What Are We Wrong About Today?

Good Morning,
 

Stocks remained in a holding pattern on Friday after China and the U.S. agreed to a phase one trade deal as investors concluded a decent week of gains.

The trade deal will include a rollback of some of the China tariffs and halts additional levies set to take effect on Sunday. China agreed to significant purchases of U.S. agricultural products, but the amount is below what the White House was reportedly pushing to get. On the U.S. side, investors were hoping for more than just a partial rollback of some tariffs.

The US markets sit at record highs and it would appear that the probability of Christmas 2019 being cancelled like Christmas 2018 is low.

Our Take

Although markets both in the US and around the world seemed to rejoice at the progress made on a phase one trade deal upon further inspection this appears to be another baby step. 

As part of the “phase one” deal, the U.S. canceled plans to impose fresh tariffs on $156 billion in annual imports of Chinese made goods-including smartphones, toys and consumer electronics-that were set to go into effect Sunday. The U.S. also slash the tariff rate in half on roughly $120 billion of goods, to 7.5% from 15%. 

Nevertheless, tariffs of 25% would remain on roughly $250 billion in Chinese goods, including machinery, electronics and furniture. 

Chinese officials said the U.S. has agreed to reduce these tariffs in stages, but U.S. Trade Representative Robert Lighthizer said there was no agreement on that, and he suggested China believes such reductions can be negotiated in subsequent phases. 

For its part, China will boost American agricultural purchases by $32 billion over previous levels over the next two years. That would increase total farm-product purchases to $40 billion a year, with China working to raise it to $50 billion a year. 

The agricultural purchases are part of a package designed to raise U.S. exports to China by $200 billion over two years, Mr. Lighthizer siad. 

Mr. Lighthizer said that China made specific commitments on intellectual property but these would be announced in the future. 

Many trade experts expected the U.S. to eliminate the tariffs imposed on retail goods on Sept. 1 or roll back more tranches of tariffs (there are currently 4 tranches in play), rather than merely halving the September tariff rates. 

So to recap we basically have a saving face ceasefire to further tariff escalations with question marks around most of the most important aspects of the dispute. 

Nevertheless, it should be seen as a positive for stocks since it could boost business confidence and that could spill over to more investment spending and higher corporate profits. In our view this confidence will likely depend on being able to tell businesses not only that tariffs are not going up but that they are going down...

Both countries have agreed to stop punching themselves in the face; but how much better if they hadn’t started at all...

From what we can see, there is nothing in this tentative deal that wouldn’t have existed in the absence of the past two years of trash talking. 

Looking at the record highs in global stock markets, it’s tempting to think that none of this really matters. But it’s worth considering how much of these returns are attributable to the global synchronization of dovish monetary policy which has cushioned a deteriorating geopolitical picture in addition to job growth which has remained strong and consumers who have continued to spend.

Although things look better now than they did in the summer, global growth in 2019 will still be the weakest since the financial crisis of 2008 and 2009, according to the International Monetary Fund, and China and the U.S. will both slow next year. With paralysis at the World Trade Organization, we could be closer to the beginning than the end of the troubles in the global trading system.

While times are good a trade fight is all fun and games. Unintended consequences are ignored, swept under the rug and to the victor go the spoils! Yet when times turn bad and the tide rushes out, those not wearing a bathing suit may finally be exposed to the merciless disdain of the crowd... 


Stock Ideas

 

In our last newsletter update we suggested a few companies we are evaluating for addition to our portfolio. We received positive feedback on the inclusion of such picks and thus we thought we would follow things up with a few updates and picks: 

UPLD (Upland Software): We still think Upland is a compelling buy here. With the recent results we saw from Enghouse, we think that fiscal '20 will be a good year for the consolidators. With a plethora of VC investments ending up as zombies (and more to come as capital becomes more disciplined), we think there is a robust pipeline in niche work management cloud companies (think software that tracks consumer sentiment when you call your telco to complain about your bill). At 3.8x sales, 13x forward PE and 4.1x book, the company is not trading at a premium valuation considering it is a consolidator with rapidly growing revenue in a highly fragmented software market. We have initiated a position and will look to add on further weakness. 

BOMN (Boston Omaha): This is another serial acquirer of an asset class that is peculiar: billboards. Billboards provide surprisingly high ROIC (not digital ones but rather regular old fashioned billboards) and have tremendous cash flow conversion. This company utilizes cash flows from billboards and invests them into other high quality companies a la Berkshire (surety insurance, bail bond insurance and municipal bond insurance companies). They also made a significant investment in Dream Homes, a niche home builder, and a regional bank. They are rapidly growing revenue and have a strong management team that has an ROIC-focused culture. Also, board members aren't paid much and all senior execs plus board members are required to purchase company stock. Stock is down over 15% this year, trading at 2017 levels and we think this presents an attractive entry point.

ATRI (Atrion): The small cap maker of fluid pumps and medical devices is having a tough Q4 as the trade deal made for a volatile period of time. The company reported slowing growth last quarter (especially in Asia) which sent the stock tumbling. Currently, the stock is trading below 50, 100 and 200 moving day average and is well off highs. With high ROIC (over 18% 5-year average) and a dividend increase of roughly 15% we think Atrion offers compelling value for the long term given the recent underperformance. We have initiated a position and will look to add on further weakness. 

Musings

Came across an interesting chart this month:

Apparently most people’s reading of the data and thus views on the economic outlook are highly correlated to their political bias. 

Thus, it is no surprise that many democrats I’ve had discussions with have largely sat the rally out since Trump’s inauguration or worse have remained completely on the sidelines assuming the U.S. economy is headed for Armageddon under the current administration. 

This sentiment was recently confirmed by the following data: “Sixty-five percent of Americans say a recession is likely in the next year — 84% of Democrats, 72% of Independents and 46% of Republicans.” 

This kind of decision making based on political bias is dangerous but oh so common. Why? 

Many possible explanations can be found in the realm of behavioural economics, but one I came across recently that is particularly illuminating: “Manson’s Law”.  

The law states that: 

“The more something threatens your identity, the more you will avoid it.” 

