Older, Slower and Entitled

Good Morning,
 

Major U.S. stock averages rebounded Friday, but closed the week in the red amid fears of the Federal Reserve pulling back its stimulus as well as concern regarding the delta variant. 

Minutes from the Fed’s July meeting released this week showed the central bank is willing to start reducing its monthly asset purchases this year. Investors sold equities and commodities this week buying bonds on fears that a “backwards looking” move by the Fed could upend the global economy already under stress by the delta variant.


Our Take


With investors considering a Fed tapering while the delta variant keeps spreading, the transition away from liquidity/policy regime to more mid-cycle markets means volatility is likely set to continue.   

Policy error represents the most obvious risk for markets. For weeks, changes in the economic data suggest that economic growth is slowing, rates have been heading lower, the dollar has headed higher, and commodities have by and large corrected. According to the bears, this picture seems to suggest that any Fed tapering this fall - just as the global economy's growth is normalizing - could create a growth scare, and as a result, that theFed would have begun taperingat the wrong moment leading to further economic weakness and eventually a stock market rout.

This may or may not occur. Corrections are inevitable and although we do think that it would be unwise to chase many major index components as future returns from these levels appear unattractive, we do believe that the strength of this bull market is remarkable. 

This year alone the S&P has hit 48 new highs. Since we finally broke through the 2007 pre-GFC highs in the summer of 2013 we’re now looking at more than 320 new highs in this bull market. The gains are smaller, befitting a less extreme year as when the S&P 500 Index has risen in 2021, the daily increase has been half what it was in 2020. But in terms of persistent, day-after-day gains, these seven months in the U.S. stock market have few historical precedents.

Interestingly, as Nir Kaissar points out for Bloomberg, the past 30 years may not be an anomaly but a new normal. 

For about 120 years from the 1870s to the 1980s, the U.S. stock market reliably reverted to its long-term average valuation, and just as important, it spent roughly equal time above and below that average. Investors could therefore expect an expensive market to become cheaper and a cheap market to become more expensive, a useful assumption when estimating future stock returns. 

Since 1990, however, the market has rarely dipped below its long-term average valuation, the notable exception being the period around the 2008 financial crisis. Neither the dot-com bust in the early 2000s nor the Covid-induced sell-off last spring managed to subdue it.

Accordingly, with volatility moderate and the uptrend persisting, any trading tools that told investors to do anything but buy are failing. When applied to the S&P 500, half of the 22 charts-based indicators tracked by Bloomberg have lost money since the end of March, back-testing data show. All of them are doing worse than a simple buy-and-hold strategy, which is up 12%. 

Over the past 10 years, the S&P 500 is up almost 360% while gold is down 2%. That’s a lost decade for gold, even after it was up 25% in 2020 and 18% in 2019.

It has been incredibly profitable to adhere to the classic mantras of “don’t fight the fed” and “the trend is your friend”. Investors buying virtually every dip have been rewarded. 

Most non-recession 10%+ corrections over the past 25 years began with certain conditions. They all typically start with wildly overbought conditions and excessive optimism. We can’t predict when the party will end, but we do believe that “wildly overbought” and “excessive optimism” are not at present characteristic of the prevailing sentiment. Furthermore, for many high quality companies, multiples have been contracting and fundamentals have been improving. You just need to know where to look….

 Musings
 

Humans are creatures of habit and easily susceptible to conditioning. From childhood we learn (the hard way) to avoid touching a hot stove and alternatively, we learn that certain behaviours such as doing our chores will earn us rewards from our parents. We learn (or are supposed to learn) that by working hard and developing the right skills and habits we will get ahead and unlock a more “pleasant” life. 

Our environment influences us. We react to the incentives and disincentives we are presented with attempting to reduce pain and maximize pleasure and this process of conditioning shapes our behaviours and attitudes. 

The economy and markets work similarly because after all, they are composed of humans. Given the incredible shock Covid-19 represented (which we are still dealing with), we’ve been thinking a lot about the conditioning it has precipitated or perhaps accelerated. How have our brains/habits and thereby societies and economies been re-wired? 

