The Art of The Deal

Good Morning,
 

Stocks closed little changed on Friday as solid quarterly results from some of the largest U.S. companies, including Microsoft, Capital One and Honeywell, counterbalanced threats made by President Donald Trump stating that he is willing to up the ante in the trade war with Beijing and could slap tariffs on every Chinese good imported to the U.S. "I'm ready to go to 500," he told CNBC, referencing the $505.5B of American imports from China in 2017, compared to the $129.9B the U.S. exported to the country last year. (an interesting blow by blow look at global trade here)

In other news, President Trump sat down with Russian counterpart Vladimir Putin in Helsinki. Crimea, Syria and election meddling were likely on the summit's agenda, but no aide or official from the U.S. delegation were present during the meeting's initial stages. A controversial press conference ensued (in which Trump seemed to prefer Putin’s story suggesting Russia’s non-involvement in the US election rather than the opinion of U.S. intelligence), coming on the tails of a tense NATO summit during which Trump lambasted allies for not meeting their defense spending commitments.

The 10-year yield ended the week at 2.90% and the two-year yield finished up at 2.60%. Some analysts saw the increased 2-10 spread as a sign that investors believe President Trump's criticism of the Fed could slow down the pace of rate hikes.

Finally, Amazon reached a $900B market value for the first time, nipping at Apple's) heels as Wall Street's most valuable. The news comes after the company announced it sold more than $100M in products during its annual Prime Day sale. Shares are up over 57% so far this year, bringing Amazon's increase to over 123,000% since it listed on the Nasdaq in 1997.

Our Take
 

As perplexing as Trump’s actions can be, instead of spilling more ink on his diversions from “accepted” presidential behavior, it may be best to try and understand his approach by attempting to apply a different mental model. The seeds of Trump’s mental model can be found in his book “The Art of the Deal”. (His approval ratings also hold other clues)

Jim Rickards points out that the book is a window on Trump’s approach to every challenge he confronts, including economic and geopolitical challenges as president.

What is Trump’s process as described in the book?

1. Identify a big goal (tax cuts, balanced trade, the wall, etc.).

2. Identify your leverage points versus anyone who stands in your way (elections, tariffs, jobs, etc.).

3. Announce some extreme threat against your opponent that uses your leverage.

4. If the opponent backs down, mitigate the threat, declare victory and go home with a win.

5. If the opponent fires back, double down. If Trump declares tariffs on $50 billion of good from China,and China shoots back with tariffs on $50 billion of goods from the U.S., Trump doubles down with tariffs on $100 billion of goods or perhaps even $505.5 billion etc. Trump may keep escalating until he wins. (or loses)

6. Eventually, the escalation process can lead to negotiations with at least the perception of a victory for Trump (North Korea) — even if the victory is more visual than real.

This approach is abnormal from a historical perspective but to the astute observer this far into his Presidency should be looking more predictable.

What should we expect moving forward in light of this mental model? Likely more dramatic policy shifts and extreme threats. The key is not to overreact and hope that all escalations lead to fruitful negotiations in step 6….

Chart(s) of the Month
 

The S&P 500 PE ratio is right in line with historical norms.

J.P. Morgan: “High yields spreads and defaults are low and not rising. Mr. Bond is not yet sniffing a potential economic problem.”
 

The Big 5 tech companies together are worth more than the bottom 282 companies in the S&P 500 yet this level of concentration is not unprecedented. In 1965 AT&T and GM represented 14.5% of the S&P 500. What is wild is that these 5 companies are all in the same industry.

Courtesy of Michael Batnick.
 

Musings

This month we released our 2nd quarter letter to our investors. Included is a discussion of portfolio changes as well as a more detailed description of a new position we’ve initiated in Industrial Alliance and Financial Services (TSX: IAG). Please contact us if you would like to see a copy of this letter.

Logos LP May 2018 Performance

 

June 2018 Return: 4.29%

2018 YTD (June) Return: 0.34%

Trailing Twelve Month Return: +11.86%

CAGR since inception March 26, 2014: +18.77%

Thought of the Month


 

"Do you have the patience to wait till your mud settles and the water is clear? Can you remain unmoving till the right action arises by itself?”– Lao-Tzu, Tao-te-Ching

Articles and Ideas of Interest

 

• These 10 stocks account for all the S&P 500’s first half gains.David Kostin, chief U.S. equity strategist at Goldman Sachs, highlighted that more than 100 percent of the S&P 500’s total return of nearly 3 percent in the first half is attributable to just 10 equities. Amazon.com Inc. alone accounts for roughly two-fifths of the benchmark gauge’s advance. Find out which they are here.

