Amor Fati

Good Morning,
 

Stocks closed at record highs on Friday to end the first trading week of the year as traders weighed the prospects of new fiscal aid as well as disappointing U.S. jobs data.

Stocks started off the new year with a slump on Monday, but the market churned higher as expectations of more government aid increased with Democrats winning two key Senate races in Georgia, according to NBC News projections.

The U.S. economy lost 140,000 jobs in December, the Labor Department said. Economists polled by Dow Jones expected a gain of 50,000.

The unexpected drop in employment came as the recent surge in COVID-19 cases across the country has forced state and local governments to re-take stricter measures to mitigate the outbreak. More than 21.5 million coronavirus cases have now been confirmed in the U.S., according to data from Johns Hopkins University. The U.S. reported more than 4,000 COVID-19 deaths Thursday -- the most virus-related deaths the country has reported in one day since the pandemic's start.

It's the third day in a row of record daily deaths from the disease, according to data from Johns Hopkins University. 

Still markets surged higher the weaker-than-expected employment print raised the possibility of more government aid from the incoming Biden administration.

Our Take
 

What a year: a global pandemic, continuous shutdowns, unparalleled government and central bank intervention, the fastest 30% drop in market history, the shortest bear market ever, followed by the quickest recovery on record!

Reflecting back on 2020, the qualities of water go far to describe what surprisingly turned out to be a great year for the bullish investor who was able to stay disciplined despite the chaos. 

Why did the markets end the year in a resounding crescendo of all-time record highs? The primary reason the rebound was so swift was due to overwhelming government and central bank intervention which allowed most business entities to keep the lights on during even the darkest of COVID-19 days. Many vulnerable “old economy” businesses were never forced to close their doors while COVID-19 made it apparent to investors that “disruptive innovation” based businesses (such as DNA sequencing, robotics, energy storage, artificial intelligence, digitization and blockchain technology) form the backbone of economies all around the globe.

The message from the stock market was clear. It saw and continues to see an economy that is fundamentally changed due to technology and is resilient enough to recover. Both the investor who was positioned in “disruptive innovation” before COVID-19 struck, and the investor who quickly recognized this theme and repositioned their portfolio, did extraordinarily well in 2020.

When it came to our portfolio at Logos LP, coming into 2020, its composition reflected an early recognition of how fundamental the above theme of “disruptive innovation” and technological change was becoming, but in the depths of March as markets plunged “limit down” and lockdowns began to grip the globe, we felt that the global economy had likely entered a period of convulsive changes, some positive and others devastating, that would shape financial markets for years to come.

As such, our portfolio’s composition has shifted to reflect our core belief that revolutionary technological changes are creating not only exponential growth opportunities but also black holes in global economies and financial markets.

Contrary to the popular discourse which pits “growth against value”, we believe that 2020 has shown us a way to synthesize the two seemingly opposite investment approaches.

In modesty, just as in the 1930s and 1940s when Benjamin Graham argued that the old investing framework which was dominated by railway bonds and insider dealing had become obsolete, we believe that the classical “value investing” doctrine can be updated.

Just as Graham provided a much-needed overhaul of investment doctrine, we believe that value investors today can improve their frameworks by incorporating into their analyses the rise of intangible assets and the importance of externalities ie. costs that firms are responsible for but avoid paying. 

From 2020 on, it has become apparent that innovation is evolving at such an accelerated pace that traditional equity and fixed-income benchmarks are being populated increasingly by so-called value traps, stocks and bonds that are "cheap" for a reason. As such, we believe that future investment success will require a certain amount of “adapting to the course of the river” in order to find oneself on the right side of disruptive change and innovation.

In John Templeton’s timeless 16 rules for Investment Success (published in 1933) he states:

“The investor who says, ‘This time is different,’ when in fact it’s virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing.”

