Good Morning,
U.S. equities fell along with the dollar (which has dropped to an 11-month low as measured by the Bloomberg Dollar Spot Index) on Friday as investors assessed an investigation into U.S. President Donald Trump that may stall his economic agenda. Nevertheless, the three major indexes notched record highs this week as quarterly earnings from S&P 500 companies largely outperform expectations. Microsoft, Honeywell and Morgan Stanley are just a few of the companies that reported earlier this week.
Next week will be the busiest one this earnings season, with about 170 S&P 500 components scheduled to report.This remains an earnings-driven market and there have not been any major surprises yet. If earnings continue to grow, stocks should keep going higher.
Calendar second-quarter earnings have mostly exceeded expectations this far. With 20 percent of S&P 500 companies having reported, 73 percent have beaten expectations and 77 percent have beaten on sales, according to John Butters, senior equity analyst at FactSet.
Our Take
Interestingly, for all the fear associated with the gridlock and incompetence in Washington research actually suggests that stocks may like government gridlock as much as they like potential tax reform. Investment research firm Ned Davis Research found that when the Philadelphia Federal Reserve's Partisan Conflict Index — a measure of political disagreement in the United States — rises above 100, the S&P 500 has risen at a 11.7 percent annual rate. In contrast, the S&P rises just 5.8 percent when the index is below 100, according to analysis published on June 27.
On Wednesday, the Philly Fed said the index reached 201.15 in June, one of only seven times it has been above 200, and close to March's record of 271.29. In this case, traders may actually like the Trump-Russia headlines causing D.C. gridlock because they don't want politicians to mess up a good thing. Earnings are growing at a record pace, and economic growth is steady — two things markets like. New legislation could force businesses to change, potentially hurting their growth...
Last week the Bank of Canada embarked on what may be the slowest cycle of interest rate increases in more than three decades as it awaits evidence that consumer prices are picking up.
Surprisingly the median forecast of 16 economists in a Bloomberg survey suggest that the central bank will raise borrowing costs in October, and then twice in 2018 to bring its benchmark interest rate to 1.5 percent.
Governor Stephen Poloz flagged the risk of higher inflation as one reason the central bank hiked for the first time in seven years last week. Yet rapid inflation is among the least of Poloz’s concerns, according to the survey. Asked to rank five risks to monetary policy in order of importance, economists put “inflation overshoots” last.
Instead the biggest risk is the opposite one, they said: that inflation remains below target. They flagged a housing correction and U.S. policies that hurt Canada’s economic growth as the second-biggest. Despite these concerns, this Friday Canada’s core consumer prices and retail sales came in higher than expected, signaling that overall inflation may turn around to clear the way for another rate increase this year...
Nevertheless, this fear is and should be shared by monetary policy watchers worldwide. As we have mentioned before, global inflation is far from target and in fact appears to be decreasing rather than increasing as expected/modeled…
Just this week The Bank of Japan kept monetary policy steady, but pushed back the timing for achieving its 2% inflation target to 2020. "Risks to the economy and price outlook are skewed to the downside," the BOJ said in a statement. Inflation targets have been pushed back six times since the central bank launched its massive stimulus program in 2013. Foreshadowing what comes next for the rest of the developed world or isolated case?
Musings
Read an interesting piece this week in Harvard Business Review which suggested that business leaders should read more science fiction. Typically the genre is associated with spaceships, aliens and distant worlds, but it offers far more than escapism. By presenting plausible alternatively realities, science fiction encourages us to confront what we think but also how we think and why we think it. Science fiction tales reveal how fragile the status quo is and how malleable the future can be.
As Eliot Peper points out, William Gibson famously coined the term “cyberspace” in his 1984 masterpiece Neuromancer. Neal Stephenson’s The Diamond Age inspired Jeff Bezos to create the Kindle; Sergey Brin mines Stephenson’s even more famous Snow Crash for insights into virtual reality and the Star Trek communicator spurred the invention of the cell phone. Just last week researchers in China successfully teleported the first object from earth into orbit...
Nevertheless, to understand the real value of science fiction it is best to view it as useful not because it may be predictive, but rather because it reframes our perspective of the world.
We can think of “science fiction” as a “mental model” in the sense used by Charlie Munger on the path to building what he terms “worldly wisdom”. Worldly wisdom is an approach to business, investing and life which is based upon using a range of different models from a range of different disciplines to produce something that has more value than the sum of its parts.
As Robert Hagstrom wrote in his book on worldly wisdom entitled Investing: The Last Liberal Art: “each discipline entwines with, and in the process strengthens, every other. From each discipline the thoughtful person draws significant mental models, the key ideas that combine and produce a cohesive understanding.”