• The average age of a successful startup founder is 45. HBR explores why and also why vc investors often bet on young founders.

• YOLO. A Boston College study has found that half of companies raising through ICOs die within four months after finalizing token sales. Is Blockchain even a revolution?

• Longer lives mean a single marriage may not be enough. More couples are wondering if the relationship they had in their first phase of adulthood is worth continuing.

• We have reached peak screen. Now revolution is in the air. Screens are insatiable. At a cognitive level, they are voracious vampires for your attention, and as soon as you look at one, you are basically toast. There are studies that bear this out. One, by a team led by Adrian Ward, a marketing professor at the University of Texas’ business school, found that the mere presence of a smartphone within glancing distance can significantly reduce your cognitive capacity. Your phone is so irresistible that when you can see it, you cannot help but spend a lot of otherwise valuable mental energy trying to not look at it.

• Can the cult of Berkshire Hathaway outlive Warren Buffett? Centuries from now, historians piecing together the narrative of this stretch of America’s existence will have to explain the curious four-decade (and counting) run in which an arena in an otherwise modest midwestern US city filled to capacity once a year for two aging billionaires talking about the stock market, life, and whatever else tickled their fancy. The annual meeting of the Omaha, Nebraska-based holding company Berkshire Hathaway has no analog in US business or culture. Buffett is 87. Munger is 94. And Berkshire Hathaway’s returns over the S&P 500 are slowing, as Buffett has warned for decades they would. Interesting article in Quartz exploring his legacy as well as his adage that America will always remain a safe bet...

• Google is building a city of the future in Toronto. Would anyone want to live there? It could be the coolest new neighborhood on the planet—or a peek into the Orwellian metropolis that knows everything you did last night. Politico magazine explores the tradeoffs and debates involved.

• In praise of being washed. Has a life of ambition and striving gotten the best of you? Do you sometimes wish you could give up a little—stop chasing so many pointless goals you probably won’t hit anyway? It’s time you got washed. A refreshing summer read in GQ.

• Scientists at a company part-owned by Bill Gates have found a cheap way to convert CO2 into gasoline. A team of scientists has discovered a cheap, new way to extract carbon dioxide from the atmosphere — which could arm humanity with a new tool in the fight against climate change.

• The friend effect: why the secret of health and happiness is surprisingly simple. Our face-to-face relationships are, quite literally, a matter of life or death. “One of the biggest predictors of physical and mental health problems is loneliness,” says Dr Nick Lake, joint director for psychology and psychological therapy at Sussex Partnership NHS Foundation Trust. “That makes sense to people when they think of mental health. But the evidence is also clear that if you are someone who is lonely and isolated, your chance of suffering a major long-term condition such as coronary heart disease or cancer is also significantly increased, to the extent that it is almost as big a risk factor as smoking.”

Our best wishes for a fulfilling month, 

Logos LP

Everything Has Been Done Before

Good Morning,
 

U.S. stocks rocketed higher on Friday, seeing the Nasdaq composite hit a new record, after February jobs growth far exceeded expectations.

The Dow Jones industrial average rose 440.53 points to close at 25,335.74, with Goldman Sachs among the biggest contributors of gains to the index. The 30-stock index also closed above its 50-day moving average, a key technical level.

The S&P 500 gained 1.7 percent to end at 2,786.57, with financials as the best-performing sector. It also closed above its 50-day moving average.

The jobs report which came out Friday was nothing short of extraordinary. The U.S. economy added 313,000 jobs in February, according to the Bureau of Labor Statistics. Economists polled by Reuters expected a gain of 200,000.

Wages, meanwhile, grew less than expected, rising 2.6 percent on an annualized basis. Stronger-than-expected wage growth helped spark a market correction in the previous month.

Our Take
 

The jobs report was impressive. For all that can be said about Trump’s unconventional decision making (his big deficits may actually make sense by spurring productivity and his “tariffs” may in fact be good for free trade) this report confirmed the underlying strength of the economy, and also diminished some of those inflationary concerns and the potential that there could be more than three rate hikes this year.

Many question how you can create this many jobs and not have wages go up more but we maintain that this phenomenon is due to a unique interplay of several factors: demographics, labour force participation and technology.

The basic formula is as follows: as labor becomes more scarce based on demographics, it constrains supply, triggering inflation. But labor scarcity, in turn, should speed the adoption of automation and trigger an investment boom. Automation investments are likely to generate supply growth just as demographics and investment both spur demand growth, creating a reasonable balance (despite rising inequality). Once the investment boom ends, however, the negative effects of automation will become more visible—namely, high levels of unemployment, wage suppression and slowing demand.
 

We may have progressed further along this matrix than some may think. Regardless, we are a long ways from the sort of wage inflation of the 1990s . . .

