Good Morning,
Stocks fell on the final day of a busy week that included the U.S.-North Korea summit, major central bank meetings and escalating trade tensions between Washington and Beijing.
The S&P 500 Index declined in heavy trading on a quadruple-witching last Friday, a quarterly event when futures and options contracts on indexes and individual stocks expire. The U.S. and China spent the day exchanging tariff threats, which drove down tech and industrial stocks, while a drop in the price of oil hit energy shares. Consumer staples and telecoms advanced, offsetting some of the drop, and the index finished with a weekly gain, if only barely.
Our Take
Value strategies continue to underperform while momentum strategies lead the market. In fact, while broad benchmarks sit relatively still, speculative shares are soaring, among them companies that recently went public, stocks favored by short sellers, and firms with weaker balance sheets. A seven-week rally was preserved in the Russell 2000, which was joined in record territory by an index of microcaps.
Gains in the third category, companies with shakier finances, breathed new life into a trade that had prevailed for most of the bull market before deterioratingas investors sought safety. Known as the low-quality rally, its revival may signal indiscriminate buying pressure is building again for equities.
Fundamentals look to be less important right now as high flying IPO’s have been surging. Technology companies that went public recently soared. Dropbox Inc., which began trading on March 23, climbed 32 percent. Cloud-based software company Zuora Inc. surged 18 percent, topping off gains of more than 50 percent since the start of the month. An exchange-traded fund that tracks newly public companies, the Renaissance IPO ETF, posted its second-best weekly gain this year. Avalara Inc., a Seattle-based company that provides sales tax-management solutions, started trading on the NYSE Friday and nearly doubled. There have been 22 technology companies to go public so far this year in the U.S., and they’ve gained an average of 70 percent, weighted by offer size, according to data compiled by Bloomberg.
Investors are no doubt chasing returns and to juice performance but this recent “risk-on” trend may also evidence investor belief that the future looks bright. A recent comment sums up the climate: “Why would you invest in a company where the balance sheet is stressed? You would do it if you felt that either the company or because of the economic situation that they’re going to grow into a more satisfactory fundamental balance sheet.”
Chart of the Month
An inverted yield curve as measured by the 10-year yield less than the two-year yield has occurred ahead of every recession in the past 40 years. The time interval between inversion and recession averages 10 months.
The chart above, courtesy of Urban Carmel, suggests we aren’t there yet.
Musings
Great article by Barry Ritholtz exploring the topic of failure and why we all as investors should learn to fail better. We should all cultivate the ability to be self-critical and implement a “standardized review process” when things go wrong.
As Ritholtz reminds us in contrast to equity investors: “Silicon Valley, technology and the venture-capital business model do a better job. Entrepreneurs and venture funders alike wear their failures like a badge of honor. Many venture capitalists even post their biggest misses on their websites. They recognize their model is to make a lot of losing bets in pursuit of finding the next big winner. Equity investors don’t have quite the same model, but they would benefit from a similar approach to recognizing their own limitations.”
The stigma that surrounds failure in asset management needs to be revisited as even juggernauts such a Buffett and Druckenmiller make big mistakes. As always, the way to avoid future failure is to embrace and learn from past failures. This piece hit home as during the month of May we exited our position in Luxoft and realized we had made a mistake. We were reminded of a few things: 1) turnarounds can take much longer than anticipated no matter how bullish one can be about the business’s prospects 2) more time means a larger opportunity cost 3) sometimes being too early is the equivalent to being wrong.
What investment mistakes have you made lately?
Logos LP May 2018 Performance
May 2018 Return: 0%
2018 YTD (May) Return: -3.79%
Trailing Twelve Month Return: +4.38%
CAGR since inception March 26, 2014: +17.99%
Thought of the Month
"You know what Kipling said? Treat those two impostors just the same — success and failure. Of course, there’s going to be some failure in making the correct decisions. Nobody bats a thousand. I think it’s important to review your past stupidities so you are less likely to repeat them, but I’m not gnashing my teeth over it or suffering or enduring it. I regard it as perfectly normal to fail and make bad decisions. I think the tragedy in life is to be so timid that you don’t play hard enough so you have some reverses.” -Charlie Munger
Articles and Ideas of Interest
- World Cup players to watch (not named Messi or Ronaldo). The diminutive Argentine and the preening Portuguese are the most recognizable players in the global tournament now under way in Russia. Oliver Staley details why eight other all-stars also deserve your attention over the next month. Apparently machine learning has come to a conclusion about which team will win. Place your bets. Mine is one France.