Aware of the seemingly endless amount of time one could spend on this topic, one thing in particular has caught our attention. 

The fact that the labor force in the US has shrunk (this is a phenomenon that is also  affecting most developed economies). The US economy has been creating jobs at a rapid clip. Employment has risen by an average of about 617,000 people per month so far this year.

While the total number of Americans who are working is still more than 5 million short of 2019 levels, there is work available. The number of open positions surged to a record 10 million-plus in June.

Nevertheless, many employers say they’re having trouble filling those jobs, even with the unemployment rate still relatively high.

That points to one big question-mark around the recovery. Americans have dropped out of the labor force.

More than half of the unemployed have been out of work for 15 weeks or longer and, on average, it’s taking people 29.5 weeks to find a job -- even with all those openings.

Why? Common explanations fall into three categories. 

1. Disruption owning to the spread of Covid-19

2. The Impact of welfare policy

3. Changes to attitudes wrought by the pandemic 

When it comes to the first bucket it is believed that school closures have made it impossible for parents, particularly mothers to take a job. The evidence of this is more mixed and less compelling. Furthermore as restrictions ease, Covid-19 recedes and children head back to school, such issues should correct. 

The second bucket is of particular interest as welfare policy (ie. entitlements) is something policy makers can control. Where do we stand on this front? There was an interesting article in the WSJ recently entitled “Hooked on Federal Checks”. The author Nick Stehle wrote: 

“My family is receiving the new Advance Child Tax Credit Payments, passed by Congress and signed into law by President Biden in March. Under this policy, I’m going to make more than $11,000 by the time I file my 2021 taxes. I “earned” this extra cash by having four children between 5 and 13.

The policy—which pays $300 a month for each child under 6 and $250 a month for each child between 6 and 17—is set to expire at year’s end, yet the Biden administration and congressional Democrats are pushing to make it permanent. If that happens, I’m looking at more than $10,000 a year for the next four years, then thousands more annually for nearly a decade after that.

Do I need this money? Thankfully, no. I have a good job that puts my family solidly in the middle class. Should I be getting this money? Absolutely not. But will I use the money? Yes. That is why this new entitlement is so dangerous.

The federal government is conditioning families like mine to expect “free” money. When you see that cash in your account, the first thought is how to use it. It becomes a habit to see and spend extra money each month. Like many habits, it is liable to worsen.”

The political discourse in Canada is no different with each challenger party putting forth colossal spending platforms designed to one up the current incumbent Liberal spending bonanza. 

Politicians of all stripes continue to clamour for more spending as they decry that life is getting more expensive. All of this while nearly 61% of U.S. households paid no federal income taxes in 2020 and central banks have spent $834 million an hour for 18 months buying bonds to force down borrowing costs since the pandemic hit (the US Fed alone has put in roughly $4 trillion). 

The question is how much longer can central banks and governments keep the cash spigots flowing at full force? Politicians appear to be openly uninterested in such trivial details.  

Many of the entitlements such as the Advance Child Tax Credit Payments discussed above or the Old Age Security benefits in Canada (only two small examples) are not primarily directed to families in poverty. 

Instead, such entitlements are better understood as an attempt to buy votes from various voting blocks. Once you come to expect an entitlement you are much less inclined to vote for someone who wants to cut off the cash. A similar understanding can be applied to the Canada Emergency Wage Subsidy, CRB, CRCB and the CRSB in Canada. The conditioning has become powerful. 

Nick Stehle points out that the price tag of such measures in terms of expanding the national debt is high yet the human cost of these policies is perhaps even higher. Since many of these benefits are not tied to work/output, people have less reason to try and climb the ladder of opportunity. 

Is this how a social safety net should work? Will such political discourse erode cultural attitudes surrounding “work ethic”? Has irreversible damage already been done? 

