Tilting the Odds in Our Favor

Good Morning,
 

Stocks gyrated between gains and losses Friday to end a volatile week on Wall Street, as investors appeared content to consolidate positions after worries over Evergrande and a slowing global economy prompted traders to pull $28.6 billion from U.S. equity funds over the first three days of the week, the most since February 2018. But stocks then staged a two-day rally after the Federal Reserve signaled no removal of its easy money policy, at least for now. 

Tech stocks trailed Friday after a crackdown on bitcoin by China overnight hurt sentiment in the sector, but financial stocks rose as the 10-year U.S. Treasury yield reached its highest since July. "What is clear is that inflation is likely to be the determining factor for liftoff and the pace of rate hikes," Deutsche Bank Chief U.S. Economist Matthew Luzzetti wrote in a note. "If inflation is at or below the Fed's current forecast next year of 2.3% core PCE, liftoff is likely to come in 2023, consistent with our view. However, if inflation proves to be higher with inflation expectations continuing to rise, the first rate increase could well migrate into 2022."

Meanwhile Nike confirmed investor concerns about the pandemic wreaking havoc with supply chains and raising costs for companies, especially multinationals. Nike shares fell 6.2% after the sneaker giant lowered its fiscal 2022 outlook because of a prolonged production shutdown in Vietnam, labor shortages and lengthy transit times.

Our Take 

Skepticism on Wall Street is widespread with most of the major investment firms calling for a 10-20% market correction. Furthermore, the popular narrative for the rest of the year appears to be falling Covid cases globally and economic acceleration favouring cyclical stocks in the energy, financial, industrial and travel sectors. For us the data is noisy. Economic acceleration could very well occur but we also believe as we have stated in the past, that there are equally compelling reasons to infer significant economic deceleration. 

At present we believe policy error in the form of excessive government intervention in the economy to be the largest risk to growth estimates. Several countries closely regulate industries, labor, and markets, set monetary policy, and provide subsidies to help boost their economies yet many countries are veering towards giving the government a level of control that would allow it to steer the economy and industry along a path of its exact choosing channeling additional private resources into strengthening state power.

The big risk for these countries is that the push winds up suppressing much of the entrepreneurial energy and incentives that have powered their boom, years of innovation and improving standards of living.

From a market standpoint, we continue to believe that as pandemic-era programs to bolster the economy are lifted there will be an easing of market conditions which favor the indexes and tech megacaps. The era of narrow stock leadership -- powered by the explosive growth in passive funds -- may be beginning to unwind. Less aggressive monetary easing ahead should expand the number of market winners favoring active management. PanAgora Asset Management’s research suggests that a cap-weighted strategy thrives as concentration rises, but delivers “significantly” lower returns when the macro climate shifts in favor of higher rates. 

The removal of policy supports could mean the fundamentals of individual companies come to the fore replacing what has been a wall of stimulus money hitting the indexes. We see much opportunity for outperformance ahead...


 Musings
 

Over the past month, as I’ve watched politicians worldwide flounder around on everything from public health, housing, the economy, taxation to capitalism itself I’ve found myself thinking more about my framework for viewing life and investing. The future is becoming more and more uncertain as the world is changing rapidly while those in power appear less and less capable of leading with grace and conviction. It is possible we are at the dawn of the period of greatest change for the past few centuries and the range of potential outcomes when pondering the coming decade or two spans from “dystopia to Renaissance”. 

In Canada and across the border in the USA, our democracies appear to be in the hands of statists who believe that government justifiably holds near-absolute power. During the recent Canadian election and the ongoing Democrat proposed 3.5T spending discussions there is little sense that there are or should be limits on the power of democratically elected governments. Such limits still exist in constitutional form, but they are being overwhelmed in spirit if not in law. A tax on wealth and capital? Previously unimaginable spending and deficits? Restrictions on the right to buy and sell property? Restrictions on speech, employment, movement and association based on “woke” ideological purity? Break up corporations? State led discriminatory attacks on certain corporations and individuals based on their ability to make profits? No worries. Big brother knows best and more government intervention and control is warranted. 