For those who may suggest that all this talk about “disruptive innovation” amounts to the same old “This time is different” story, it is important to remember a quote by Blogger Jesse Livermore at Philosophical Economics: 

“Not only is this time different, every time is different.  That’s why so many investors are able to outperform the market looking backwards, using curve-fitted rules and strategies. But when you take them out of their familiar historical data sets, and into the messiness of reality, where conditions change over time, the outperformance evaporates.”

He continues:

“Now, in hearing this suggestion, readers will scoff: “So you’re saying this time is different?” Of course I am.  Of course this time is different.  By suppressing this conclusion, even when the data is screaming it in our faces, we hinder our ability to adapt and evolve as investors.  Reality doesn’t care if “this time is different” will upset people’s assumptions and models for how things are supposed to happen. It will do whatever it wants to do.”

This is the problem with many more “traditional” value investors who for years now have found themselves on the wrong side of disruptive change and innovation. The process of learning and growing as an investor is never over. It is a lifelong pursuit.

Alternatively, investors that blindly follow valuation metrics based purely on past averages are falling prey to their own psychological issues even though they think they are acting rationally by following their models.

To simply look back historically at a few classic valuation metrics and say prices are below average, so buy or prices are above average so sell is a recipe at best for mediocrity and at worst for disaster.

It’s never that black and white. If investors would have simply followed those easy models, they would have likely sat on the sidelines for the bulk of this market cycle. It’s far too difficult to use one or even a handful of classic indicators to know exactly when a cycle is at a major inflection point and about to change directions because at the end of the day they are driven by irrational human emotions.

Perhaps our biggest investment takeaways from 2020 is that markets will:

1) always be different in terms of their current state and what factors are contributing to the prices of certain securities. We believe that moving forward, avoiding industries and companies in the clutches of "creative destruction" and embracing those creating "disruptive innovation" will prove lucrative; and

2) never be different when it comes to our inherent irrational human emotions and biases: manias and panics won’t be disappearing any time soon.

Musings

Investors ended one of the market’s wildest years on record by piling into everything from bitcoin to emerging markets, raising expectations that a powerful economic comeback will fuel even more gains.

The breadth of this rally is remarkable. It can be thought of as an “everything rally” which has sent most assets to record highs. It was a good year for those who held assets and a painful year for those with few skills, little education and no assets. The result is a financial chasm between the have and the have-nots which is much deeper than what existed prior to the onslaught of COVID-19.

We expect the chasm to widen even further in the coming years as disruptive innovation wreaks havoc on any individual or company not investing aggressively in innovation. In harm's way are companies that have spent the last 10-20 years engineering their financial results to satisfy the short-term demands of short-sighted investors and individuals who are unwilling to update their playbooks and skillsets. We believe the winners will win big and the losers, particularly those that have levered balance sheets (often companies who employ many low skilled workers) to satisfy certain stakeholders, and those who refuse to upskill will be dislocated leading to even greater levels of permanent unemployment.

Nevertheless, we believe there is reason for optimism.

1) The economy and markets have a history of finding a way through unprecedented challenges. It is important to reflect on the historical ability of humankind to adapt and innovate in the face of hurdles, even those that seemed insurmountable. We created a vaccine in record time, avoided what could have been an economic depression and will continue to push on in 2021.
 

2) There are still compelling reasons to invest in 2021. There's still much work to be done, but the U.S. and global economies are on a trajectory of recovery, which provides a favorable environment for risk assets. On the whole, U.S. economic data is still coming in better than expected, even if momentum has slowed. Manufacturing activity, initial unemployment claims and consumer activity have all rebounded impressively off lows. The Federal Reserve is unlikely to deviate from its accommodative course especially with so many still unemployed. Economies are getting massive liquidity injections, cash in circulation is soaring and annual growth of U.S. cash in circulation typically peaks at the start of economic cycles. The world is positioned for synchronized global growth and companies are positioned for impressive earnings growth. Inflation may ramp up a bit, but we think that the probability that it will upend markets in any meaningful way is low as policy makers and central banks are well aware of the disastrous consequences of any sudden rise in inflation (asset prices at all time highs supporting the “wealth effect” underpinning the recovery, a plethora of overleveraged zombie firms and perhaps most importantly most states’ vastly expanded balance sheets-both governments’ debt and central banks’ liabilities). 
 