This idea dovetails on the third category of common explanations: changes to attitudes wrought by the pandemic. One intriguing possibility is that the pandemic has made people value work less. The pandemic forced us all to take a hard look in the mirror and many surveys suggest that people now treasure time with family more than they once did. A shift in attitudes towards work is hard to pin down yet a recent study from Britain suggests that people want to work fewer hours even if their pay falls.  

By making unemployment insurance schemes (entitlements) competitive with market wage rates in a pandemic, it would come as no surprise if attitudes surrounding work ethic have suffered. Rewards and incentives change habits and behaviour. The longer this dynamic persists, the longer and more difficult it will be to reshape such habits and adjust behaviours. 

It is still too early to tell how much work ethic has suffered yet this potential conditioning accelerated by COVID-19 is not a positive development. 

The economic carnage brought on by Covid-19 induced lockdowns necessitated extraordinary monetary and fiscal intervention. Politicians and Central bankers had to act. The problem we see today is that a potential pandora’s box of entitlement and complacency has been opened. 

When leaders have simply to open the spigot to earn votes, there is little incentive to improve the quality of leadership. Hence, in our opinion, the disastrous state of leadership today. 

Thomas Jefferson and Alexander Hamilton agreed on little publicly, but they did agree that when the public treasury becomes a public trough and voters take notice, they will send to government only those who promise them a bigger piece of the government pie.

There’s an old theory that wealthy democracies follow a socio-economic cycle from slavery to spiritual faith, to great courage, to liberty, to abundance and wealth, to complacency, to apathy, to dependence and back to slavery. Judging from the post Covid-19 socio-economic climate we appear to be on a problematic path to complacency and apathy. 

When entitlement is not linked to output and contribution there is little willingness to accept responsibility for one’s own life - which is the source from which self-respect and thus character, springs. Instead, one develops the perception that the outcomes of one’s life are entirely out of one’s hands. 

And to be without character is perhaps the worst fate of all. 

Charts of the Month

Valuations are certainly in the upper band even when measured against the past 25 years, which has been a time filled with higher-than-average historical valuations. Here’s one that may surprise you though — this year we’ve actually seen multiples on the S&P 500 contract:

JP Morgan also broke out valuations and earnings by the top 10 stocks in the S&P (which also includes Berkshire Hathaway, Tesla, Nvidia, JP Morgan and Johnson & Johnson) and everything else:

The top 10 stocks are now close to 30% of the market. This sounds concerning until you see they contributed 34% of the earnings over the past year. These companies are large for a reason.

They’re also expensive for a reason. You can see once you take away the top 10 holdings, the valuation of the other 490 or so stocks doesn’t look all that bad.

Logos LP July 2021 Performance

July 2021 Return: -1.18%

2021 YTD (July) Return: 7.28%

Trailing Twelve Month Return: 41.47%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 24.39%
 

Thought of the Month

“Enough of this miserable, whining life. Stop monkeying around! Why are you troubled? What’s new here? What’s so confounding? The one responsible? Take a good look. Or just the matter itself? Then look at that. There’s nothing else to look at. And as far as the gods go, by now you could try being more straightforward and kind. It’s the same, whether you’ve examined these things for a hundred years or three.” - Marcus Aurelius


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Articles and Ideas of Interest

• Florida is America's Future: Old, Southern and Retired. Why we should be concerned that the fastest-growing cities in the U.S. are retirement villages in the South. One of the most important trends to emerge from the 2020 Census didn't get much attention last week, but it reveals more about how both the U.S. economy and its politics will look in the coming years than most other details focused on by the news media. Americans' vision of their city of the future typically involves skyscrapers populated by large new technology companies. Yet the 2020 Census didn't point to San Francisco or New York as the fastest-growing city, or even one of the dozens of smaller metros that emulate them. The fastest growing metro area in the U.S. is the Villages, a retirement community in central Florida. And that's indicative of an economy that's older, less dynamic and more reliant on government benefits. It also points to a growing concentration of political and economic power in the south. Why is no one talking about this?  
  