The overall ideological thread today has been that governments have the power and the right to do whatever they want — a trend that COVID-19 appears to have entrenched globally. 

Authoritarianism is on the rise around the world with governments becoming less transparent and losing the people's trust. The latest report 'Freedom in the World 2021' by Freedom House is sobering. The report, which is an annual country-by-country assessment of political rights and civil liberties, downgraded the freedom scores of 73 countries, representing 75 per cent of the global population. Democracy has eroded in the United States as well, the report noted.
 

While still considered 'free', the United States has experienced further democratic decline. The US score in 'Freedom in the World' has dropped by 11 points over the past decade, and fell by three points in 2020 alone. 

How much of the above is in our control? The rules of the game keep shifting as the state increasingly imposes its will on markets, society and culture. Watching this distressing reality unfold, largely out of my control, has prompted me to think more deeply about my framework for viewing life and investing. 

As a starting point, William Green in his fantastic new book suggests that it’s helpful to view investing and life as games in which we must consciously and consistently seek to maximize our odds of success. The rules are slippery and the outcomes unpredictable yet there are intelligent ways to play as well as stupid ones. 

How can we avoid swimming upstream and instead be carried with the current? How do we tilt the odds in our favor regardless of the environment or “playing field”? 

When it comes to investing, much ink has been spilt on this. Without diving too deeply we could distill the common “get an edge” formula into the following principles:

Be patient and selective exploiting neglected and misunderstood market niches. 

Say no to almost everything. 

Exploit the market’s bipolar mood swings. 

Buy companies at a discount to their intrinsic value. 

Stay within your circle of competence. 

Filter out the noise, keep things simple and avoid anything too complex. 

Make a small number of bets with minimal downside and high upside. 

Control your emotions and be patient. 

Simple but not always easy to follow. But my goal here isn’t to review the core principles that most investors likely already know, or should know. 

Instead, faced with the increasingly frustrating and downright depressing global macro political environment I tried to think about the times in my investing career I was best able to follow the above principles. 

What I found was that essentially all of the moments I had achieved some sort of “high performance” or “success” occurred in periods of time in my life in which I was joyous. Periods of time when I was particularly happy.  

Interestingly, perhaps the most consistent way we can maximize our odds of success is adopting an optimistic and positive attitude. Shawn Achor in his fascinating book “The Happiness Advantage” explains that “waiting to be happy limits our brain’s potential for success, whereas cultivating positive brains makes us more motivated, efficient, resilient, creative, and productive, which drives performance upward.”

New research in psychology and neuroscience demonstrates that we become more successful when we are happier and more positive. In his book, Achor outlines that: “doctors put in a positive mood before making a diagnosis show almost three times more intelligence and creativity than doctors in a neutral state, and they make accurate diagnoses 19 percent faster. Optimistic salespeople outsell their pessimistic counterparts by 56 percent. Students primed to feel happy before taking math achievement tests far outperform their neutral peers.” 

Unfortunately, for most of us, we are conditioned from birth to believe that once we become successful then we will be happy. Success is conceptualized as a necessary condition for happiness. If we get the promotion/raise/car/return [insert success/external validation], we will be happy. But with each victory the goals shift and the happiness gets pushed further out. 

Instead, in the face of an increasingly precarious future including its associated “FUD: Fear, Uncertainty and Doubt” I think that focusing on happiness as a precursor to success rather than simply its result is game changing. This kind of relationship with happiness is the ultimate way we can tilt the odds in our favor in investing and perhaps more importantly in life. 

Anytime you get a truth that much of humanity doesn’t understand, that’s a large competitive advantage. Intelligent people are easily seduced by complexity while underestimating the importance of simple ideas that carry enormous weight. When you consistently apply a powerful idea such as the happiness advantage with thoughtful diligence, the effects may astonish you...