3) A business-friendly approach to taxes and regulation has been a key driver of markets over recent years and there is little reason to believe this will change as there is little appetite to derail the fragile recovery and instead, there is appetite for major infrastructure spending. With neither political party having a significant majority in the Senate, this will likely mitigate the scale of fiscal policy shifts.

The real question is how much of the above 3 factors have investors already priced into markets? To what extent have investors pulled forward future returns to the present?

We are certainly flying high yet that doesn’t mean that stocks can’t push higher still. When studying the history of stock market excesses, particularly the excess of the 1999/2000 era what is apparent is that calling the market overextended or spotting a bubble is easy as investors were comparing the internet sector to tulip mania as early as mid-98. What is much more difficult is the ability to time a profitable exit...

As Epictetus in Discourses, 2.5.4-5 reminds us:

“The chief task in life is simply this: to identify and separate matters so that I can say clearly to myself which are externals not under my control, and which have to do with the choices I actually control. Where then do I look for good and evil? Not to uncontrollable externals, but within myself to the choices that are my own…”

2020 so starkly reminded us of the virtues of humility. To be humble in our predictions and forecasts. Humble as to what we believe we can control. Humble as to our talents and abilities. Open to an attitude of “Amor fati” which may be translated as "love of fate" or "love of one's fate".

Willing to embrace an attitude in which one sees everything that happens in one's life, including suffering and loss, as good or, at the very least, necessary.

Charts of the Month

Financial conditions are also the most loose on record.

While many stocks have delivered other worldly performance.

As mania spread to derivatives.

Amazing comeback story.

Last year 54% of all new cars sold in Norway were battery-powered electric vehicles, making Norway the first country in the world where electric vehicles (EVs) outsell traditional petrol, diesel or hybrid vehicles. With new models from Tesla, BMW, Ford & Volkswagen all due to hit the market next year, Norway seems very much on track to meet their target of ending the sale of diesel and petrol cars by 2025. Perhaps the world is next?

Logos LP December 2020 Performance

December 2020 Return: 5.48%
 

2020 YTD (December) Return: 99.71%
 

Trailing Twelve Month Return: 99.71%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +25.43%

Thought of the Month

"Join with those who are as flexible as the wood of your bow and who understand the signs along the way. They are people who do not hesitate to change direction when they encounter some insuperable barrier, or when they see a better opportunity. They have the qualities of water: flowing around rocks, adapting to the course of the river, sometimes forming into a lake until the hollow fills to overflowing, and they can continue on their way, because water never forgets that the sea is its destiny and that sooner or later it must be reached.” — Paulo Coelho “The Archer”

Articles and Ideas of Interest

• The pro-Trump mob was doing it for the gram. But it was also quickly apparent that this was a very dumb coup. A coup with no plot, no end to achieve, no plan but to pose. Thousands invaded the highest centers of power, and the first thing they did was take selfies and videos. They were making content as spoils to take back to the digital empires where they dwell, where that content is currency.

• What Warren Buffett’s losing battle against the S&P 500 says about this market. In 2020, Berkshire Hathaway shares were up, but not by much (2%), against an S&P 500 that gained over 18%, with dividends reinvested, according to S&P Global. Taken together, the two-year stretch of 2019 and 2020 marked one of the biggest gaps between Berkshire and the broader U.S. stock market in recent history, with the Buffett trailing the index return by a combined 37%. What does it mean?

• Does Joe Biden have too much power as he will undoubtedly face pressure from extremist left to use it? Joe Biden has a problem on his hands, other than the man in the White House who refuses to behave himself or go away. Kelly McParland digs in. How concerned should investors be about Biden’s tax proposals? After the Democratic sweep of both Georgia senate seats this week, Goldman Sachs now expects the Fed to raise interest rates in 2024 instead of 2025.
   

