 Index, things were a little more complicated. An equal weight version of the S&P 500 that strips out market value biases just posted its biggest weekly drop since May, and its worst week versus the regular S&P 500 all year. The reason: while enough megacap stocks rose to keep the S&P 500 afloat, single-stock blowups were far more common than single-stock rallies.

Perhaps we haven’t quite reached euphoria just yet…
 

Musings
 

During these summer months I’ve gotten the opportunity to reconnect with old friends and learn a few new things whilst doing so. Of great interest have been several conversations with those in the corporate sector.

Among many other enlightening insights, I was startled to hear of a new phenomenon in current deal making circles: deal quality has been decreasing. Deals are getting done that just 1-3 years ago would have been laughed at for their overvaluation, shoddiness, and/or high risk. Interesting data tending to support that risk-taking may be on the rise...

If not by coincidence one of our favorite investors Howard Marks put out a cautionary memo last week entitled “There they go again...Again” suggesting that “they” are “engaging in willing risk-taking, funding risky deals and creating risky market conditions.

Marks suggests 4 attributes of today’s investment environment: 1) uncertainties are unusual in number and scale 2) prospective returns for the vast majority of asset classes are about the lowest they have ever been 3) asset prices are high across the board 4) pro-risk behaviour is commonplace

These attributes support his overall suggestion that in this environment one should move forward with caution. As always, the memo is worth a close read.

Marks supports his 4 overarching attributes of the current market environment with several fascinating vignettes each showcasing “willy nilly risk taking” in a variety of asset classes.

1. U.S. equities: Many metrics such as average p/e, Shiller p/e and the “Buffett yardstick” and record low interest rates suggest stock prices are at lofty levels.

2. The VIX: The VIX is at record lows and this suggests that investor sentiment is largely positive.

3. Super-stocks: Bull-markets are marked by a single group of stocks that are “the greatest” and the FAANGs are having their moment. When the mood is positive multiples rise as one “can’t lose” in these names.

4. Passive investing/ETFs: These approaches are on the rise and in the current up-cycle, over-weighted, liquid, large-cap stocks have benefitted from forced buying on the part of passive vehicles, which don’t have the option to refrain from buying a stock just because its overpriced. Investors are thus turning capital over to a process in which neither individual holdings nor portfolio construction is the subject of thoughtful analysis and decision-making, and in which buying takes place regardless of price…

5. Credit: Low grade credit instruments are proliferating. Junk bond offerings are over subscribed and offer weak investor protections.

6. Emerging market debt: For only the third time in history, emerging market debt is selling at yields below those on U.S. high yield bonds.  

7. Private equity: PE firms will probably add more than a trillion dollars to their buying power this year.  Where will it be invested at a time when few assets can be bought at bargain prices? Too much money is chasing too few good deals. Standards are relaxing.

8. Venture capital: SoftBank’s recent raising of $93 billion for its Vision Fund for technology investments – presumably on the way to $100 billion. Can one wisely invest $100 billion in technology?

9. Digital currencies: digital currencies are nothing but an unfounded fad (or perhaps even a pyramid scheme), based on a willingness to ascribe value to something that has little or none beyond what people will pay for it.  The same description can be applied to the Tulip mania that peaked in 1637, the South Sea Bubble (1720) and the Internet Bubble (1999-2000).

This is a fascinating selection of examples yet perhaps the most interesting thing in the memo was his acknowledgement that many market participants are aware of these issues and agree that things can’t go well forever – that the cycle is extended, prices are elevated and uncertainty is high.

These cautious beliefs are what makes calling a top in this market so hard. Just this week CNBC ran a poll which asked readers “Is the stock market about to suffer an epic crash?”

11,736 readers voted and 44% of them said yes, 33% said no and 26% said not sure.

Think about that.

The poll didn't ask, "Is the stock market overvalued?" or "Will the stock market decline for the rest of the year?" (or in the next year, or anything like that). It asked about "an epic crash," and not just any time, but specifically about whether the market is about to crash. "About to" means that it's going to happen very soon.

It is rather incredible that such a large proportion of people say they expect such an extreme and rare event to happen within such a narrow time frame.

Not to mention, as Josh Brown reminded us in response to the Marks memo, that we’ve got an entirely lost generation of investors, the millennials, who prefer to hold cash and even bonds than own stocks.

Could the behaviour of the crowd (as Brown defines it) be telling a different story than the anecdotes in the Marks memo? A story of caution and bearishness?

Without a doubt, as Josh Brown points out, it is as good a time as any to be cautious as caution should be the default orientation for any serious investor.