Musings

I shared an interesting chart in the Economist with some friends this week which sparked a spirited discussion:

The debate focused on whether or not such historical data offers the investor anything of value. Certain friends suggested that the world in 1900 was vastly different than the world today and thus such data was of limited use.

What struck me most about the discussion wasn’t the comparison between what the world looks like today vs. what it looked like over 100 years ago, it was the ease with which we are able to overlook history in an effort to justify the perceived novelty and uniqueness of whatever appears to be relevant in the moment.

Think cannabis, blockchain, bitcoin, AI, cryptocurrency and whatever else is hot right now. This isn’t to say that these “new” things aren’t relevant.

But it is to say that broadly speaking everything has been done before as human nature hasn’t changed all that much. As Morgan Housel reminds us: The scenes change but the behaviours and outcomes don’t.

"Historian Niall Ferguson’s plug for his profession is that “The dead outnumber the living 14 to 1, and we ignore the accumulated experience of such a huge majority of mankind at our peril.”

The biggest lesson from the 100 billion people who are no longer alive is that they tried everything we’re trying today. The details were different, but they tried to outwit entrenched competition. They swung from optimism to pessimism at the worst times. They battled unsuccessfully against reversion to the mean.

They learned that popular things seem safe because so many people are involved, but they’re most dangerous because they’re most competitive.

Same stuff that guides today, and will guide tomorrow. History is abused when specific events are used as a guide to the future. It’s way more useful as a benchmark for how people react to risk and incentives, which is pretty stable over time.”

Logos LP February 2018 Performance

February 2018 Return: -3.75%

2018 YTD (February) Return: -2.24%

Trailing Twelve Month Return: +21.02%

CAGR since inception March 26, 2014: +19.72%

Thought of the Month


 

"The way to outperform over the long haul typically isn’t done by being the top performer in your category every single year. That’s an unrealistic goal. A better approach is to simply avoid making any huge errors and trying to be more consistent. The top performers garner the headlines in the short-term but those headlines work both ways. The top performers over the long-term understand that’s not how you stay in the game over the long haul.” -Ben Carlson

Articles and Ideas of Interest
 

• When value goes global. Interesting piece in Research Affiliates magazine suggesting that the value premium that is traditionally associated with stock selection and market timing works just as well when applied globally across major asset classes. The alternative value portfolios studied are typically uncorrelated with their underlying asset classes, traditional value approaches, and each other, thereby offering meaningful diversification benefits alongside attractive excess return potential. The success of global value portfolios hinges on their design, which allows investors to gain better exposure to desired risk premia not easily available when investing in a single market.

• Rational Irrational Exuberance. We tend to be uncomfortable with the notion that an economy’s fundamentals do not determine its asset prices, so we look for causal links between the two. But needing or wanting those links does not make them valid or true.

• If you’re so smart, why aren’t you rich? Turns out it’s just chance. The most successful people are not the most talented, just the luckiest, a new computer model of wealth creation confirms. Taking that into account can maximize return on many kinds of investment.

• Why doesn’t more money make us happy? Dan Gilbert, social psychologist and author of Stumbling on Happiness showed that people who recently became paraplegics are just as happy one year later as people who won the lottery. Relative to where we thought our happiness would be after winning the lottery, we adjust downward, and relative to where we thought our happiness would be after losing our legs, we adjust upward….Interesting piece from Michael Batnick that suggests that this concept makes sense in theory, but not in practice. Like many things in life, it’s an idea that is hard to truly believe until we experience it for ourselves.

• The town that has found a potent cure for illness- community. What a new study appears to show is that when isolated people who have health problems are supported by community groups and volunteers, the number of emergency admissions to hospital falls spectacularly. While across the whole of Somerset emergency hospital admissions rose by 29% during the three years of the study, in Frome they fell by 17%. Julian Abel, a consultant physician in palliative care and lead author of the draft paper, remarks: “No other interventions on record have reduced emergency admissions across a population.” No wonder what causes depression most of all is a lack of what we need to be happy, including the need to belong in a group, the need to be valued by other people, the need to feel like we’re good at something, and the need to feel like our future is secure.

• Could capitalism without growth build a more stable economy?New research that suggests – that a post-growth economy could actually be more stable and even bring higher wages. It begins with an acceptance that capitalism is unstable and prone to crisis even during a period of strong and stable growth – as the great financial crash of 2007-08 demonstrated.