   

• The Opposite of Toxic Positivity. Countless books have been written on the “power of gratitude” and the importance of counting your blessings, but that sentiment may feel like cold comfort during the coronavirus pandemic, when blessings have often seemed scant. Refusing to look at life’s darkness and avoiding uncomfortable experiences can be detrimental to mental health. This “toxic positivity” is ultimately a denial of reality. Telling someone to “stay positive” in the middle of a global crisis is missing out on an opportunity for growth, not to mention likely to backfire and only make them feel worse. As the gratitude researcher Robert Emmons of UC Davis writes, “To deny that life has its share of disappointments, frustrations, losses, hurts, setbacks, and sadness would be unrealistic and untenable. Life is suffering. Scott Barry Kaufman for The Atlantic suggests that no amount of positive thinking exercises will change this truth.

• The Coronavirus Is Here Forever. This Is How We Live With It. Sarah Zhang for the Atlantic suggests that we can’t avoid the virus for the rest of our lives but we can minimize its impact. The current spikes in cases and deaths are the result of a novel coronavirus meeting naive immune systems. When enough people have gained some immunity through either vaccination or infection—preferably vaccination—the coronavirus will transition to what epidemiologists call “endemic.” It won’t be eliminated, but it won’t upend our lives anymore. Politicians crafting policy based on “Covid zero” are going down a dangerous path…

• Warren Buffett’s Cash Trap Can Snare Big Tech, Too. The Berkshire Hathaway CEO has more cash than he knows what to do with. But Apple, Amazon and other tech giants face a similar dilemma. It may remain one of Buffett’s most memorable lessons. Even as tech company after tech company has joined the $1 trillion and then $2 trillion market-cap club during the pandemic, they all have something in common with Buffett: more cash than they know what to do with. It’s a good problem to have until it isn’t.
  
   

• Companies and Families Are Loading Up on Debt. It Could Be a Dangerous Trend. For folks with finances stretched by inflation, using “buy now, pay later” (BNPL) to help pay for luxuries or even necessities, such as an updated wardrobe to return to work, might be the clincher in the purchasing decision. Square’s ability to provide ready funding to merchants and consumers apparently justifies the $29 billion price tag for Afterpay—equal to an enterprise value of 35 times gross profit for the next 12 months, according to MoffettNathanson analyst Lisa Ellis. But it belies the notion of flush consumers. Or does it?
  
   

• Why Managers Fear a Remote-Work Future. Interesting take on remote work by Ed Zitron in the Atlantic suggesting that like it or not, the way we work has already evolved. Remote work lays bare many brutal inefficiencies and problems that executives don’t want to deal with because they reflect poorly on leaders and those they’ve hired. Remote work empowers those who produce and disempowers those who have succeeded by being excellent diplomats and poor workers, along with those who have succeeded by always finding someone to blame for their failures. It removes the ability to seem productive (by sitting at your desk looking stressed or always being on the phone), and also, crucially, may reveal how many bosses and managers simply don’t contribute to the bottom line.
  
   

• Why is China smashing its tech industry? Noah Smith suggests that it has something to do with what countries consider to be the “Tech Industry”. China may simply see things differently. It’s possible that the Chinese government has decided that the profits of companies like Alibaba and Tencent come more from rents than from actual value added — that they’re simply squatting on unproductive digital land, by exploiting first-mover advantage to capture strong network effects, or that the IP system is biased to favor these companies, or something like that. There are certainly those in America who believe that Facebook and Google produce little of value relative to the profit they rake in; maybe China’s leaders, for reasons that will remain forever opaque to us, have simply reached the same conclusion.