But I believe this debate highlights something else of great importance that has plagued the pundit, the asset manager and the individual investor throughout this epic bull run: the consensus or “crowd” has been incredibly hard to pin down. Each of these groups seems unable to agree upon what the “consensus view” is.

Timeless investment wisdom suggests that avoiding the crowd is a good bet for beating the stock market but this is difficult for most as there is ample evidence to support one’s own definition of “the crowd”.

The crypto currency trader believes his asset class is misunderstood and unloved. He sees himself as ahead of the curve and thus ahead of the crowd while the value investor looks upon him with disdain. “Just another herd follower chasing returns with the crowd…”

As such, rather than expending excessive energy on the identification of “the crowd” it may be best to humbly return to first principles: What do I understand and what is my sphere of investment competence? What do I reasonably believe is valuable and can be acquired for less than it should be? Am I being skeptical enough? Do I accept that there is no free lunch?


Logos LP in the Media

 

Commentary from Logos LP on investment opportunities in the defense sector in Forbes Magazine.
 

Thought of the Week

"Anyone can hold the helm when the sea is calm.” -Publilius Syrus

Articles and Ideas of Interest

• How bond markets can predict moves in stocks. Interesting research suggesting that high-yield bonds moving with the ebbs and flows of U.S. earnings announcements tend to predict stock returns for a slew of issuers -- particularly firms with a modest level of institutional equity ownership. So perhaps stock investors seeking an informational edge should keep their eyes on junk-bond prices on the heels of earnings reports.

• Commodities are a losing bet. Over the past 10 years, the Bloomberg Commodities Index is down 6.5 percent per year for a total loss of almost 50 percent. Over that same time frame, the S&P 500 is up a total of close to 100 percent, or a 7 percent annual return. This difference in performance has led to a huge divergence in the ratio of commodities to stocks, which has compelled some investors to ask whether there is a buying opportunity in commodities. There is also no financial reason that dictates that commodities must exhibit mean reversion. They provide no dividends or income. They don’t have earnings. Commodities are more of an input than a financial asset. In many ways, a bet for commodities is a bet against technology and innovation. Commodities have shown lower returns than cash equivalents with higher volatility than stocks. This is a poor risk-return relationship.

• There is no U.S. wage growth mystery. Economists are puzzled over U.S. wage growth, wondering why it has been so slow despite a labor market that is allegedly back to or close to full employment. Nice piece in Moody’s suggesting that if you look at the right wage growth and the right measure of employment slack there is no mystery: Wage gains are right where they should be. And it indicates the labor market has room to improve.

• Is productivity growth becoming irrelevant? As we get richer, measured productivity may inevitably slow, and measured GDP per capita may tell us ever less about trends in human welfare. Measured GDP and gains in human welfare eventually may become entirely divorced. Imagine in 2100 a world in which solar-powered robots, manufactured by robots and controlled by artificial intelligence systems, deliver most of the goods and services that support human welfare. All that activity would account for a trivial proportion of measured GDP, simply because it would be so cheap. Conversely, almost all measured GDP would reflect zero-sum and/or impossible-to-automate activities – housing rents, sports prizes, artistic performance fees, brand royalties, and administrative, legal, and political system costs. Measured productivity growth would be close to nil, but also irrelevant to improvement in human welfare.

• Why aren’t Americans moving anymore? In the 1990s, 3% of Americans moved out of state each year. Now the rate is half that, with US mobility hitting the lowest level since World War II. “The lack of mobility in the American workforce is a huge blocker of our economic growth,” says Ryan Sager, editorial director for Ladders. It's "definitely hurting Main Street,” writes business analyst Thanh Pham, who says there’s a mismatch between cities with abundant jobs and areas with potential workers. There are myriad reasons for the slowdown in mobility, from lack of job stability to the prohibitive expense of actually moving. Aeon suggests we are living in the quitting economy where employees are treated as short-term goods and thus market themselves as goods, always ready to quit.

• A highly successful attempt at genetic editing of human embryos has opened the door to eradicating inherited diseases. This is huge and ushers in a new era. Shoukhrat Mitalipov has performed the first highly successful use of the gene-editing technique called Crispr to improve human health: his team was able correct a genetic mutation that causes a life-threatening cardiac disease. None of the embryos were allowed to come to term. But if Mitalipov has his way, future projects could eradicate a disease that affects millions—one in 500 people carry the mutation—and even kills unsuspecting, seemingly fit adults.          

• Best summer reads 2017. Great list out of The Guardian. My favorite I revisit each summer: Herman Hess - Sidhartha.

Our best wishes for a fulfilling week, 
 

Logos LP