Mark Manson explains: “that means the more something threatens to change how you view yourself, how successful/unsuccessful you believe yourself to be, how well you see yourself living up to your values, the more you will avoid ever getting around to doing it.”

The world is a noisy place. On a daily basis we are bombarded with a plethora or people, activities and data. In light of this noise, we as humans find a certain comfort in knowing how we fit in the world. 

Anything that disturbs that comfort, threatens it or destabilizes it- even if it could potentially make our lives better (ie. learning something new, enriching us, challenges us to grow)- is inherently “scary”. 

What is fascinating about this law is that it applies to both good and bad things. Working hard earning thousands or even millions could threaten your identity as someone with grievances against the wealthy as much as failing in some way, losing all of your hard earned money could threaten your identity as a “successful” person. 

This is why people are often so afraid of success for the same reason they are afraid of failure: “it threatens who they believe themselves to be”. 

A few common examples of this phenomenon: 

You don’t invest in the stock market and ignore a favorable earnings, revenue and macro backdrop because it could threaten your identity as a Trump hater, staunch democrat, civil rights/99% advocate or simply as a bear who keeps trying to call “the top”. Result: you miss out on years of gains and can’t retire because you’ve failed to generate adequate returns. 

You don’t invest in the stock market and ignore the data that stocks outperform real estate over the long term because it could call into question your identity as someone who puts their nest egg in real estate like everyone you know. Result: your retirement is hoo-hum because you’ve failed to generate any significant returns creating cash-flow issues. 

You don’t wind up a failing business venture with obviously bad unit economics because that would call into question your identity as a high-flying “successful” tech entrepreneur. Result: you tax your life by a few years and burn your investor capital in addition to your reputation. 

You avoid telling your significant other that you feel the two of you are not a fit because ending the relationship would threaten your identity as a nice, loyal boyfriend in a “good relationship”. Result: you tax your life, miss out on meeting someone who is a great fit and both you and your significant other become bitter and resentful. 

These are only a few common examples yet they illustrate the point that we consistently pass up important opportunities because they threaten to change how we view and feel about ourselves. They threaten the values that we’ve learned to live up to and which anchor our lives and conceptions of self. 

We protect these values. We avoid opportunities and people that threaten them. We surround ourselves with people and opportunities that will reinforce them. 

I was walking down the street recently and saw a sign on a high school which advertised the school as a place where the students can “find themselves”. This is the zeitgeist of the times. 

The problem with this tired trope is that most people find themselves and never let go…

In a way, what we should consider is never finding ourselves. This is what keeps us learning and growing. Seeing ourselves as a canvas that is never really complete can keep us humble and open to new places, opportunities and people. 

Instead of anchoring to our existing beliefs and then trying to prove them right, we should consider chipping away at the ways in which we are wrong one day so that we will be a little less wrong the next…

What are we wrong about today that can lead to our improvement tomorrow?

Charts of the Month

Maybe things aren't so bad? 

Does the future belong to Millennials? 

Stock picking can be rewarding...

Logos LP November 2019 Performance
 

November 2019 Return: 9.63%
 

2019 YTD (November) Return: 37.70%
 

Trailing Twelve Month Return: 28.16%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +16.04%

Thought of the Month


 

"Everything is passing. Enjoy its momentariness.” – Mooji

Articles and Ideas of Interest

 

• Kids are expensive. How expensive? Forget retiring any time soon—or maybe ever—if you’re considering raising multiple children. According to Investopedia: Parents tend to underestimate the cost, even of that first year, as a recent survey by personal finance website NerdWallet points out. The actual cost of raising a baby in its first year is around $21,000 (for a household earning $40,000) and $52,000 (for one bringing home $200,000). According to the poll, 18% of parents thought it would cost $1,000 or less and another 36% put the price tag at between $1,001 and $5,000. You’re going to pay a lot of money for that cute little bundle – somewhere around $233,610 by the time the baby turns 18, according to a 2017 Department of Agriculture (USDA) study.

• Hippie Inc: How the counterculture went corporate. The Economist explores how half a century on from the summer of love, marijuana is big business and mindfulness a workplace routine. Nat Segnit asks how the movement found itself at the heart of capitalism. 

• The bad news about women on boards. Research suggests investor bias penalises companies when they make diverse appointments. As reported in the Financial Times: “When Isabelle Solal and Kaisa Snellman looked at 14 years’ worth of data from more than 1,600 US public companies, they made a disturbing discovery: businesses that put a woman on the board then suffered a two-year decline in their market value. Worse, the penalty was greater for companies that had splashed out on measures to boost diversity, such as better work-life balance policies. Their market value fell by nearly 6 per cent after a woman joined the board.” Why? The researchers found that investors think boosting board diversity is a sign that a company is more interested in social goals than maximising shareholder value...

• The most dangerous of all people is the fool who thinks he is brilliant. We all suffer from overconfidence at times (some with more frequency than others) yet Jason Zweig does an excellent job in this piece of reminding us of the blunders that can stem from presuming we know more than we do, more than the people around us, more than the people who came before us, more than the people who have spent decades studying a topic or working in a field. The dangers of underestimating the difficulty of problems and overestimating the ease of solutions.

• How much runway should a founder target between financing rounds? According to CBInsights, running out of cash is the second leading cause of startup failure. Needless to say—it’s an important question to get right. Is it possible that the startup failure rate is so high partially because conventional wisdom tells founders to prepare for 12-to-18 months between financing events when in reality they should be preparing for longer as the experienced VCs suggest? Sebastian Quintero ingests all of Crunchbase’s data to find out. His team finds that it possible that the conventional wisdom of 12 to 18 months between financing events is an influential factor leading to high startup failure rates as the hard data says entrepreneurs should plan for at least 18–21 months of runway, and as much as ~35 months if they want to play it safe and stay within one standard deviation from the mean. 

• OK Boomer, Who’s Going to Buy Your 21 Million Homes? Baby boomers are getting ready to sell one quarter of America’s homes over the next two decades. The WSJ reports that the problem is many of these properties are in places where younger people no longer want to live. If demand the demand isn’t what everyone said it would be, what happens to prices? Think steep discounts — sometimes almost 50%, and many owners end up selling for less than they paid to build their homes. What then happens to retirement?
  