Charts of the Month

According to the Fed's Z.1 report, U.S. Household net worth rose at a solid 18.4% rate in Q2 to $142 Trillion, after gains of 16.7% in Q1 and 28.5% in Q4 '20. The "Wealth Effect" is one of the most important statistics we can use to measure how American households are faring. This measurement leads to the "feel good" effect that adds to the confidence to go out and spend. It is comical that this report never makes a headline. Then again the popular rhetoric is still concentrating on how BAD things are out there. The data on consumers doesn’t seem to support that outlook...

Men are falling behind remarkably fast, abandoning higher education in such numbers that they now trail female college students by record numbers. No one is talking about it.

Logos LP August 2021 Performance

August 2021 Return: 10.23%

2021 YTD (August) Return: 18.26%

Trailing Twelve Month Return: 57.07%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 25.71%

 
Thought of the Month

“The very purpose of religion is to control yourself, not to criticize others. Rather, we must criticize ourselves. How much am I doing about my anger? About my attachment, about my hatred, about my pride, my jealousy? These are the things that we must check in daily life.” -Dalai Lama.

Articles and Ideas of Interest

• ESG is inflationary. As the global economy rebounds, the likelihood of inflation has become the dominant economic story. You can’t watch the financial news for long without hearing about inflation. At the same time, environmental, social, and governance (ESG) initiatives continue on an inexorable march to greater public perception. However, despite both issues occupying ever more column inches, one consideration has been underexplored; ESG will add to inflationary pressures. TwentyFour Asset Management suggests that yes, ESG is a new source of inflation that was not so present in the previous cycle and cannot be overlooked when forming a view on this cycle’s inflation outlook. How willing will consumers be to shoulder such rapidly increasing costs? There's arguably a point at which a preponderance of inflationary pressures may backfire, with people suddenly demanding governments do something (anything!) to ensure access to cheaper energy (never mind whether it's dirty or not)...Britain looks set to bump up against this reality as some customers are facing a 50% increase in their energy bills…
   

• Replicating private equity with liquid public securities. According to a Harvard Business School study, it is possible to replicate private equity returns with liquid public securities. “A passive portfolio of small, low EBITDA (earnings before interest, taxes, depreciation, and amortization – a commonly used measure of cash flow) multiple stocks with modest amounts of leverage and hold-to-maturity accounting of net asset value produces an unconditional return distribution that is highly consistent with that of the pre-fee aggregate private equity index.” Accelerate in a fascinating report believes that Harvard has it right, despite claims from private equity executives insisting otherwise.

• Lie Flat’ if you want, but be ready to pay the price. ​​The new “lie flat” social protest movement seems to be catching on. It started among overworked Chinese factory workers burned out from grueling 12-hour, six-day work weeks, and the unrelenting pressure from the government and society to climb the economic ladder. So some Chinese millennials formed an underground movement to opt out of work and the pressures of society. Never ones to miss a chance to cry “hardship,” upper-middle-class, well-educated young Americans are also getting in on the action, claiming they, too, are burned out and quitting their jobs to do nothing. What this trend will mean for China is unclear, but Allison Schrager suggests that Americans who choose to lay down in lieu of work may end up worse off than they think.
  
   

• The ‘melancholic joy’ of living in our brutal, beautiful world. Brian Treanor writes that it’s a challenging time to be an optimist. Climate change is widespread, rapid and intensifying. The threat of nuclear war is more complex and unpredictable than ever. Authoritarianism is resurgent. And these dangers were present even before we were beset by a historic pandemic. The data clearly show that based on certain objective measures of wellbeing we are living in the best of times – yet many people feel dissatisfied. In some places, including the US, self-reported happiness has actually been on the decline. So how should we view the state of the world: with optimism or pessimism? In answering, Treanor suggests that we must contemplate the broad sweep of both the world’s goodness and its evils.
  