• What’s Holding Back China’s Recovery? The Kids Aren’t Alright. There are many answers, but one important piece of the puzzle is starting to become clear: Young workers and job seekers, who often spend more of their income since they are just starting out, are struggling. Until that is rectified, regaining China’s pre-pandemic consumption-growth trend could be challenging. Online movements springing from youth discontent such as “tang ping” or “lying flat,” which was started by a disenchanted former factory employee and rejects overwork, may be difficult to fully suppress. This problem is affecting most nations globally as policy makers ignore the plight of the next generation…
  
   

• America’s Investing Boom Goes Far Beyond Reddit Bros. Robinhood traders have earned the most attention, but they’re only part of a larger story about class stagnation and distrust. Fascinating account by Talmon Joseph Smith in the Atlantic of the investing craze that has characterized the post pandemic world. In a series of interviews conducted with economic analysts, amateur and professional investors, cryptocurrency lovers, and former hedge-fund managers, several people expressed the view that the subcultures born out of America’s untamed investing boom are many and varied. They’re diverse, if not integrated; some silly, some assiduous—yet all infused with a quiet desperation to reach escape velocity and defeat the gravitational pull of class stagnation that’s lasted decades...

Our best wishes for a month 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

A Crisis Of Intelligence

Good Morning,
 

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

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

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

Our Take

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

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

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

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

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

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

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

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


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

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

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

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

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

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

So what to do in the face of the above? 

Musings

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 
Charts of the Month

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

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

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

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

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

Logos LP September  2020 Performance

September 2020 Return: 0.76%
 

2020 YTD (September) Return: 51.51%
 

Trailing Twelve Month Return: 67.44%
 

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

Thought of the Month

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

Articles and Ideas of Interest

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

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

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

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

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

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

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

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

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

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

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

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

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

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

  Logos LP

Everything is F*cked But Hope Springs Eternal

Good Morning,
 

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

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

Our Take

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

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

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

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

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

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

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

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

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

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

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

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Musings
 

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

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

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

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

-”The Death of the American Dream” 

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

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

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

He furthers that: 

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

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

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

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

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

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

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

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

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

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

Charts of the Month

Where is hope trending? 

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

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

Logos LP August  2020 Performance

August 2020 Return: -0.71%
 

2020 YTD (August) Return: 50.36%
 

Trailing Twelve Month Return: 57.65%
 

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

Thought of the Month


 

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

Articles and Ideas of Interest

 

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

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

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

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

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

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

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

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

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

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

Logos LP

Laugh Now Cry Later

Image Source: From Drake's Laugh Now Cry Later music video, 2020.Courtesy of UMG / Republic / OVO

Good Morning,
 

Stocks rose on Friday, lifted by strong U.S. economic data, to end a week that saw the broader market reach a record level. 

The bull market was strong before the virus and it has now regained its stride. This week's price action confirmed that. A 55% move off the lows in five months is the quickest and strongest recovery after a BEAR market low. The comeback rally appears to be the beginning of a new bull market. 

On Friday the Nasdaq hit its 35th new high in 2020 while the S&P recorded its 15th high with a close at 3,397. Both of those indices posted their fourth straight week of gains. The Dow 30 and the Dow Transports were both unchanged on the week, while the small caps as measured by the Russell 2000 fell 1.5%. 

This week, concerns over a new coronavirus stimulus bill kept the market’s gains in check as party representatives appeared unable to come to an agreement on the terms of a package. 

Washington continues to bicker while markets hit fresh record highs as we experience the strongest start to any month of August in 20 years. 

What to make of the haters who are still singing the “too much complacency” / “a total disconnect from the real economy” / “only a handful of stocks are rising” tune?

Our Take
 

Below I will get into why we, as investors, are predisposed to looking out for dangers that may upset our investment plans, but first I want to point out what is being lost in neverending gloom and doom of the popular financial media. 

For those who wonder why we are hitting new highs or who fear that the risk-reward is most certainly now skewed to the downside I would recall the following FACTS:

-Retail Sales hit a record high last week, and now Housing Starts and Building Permits are back to pre-pandemic levels.

-Airline passenger traffic has continued to improve off its lows from April, and the seven-day average traffic is the strongest since March 22nd.

-Adjusted for seasonal factors, the IHS Markit Flash U.S. Composite PMI Output Index posted 54.7 in August, up from 50.3 at the start of the third quarter, and signaled a strong increase in output (18-month high). Moreover, it marked the sharpest upturn in private sector business activity since February 2019.