• The American Dream is killing us. Mark Manson puts together an interesting review of American history suggesting that from a unique intersection of good fortune, plentiful resources, massive amounts of land, and creative ingenuity drawn from around the world that the idea of the American Dream was born. He holds that the American Dream is simple: “it’s the unwavering belief that anybody — you, me, your friends, your neighbors, grandma Verna — can become exceedingly successful, and all it takes is the right amount of work, ingenuity, and determination. Nothing else matters. No external force. No bout of bad luck. All one needs is a steady dosage of grit and ass-grinding hard work. And you too can own a McMansion with a three-car garage… you lazy sack of shit.” And in a country with constantly increasing customers, endlessly expanding land ownership, endlessly expanding labor pool, endlessly expanding innovation, this was true. Until recently…
  

• If you can manage a waffle house you can manage anything. A day doesn’t go by without us hearing about some “high-flying”/”high-tech” company raising capital. The founders are excited (yet have no experience in the space), everyone is excited and the space is “ripe” for disruption (yet no one has done a proper analysis of the business’s unit economics). What most don’t hear about or conveniently forget is that a year of two later the founders are looking to wind the thing up. The WSJ pens a refreshing article suggesting that running a 24-hour budget diner isn’t glamorous, but it forces leaders to serve others with speed, stamina and zero entitlement. What if all founders operated with zero entitlement? Now that would be an exciting “disruption”...

• What powered such a great decade for stocks? This formula explains it all. This is a nice follow up to our last newsletter entitled “Haters Gonna Hate”. Market Returns = Dividend Yield + Earnings Growth +/- Changes in the P/E Ratio. Contrary to popular belief, Ben Carlson demonstrates that a vast majority of the gains over the past decade can be explained almost exclusively by improving fundamentals. Yes that's right the market isn’t a ponzi scheme a product of financial engineering, stock buybacks and central bank money printing! Earnings growth and dividends explain nearly 97% of the annual returns for the 2010s. Many would argue the only reason earnings growth has been so strong is because of the massive stimulus we’ve received from low interest rates. Ben isn’t saying valuations haven’t risen in this time (they have). It’s just that they’ve risen in concert with corporate profits.

• A mysterious voice took over investing. I know what it is. The Institutional Investor examines the link behind the decline of value, hedge funds and alpha everywhere. Since the 2008 crisis, the Standard & Poor’s 500 Growth Total Return Index has beaten its Value Total Return counterpart in eight of 11 years, including 2019 for the year to date. Growth has put up average annualized returns of 9.4 percent in the decade since the crisis, versus just 5.6 percent for value. Worse, value has suffered through three negative years during that span, whereas the growth index has not experienced a single one. Spoiler: data and the rise of the machines. We simply cannot compete with this computational supremacy. Our human brains, about 1,260 cubic centimeters on average, have been essentially unchanged for nearly 200,000 years.

Our best wishes for the happiest of Holidays filled with joy and gratitude, 

Logos LP

The Disciplined Pursuit of Less

Good Morning,
 

Stocks fell from all-time highs on Friday after the release of stronger jobs data dampened hope for easier Federal Reserve monetary policy. 

Despite Friday’s losses, the major indexes posted solid weekly gains. The Dow and S&P 500 rose more than 1% each this week while the Nasdaq gained nearly 2%. Stocks also posted all-time highs on Wednesday.

The U.S. economy added 224,000 jobs in June. Economists had forecast the U.S. added 165,000 jobs in June, after a stunningly low 75,000 jobs were created in May, according to Dow Jones.

Our Take

Summer is upon us and the market has so far continued to reward the bulls after what has been a great first half of the year. In fact, we just witnessed the best June for the S&P since 1955. Pretty impressive given the noise we heard from the “Sell in May Crowd”. The latest market high was the 210th for the S&P 500 since 2013. Funnily enough, for those paying attention, every one of them was called THE top…
 

Having said that, we are finding it more difficult than ever to find fairly/under priced assets of ANY kind. Looking across public, private, alternative and real estate markets we see little opportunity for outsized returns moving forward. 

The balance of probabilities is beginning to tilt to the downside rather than to the upside as most of the silver bullets have been fired: tax cuts, rate cuts, accommodative monetary policy, share buybacks and animal spirits. What drives earnings higher and further multiple expansion we are beginning to become unsure...at the end of the day as Michael Batnick has recently reminded us the last 10 years have been the best ten ever for U.S. stocks: "Can this bull market continue? Yes, of course. It’s already gone on longer than many people thought it would, myself included. But is it likely to be as strong as it was over the last ten years? No, almost certainly not."

In other news, our CIO Peter was featured on MOI Global to discuss Zscaler. 

Musings

Last month I took a much needed week off and early into my European vacation, something startling occurred: my cellphone vanished. As someone typically attached to their phone, as a “necessary work evil”, my initial reaction was panic. 

How was I to know what was going on without my notifications? How would I be aware of the “newsworthy” developments as they transpired? How were my clients to reach me on a whim? How would I be able to react with immediacy and urgency upon notification? How would I be privy to my professional network’s latest career “humble brags” on LinkedIn? And of course (I’ll admit it), how would I be able to observe what my “friends” on Instagram were up to? 

I saw my options as two-fold: 1) get a new phone 2) spend my week of vacation without a phone and use my laptop to periodically check emails 

After a bit of deliberation, looking out over the Mediteranean, I decided to choose option 2. I found the first day without my phone hard. I became acutely aware of the habit I had built up which many of us seem to share: the urge to reach for one’s cell. I felt it on numerous occasions. At times precipitated by seeing my friends reaching for/looking at their phones and at other times simply a habit in which I would feel myself reaching only to find nothing to grasp. 

As the days rolled by, the habit began to fade. Instead of yearning for my phone seeing others on theirs, I began feeling more intimately connected with the present moment. Riding in a taxi became about observing the beauty of the scenery as it flashed by and laying on the beach became about reflecting on my life, rather than scrolling through emails, reading the news or worse scrolling through curated images and videos of other people’s lives. 