Although it may be a stretch to call science fiction a “discipline” it is useful to consider it a mental model which helps us to question our assumptions.
Assumptions which lead us to follow the herd. Assumptions which lead us to make decisions which are merely average and at times assumptions which can cause disaster.
As such, “science fiction” can increase the power of a latticework of such mental models which extends far beyond narrow questions. Such a latticework can lead to rich and unique understanding of the full range of market forces- new business opportunities and trends, emerging markets, the flow of money, international shifts, the economy in general and the actions/behaviour of humans in society and markets.
Assumptions can be useful as they help us with the cognitive shortcuts we need for navigating an increasingly complex and noisy world. Nevertheless, they can also be detrimental as they fail to update as the world changes and condition us to be trend followers.
Superior decision makers, businesess people and investors train themselves to do the exact opposite. They train themselves to think in a way that is different than others, more complex and more insightful. By definition, most of the crowd can’t share such a way of thinking.
Thus, the judgements, ideas and assumptions of the crowd can’t hold the keys to success. Instead to free your mind from its false constraints and assumptions and connect with the intellectual explorer within, consider some science fiction this summer and your investment returns may just improve...
I recommend The Dispossessed by Ursula K. Le Guin and for a list of the top 25 works click here.
Let the mind bending begin...
Thought of the Week
"The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.” - Warren Buffett
Articles and Ideas of Interest
- Americans agree on the best way to invest their money - but they’re wrong. A new survey by Bankrate.com through Princeton Survey Research Associates International asked more than 1,000 Americans what they consider the best way to invest money they won't need for 10 or more years. The most popular answer, chosen by 28 percent of respondents, is to use it to buy real estate. Zero-risk cash investments, such as high-yield savings accounts, came in second with 23 percent of respondents, while the stock market took third place, with 17 percent of respondents. Yikes….does this support the thesis that US stocks find themselves in a bubble? (full article in CNBC here).
- Just because something is popular doesn't mean it's wise. Bankrate cites a study from London Business School and Credit Suisse, which found that after adjusting for inflation, housing offered returns around 1.3 percent per year from 1900 to 2011, while stocks performed more than four times better. If you believe the story that everyone else believes you will get what everyone else always got. Only a skeptic can separate the things that sound good and are from the things that sound good and aren’t...The ultimately most profitable investment actions are by definition contrarian: you’re buying what everyone else is selling (and thus the price is low) or you’re selling when everyone else is buying (and the price is high). These actions are lonely and uncomfortable because most people don’t believe them or do them...Next time you look at your “investments” consider how comfortable you are…
- A leading “happiness” researcher says we’re giving our kids bad advice about how to succeed in life. Habits are built at an early age yet these principles appear to be timeless and thus valuable at any age. Emma Seppala Science Director of Stanford University’s Center for Compassion and Altruism Research and Education suggests that many widely held theories about what it takes to be successful are proving counterproductive. Surprise surprise conventional wisdom/assumptions appear to be flawed. The problems and solutions are as follows:
- Focus on the future. Keep your eyes on the prize
- What we should be saying: Live (or work) in the moment
- Stress is inevitable - keep pushing yourself
- What we should say: Learn to chill out
- Stay Busy
- What we should say: Have fun doing nothing
- Play to your strengths
- What we should say: Make mistakes and learn to fail
- Know your weaknesses, and don’t be soft
- What we should say: Treat yourself well
- It’s a dog eat dog world
- What we should say: show compassion to others
- Why Canada is able to do things better. Interesting perspective in the Atlantic suggesting that most Canadians understand that when it comes to government, you pay for what you get. Since the election of Donald Trump, there’s been no shortage of theories as to why America’s social contract no longer seems to work—why the United States feels so divided and dysfunctional. Hyper-partisanship, racist tendencies, secular politics of race and nationalism? The author suggests something more mundane: “The United States is falling apart because—unlike Canada and other wealthy countries—the American public sector simply doesn’t have the funds required to keep the nation stitched together. A country where impoverished citizens rely on crowdfunding to finance medical operations isn’t a country that can protect the health of its citizens. A country that can’t ensure the daily operation of Penn Station isn’t a country that can prevent transportation gridlock. A country that contracts out the operations of prisons to the lowest private bidder isn’t a country that can rehabilitate its criminals.”
- Earth’s sixth mass extinction event is underway. Researchers talk of “biological annihilation” as this new study reveals billions of populations of animals have been lost in recent decades. There hasn’t been much talk of the effects of climate change of late but this piece does a great job of highlighting new research which analysed both common and rare species and found billions of regional or local populations have been lost. The researches blame human overpopulation and overconsumption for the crisis and warn that it threatens the survival of human civilisation, with just a short window of time in which to act.