-U.S. Services Business Activity Index at 54.8 (50.0 in July). 17-month high.

-U.S. Manufacturing PMI at 53.6 (50.9 in July). 19-month high.

-U.S. Manufacturing Output Index at 53.9 (51.7 in July). 19-month high.

Siân Jones, Economist at IHS Markit noted a strong expansion in U.S. private sector output in August:

"August data pointed to a further improvement in business conditions across the private sector as client demand picked up among both manufacturers and service providers. Notably, the renewed increase in sales among service sector firms was welcome news following five months of declines."

"Encouragingly, firms signalled an accelerated rise in hiring, as greater new business inflows led to increased pressure on capacity. Some also mentioned that time taken to establish safe businesses practices had now allowed them to expand their workforce numbers."

"However, expectations regarding output over the coming year dipped slightly from July due to uncertainty stemming from the pandemic and the upcoming election. Meanwhile, cost burdens surged higher amid reports of greater raw material prices. Although manufacturers increased their selling prices at a faster rate to help compensate, service sector firms noted that competitive pressures and discounting to attract customers had stymied their overall pricing power."
 

Furthermore when we move from the macro backdrop to the company level we see similar green shoots: 

-We continue to see extremely strong beat rates, especially for bottom-line EPS numbers. Overall, 82% of companies have reported earnings better than expected with an aggregate earnings surprise of ~22%.

-Forward guidance continues to be as positive as investors have ever seen it, but not many analysts are talking about it. 

Today, the haters state that technology stocks are in a new bubble, but the data may suggest otherwise. When compared to other sectors,  the Technology sector easily has the strongest EPS beat rate this season at 87%. Industrials, Consumer Staples, and Materials have the next strongest beat rates, while Energy and Real Estate have the weakest beat rates in the 50s. Do these numbers suggest that the market is irrational?

What of the claim that technology is doing ALL of the heavy lifting and this can’t go on? Is this even accurate? 

This may sound hard to believe, but the Technology sector ETF is just the sixth best performing sector in the third quarter and underperforming the S&P 500.

Industrials, Consumer Discretionary, Materials, and Communication Services are all posting double-digit percentage gains this quarter. With Consumer staples posting a 9+% gain, that is also higher than the 8.8% gain for the Technology sector in Q3.

The S&P is also up 9+% for the quarter. Let's not forget that Small Cap Growth, Small Cap Value, and Mid Cap value are also posting double-digit percentage gains in Q3 as well…

What about the general claim that the market is overpriced? The S&P 500 is trading at 10% above its 200-day moving average, similar to where it traded in February and at other previous market highs so there isn’t much new to see here yet what of the claim that the market is overvalued?

This appears to be a popular opinion as cash on the sidelines continues to to hit record highs. The double dip narrative appears to be gaining steam with every new fresh record high. Are stocks overvalued? The following tweet offers some insight:

Barry’s tweet is a reminder that classic “quick and dirty” valuation tools such as PE multiple should be relied upon with caution. What “expert” truly has any idea how high the PE multiple should be with an unlimited level of monetary stimulus and backstop of credit from the Fed? What investor has been here before? 

At minimum, it isn’t unreasonable to assume that the multiple should NOT be in line with historical norms. Therefore, the overvaluation “models” many investors and classical “value investors” cling to simply cannot hold the same weight they did with the 10-year Treasury at 0.68% when the historical norm is well above 5.0% (see Morgan Housel’s article below on Expiring Skills vs. Permanent Skills).

In fact, Kai Wu of Sparkline capital has put together an interesting research report which suggests that classical “value investing” has a long and distinguished pedigree but is currently in a deep thirteen-year drawdown as its “models” have rotated such investors into a massive losing bet against technological disruption. 
 

This is not the time for dogma. The old playbooks should at minimum be questioned. More than ever before, espousing a flexible approach is required. Inspiration from the old and appreciation for the new is a must as the “New” economy becomes THE economy.  