What I learnt in my week without a phone was the following equation: 

No phone = less noise = more presence in the moment = more clarity. 

This isn’t to say I didn’t get a phone when I returned from my vacation, but it is to say that my experience brought to my attention what Greg McKeown has dubbed “the clarity paradox”. 

The clarity paradox can be summed up in four phases: 

Phase 1: When we really have clarity of purpose, it leads to success.

Phase 2: When we have success, it leads to more options and opportunities.

Phase 3: When we have increased options and opportunities, it leads to diffused efforts.

Phase 4: Diffused efforts undermine the very clarity that led to our success in the first place.

Curiously, success can be a catalyst for failure. When we reach a certain level of success, we often then pursue more of it in an undisciplined way. We become attached and get side tracked. We get off course attracted by the allure of the “next opportunity” or “next thing”. 

What my cell phone experience opened my eyes to, were phases 3 and 4 of the clarity paradox. Unenlightened about our phone’s ability to clutter our minds with increased options and opportunities, we often allow our attention to be diffused at best, or completely monopolized at worst. 

It's no surprise to me that in a recent article on CNBC, the biggest complaint millennials had about their lives is: “I have too many choices and I can’t decide what to do. What if I make the wrong choice?”.

When faced with too many choices: 

1. Quality of decision making goes down

2. Satisfaction with choices goes down 

3. Decision paralysis sets in and no choice is made at all 

Now home with a new phone, armed with a more enlightened understanding of its impact on my psyche, I’ve resolved to do things a bit differently in my personal and professional life, to engage in the “disciplined pursuit of less”: 

1. Remove clutter by narrowing focus:  If you don’t absolutely love something then eliminate it. Don’t settle for good opportunities, focus on great ones which sit at the intersection between: your talents, what the world needs more of and what you are passionate about. 
    

2. Ask what is essential and eliminate the rest: We naturally gravitate towards clutter and attachment, we hoard, we suffer from loss aversion, the sunk cost fallacy and the endowment effect ie. we value an item more once we own it and we make the things we are attached to a part of our identities. We prefer to hold onto people, places, things and investments rather than let them go. If we can instead ask “is this necessary?” we will quickly realize most things aren’t. Remove them. Want to try something new? Get rid of something old first. 
    

3. Practice self-awareness and equanimity: This is the most important factor in attaining and maintaining clarity. Make a habit of looking in the proverbial “mirror” and asking “who am I?” What is important to me right now? How do I feel about my current situation? We as humans suffer from attachment which refers to the unrelenting drive to succeed, to acquire, to compete, to control, and to the inability to let go. Without the things we attach to, our views of ourselves become unacceptable, as if the house, the car, the job title, the watch or the fancy friends make us worthy and enhances our self esteem and position in the world. On the other hand equanimity refers to the ability to accept what is without resistance. When you resist, not only do you suffer but you also perpetuate suffering. The reality is that when you resist, suffering persists. Resisting what arises internally causes concentration, clarity and equanimity to decrease and as they decrease, suffering increases. Lost the promotion? Couldn’t afford the new watch? Startup has collapsed? Practicing equanimity and non-attachment allows us to avoid suffering and maintain clarity. This isn’t to suggest a passive or indifferent attitude. It is instead to embrace “a gentle matter of factness” with your sensory experience. “Equanimity” means balance; and in practical terms means “don’t fight with yourself” accept people and situations for what they are not as you wish they were. 

Whether as an organization or as an individual the ability to establish and maintain clarity will have an enormous impact on whether outcomes will be positive or negative. Purposefully having the courage to address “the undisciplined pursuit of more” by practicing “the disciplined pursuit of less” will differentiate your outcomes from the crowd, whether you throw your cellphone to the wind or not. 

Charts of the Month

The current expansion has just tied the 1990s' expansion for the longest in history, and then anything after that will be a record. Good news, but the recovery has also been the weakest.

Monthly data from the Conference Board showed that the leading versus coincident indicator ratio was down slightly on the month.

Household debt in the USA may be at record levels yet household debt as a percentage of personal income is at a 40 year low.

Logos LP June 2019 Performance

June 2019 Return: 5.57%
 

2019 YTD (June) Return: 25.35%
 

Trailing Twelve Month Return: 3.25%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014:+15.31%

Thought of the Month


"An intense love of solitude, distaste for involvement in worldly affairs, persistence in knowing the Self and awareness of the goal of knowing-all this is called true knowledge.” -The Bhagavad Gita

Articles and Ideas of Interest

• What you lose when you gain a spouse. What if marriage is not the social good that so many believe and want it to be? The Atlantic explores the notion that marriage is the best answer to the deep human desire for connection and belonging finding it to be incredibly seductive.

• The advantage of being underemployed. The five-day, 40 hour workweek is incredibly outdated. The irony is that people can get some of their most important work done outside of work, when they’re free to think and ponder. The struggle is that we take time off maybe once a year, without realizing that time to think is a key element of many jobs, and one that a traditional work schedule doesn’t accommodate very well.

• Why startups are more successful than ever at unbundling incumbents. These companies are essentially product design teams that are focused on iterating fast to find product-market fit. They are able to offer fundamentally better products and services than the incumbents because of the product-centric DNA of the management teams. Second, these companies rent all aspects of operational scale from partners and eliminate any capital expenditures or operational inertia from their execution plans.

• Liquidity and a ‘Lie’: Funds confront $30 trillion wall of worry. Now, with warnings growing louder about the risks money managers have taken with hard-to-trade investments, Wall Street is starting to wonder: Just where will this end? That question is reverberating across the financial world after the head of the Bank of England warned that funds pushing into a host of risky investments -- in some cases, without investors fully understanding the dangers -- have been “built on a lie.’’ Some $30 trillion is tied up in difficult-to-trade investments, he noted earlier this year. The big worry is that the now-troubled European funds that embraced such investments, only to stumble when investors asked for their money back, are just the tip of the iceberg. Exposure to illiquid assets and poor-quality bonds has crept into funds as managers hunt for whatever returns they can find in today’s low-interest-rate world. The troubles in Europe are reminders of the Icarus-style demise that active managers can meet when they wander into tough-to-trade products, while promising investors the ability to cash out easily. Lets also note that private equity dealmaking has reached new heights. It has swelled to its highest level(paywall) since before the 2008 global recession, and there’s no sign of slowing: buyout firms have nearly $2.5 trillion in unspent funds primed for investment.