   

• The everything bubble and TINA 2.0. FTX research does an fantastic job of exploring that common statement that “We are in an everything bubble” reviewing the data and going asset by asset. Worth the read. Spoiler: There’s most certainly pockets of excess in nearly every corner of the financial markets, but there’s also ample opportunity.
   

• Why is gold not rising? Interesting take on the shiny metal (albeit from a gold bug) via GoldSwitzerland.
  
   

• Silicon Valley is searching for the fountain of youth in a bill. Human aging is the latest and greatest field being disrupted by technology. The big picture: Work on therapeutics that could slow or even prevent the aging process is moving out of the fringes and into the mainstream, fueled by funding from tech billionaires who have one thing left to conquer: death.

• What if people don’t want a career? Charlie Warzel, a reporter on the future of work has found an interesting and potentially profound trend: the growing skepticism around ‘careers.’ ‘Careerist’ has long been a dirty word in the working world — usually it’s meant to signify a cynical, ladder climbing mentality. A careerist isn’t a team player. They care more about the job title and advancement than the work. The current brand of career skepticism he is talking about is different, more absolute. It’s not a rejection of how somebody navigates the game, it’s a rejection of the game itself. The idea isn’t limited to a specific age group, but the best articulation of it comes from younger Millennials and working age Gen Zers. Many of them are fed up with their jobs and they’re quitting in droves. Even those with jobs are reevaluating their options. What comes next?
   

• You are living in the Golden Age of stupidity. The convergence of many seemingly unrelated elements has produced an explosion of brainlessness. Interesting take by Lance Morrow suggesting that stupidity dominates in our time because of a convergence of seemingly unrelated elements (the death of manners and privacy) that - mixed together at one moment, in our cultural beaker - have produced a fatal explosion.

• Why you need to protect your sense of wonder - especially now. As the pandemic era goes on, more than ever we need ways to refresh our energies, calm our anxieties, and nurse our well-being. The cultivation of experiences of awe can bring these benefits and has been attracting increased attention due to more rigorous research. At its core, awe has an element of vastness that makes us feel small; this tends to decrease our mental chatter and worries and helps us think about ideas, issues, and people outside of ourselves, improving creativity and collaboration as well as energy. David Fessell and Karen Reivich, a physician and a psychologist, have facilitated hundreds of resilience and well-being workshops; they suggest for HBR a number of awe interventions for individual professionals as well as groups. 

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

Logos LP

How did we do in 2019? Sell in 2020?

Good Morning,
 

Stocks rose slightly on Friday as Wall Street wrapped up a nice weekly performance that featured new record highs for the major indexes amid strong global economic data and a solid start to the earnings season. 

Friday’s gains came after Chinese industrial data for December topped expectations overnight, with production rising 6.9% on a year-over-year basis. The overall Chinese economy grew by 6.1% in 2019, matching expectations. 

In the U.S., housing starts soared nearly 17% in December and reached a 13-year high. That data follows Thursday’s release of better-than-forecast weekly jobless claims and strong business activity numbers from the Philadelphia Federal Reserve.

Stocks are gaining to start the year with bullish investor sentiment on the rise and the naysayers in sync with calls of an “overbought” market “ripe” for a fall (more than three months have gone by since the S&P 500's last decline of 1% or more back on October 9th).

Meanwhile hedge fund billionaires David Tepper and Stanley Druckenmiller are confident in the current bull run. 

Tepper told CNBC’s Joe Kernen in an email: “I love riding a horse that’s running.” Tepper, meanwhile, told Kernen in a separate email he is still bullish in the “intermediate term” in part because of the Federal Reserve’s current monetary policy stance.

A solid start to the corporate earnings season has also provided a supportive backdrop to the market as more than 8% of the S&P 500 have reported quarterly results thus far and of those companies, 72% of companies gave posted better-than-expected earnings.