• Is it time to say it? That retirement is dead? What will take its place? The numbers are startling: Thirty-four percent of workers have no savings whatsoever; another 35 percent have less than $1,000; of the remaining 31 percent, less than half have more than $10,000. Among older workers between 50 and 55, the median savings is $8,000. And this is total savings, including retirement accounts. Contrast that with the fact that experts say you should have eight times your preretirement annual salary saved in order to retire by 65 and continue a reasonable quality of life, commensurate with what you have become accustomed to.  

• Blockchain is meaningless. People keep saying that word but does it really mean?

Our best wishes for a fulfilling month, 

Logos LP

What Is The Purpose Of Tax Reform?

Good Morning,
 

U.S. stocks climbed to records as the latest jobs report boosted optimism in the world’s largest economy, continuing equity rallies that took hold in Asia and Europe. The dollar posted its best week this year.

The S&P 500 Index and Dow Jones Industrial Average closed at all-time highs in light volume after data showed hiring increased by more than forecast in November and the unemployment rate held at a 17-year low of 4.1%. The dollar briefly edged lower as investors assessed tepid wage growth that missed estimates, then resumed its fifth consecutive gain. Average hourly earnings — a closely watched component of the report — rose 0.2 percent for November and 2.5 percent for the year. Economists expected a monthly increase of 0.3 percent or 2.7 percent for the year. Ten-year Treasury yields inched higher.

The jobs data added to a run of recent news that has been contributing to investor confidence after the U.S. government averted a shutdown and tax reform negotiations made progress.

Our Take
 

This melt-up may have legs as forecasts for U.S. growth have been too pessimistic. Nevertheless, despite a mostly solid run of job growth, 2017 ends pretty much where it began — with wage growth stuck and inflation subdued.

This nonfarm payrolls report brought with it news all too familiar to the post-crisis economy. The 228,000 jobs created formed a solid foundation, but the pedestrian 2.5 percent average hourly earnings growth left many scratching their heads wondering how a 4.1 percent unemployment rate, the lowest in 17 years, still wasn't producing fatter paychecks.

The lack of wage growth at the aggregate level despite the declines in the unemployment rate and strong job gains remain a mystery.

Central bankers can control short-term interest rates but as has become glaringly obvious in the post recessionary world, long-term ones are out of their purview.  

Ms. Yellen’s Fed has raised rates twice this year and will likely raise a third time this month. In October the Fed began reversing quantitative easing (QE), purchases of financial assets with newly created money. Despite all this monetary tightening, yields on ten year Treasury bonds have fallen from around 2.5% at the start of 2017 to about 2.3% today. As a result the “yield curve” is flattening. The difference between ten year and two year interest rates is at its lowest since November 2007.

The yield curve matters as it has inverted- ie. long-term rates have dipped below short term ones-just before each of the past seven American recessions.

The yield curve reflects where markets expect Fed Policy to go and what we are seeing is an expectation that rates are not likely to increase.

Why? Falling inflation risk may explain the falling yield curve but as the Economist suggests, what is most likely is that markets are losing confidence in the Fed’s ability to raise rates without inflation sagging. This nonfarm payrolls report will only accelerate this loss of confidence.  

Musings
 

So what of Trump’s new tax reform package? Despite Trump’s approval ratings hitting a new low, the market appears to be applauding it. From our perspective, although this tax package will likely stimulative in the short term, in the long term a fiscal stimulus through generalized tax cuts is unnecessary, and destabilizing, in an economy running substantially above its 1.5 percent potential (and non-inflationary) growth on the steam of exceptionally loose monetary policy.

Furthermore, deep corporate tax-cuts (which have been tried before by Ronald Reagan) don’t seem to work.

The Trump team’s argument goes something like this: Cutting taxes on businesses will free up profits they will invest in new factories, research and development, and new equipment. The resulting investment boom will spur growth, as firms hire and as workers harness new ideas and equipment to produce more than they used to.

If we look at the Reagan years, investment fell—that was the weakest period of investment in the postwar period.

The same is likely to occur today. Firms aren’t cashed constrained. They aren’t asking for more money then and they certainly aren’t asking for more now. In fact, companies don’t even know what to do with their money. Companies today are sitting on record cash piles (roughly $1.84 trillion).

When asking the question of what companies will do with a windfall of after tax-profits,  Quartz points out that the odds that it will flow back into the real economy (investment) aren’t looking good. Many major companies are planning to hand that money to their investors through dividends and share buybacks. In fact, when Gary Cohn, Trump’s economic guru, asked a gathering of corporate leaders who was planning to reinvest their tax cuts, few raised their hands, Bloomberg recently reported. What these cuts will likely do is inflate asset prices even further as the bill directs the largest tax cuts as a share of income to the top 5 percent of taxpayers and by 2027, taxes on the lowest earners would go up.