• Random darts beat hedge fund stars - again. A stock-picker’s market? Not so much. Can you successfully pick stocks with a dart board? The writers at The Wall Street Journal thought so. To test their idea, the writers threw darts at a stock list in the newspaper. From those random hits they built a portfolio to stack up against highflying financial elites. Those elites meet at the Sohn Investment Conference, held each May in New York. The attendees are full-time active investors, people who spend 365 days and nights a year thinking hard about what investments to own and why. So how did the dart-throwing journalists do this year? “The results were brutal,” recounts Spencer Jakab of the Journal. The random writer picks beat the pros by 27 percentage points in the year through April 22. “Only 3 of 12 of the Sohn picks even outperformed the S&P 500. Choose your managers wisely.. 

• Could the U.S. be heading to a future of zero interest rates forever? It’s the obvious way to avert national bankruptcy as the country keeps piling on debt. If it decides to let the debt grow, it will have to borrow more and more in order to cover its increasing interest, and both borrowing and interest costs will snowball. That could provoke what the CBO calls a fiscal crisis -- a private investor panic about the government’s ability to repay its debt, causing a drop in bond prices that render financial institutions insolvent and causing an economic crisis. The government thus has a good reason not to let debt spiral out of control. And the easiest way to keep that from happening is for the Federal Reserve to cut interest rates to zero and keep them there. Welcome to Japan!

• To succeed in America it’s better to be born rich than smart. Children in the U.S. are told from an early age that hard work pays off, starting with their time at school. But according to a recent report from the Georgetown Center on Education and the Workforce (CEW), “Born to Win, Schooled to Lose, ” being born wealthy is a better indicator of adult success in the U.S. than academic performance. “To succeed in America, it’s better to be born rich than smart,” Anthony P. Carnevale, director of the CEW and lead author of the report, tells CNBC Make It. “People with talent often don’t succeed. What we found in this study is that people with talent that come from disadvantaged households don’t do as well as people with very little talent from advantaged households.” How much longer will the majority allow this sorry state of affairs to persist?

• Your professional decline is coming (much) sooner than you think. There is a message in this for those of us suffering from the Principle of Psychoprofessional Gravitation. Say you are a hard-charging, type-A lawyer, executive, entrepreneur, or—hypothetically, of course—president of a think tank. From early adulthood to middle age, your foot is on the gas, professionally. Living by your wits—by your fluid intelligence—you seek the material rewards of success, you attain a lot of them, and you are deeply attached to them. But the wisdom of Hindu philosophy—and indeed the wisdom of many philosophical traditions—suggests that you should be prepared to walk away from these rewards before you feel ready. Even if you’re at the height of your professional prestige, you probably need to scale back your career ambitions in order to scale up your metaphysical ones.

Our best wishes for a fulfilling July,

Logos LP

2018 Meltdown and What to Think of 2019?

Good Morning,
 

Santa Claus rally? No Santa Claus rally? Naughty or nice? One thing is for sure the last two weeks on Wall Street have been gut wrenching. Not for the faint of heart. During that time, the major U.S. stock indexes have suffered losses that put them on track for their worst December performance since the Great Depression. Investors have also been gripped by volatile swings in the market as they grapple with a host of issues.
 

The S&P 500 has logged six moves of more than 1 percent over the period, three of which were of more than 2 percent. For context, the broad index posted just eight 1 percent moves in all of 2017.
 

The Dow Jones Industrial Average, meanwhile, has seen seven days of moves greater than 1 percent. Its intraday points ranges also widely expanded. The 30-stock index has swung at least 548 points in eight of its past nine sessions, and also posted its first single-day 1,000-point gain ever on Wednesday. The index ended down 76 points Friday after vacillating throughout the session.
 

These moves are remarkable and what has been equally remarkable has been the fact that many pundits and astute market veterans haven’t had much of a satisfying explanation; fears of the Fed after Chairman Jerome Powell said he did not anticipate the central bank changing its strategy for trimming its massive balance sheet, a U.S. federal government shutdown, disfunction in Washington (almost every part of Trump's life is now under investigation), slowing global growth, weaker data coming out of the U.S., “end of cycle”, and thus fears of a recession. All of which seem convincing as a root cause of this vicious selling. Watching CNBC has been almost comical with pundits like Jim Cramer recommending gold one day only to recommend nibbling on stock as markets move higher the next.
 

2018 was the year nothing worked: In fact, in 2018, just about every single asset class one can invest in — from stocks around the globe to government debt to corporate bonds to commodities — have posted negative returns or unchanged performance year to date.
 

Even during the financial crisis in 2008, government bonds and gold worked...
 

What gives?

Our Take

While any 20 percent sell-off hurts (both the Russell 2000 and Nasdaq led the way into bear market territory. The S&P 500 (-19.8%) and the Dow 30 (-18.8%) did manage to fall just short of the 20% threshold yet the average stock is down far more than that) the one happening now is far from unheard of in terms of depth or velocity. Over the past 100 years, there are almost too many examples to count of stocks tumbling with comparable force.
 

THIS IS INEVITABLE AND NORMAL. WELCOME TO THE STOCK MARKET.

Investors over the Holidays have time to reflect on history, now that stocks have avoided a fourth straight down week via the biggest one-day rally since 2009. After coming within a few points of a bear market on Wednesday, the damage in the S&P 500 stands at 15 percent since Sept. 20.
 

This is normal but seems abnormal because we are all talking about it from morning to night.
 

As we are reminded by a recent article in Bloomberg: “A fair amount of complaining has gone on in recent months about the role of high-frequency traders and quantitative funds in the drubbing that reached its peak around Christmas. Perhaps. Those groups are big, and in the search for villains, they make easy targets. Treasury Secretary Steven Mnuchin is among the people who have made the connection.
 

One thing that makes it tough to lay blame for the meltdown on machine-based traders is the many past instances when markets fell just as hard without their help. The Crash of 1929 is one big example. However bad this market is, it’s a walk in the park compared with then.”
 