Our Take

With indexes trading at record highs, the S&P 500 up 13 of the past 15 sessions and with stocks trading at historically high levels versus earnings, expected profits and sales, it is understandable that investors might feel uncomfortable putting more money to work. 

Furthermore, as Nick Maggiulli reminds us, investors are faced with the common refrain that markets are “due” for a pullback. The reality is that markets are never “due” for anything. After studying the historical data Nick demonstrates that there is little to no relationship between prior 10-year returns and growth over the next 10 years.

For example, if you look at how the S&P 500 performed over its prior 10-years (starting in 1936) and then look at how it grew in the future, you won’t see much of a pattern. 

Interestingly, Nick demonstrates that “while the prior 10 years show little to no relationship with future returns, this is not necessarily true if we look at returns over the last 20 years.  Typically, if U.S. markets did well over the prior 20 years, they did poorly in the next 10 years, and vice versa.”  

Nick’s research suggests that if history were to repeat itself in some meaningful way, the S&P 500 would be 4x higher by 2030 than where it is today. 

Is this such an outrageous prediction given where we stand with persistently low borrowing costs and inflation? 

Sarah Ponczek in a recent piece in Bloomberg explored this “new regime for stocks” and found that stock prices have the potential to rise a lot more before reaching valuations that are justified by bond rates. Some suggest as high as 30 times earnings on the S&P. 

Near 3,330, the S&P 500 currently trades at 22 times recorded earnings. Getting to 30 times would place the benchmark close to 4,500, a gain of more than 35%.

There is no doubt that buying a quality asset at a low/reasonable price is more attractive than purchasing it a higher price. Yet the more interesting point to be gleaned from the above is that divesting or not investing at all based on the simple adage that ‘The market’s expensive therefore I’m a seller’ rarely works. The market historically has been rewarded with higher valuations when interest rates and inflation are subdued. 

Although there are no laws which guarantee the market will follow this historical trend and/or for how long, it is interesting to consider that those predicting a poor decade for stocks ahead may not have the data/evidence on their side…


Stock Ideas
 

For some of our picks for 2020 please find them on Yahoo Finance here.

Musings

For our thoughts about 2019, our portfolio composition headed into 2020, and our outlook for 2020 please find a copy of our 4Q annual letter to our partners on ValueWalk accessible here. 

Charts of the Month

Logos LP December 2019 Performance
 

December 2019 Return: -0.06%
 

2019 YTD (December) Return: 37.62%
 

Trailing Twelve Month Return: 37.62%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +15.77%

Thought of the Month


 "The world is ruled by letting things take their course.” – Lao-Tzu


Articles and Ideas of Interest

 

• Banks that shun risky borrowers offer rosy view of the U.S. Consumer. With most U.S. households spending more and paying their bills on time, their creditors are feeling more confident than ever. To hear the CEOs of the nation’s largest banks tell it this week, rarely has the American consumer been in better shape. Nevertheless, these banks may reflect the fact that banks have focused more on the wealthy and those with excellent credit as Nationwide, four in 10 adults don’t have the cash to cover an unexpected $400 expense, according to a 2018 survey by the Federal Reserve.

• Ten charts that tell the story of 2019. The power of a good chart or map lies in its ability to inform the debates and decisions that lie ahead. Here are 10 graphics published by the Financial Times in 2019 where the real story is often about what happens next — in the years, decades and centuries to follow.

• 19 big predictions about 2020, from Trump’s reelection to Brexit. Will Biden win the nomination? Will Netanyahu hang on in Israel? Will global poverty see a decline? The staff of Future Perfect forecasts the year ahead. The future perfect team at Vox weighs in.