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Musings

I recently heard Drake’s new hit single “Laugh Now Cry Later,” on which Drake and Lil Durk rap about the high-life they live hoping to live in the moment and deal with pain and troubles later. As usual, Drake has aptly captured the spirit of the moment at a time when it appears that governments and central banks around the world are engaging in ever increasing monetary and fiscal stimulus that favors immediate pleasure, pushing pain and troubles to some future date for some future generation. 

The deficit spending for the U.S. is over $3 trillion so far this year and for Canada, close to $75 billion. While the costs are clear, the benefits are less so. Financial relief for millions of Americans and Canadians furloughed or unemployed has certainly been a short-term humanitarian gift but what about the future? 

As both governments in the USA and Canada look to additional government spending they must acknowledge the fact that monetary and fiscal spending have not generated ​significant growth ​over the past decade. 

As Michael Farr suggests, “our current efforts continue to make the same mistakes.  There are two primary mistakes: one, while surges of liquidity can stave off economic collapse​, and provide needed relief, they have little ability to stimulate ​sustained growth.  When growth doesn’t come, policy makers add more stimulus.  Two, cheap money has increased supply and done little to increase demand.”

The injections over the past ten years of QE haven’t created any multiplier effect. A trillion dollar injection results in a one-time trillion dollar surge and another trillion in debt because the U.S. doesn’t have an extra trillion lying around somewhere (the USA hasn’t run a surplus since the 1990s). 

Instead, the dollars should be funnelled to things that will grow and create jobs and increase over time. In short, there needs to be a clear ROI on future spending beyond the payment of another month’s rent or mortgage. This is the kind of investment that successful private industry and individuals would make. 

Unfortunately, policy makers have chosen to continue on a kind of willfully blind panglossian adventure in which they take the recipients of stimulus to an amusement park only to have them return to their same old same old. While at the park they feel pretty good. They temporarily forget their struggles and pain as they live the highlife only to return out another trillion in cash. When the high fades, a weak business pre-pandemic is still a weak business, a poor/precarious skill set/job is still a poor/precarious skill set/job. 

Instead, policy makers will need to have the courage to confront the harsh realities of this “Laugh Now Cry Later” economy. The rapid adoption of remote work and automation is accelerating inequalities which were in place well before the pandemic. The resulting ‘K’ shaped recovery has been and will continue to be good for professionals with the right skills who are largely back to work, with stock portfolios approaching new highs—and bad for everyone else.

The stimulus dollars as they are currently being deployed are not addressing this reality. Over the past ten years to today, the economy has no longer been creating steady jobs for low-skilled, low-wage workers as fast as it once was. Things will not go back to the way they were. No amount of protectionism or taxation of the hyper-rich will make it so. 

Alternatively, if policy makers are to have a chance at stimulating the kind of sustained growth we need, they will need to acknowledge that not all skills, jobs and businesses are created equal. Certain uses of capital and certain skills have higher ROIs than others. 

They will need to be more discerning capital allocators if they wish to stimulate a generation of producers, earners, consumers, tax payers, creative innovators and problem solvers that would better the future for generations to come. 

Sadly, looking at the sorry state of the current political discourse, such courage appears to be in short supply. 

After all, perhaps given how uncertain the future now looks and how much harder it will be for most to make a buck, many may be satisfied with what they can get. Even if it’s just a free trip to Wonderland…

Charts of the Month

After slowing to a trickle in March, public listings roared back and are now on pace to reach their highest levels since the peak of the dot-com boom in 2000.

Robot subsidy: Payroll and related taxes have held steady over the past 40 years, but the effective tax rate on automation has fallen. Translation: Economists argue we are now subsidizing the replacement of humans with robots, even when robots aren't as productive.  

Logos LP July 2020 Performance

 
July 2020 Return: 4.77%
 

2020 YTD (July) Return: 51.44%
 

Trailing Twelve Month Return: 59.30%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +21.91%
 

Thought of the Month

"“The worst loneliness is to not be comfortable with yourself.”– Mark Twain

Articles and Ideas of Interest

 

• Even a global pandemic can’t slow the US IPO market down. After slowing to a trickle in March, public listings roared back and are now on pace to reach their highest levels since the peak of the dot-com boom in 2000.