This at a time when we find ourselves in what could be argued is an “everything bubble”. At a time when a cool $1 million which has long been considered the gold standard of retirement savings, has become only a fraction of what you will really need.A time when 44 percent of millennials would prefer to live in a socialist country, compared with 42 percent who want to live under capitalism. A time when 41 million Americans officially live in poverty. A time when  bitcoin is the most popular search on Google as well as the most popular news story on virtually every news outlet….

What goes up must come down….In this environment, where the balance of risk is likely to the downside, buying EXTRA thoughtfully is warranted.

Logos LP November Performance

November 2017 Return: +7.33%

2017 YTD (November) Return: +28.83%

Trailing Twelve Month Return: +35.67%

CAGR since inception March 26, 2014: +20.65%


 

Thought of the Week 

 

"Do you wish to rise? Begin by descending. You plan a tower that will pierce the clouds? Lay first the foundation of humility.” -Saint Augustine

Articles and Ideas of Interest
 

• Collective intelligence can change the world. Combining the minds of humans and machines to avoid confirmation bias. A group with a more autonomous intelligence will fare better than one with less autonomy. It will fall victim less often to the vices of confirmation bias or functional fixedness. It is more likely to see facts for what they are, interpret accurately, create usefully or remember sharply. Knowledge will always be skewed by power and status as well as our pre-existing beliefs. We seek confirmation. But these are matters of degree. We can all try to struggle with our own nature and cultivate this autonomy along with the humility to respond to intelligence. Or we can spend our lives seeking confirmation. Over the Holidays -- give yourself the freedom to explore, think and imagine without constraint.

• There’s an implosion of early-stage VC funding, and no one’s talking about it. Amid record amounts of capital raised by VCs worldwide, and a sharp rise in the number of private “unicorns” valued at $1 billion-plus, therehas been a quiet, barely noticed implosion in early-stage VC activity worldwide. This is now a three-year trend, so cannot be “blamed” on macro or short-term factors. More worryingly, it comes at a time of unprecedented stock market valuations worldwide. Whether the early-stage VC implosion is healthy or disastrous for the tech ecosystem remains to be seen. This is likely healthy over the long run in order to break Silicon Valley’s never-ending startup cycle: Startup employees get rich quick and quit to become venture capitalists.

• Mysterious object confirmed to be from another solar system.Astronomers have named interstellar object ’Oumuamua and its red colour suggests it carries organic molecules that are building blocks of life. Interestingly, NASA has also found another 20 promising planets for humans to colonize.

• Net neutrality: catastrophe or a non-event?  Some suggest that the internet is dying and that repealing net neutrality hastens that death. Others suggestthat concerns over net neutrality are overblown as public blowback in past cases of service providers blocking sites that are competitive has been fierce, scaring other providers from following suit. Second, blocking competitors to protect your own services is anticompetitive conduct that might well be stopped by antitrust laws without any need for network neutrality regulations.
  
   

• Will BlackRock and Vanguard own everything by 2028? Imagine a world in which two asset managers call the shots, in which their wealth exceedscurrent U.S. GDP and where almost every hedge fund, government and retiree is a customer. It’s closer than you think. BlackRock Inc. and Vanguard Group  — already the world’s largest money managers — are less than a decade from managing a total of $20 trillion, according to Bloomberg News calculations. Amassing that sum will likely upend the asset management industry, intensify their ownership of the largest U.S. companies and test the twin pillars of market efficiency and corporate governance.

• Robots aren’t killing jobs fast enough-and we should be worried.Interesting perspective on this. In fact, data show that the US labor market is the calmest it has been in more than 160 years. The problem is there is not enough disruption. If anything, we need more jobs destroyed. That argument, made by Robert Atkinson and John Wu of the Information Technology and Innovation Foundation, a think tank promoting policies that spur innovation, is a novel one. Their belief that we are in an age of stagnation, not disruption, is based on a decade-by-decade analysis of how quickly occupations have been appearing and disappearing since 1850. No wonder Google, Amazon have found that not everyone is ready for AI.

• How high will bitcoin go? Should you buy in? What is next for cryptocurrencies? Well ladies and gents even the most staunch haters arethrowing in the towel with Jamie Dimon recently suggesting a reversal of his position stating that “I'm open-minded to uses of cryptocurrencies if properly controlled and regulated." Make no mistake this is a frenzy much like the dot-com bubble in 1995. Perhaps even larger as bitcoins appear to be at least 4 times as expensive as dot-com stocks were at their height. Interestingly, few are talking about its energy use implications: By July 2019, the bitcoin network will require more electricity than the entire United States currently uses. By February 2020, it will use as much electricity as the entire world does today. Is this sustainable? The cryptocurrency’s price is completely unreal. Then again so is money...The problem is that it is clear that this is not a currency. Most are buying and holding in hopes of future gains. This is an asset class and as seen many times before, when lots of investors buy an illiquid asset, the price can rise exponentially yet at some point the urge to turn all those digital zeros into cars and iPhones will prove too great. Getting out of an illiquid asset can be much harder than getting in. When that rush inevitably happens, people are going to get hurt. Rule number 1: don’t lose money. Rule number 2: don’t forget rule number 1.