• The pressing need for everyone to quiet their egos. Scott Barry Kaufman for the Scientific American suggests why quieting the ego strengthens your best self. We are more divided than ever as a species with anxiety and depression at record highs. What is the answer? The quiet ego approach. The goal of the quiet ego approach is to arrive at a less defensive, and more integrative stance toward the self and others, not lose your sense of self or deny your need for the esteem from others. You can very much cultivate an authentic identity that incorporates others without losing the self, or feeling the need for narcissistic displays of winning. A quiet ego is an indication of a healthy self-esteem, one that acknowledges one’s own limitations, doesn’t need to constantly resort to defensiveness whenever the ego is threatened, and yet has a firm sense of self-worth and competence.

• Why doing good makes it easier to be bad. In an age where corporate “do-goodism” / “corporate social responsibility” is en vogue, you might wonder how people who seem so good in public could be so bad in private. The theory of moral licensing could help explain why: When humans are good, it says, we give ourselves license to be bad.

• What makes a good life? Lessons from the longest study on happiness. What keeps us happy and healthy as we go through life? If you think it's fame and money, you're not alone – but, according to psychiatrist Robert Waldinger in this TED talk, you're mistaken. As the director of a 75-year-old study on adult development, Waldinger has unprecedented access to data on true happiness and satisfaction. In this talk, he shares three important lessons learned from the study as well as some practical, old-as-the-hills wisdom on how to build a fulfilling, long life.
  
   

• Why you will marry the wrong person. Alain de Botton for the NYT suggests that though we believe ourselves to be seeking happiness in marriage, it isn’t that simple. What we really seek is familiarity — which may well complicate any plans we might have had for happiness.
  
   

• Reports of value’s death may be greatly exaggerated. Many investors are reexamining their exposure to the value style given the extraordinary span—over 12 years—of underperformance relative to growth investing. Given the long historical record of value investing, and its solid economic foundations (dating back to the 1930s and, less formally, dating back centuries), it is unlikely that the period up to 2007 was a result of overfitting. The three other explanations, however, deserve a deeper examination. It is likely that no one story accounts for the underperformance; it is probably a combination of all three. Rob Arnott for Research Affiliates digs in.  

Our best wishes for a fulfilling January,

Logos LP

Haters Gonna Hate

Good Morning,
 

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

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

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

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

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

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

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

Our Take

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

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

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

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

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

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

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

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

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

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

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

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

Musings

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

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

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

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

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

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

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

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

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

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

Charts of the Month

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

Logos LP September 2019 Performance

September 2019 Return: -5.13%
 

2019 YTD (September) Return: 24.62%
 

Trailing Twelve Month Return: 4.67%
 

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

Thought of the Month

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

Articles and Ideas of Interest

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

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

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

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

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

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

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

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

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

  Our best wishes for a fulfilling October,

  Logos LP
  

These Halcyon Days

Good Morning,
 

Stocks closed lower on Friday after it was reported that trade talks between China and the U.S. had stalled and tit-for-tat tariffs soured the process. The late-day sell-off underscored the fragile mood in financial markets destabilized by concerns that the escalating trade war will undermine global growth.

President Donald Trump took steps toward calming nerves by postponing any tariffs on Japanese and European cars, while agreeing to end levies on Canadian steel and aluminum imports. But the status of talks with China remained unclear as investors headed into the weekend.

It was also the fourth straight weekly drop for the Dow.

Earlier this week, under the banner of a threat to the “national security” of the U.S., the administration made it harder for U.S. companies to do business with Huawei, a giant telecommunications company in China. U.S. firms that want to do business with Huawei must now have a license.

On the positive side, U.S. consumer confidence sentiment gauge reached a 15-year high with stocks near records and A Wells Fargo/Gallup survey found small business confidence rebounded strongly in the second quarter, matching a record, as current conditions posted a new high and recession concerns diminished. Top worries were attracting customers and new business, followed by hiring and retaining staff.


Our Take

Take a deep breath, these are halcyon days. Enjoy. The data coming out of the U.S. is for the most part still supportive of the view that things are pretty good (For a nice overview see here). Let's remember that the S&P 500 is still up about 14% YTD.