- There are two kinds of popularity and we are choosing the wrong one. Which kind of popularity you pursue matters, says Mitch Prinstein, a professor and director of clinical psychology at the University of North Carolina. He recently published Popular: The Power of Likability In A Status-Obsessed World. Prinstein delves into reams of research about what popularity is, and what effects it has on us. He shows that people who seek to be likable tend to end up healthier, in better relationships, with more fulfilling work, and even live longer. Status-seekers, on the other hand, often end up anxious, depressed, and with addiction problems. In the age of Instagram, it’s no surprise that most of us are gravitating to the wrong kind...Getting lost in the pursuit of status will likely come with sacrificing of the only relationships that matter..No wonder we are living in the golden age of “bailing”. David Brooks for the NYT suggests that “There was a time, not long ago, when a social commitment was not regarded as a disposable Post-it note, when people took it as a matter of course that reliability is a core element of treating people well, that how you spend your time is how you spend your life, and that if you don’t flake on people who matter you have a chance to build deeper and better friendships and live in a better and more respectful way. Of course, all that went away with the smartphone.”
- Machines taking over hedge funds despite lack of evidence they outperform humans. Data science is a big part of the comeback story as Credit Suisse’s mid-year survey says 81% of investors likely to put money in hedge funds during the second half of 2017. About 60% of those investors are planning to increase allocations to quantitatively focused strategies over the next 5 years. To be sure, just because a hedge fund has a quantitative strategy does not guarantee returns. A recent Barclays report showed that while investors perceive quant strategies outperform those that are less technology-driven, there's no research that would indicate that is actually the case. In the first half of the year, so-called systematic diversified strategies, or those that have investment processes managed almost entirely by computers and have very little human influence over portfolio management, underperformed other strategies, according to new data by Hedge Fund Research Inc. The HFRI Macro: Systematic Diversified Index declined 2.8 percent during the first half of 2017, while the broader industry gained 3.7 percent. While the headcount, assets and interest appear to be growing, it doesn't appear that the returns are following suit. Interestingly, human brains are able to do useful things that machine brains currently cannot: forget. What does it mean to be human in a world filled with robots anyway? Quartz inquires.
Lots of talk about bubbles these past few weeks. Justified? Recently for Fox News Greg Ip wrote that: “If you drew up a list of preconditions for recession, it would include the following: a labor market at full strength, frothy asset prices, tightening central banks, and a pervasive sense of calm. In other words, it would look a lot like the present.” In another recent piece Scott Galloway convincingly paints a picture of the “full-monty bubble” we are nearing. As evidence, he mentions some hard metrics but focuses on a few interesting soft ones:
-Mediocrity + two years tech experience = six figures
-Bidding wars for commercial real estate
-Gross idolatry of youth
-You can’t get a table at average restaurants
-There’s an Uber for private jets
-Jay Z and Jared Leto are considered thoughtful startup investors
-The food at your company is … good
-A lot of articles explaining why “this time is different” (here, here, and here)
-You’re introduced to remarkably uninteresting tech people at Cannes, who people think are “fascinating”
-Tech CEOs are on the cover of fashion magazines and marrying supermodels
-Founders of tech firms believe it’s their responsibility to put a man on Mars and cure death because … you know, they’re awesome
-Billionaires with undergraduate and graduate degrees pay kids to drop out of college#negligent
-Currencies mined by machines are … currency (I have a better understanding of the chemical underpinnings of a Leonid Meteor Shower than Bitcoin or Ethereum #huh)
-There are CEOs of two firms at once
This list I must say is convincing but it should be remembered that calling a market top is incredibly difficult as the only thing we can predict is the inevitability of market cycles. Why? Primarily because the future is unknown. Thus, as the calls of a market top multiply (which at present they are) the best response is simple: try to figure out what is going on around you, and try and use that to guide your actions. Is the pendulum oscillating at its peak ready to swing back to the opposite extreme? Or is it just passing its midpoint? Or as Barry Ritholtz teases, you can join the crowded landscape of pundits predicting the next crash by following his guide: 1) pick a bogeyman 2) cite household authority figures 3) always be confident 4) pay attention to non-financial events 5) pick a favoured asset class 6) charts, plenty of charts 7) claim vindication early and often 8) don’t forget the esoteric technical indicators 9) ignore contradictory data 10) don’t manage money...
Our best wishes for a fulfilling week,
Logos LP