• A majority of investors believe the stock market is in a bubble - and many fear a recession, according to an E*Trade survey. A new E*Trade Financial survey of 904 active investors revealed that 66% of them believe the stock market is either fully or somewhat in a bubble. An additional 26% said the stock market is "approaching a market bubble." The survey also revealed that recession fears linger. 32% of investors listed a recession as their top portfolio risk right now. But they remain fully invested with inflows surging and the consensus long…
  
   

• Canadian expert's research finds lockdown harms are 10 times greater than benefits. Finally an honest analysis of ROI from an early proponent of lockdowns. Emerging data has shown a staggering amount of so-called ‘collateral damage’ due to the lockdowns. This can be predicted to adversely affect many millions of people globally with food insecurity [82-132 million more people], severe poverty [70 million more people], maternal and under age-5 mortality from interrupted healthcare [1.7 million more people], infectious diseases deaths from interrupted services [millions of people with Tuberculosis, Malaria, and HIV], school closures for children [affecting children’s future earning potential and lifespan], interrupted vaccination campaigns for millions of children, and intimate partner violence for millions of women. In high-income countries adverse effects also occur from delayed and interrupted healthcare, unemployment, loneliness, deteriorating mental health, increased opioid crisis deaths, and more.

• After embracing remote work in 2020, companies face conflicts making it permanent. Although the pandemic forced employees around the world to adopt makeshift remote work setups, a growing proportion of the workforce already spent at least part of their week working from home, while some businesses had embraced a “work-from-anywhere” philosophy from their inception. But much as virtual events rapidly gained traction in 2020, the pandemic accelerated a location-agnostic mindset across the corporate world, with tech behemoths like Facebook and Twitter announcing permanent remote working plans. Not everyone was happy about this work-culture shift though, and Netflix cofounder and co-CEO Reed Hastings has emerged as one of the most vocal opponents. “I don’t see any positives,” he said in an interview with the Wall Street Journal. “Not being able to get together in person, particularly internationally, is a pure negative.” Very interesting expose in Venture Beat. 

• The Life in The Simpsons Is No Longer Attainable. The most famous dysfunctional family of 1990s television enjoyed, by today’s standards, an almost dreamily secure existence that now seems out of reach for all too many Americans. I refer, of course, to the Simpsons. Homer, a high-school graduate whose union job at the nuclear-power plant required little technical skill, supported a family of five. A home, a car, food, regular doctor’s appointments, and enough left over for plenty of beer at the local bar were all attainable on a single working-class salary. Bart might have had to find $1,000 for the family to go to England, but he didn’t have to worry that his parents would lose their home.

• mRNA vaccines could vanquish Covid today, cancer tomorrow. The incredible progress made in developing the Covid vaccines should not be understated as we may be on the edge of a scientific revolution in human health. It looks increasingly plausible that the same weapons we’ll use to defeat Covid-19 can also vanquish even grimmer reapers — including cancer, which kills almost 10 million people a year.

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

Logos LP

Has the stock market gone mad?

Good Morning,
 

Stocks rose on Friday even after the ugliest monthly jobs report EVER as investors bet the worst of the coronavirus and its impact on the economy has passed.

The Labor Department said a record 20.5 million jobs were lost last month, adding that the unemployment rate jumped to 14.7% from 4.4% levels unseen since the Great Depression. Both the spike in job losses and the unemployment-rate surge are post-World War II records. 

To be sure, neither print was as bad as feared. Economists polled by Dow Jones expected a loss of 21.5 million jobs and an unemployment rate of 16%.

This week also saw bankruptcies continue to pile up with Neiman Marcus filing days after J. Crew threw in the towel, and J.C. Penny is likely to follow suit next week. 

On the other hand, stock indexes have rallied aggressively off their March lows as investors bet on an eventual reopening of the economy and that many tech companies would see solid revenue even through the shutdowns. 