We are worrying about the wrong kind of AI. There’s a bigger AI threat than computers achieving consciousness. Rapid progress in lab-grown “mini brains” from human cells brings up huge ethical challenges. Consider that biologists have been learning to grow functioning “mini brains” or “brain organoids” from real human cells, and progress has been so fast that researchers are actually worrying about what to do if a piece of tissue in a lab dish suddenly shows signs of having conscious states or reasoning abilities. While we are busy focusing on computer intelligence, AI may arrive in living form first, and bring with it a host of unprecedented ethical challenges.
- Tudor Jones says his social impact ETF has potential to rival the S&P 500. Paul Tudor Jones said Tuesday that a new exchange-traded fund about investing based on social impact could one day rival the benchmark U.S. stock index. Social impact investing is making a real impact in private markets. Look for it to grow in popularity in public markets.
- Why China 'holds all the aces' in a full-blown US-China trade war. U.S. tariffs on $50 billion of China goods were imposed Friday to protect U.S. intellectual property and technology. It prompted China to retaliate. But before evaluating the policy prescriptions for this problem, we must first consider the starting point, which is flawed. The current $370 billion deficit estimate does not account for value-added. When looking at the value-added content of Chinese exports, the U.S. deficit with China is actually only half of what it seems. And if we then add back the U.S. surplus in "invisibles" and how much money the United States brings back from investments in China, the U.S.–China deficit shrinks from 2 percent of U.S. GDP to 0.8 percent, a report from Oxford Economics revealed. Furthermore, the reality is that many of the Trump administration's articulated demands are things that China is already doing, albeit at a somewhat slower pace. The United States wants China to buy more American goods and services — and so does China. Trump wants to impose stiff tariffs to prevent China from flooding the American market with increasingly less expensive technological products, like smartphones, computers and related accessories, which collectively comprise China's biggest exports to the United States. And China agrees — they want to export higher value-added goods, especially those with a high innovation content. Interests are much more aligned than either country wants to admit.
- You should be sleeping more than eight hours a night. Here’s why. To set the record straight about being horizontal, Quartz spoke to one of the world’s most-talked-about sleep scientists. Daniel Gartenberg is currently working on research funded by the National Science Foundation and the National Institute of Aging and is also a TED resident. (Watch his talk on deep sleep here.) He’s also an entrepreneur who has launched several cognitive-behavioral-therapy apps, including the Sonic Sleep Coach alarm clock. All that with 8.5 hours’ of sleep a night. Some topics covered: why 8.5 hours of sleep is the new eight hours, the genes that dictate if you’re a morning person or a night owl, why you should take a nap instead of meditating, how sleep deprivation can be a tool to fight depression, why sleep should be the new worker’s rights and tips on how to get a better night’s rest (hint: it’s not your Fitbit).
- Here’s Mary Meeker’s essential 2018 Internet Trends report. A few highlights: Ecommerce vs Brick & Mortar: Ecommerce growth quickens as now 13% of all retail purchases happen online and parcel shipments are rising swiftly, signaling big opportunities for new shopping apps.Amazon: More people start product searches on Amazon than search engines now, but Jeff Bezos still relies on other surfaces like Facebook and YouTube to inspire people to want things. Subscription services: They’re seeing massive adoption, with Netflix up 25%, The New York Times up 43%, and Spotify up 48% year-over-year in 2017. A free tier accelerates conversion rates. Privacy: China has a big opportunity as users there are much more willing to trade their personal data for product benefits than U.S. users, and China is claiming more spots on the top 20 internet company list while making big investments in AI.
Our best wishes for a fulfilling month,
Logos LP