• Me, myself and iPhone. Fascinating research presented in the Economistsuggesting what we already know (subconsciously): the many hours young people spend staring at their phones is having serious effects. Adolescents who spent more time on new media-using Snapchat, Facebook or Instagram on a smartphone were more likely to agree with remarks such as: “The future often seems hopeless” or “I feel like I can’t do anything right.” Those who used screens less, spending time playing sport, doing homework, or socialising with friends in person, were less likely to report mental troubles.

Our best wishes for a fulfilling week,  
 

Logos LP

Temperament Determines Outcomes

Good Morning,
 

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

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

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

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

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

Our Take
 

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

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

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

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

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

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

Musings
 

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

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

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

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

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

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

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

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

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

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

Thought of the Week

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

Articles and Ideas of Interest

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

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

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

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

  
   

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

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

Our best wishes for a fulfilling week, 
 

Logos LP

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

Our Institutions Are Breaking

Good Morning,
 

Last week the S&P 500 Index pushed past 2,500 for the first time, notching its third round-number milestone of the year as the bull market in U.S. equities rages on. With a gain of 10.4% through the end of August, this year ranks as the fourth best start to a year in the last ten years, behind 2013 (+14.5%), 2009 (+13.0%) and 2012 (+11.8%).

The benchmark gained 0.2 percent to 2,500.23 last Friday, capping its biggest weekly advance since January, as technology shares rebounded and banks climbed with Treasury yields. Up 12 percent since January, the S&P 500 is on course for its best annual gain in four years.

Equities broke out of a month long trading range after the worst-case scenarios from Hurricane Irma and North Korea failed to materialize. As geopolitical fears subsided, investors shifted focus back to fundamentals, where economic growth remains stable and corporate earnings are expected to increase every year through at least 2019.

Another piece of good news last week: America's middle class had its highest earning year ever in 2016, the U.S. Census Bureau reported Tuesday. Median household income in America was $59,039 last year, surpassing the previous high of $58,655 set in 1999, the Census Bureau said.

Our Take
 

Strength is appearing to beget strength. In each of those three years above (2013, 2009, 2012) where the S&P was up significantly in the first eight months of the year, the remainder of the year saw further upside with a median gain of 9.3%.

In addition to those three years, the last four months of each calendar year has been strong throughout the entire bull market. The S&P 500 has been up every time for a median gain of 3.4%.

On a total return basis, the the index was up an impressive 16.2% over last year through the end of August. The historical average is 11.7% going back to 1928. Can things continue?

The trend may be up but either way we subscribe to a more reserved view well described in a note entitled “Yet Again?” released last week by Howard Marks. In this memo, which served as a follow up to his other recent memo entitled “There They Go Again” released on July 26, Marks suggests that investors are no longer being offered value in the market at cheap prices and thus should pull back and be less aggressive. Marks suggested that the market is not currently a “nonsensical bubble” but rather is simply high and therefore risky.

Risk may have increased as prices have risen yet the interesting question then is: “So what should we do?” At our 2017 high this year our fund was up roughly 25%. We have since come off this high and are in the process of re-calibrating our expectations in what we believe to be a more “low-return” environment. What does this mean?

As Marks reminds us in his memo the options are limited:

1. Invest as you always have and expect your historic returns.

2. Invest as you always have and settle for today’s low returns.

3. Reduce risk to prepare for a correction and accept still-lower returns.

4. Go to cash at a near-zero return and wait for a better environment.

5. Increase risk in pursuit of higher returns.

6. Put more into special niches and special investment managers.

#1 would make no sense.

#2 is difficult.

#3 makes sense if you think a correction is coming but could cost you.

#4 is tough as zero-returns are rarely ever acceptable.

#5 is deceptive as high risk does not assure higher returns. It means accepting greater uncertainty with the goal of higher returns and the possibility of substantially lower (or negative) returns.

#6 is good as they can offer higher returns without proportionally more risk. That is if they can be identified.  

Like Marks, we believe that none of these options is perfect but that there are no others. Thus, as we re-set expectations in an environment promising lower returns we will do the things we have always done remaining largely fully invested and accept that returns will be lower than they traditionally have been (#2). While we do what we have always done we will employ more caution than usual especially with regards to price (#3) and we will work diligently to find special opportunities that lie “off the beaten track” (#6).