• After tapping the bond market at a record-shattering pace in recent months, Corporate America is more indebted today than ever before. And while much of that fresh cash -- more than $1.6 trillion in total -- helped scores of companies stay afloat during the pandemic lockdown, it now threatens to curb an economic recovery that was already showing signs of sputtering. Many companies will have to divert even more cash to repaying these obligations at the same time that their profits sink, leaving them with less to spend on expanding payrolls or upgrading facilities in months ahead. Leverage ratios have never been higher for U.S. companies.

• Scientists discover a major lasting benefit of growing up outside the city. As the recession is predicted to slam cities and many rush to leave them, the data seems to support the move. Using data from 3,585 people collected across four cities in Europe, scientists from the Barcelona Institute for Global Health (also called IS Global) report a strong relationship between growing up away from the natural world and mental health in adulthood. Overall, they found a strong correlation between low exposure to nature during childhood and higher levels of of nervousness and feelings of depression in adulthood. Co-author Mark Nieuwenhuijsen, Ph.D., director of IS Global’s urban planning, environment and health initiative, tells Inverse that the relationship between nature and mental health remained strong, even when he adjusted for confounding factors.

• What if we could live for a million years? Past generations used to say that even though we cannot postpone natural death, we can control how we live. They also believed that there is “nothing new under the sun.” Both statements are inaccurate from our current perspective. With advances in bioscience and technology, one can imagine a post-COVID-19 future when most diseases are cured and our life span will increase substantially. If that happens, how would our goals change, and how would this shape our lives? Fascinating article in the Scientific American outlining what a post-death world could look like.

• Is inflation really what we should be worrying about? With many pundits pushing gold as their investment of choice, deflation remains the bigger danger from the collapse in global demand, rather than a surge in inflation.

• Delisting Chinese Firms: A cure likely worse than the disease. Interesting article by Jesse Friend suggesting that if the proposed legislation becomes law, its cure could be worse than the disease. Both Chinese controlling shareholders and the Chinese government are likely to exploit such a trading ban to further their own objectives, at the expense of Americans holding shares in these firms.

• The unstoppable Damian Lillard is the NBA superstar we deserve. He’s lifted his game to new heights inside the NBA bubble, but what sets the Trail Blazers’ point guard apart is the fierce loyalty and outsider spirit that’s driven him from the start. His unwillingness to run from “the Grind” is an inspiration.

• The unravelling of America. Interesting perspective (albeit a bit depressing) on America by anthropologist Wade Davis in the Rolling Stone in which he suggests that COVID has reduced to tatters the illusion of American exceptionalism. At the height of the crisis, with more than 2,000 dying each day, Americans found themselves members of a failed state, ruled by a dysfunctional and incompetent government largely responsible for death rates that added a tragic coda to America’s claim to supremacy in the world. Using compelling data and the historical context of other great empires, he paints a picture of a country in decline. Nothing lasts forever - perhaps America’s best days are behind it?

• Expiring vs. Permanent Skills.  Morgan Housel knocks it out of the park with this one in which he explains that every field has two kinds of skills: Expiring skills, which are vital at a given time but prone to diminishing as technology improves and a field evolves. Permanent skills, which were as essential 100 years ago as they are today, and will still be 100 years from now. Both are important. But they’re treated differently. Expiring skills tend to get more attention. They’re more likely to be the cool new thing, and a key driver of an industry’s short-term performance. They’re what employers value and employees flaunt. Permanent skills are different. They’ve been around a long time, which makes them look stale and basic. They can be hard to define and quantify, which gives the impression of fortune-cookie wisdom vs. a hard skill. But permanent skills compound over time, which gives them quiet importance. Morgan provides an excellent list of certain key permanent skills applicable to many fields.

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

Logos LP