This pattern holds for the Dot-com Bust (S&P 500 lost 35 percent over the course of two months), Black Monday of 1987 (S&P 500 rose 36 percent between January and August 1987 in what was set to be the best year in almost three decades. Then the October sell-off pushed the S&P into a 31 percent correction over just 15 days), 1974 Sell-Off (the S&P 500 saw the index fall 33 percent in 115 days as a weakening economy, rising unemployment and spiking inflation pushed investors to head for the exits. Stocks subsequently rebounded, surging more than 50 percent between October 1974 and July 1975), 1962 Rout (S&P 500 Index lost a quarter of its value between March and June 1962), Not so Fat ‘57 (20 percent correction over 99 days in 1957).
 

Last I checked there were no high frequency traders then BUT there were equally dysfunctional administrations and equally irrational humans…
 

The selling is likely overdone. When the SP 500 peaked in late September '18, the forward 4 quarter estimate was $168.72; today, that same estimate is $169.58. The point is with the S&P 500 index falling some 15%, the forward estimate on which it's valued is actually slightly higher. The question is will these estimates hold. Clearly the stock market is not so sure despite the fact that the U.S. economy is in a good position to sustain a 2.5-3 percent growth rate in 2019.
 

With the selling frenzy pushing stock prices lower, investors are now pricing in zero growth in earnings for 2019. Is this reasonable? 2018 earnings will come in at around $162 for the year. Clearly, the market has lost a lot of confidence in the staying power of earnings and the health of the economy. If we apply a conservative 14-15 multiple to that, it yields a range for the S&P at 2,268-2,430. So with the index closing at 2,488 Friday, we are just above that range. The issue is that the stock market generally overshoots in either direction when it sees change. Emotion takes over and causes the rapid move.
 

Despite existing negativity, the market’s valuation has changed for the better. The S&P 500 is actually heading into 2019 with a P/E ratio right in line with its historical average going back to 1929. And if you look just at the last 30 years going back to 1990, it is actually undervalued.
 

Unless one sees another financial crisis upon us (which at this time we do not), the probability is high that this could also mark a near term low.
 

As for investor sentiment, bearishness sits at record highs. In fact, half of individual investors now describe themselves as “bearish” for the first time since 2013. The latest AAII Sentiment Survey shows greater polarization, with neutral sentiment falling to an eight-year low.
 

On December 24 73% of financial stocks hit 52-week lows. That exceeds all days from the worldwide financial crisis…
 

In the past 28 years, there have been 2 times when every stock in the 2&P 500 Energy sector was below their 10-, 50-, and 200 day average and more than half were trading at 52 week lows.
1) During the depths of the 2008 financial crisis
2) Now

The pendulum of the market may be set for a swing in the other direction.


A Few Things We Like for 2019 That We Have Been Nibbling On During The 2018 Rout

Cerner Corp. (CERN:NASDAQ): major player in the healthcare IT industry as its software is highly integrated into the operations of several large provider networks. The firm has internally developed much of its software, which makes its product lineup close to seamless and effective within the healthcare IT sector. The secular demand tailwinds for Cerner’s products are robust given ACA mandates that require providers to upgrade their health records management systems. This highly positive trend will be enhanced over the next several years by changing payer reimbursement structures. Trading at a roughly 30% discount to intrinsic value (earnings based DCF), 10 year low P/E, P/S and P/FCF.

CGI Group Inc. (GIB.A:TSX): deeply embedded in government agencies across North America and Europe. Gained greater scale with its acquisition of Logica in 2012. This scale will allow the firm to better meet the needs of global clients. The firm has a backlog of signed contracts of more than CAD 21 billion, with an average duration of approximately five to seven years. Growing IT complexity is expected to support long-term demand for IT services as companies look to simplify and streamline their IT landscape. Trading at a roughly 20% discount to intrinsic value (earnings based DCF), attractive 10 year low P/E, PEG ratio and EV/EBIT.


Chart(s) of the Month 


“Equity prices are said to have far outpaced earnings during this bull market. In fact, better profits accounts for about 70% of the appreciation in the S&P over the past 8 years. Of course valuations have also risen, that is a feature of every bull market, as investors transition from pessimism to optimism. But this has been a much smaller contributor. In comparison, 75% of the gain in the S&P between 1982-2000 was derived from a valuation increase (that data from Barry Ritholtz).”
 

Musings

I began reading a fantastic book over the break which I highly recommend entitled “The Laws of Human Nature” by Robert Greene. The book takes as its fundamental premise that we humans tend to think of our behaviour as largely conscious and willed. To imagine that we are not always in control of what we do is a frightening thought, but in fact is the reality. We live on the surface, reacting emotionally to what people say and do. We settle for the easiest and most convenient story to tell ourselves.
 

Greene writes: “Human nature is stronger than any individual, than any institution or technological invention. It ends up shaping what we create to reflect itself and its primitive roots. It moves us like pawns. Ignore the laws at your own peril. Refusing to come to terms with human nature means that you are dooming yourself to patterns beyond your control and to feelings of confusion and helplessness.”
 

These principles are all the more relevant in light of 2018’s market action. What is interesting is that like this sell off (including the cryptocurrencies sell off), when we look back at other selloffs like that of 2008, most explanations emphasize our helplessness. We were tricked by greedy banking insiders, mortgage lenders, poor government oversight, computer models and algorithmic traders etc.
 

What is often not acknowledged is the basic irrationality that drove these millions of buyers and sellers up and down the line.
 

They became infected with the lure of easy money. The taste of wealth and the envy of their fellow market participants appearing to make effortless gains.
 

This made even the most rational, experienced and educated investor emotional. Hungry for his own slice of the action. Ideas were rounded up to fortify such behaviour such as “this is game changing technology, this time it is different and housing prices never go down”. A wave of unbridled optimism takes hold of the mind and panic sets in as reality clashes with the story most people have accepted.
 

Once “smart people” start looking like idiots, fingers begin to get pointed at outside forces to deflect the real sources of the madness. THIS IS NOTHING NEW. IT IS AS OLD AS THE HUMAN RACE.
 