Musings
 

I attended a conference this week in Toronto called Elevate TO. The purpose of the conference was to showcase the City as a growing hotbed of innovation. The presenters ranged from local politicians, to start-up founders to Canadian technology luminaries. One talk by Salim Ismail the technology entrepreneur and best-selling author of Exponential Organizations really stood out. (for a youtube video see here)

The crux of his talk is that society needs to shift from linear thinking to exponential thinking in order to adapt to a world which is changing faster than our institutions and minds can keep pace with.

But what is linear bias? We’ve seen consumers and companies fall victim to linear bias in numerous real-world scenarios. Although there are many such examples, a nice one relates to intangibles like consumer attitudes.

In a recent HBR article the author suggests looks at consumers and sustainability. We frequently hear executives complain that while people say they care about the environment, they are not willing to pay extra for ecofriendly products. Quantitative analyses bear this out. A survey by the National Geographic Society and GlobeScan finds that, across 18 countries, concerns about environmental problems have increased markedly over time, but consumer behavior has changed much more slowly. While nearly all consumers surveyed agree that food production and consumption should be more sustainable, few of them alter their habits to support that goal.

What’s going on? It turns out that the relationship between what consumers say they care about and their actions is often highly nonlinear. But managers often believe that classic quantitative tools, like surveys using 1-to-5 scales of importance, will predict behavior in a linear fashion. In reality, research shows little or no behavioral difference between consumers who, on a five-point scale, give their environmental concern the lowest rating, 1, and consumers who rate it a 4. But the difference between 4s and 5s is huge. Behavior maps to attitudes on a curve, not a straight line.

Companies typically fail to account for this pattern—in part because they focus on averages. Averages mask nonlinearity and lead to prediction errors. For example, suppose a firm did a sustainability survey among two of its target segments. All consumers in one segment rate their concern about the environment a 4, while 50% of consumers in the other segment rate it a 3 and 50% rate it a 5. The average level of concern is the same for the two segments, but people in the second segment are overall much more likely to buy green products. That’s because a customer scoring 5 is much more likely to make environmental choices than a customer scoring 4, whereas a customer scoring 4 is not more likely to than a customer scoring 3.

This illustration does a great job to outline the problem. The current climate of rapid technological development and change is rooted in exponential thinking. If you look at the biggest problems in the word such as the climate change, economic growth, pandemics and sociopolitical upheaval etc. they are rooted in exponential accelerators and factors. The problem is that many of us (including our leaders) don’t understand this phenomenon and this is the fundamental cognitive gap that we are facing. This gap is causing immense stress as evidenced by the increasing failure of our institutions (Occupy Wallstreet, the Arab Spring, the election of Donald Trump, the surge in nationalism, racism and authoritarianism) which were created in a fundamentally linear world.

When you have an information based environment it goes into an exponential growth path and it starts doubling in price performance every 1 to 2 years. Now we have whole industries and livelihoods like music, newspapers, retail, manufacturing etc. caught up in this vortex of exponential creative destruction as our world is not set up for this.

When you think about all the mechanisms we use to run the world: our social structure, our civics, our politics, our legal systems, our patent systems, our monetary policy systems, our financial systems, our healthcare systems, our education systems they are all geared for the linear world of 100 or 200 years ago when information was scarce. Lets remember that marriage was invented about 15 000 years ago when lifespans were about 25. You grew up, had kids and you died. Was it really designed to last 50-60 years? What happens when lifespans hit 120-150 years?

These mechanisms are all breaking or are already broken. We simply aren’t set up for the exponential world of today and certainly not for the world of tomorrow.

Most of the changes that set this exponential world in motion happened about 25 years ago with the advent of the internet yet now we have moved into the world of 3D printing, AR/VR, synthetic biology, blockchain technologies, advanced robotics and artificial intelligence.

We have a forcing problem with technology. Moore’s law has been doubling computing power for over 60 years and now we have over 12 technologies operating at that same pace: neuroscience, drones, biotech, and even solar cells are doubling in their price performance every 22 months and have been for over 40 years. At this pace we will hit 100% world energy supply that can be delivered by solar in less than 2 decades...Energy that has been scarce for most of human history is about to become abundant...

These exponential and thus highly disruptive technologies will only increase the stress that currently characterizes our world absent the ability of our leaders and I would argue ourselves to learn how to navigate these technologies and update the mechanisms which run our world grounding them in exponential thinking.