With stocks struggling to find direction amid heightened volatility over increased tariffs and threats of new ones as the White House and China battle over trade, many investors are overreacting and trading headline noise. *(Interestingly Trump’s China fight/tariffs has enjoyed broad support from American business, the Democrats and the Republicans)

They would be better served if they recalibrated their expectations on the outcome and timing of any future agreement on the China/U.S. tariff issue.
 

We’ve heard murmings that this is a Trump powerplay: a mastery of the art of timing. A sniffing out of the right moment to strike a deal with China to save the day just as Americans head to the polls. Vanquishing a saviour who has adroitly played on what voters hold dear and what they fear would certainly be a difficult task for the Democrats...

The above narrative may or may not be accurate but regardless, to expect a quick deal is to completely misunderstand the deep differences in the two countries economic models (state capitalism vs. free-market capitalism). These differences ensure that their trading relations will likely be unstable for years to come.

It should be remembered that the Chinese government allocates capital through a state-run banking system with $38trn of assets. Attempts to bind China by requiring it to enact market-friendly legislation are unlikely to work given that the Communist Party is above the law.

These are issues that have been around for decades. Stable trade relations between countries require them to have much in common such as how commerce should work, what role the state should have and a commitment to the enforcement of rules. Look no further than the (for the most part successful) renegotiation of NAFTA (Mexico, USA, Canada).

Compounding the friction between these competing economic visions is that fact that many in the U.S. are suffering from a lack of self-confidence (“bullying behaviour”) as they witness China’s rise.

The problem with this administration's heavy handed approach is that it has made it difficult for China’s leadership to frame the trade spat domestically as anything other than an effort to undermine China’s rise. The shift toward a nationalist tone coincides with Beijing’s hardened trade negotiating position.

The problem is that an intensified conflict over trade and nationalism that results in harm to U.S. interests will make China less appealing to foreign investors, something Beijing can ill afford at a time when its economy is already slowing. Moreover, previous protests have shown that promoting nationalism can boomerang on the Chinese state and lead to unwanted social disruptions.

As such, the probability of some kind of a resolution is high.

For the investor, it is important to come to terms with any pervasive “fear” of “losing money” and  corresponding unwillingness to take a long-term view. Making rash decisions each time there is a change in the short-term trend due to a headline is a recipe for the investor to realize low returns on capital or worse: no return on capital.

Musings

This month we were featured/interviewed by two wonderful organizations.

ValueWalk: https://valuewalkpremium.com/2019/05/eter-mantas-and-matthew-castel-general-partners-of-logos-lp-talk-small-cap-investing/

MOI Global: https://moiglobal.com/peter-mantas-2019/

Only a short note this week on portfolio concentration. This month we fielded several questions regarding the concentration of our portfolio and thought it may be useful to explain our view that concentration as a strategy is more attractive than diversification.

Why?

1. Better information increases the probability of superior returns, so a concentrated fund allows the investor to conduct thorough research and understand the intricacies of the business in order to take advantage of mispricings in the market. Instead, lack of concentration leads to making investment decisions based on superficial reasons or worse: emotion.

2. If the target range of holdings is narrow, the investor is setting a higher hurdle rate for investment quality and return. Investors can be more discriminating, avoiding stocks or sectors that are not high quality and focus on a smaller group of companies that meet their strict metrics.

3. There is also the issue of cost. With low to no-cost ETFs, there is simply no justification for an active investor/manager to construct a portfolio with a large number of holdings that mimics the benchmark. Better to own the benchmark in a low cost way.

Charts of the Month


According to a new survey by Charles Schwab, almost half of millennials (49%) say their spending habits are driven by their friends bragging about their purchases on social media vs. around one-third of Americans in general. link

Tech bubble all over again?