Understand: Bubbles/corrections/bear markets “occur because of the intense emotional pull they have on people, which overwhelm any reasoning powers an individual mind might possess. They stimulate our natural tendencies toward greed, easy money, quick results and loss aversion."
 

It is hard to see other people making money and not want to join in. It is also equally hard to watch one’s assets drop in value day after day. THERE IS NO REGULATORY FORCE ON THE PLANET THAT CAN CONTROL HUMAN NATURE.
 

As demonstrated above, the occurrence of these selloffs will continue as they have until our fundamental human nature is altered or managed.
 

As such, it is important during these periods that we look inward to acknowledge and understand the true causes of these phenomenon and even take advantage of them as they occur. The most common emotion of all being the desire for pleasure and the avoidance of pain. The most meaningful experiences of pleasure typically follow the most most meaningful experiences of pain…

Logos LP November 2018 Performance

November 2018 Return: 0.15%

2018 YTD (November) Return: -11.06%

Trailing Twelve Month Return: -7.60%

CAGR since inception March 26, 2014: +14.06%

Thought of the Month

"If you have trouble imagining a 20% loss in the stock market, you shouldn't be in stocks."

-- John Bogle

Articles and Ideas of Interest

• 2018: The Year of the Woeful World Leader. Trump, May, Macron, Merkel. Italy, Spain, Sweden, Latvia. Even the dictators stumbled. So much bad governing, so little time.   

• What the Fall of the Roman Republic can teach us about America. The bad news is that the coming decades are unlikely to afford us many moments of calm and tranquillity. For though four generations stand between Tiberius Gracchus’ violent death and Augustus’ rapid ascent to plenipotentiary power, the intervening century was one of virtually incessant fear and chaos. If the central analogy that animates “Mortal Republic” is correct, the current challenge to America’s political system is likely to persist long after its present occupant has left the White House. 

• Low fertility rates aren’t a cause for worry. AI, migration, and being healthier in old age mean that countries don’t need to rely on new births to keep growing economically.  

• Start-Ups aren’t cool anymore. A lack of personal savings, competition from abroad, and the threat of another economic downturn make it harder for Millennials to thrive as entrepreneurs.

• This McKinsey study of 300 companies reveals what every business needs to know about design for 2019. In a sweeping study of 2 million pieces of financial data and 100,000 design actions over five years, McKinsey finds that design-led companies had 32% more revenue and 56% higher total returns to shareholders compared with other companies.
   

• What do we actually know about the risks of screen time and digital social media? Some tentative links are in place, but many crucial details are fuzzy.

• Start-up economy is a 'Ponzi scheme,' says Chamath Palihapitiya. Tech investor Chamath Palihapitiya addressed concerns about his investment firm, Social Capital, while also calling the start-up economy "a multivariate kind of Ponzi scheme.”

Our best wishes for a fulfilling 2019, 

Logos LP

Do Bull Markets Die Of Old Age?

Good Morning,
 

The S&P 500 and Nasdaq composite closed lower on Friday as tensions between the U.S. and China weighed on investor sentiment while both countries continued negotiations on trade.

On Thursday, the two largest economies in the world began the second round of trade talks. But President Donald Trump told reporters he doubted the negotiations would be successful.

Later, reports emerged saying China would offer the U.S. a $200 billion trade surplus cut. Those reports, however, were quickly denied by a Chinese ministry spokesman on Friday.

Investors are closely watching progress on the latest China-U.S. trade talks for signs of a breakthrough that could reignite a recent rally in global equities, while factoring in oil prices at a four-year high and a 10-year Treasury yield now firmly above 3 percent. Politics in peripheral Europe are also back in the spotlight after Italy’s populist leaders sealed a coalition agreement and a plan for reforms seen as a challenge to the European Union establishment.
 

Our Take

In a bull market pushing through its 10th year, market timing has again become a preoccupation. One week stocks are climbing to reflect fundamentals ie. stellar earnings growth. The next they’re dropping as yields jump, trade talks with China stall and an executive suggests “peak earnings” on a call. The cost is less to the wallet than the psyche, given that we are coming off two years of relatively straight line low volatility gains.

Furthermore, both stock market bulls and bears can marshal data in their favor. Considering the S&P 500’s current forward P/E which runs above its 5 and 10 year averages, as well as its elevated CAPE ratio, the market looks rich. On the other hand, looking at the market’s PEG ratio or a P/E that accounts for earnings growth, stocks appear to be trading at their cheapest level since 2012...

Best to focus on particular businesses rather than on market prices. How could the business create value in the years ahead? As Thomas Phelps reminds us: “When experienced investors frown on gambling with price fluctuations in the stock market, it is not because they don’t like money, but because both experience and history have convinced them that enduring fortunes are not built that way.”


Chart of the Month

Source: More Than Never. Less Than Always


Musings
 

This month, the current U.S. expansion reaches the 107-month mark, making it the second longest business cycle expansion in the post-war period. It’s looking increasingly likely that this expansion will continue for more than a year and will become the longest since World War II. Most economists will tell you that expansions don’t die of old age, but the odds of fatal mistakes and excesses increase the older they get.

The age of this bull market is the elephant in the room for investors who each year get less enthusiastic about increasing long exposure. How worried should we be? What should we make of comments suggesting that things have “peaked”?

What should be remembered is that output growth during this expansion has severely lagged other expansions. There has been no robust recovery. The slow start in this expansion in the wake of the Great Recession was counterintuitive to the thinking of most analysts, who expected a robust recovery following the worst recession in a generation. However, there is evidence indicating that recessions caused by financial crises tend to be deeper and have longer recovery times than normal recessions.

In addition, this expansion has seen comparatively low rates of personal consumption. Personal consumption which comprises nearly 70% of GDP, has been a major contributor to the overall slow economic performance in the current expansion. Real consumption has grown by 23% since the summer of 2009, compared to growth rates of 41% and 50% at the same point in the expansions of 1991-2001 and 1961-1969, respectively.
 