The problem is that if you attempt disruptive innovation in any organization or perhaps mind, its immune system will attack you. All of our organizations and mechanisms we use to run the world are built to resist change and withstand risk. Try and change education: teachers unions attack, try to update transportation:  taxi drivers attack, try and marry/date someone outside of your accepted circle: your parents or friends attack, try and actually reform the French economy: the unions attack and your approval ratings tank etc.

We’ve got to solve our immune system problem and the future will belong to those people, those leaders, those businesses and those countries that can do so. Can we scale as fast as technology?

Logos LP August Performance

August 2017 Return: -4.55%

2017 YTD (July) Return: +13.27%

Trailing Twelve Month Return: +13.01%

CAGR since inception: +17.84%

Logos LP in the Media

ValueWalk has done a special feature on us and some of our best ideas that will be released this month. For a teaser please click here.

Thought of the Week

"I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.” -Jimmy Dean

Articles and Ideas of Interest

• Robots and AI may not take our jobs after all. Liz Ann Sonders posted the graphic below showing how e commerce has created more jobs that it has taken away.

• Furthermore, automation commonly creates more, and better-paying, jobs than it destroys. Greg Ip for the WSJ explains. Stop pretending you really know what AI is and read this instead.

• What goes up must come down for cryptocurrencies. The summer of bitcoin looks to be ending badly. The biggest cryptocurrency dropped as much as 40 percent since reaching a record high of $4,921 on Sept. 1, cutting about $20 billion in market value. The collapse extended to as much as 30 percent this week since China began sending stronger signals of a clampdown on Sept. 8, making this the biggest five-day decline since January 2015, when it traded at around $200. JPMorgan Chase CEO Jamie Dimon took a shot at bitcoin, saying the cryptocurrency "is a fraud" but can you really blame him given Bitcoin’s status as “the most crowded investment in the world”? Don’t believe the hype about the tremendous returns on “initial coin offerings”. Great piece on ICOs and the promise and perils of global capital markets for everyone. Canada also poured cold water on ICOs in a notice last week, in which regulators there warned that the "coins" in "Initial Coin Offerings"—a popular new way for companies to raise money using cryptocurrency—are likely to be securities. What’s interesting is that with the changing of the tides it hasn’t just been bitcoin tanking. Virtually all cryptocurrencies have taken a beating. Nevertheless, the coins already appear to be recovering...

• In world of supposed bubbles here’s what investors fear most. From Alan Greenspan and the current Federal Reserve staff to fund managers hoarding cash, people feel queasy about asset prices. Euro high-yield debt is trading in line with U.S. Treasuries for the first time ever. Tajikistan is selling Eurobonds as yields on the junkiest emerging markets drop below 6 percent. An exchange-traded fund for betting on low volatility has more than doubled in size this year. And let’s not get started on the bitcoin rally.

• Making money during the apocalypse. Bryan Menegus reports for Gizmodo from a conference whose attendees envisage a future where capitalism is under siege. “The machinery of freedom” apparently will include floating sea colonies, special economic zones, and stateless cryptocurrencies. And it’s up to these elite techno-libertarian attendees to ensure that future happens—whether it benefits the rest of the world or not.

• How Warren Buffett broke American Capitalism. Provocative piece in the FT time suggesting that the investment style of Warren Buffett may have had disastrous effects on the economy. Are “high moats” not simply “monopolies”? Can an investment philosophy have negative effects on an economy?

• Mind control isn’t sci-fi anymore. 2017 has been a coming-out year for the Brain-Machine Interface (BMI), a technology that attempts to channel the mysterious contents of the two-and-a-half-pound glop inside our skulls to the machines that are increasingly central to our existence. The idea has been popped out of science fiction and into venture capital circles faster than the speed of a signal moving through a neuron. Facebook, Elon Musk, and other richly funded contenders, such as former Braintree founder Bryan Johnson, have talked seriously about silicon implants that would not only merge us with our computers, but also supercharge our intelligence.

• The healing power of nature. The idea that immersing yourself in forests and nature has a healing effect is far more than just folk wisdom. Blood tests revealed a host of protective physiological factors released at a higher level after forest, but not urban, walks. Among those hormones and molecules, a research team at Japan’s Nippon Medical School ticks off dehydroepiandrosterone which helps to protect against heart disease, obesity and diabetes, as well as adiponectin, which helps to guard against atherosclerosis. In other research, the team found elevated levels of the immune system’s natural killer cells, known to have anti-cancer and anti-viral effects. Meanwhile, research from China found that those walking in nature had reduced blood levels of inflammatory cytokines, a risk factor for immune illness, and research from Japan’s Hokkaido University School of Medicine found that shinrin-yoku lowered blood glucose levels associated with obesity and diabetes. GET OUT THERE.

Our best wishes for a fulfilling week, 
 

Logos LP

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