Logos LP April 2019 Performance
 

April 2019 Return: 10.08%
 

2019 YTD (April) Return: 23.87%
 

Trailing Twelve Month Return: 6.60%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014:+15.58%

Thought of the Month

"Knowledge is learning something new every day. Wisdom is letting go of something every day.”-Zen Proverb

Articles and Ideas of Interest 

 

• Why we’ll never be happy again. Ben Carlson suggests that there are two things people need to understand about humanity:(1) Things are unquestionably getting better over time. (2) People assume things are unquestionably getting worse over time. Is there a silver lining?

• Inflated credit scores leave investors in the dark on real risks. Consumer credit scores have been artificially inflated over the past decade and are masking the real danger the riskiest borrowers pose to hundreds of billions of dollars of debt. That’s the alarm bell being rung by analysts and economists at both Goldman Sachs Group Inc. and Moody’s Analytics, and supported by Federal Reserve research, who say the steady rise of credit scores as the economy expanded over the past decade has led to “grade inflation.”

• What makes a great business? Great article by Travis Wiedower regarding what makes a great business. In summary, there’s no getting around that businesses have to invest capital at high rates of return to be successful. To do so, they probably need several strong competitive advantages that keep potential competitors away. Finally, organic growth of new products usually outperforms other types of growth, especially large acquisitions. Those are the base rates of what makes a great business.

• Putting your phone down may help you live longer. By raising levels of the stress-related hormone cortisol, our phone time may also be threatening our long-term health.

• If this is a tech bubble in stocks, it’s the expansionary phase. Is this the tech bubble part two? It’s fair to ask, given how big that index is getting versus the rest of the market. At about 36 percent of the S&P 500, it’s creeping up on 1999-style dominance. Arguing against the comparison is the share of overall earnings its companies generate. Going by the quarter they just reported, it’s four times as much as 20 years ago. 

• The Age of the influencer has peaked. It’s time for the slacker to rise again. It’s hard to remember a time when scrolling through Instagram was anything but a thoroughly exhausting experience. Where once the social network was basically lunch and sunsets, it’s now a parade of strategically-crafted life updates, career achievements, and public vows to spend less time online (usually made by people who earn money from social media)—all framed with the carefully selected language of a press release. Everyone is striving, so very hard- #nevernotworking. And great for them....But sometimes one might pine for a less aspirational time, when the cool kids were smoking weed, eating junk food, and… you know, just chillin’. Quartzy suggests that the slackers are back…

• Getting rich vs. Staying rich. Fantastic article by Morgan Housel in which he explores the following pattern: Getting rich can be the biggest impediment to staying rich. It goes like this. The more successful you are at something, the more convinced you become that you’re doing it right. The more convinced you are that you’re doing it right, the less open you are to change. The less open you are to change, the more likely you are to tripping in a world that changes all the time. There are a million ways to get rich. But there’s only one way to stay rich: Humility, often to the point of paranoia. The irony is that few things squash humility like getting rich in the first place.

• Private equity’s allure poses big risks for the stock market and its investors in the next recession. Private equity is becoming the go-to for active investors — a trend which AllianceBernstein expects to continue for the next decade. The shift, which is well underway, could have implications for the stock market and its investors, especially in a recession. “It throws a spotlight on the resilience of the liquidity of public markets and even questions the point of a public stock market,” Bernstein senior analyst Inigo Fraser-Jenkins says. No wonder Buffett has also sounded the alarm suggesting that private equity returns have been inflated and bondholder covenants have “really deteriorated”.

• Is CBD the cure-all it’s touted to be? The cannabis derivative is being tested as a treatment for everything from brain cancer to opioid addiction to autism-spectrum disorders. Whether it can live up to the hype is still an open question, writes Moises Velasquez-Manoff in the New York Times Magazine. Meanwhile Americans can expect to bombarded by ever more CBD-infused products as Green Growth Brands Inc. is partnering with Abercrombie & Fitch Co. to sell its CBD-infused bath bonds and other body care products in a limited number of stores.

Our best wishes for a fulfilling May,

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