Consumers are not the only group that has shown uncharacteristic restraint during this expansion; investment by the private (non-government) sector has also lagged since the last recession. Real private fixed investment has grown by 50% in this expansion, compared to growth rates of 89% and 76% at comparable points in the 1991-2001 and 1961-1969 expansions, respectively.

Perhaps one of the most interesting aspects of this U.S. expansion is its global ubiquity. The subpar economic growth seen in the U.S. following the global financial crisis has been simultaneously experienced by many other countries. Whatever the causes of mediocre economic growth in the U.S., the same factors have been at work around the world due to the increasing level of global economic interdependence.

So what?

All we can say at this point is that the mediocre growth of the U.S. economy since the Great Recession is likely a contributing factor in this expansion’s length. As such, although there appears to be pockets of excess across the market (see below), there doesn’t seem to be the kind of widespread excess and economic robustness which is typically characteristic of an expansion’s “final inning”. This time may be “different”, yet the faster and higher you climb, the further and faster you fall. Have we climbed high? Have we climbed fast?

Long-term investors should be wary of remaining “underinvested” on the sidelines waiting for the cycle to turn, as the wait may be longer than planned.

Logos LP April 2018 Performance



April 2018 Return: -3.84%

2018 YTD (April) Return: -3.79%


Trailing Twelve Month Return: +8.22%


CAGR since inception March 26, 2014: +18.39%

Thought of the Month


 

“Over all, 76 percent of the companies that went public last year were unprofitable on a per-share basis in the year leading up to their initial offerings, according to data compiled by Jay Ritter, a professor at the University of Florida’s Warrington College of Business. That was the largest number since the peak of the dot-com boom in 2000, when 81 percent of newly public companies were unprofitable. Of the 15 technology companies that have gone public so far in 2018, only three had positive earnings per share in the preceding year, according to Mr. Ritter.” -Kevin Roose

Articles and Ideas of Interest

 

• Hooray for unprofitable companies!  Interesting article in the NYT that discusses an omnipresent characteristic of this cycle: the proliferation of unprofitable companies. The start-up pitch is basically this: “It’s called the 75 Cent Dollar Store. We’re going to sell dollar bills for 75 cents — no service charges, no hidden fees, just crisp $1 bills for the price of three quarters. It’ll be huge. You’re probably thinking: Wait, won’t your store go out of business? Nope. I’ve got that part figured out, too. The plan is to get tons of people addicted to buying 75-cent dollars so that, in a year or two, we can jack up the price to $1.50 or $2 without losing any customers. Or maybe we’ll get so big that the Treasury Department will start selling us dollar bills at a discount. We could also collect data about our customers and sell it to the highest bidder. Honestly, we’ve got plenty of options. If you’re still skeptical, I don’t blame you. It used to be that in order to survive, businesses had to sell goods or services above cost. But that model is so 20th century. The new way to make it in business is to spend big, grow fast and use Kilimanjaro-size piles of investor cash to subsidize your losses, with a plan to become profitable somewhere down the road.” Instead of pointing the finger at Musk and his unprofitable counterparts the author makes an interesting suggestion: For consumers who are willing to do their research, though, this can be a golden age of deals. May you reap the benefits of artificially cheap goods and services while investors soak up the losses. What could go wrong?

• Who’s winning the self-driving car race? A scorecard breaking down everyone from Alphabet’s Waymo to Zoox. Spoiler alert: Tesla isn’t even top contender.

• Could Argentina’s woes be the tip of the iceberg of an even bigger crisis for the world economy? Tightening U.S. monetary policy could threaten a broad range of emerging markets. Tighter monetary policy will drain liquidity and lift borrowing costs for much of the world economy. Debtors beware.

• You’re not just imagining it. Your job is absolute BS. Anthropologist David Graeber’s new book accuses the global economy of churning out meaningless jobs that are killing the human spirit. There is no doubt that many jobs could be erased from the Earth and no one would be worse off, but this is a tough argument to make as personal fulfillment is relative. Furthermore, in his comfortable seat as a professor at an esteemed institution, musing amusedly about the mind-numbing hours most working people have to put in and put up with—even at jobs that have lively, meaningful moments—appears to fit neatly in his own category of a BS job…

• Bitcoin fans troll Warren Buffett with ‘Rat Posion Squared’ clothing line. Oh it's on! A 10 year wager perhaps between the CCI30(A Crypto Currencies Index) against the SPY (a low cost S&P 500 ETF)? Any takers?  

• Why winners keep winning and why accepting luck as a primary determinant in your life is a freeing worldview. Cumulative advantage goes a long way to explain a moat.  The Matthew effect, and explains how those who start with an advantage relative to others can retain that advantage over long periods of time. This effect has also been shown to describe how music gets popular, but applies to any domain that can result in fame or social status.  As for luck, when you realize the magnitude of happenstance and serendipity in your life, you can stop judging yourself on your outcomes and start focusing on your efforts. It’s the only thing you can control. 

• The epic mistake about manufacturing that’s cost Americans millions of jobs. Quartz suggests that it turns out that Trump’s story of US manufacturing decline was much closer to being right than the story of technological progress being spun in Washington, New York, and Cambridge. Thanks to a painstaking analysis by a handful of economists, it’s become clear that the data that underpin the dominant narrative—or more precisely, the way most economists interpreted the data—were way off-base. Foreign competition, not automation, was behind the stunning loss in factory jobs. And that means America’s manufacturing sector is in far worse shape than the media, politicians, and even most academics realize.

• The burbs are back. Americans are once more fleeing the cities to the suburbs. According to the National Association of Realtors, a trade association for estate agents, more than half of Americans under the age of 37—the majority of home-buyers—are settling in suburban places. In 2017, the Census Bureau released data suggesting that 25- to 29-year-olds are a quarter more likely to move from the city to the suburbs than to go in the opposite direction; older millennials are more than twice as likely. Economic recovery and easier mortgages have helped them on their way. Watch this trend continue as interest rates rise and large mortgages become even more difficult to obtain.

• Biology will be the next great computing platform. Just as the exponential miniaturization of silicon wafers propelled the computing industry forward, so too will the massive parallelization of gene editing push the boundaries of biology into the future.

Our best wishes for a fulfilling month, 

Logos LP