The S&P 500 has bounced more than 30% from its virus low and is just 13.6% away from its record high. The Nasdaq Composite is more than 35% off its lows and is now up 1.6% for 2020. Gains from Facebook, Amazon Alphabet and Apple helped lift the index back into positive territory for 2020. At one point, the Nasdaq was down more than 25% year to date. 

Why are the major indexes rising in the face of historic job losses? 

Our Take

Many investors (and the public at large) continue to doubt this rally and believe that the stock market has become decoupled from reality. They claim that everything is “fake” and that a great reckoning is coming. With every tick higher on the indexes, they retort that “it is still early”. 

From 2009 on this has been and continues to be “The most hated bull market of all time.” In our view, the bearishness going on right now is nothing new. 

AAII's weekly investor sentiment survey this week showed only 23.6% of respondents reporting as bullish. That marks the lowest level since the COVID-19 pandemic began and the lowest reading since October of last year (20.31%).

Meanwhile, for the fifth time in the past nine weeks, the bearish sentiment came in above 50%. Bearish sentiment this week rose to 52.6% from 44%. That marks the highest level for bearish sentiment of not only 2020, but that is the highest level since April of 2013 and in the 98th percentile of all readings since the beginning of the survey in 1987.

The survey's historical bullish average is 38% and bearish average is 30.5%. 

As for the majority of the world’s wealthiest investors, they are waiting for stocks to drop further before buying again, on concerns about the pandemic’s impact on the global economy, according to a poll by UBS Global Wealth Management.

Among the surveyed investors and business owners with at least US$1 million in investable assets or in annual revenue, 61 per cent want to see equities fall another five per cent to 20 per cent before buying, while 23 per cent say it’s already a good time to do so. Some 16 per cent say that now is not the time to load up on stocks as it’s a bear market.

 

Sir John Templeton has said, “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.” We have spent most of the past 10 years dealing with investor pessimism or, at best, skepticism. 

Today is no different. The market is not nearly as optimistic as the bears would have us believe and in fact appears to reflect the prevailing pessimism outlined above. As such, the recent rally appears quite logical. 

Ensemble capital has smartly pointed out that: 

"The most important thing to keep in mind is that S&P 500 is often referred to as “the market,” but of course the S&P 500 is essentially the 500 largest companies in the US, which, especially during this crisis, are not indicative of the economy as a whole. 

And the largest 25 companies make up nearly 40% of the S&P 500. Here is a list of those companies: Apple, Microsoft, Google, Facebook, Berkshire Hathaway, AT&T, Johnson & Johnson, Intel, Verizon, JP Morgan, Amazon, United Health, Pfizer, Bristol Myers, Merck, AbbVie, Bank of America, Proctor & Gamble, Cisco, Comcast, Visa, Home Depot, IBM, CVS, Amgen.

Now whatever you think about those companies, most all investors would agree that they are far, far more likely to survive this crisis than the average company. And, in fact, with so many smaller companies struggling it seems very likely that many of these large companies will thrive in a post-Coronavirus world in which their competition has been dealt a huge setback.

So looked at this way, the fact that the S&P 500 is only down 16% from its highs does not suggest that the market thinks the economy will be OK, but rather that the largest companies in the world will see their way though, and as demand returns they will face much less competition.”

Josh Brown has also remarked an important principle about markets: 

"The major stock market averages don’t necessarily have to resemble the conditions on the ground where you live. They don’t have to be representative of Main Street in Anytown, USA. And they don’t have to match up in a linear fashion with any of the data you and I are seeing from one day to the next.”

When you hear the negative headlines about the shutdowns of department stores, leisure, home furnishings, casinos, auto manufacturers, hotels, and homebuilders, remember that they make up about 1% of the S&P 500. So while these represent a big part of our daily lives, they are a tiny portion of the S&P 500. Perception is not reality. 

Instead, if you look at what has been leading the market higher it is most certainly not those industries and businesses outlined above most hit by the pandemic induced shut down. Economically sensitive stocks continue to languish, in addition to firms with weaker balance sheets as well as smaller companies composing the Russell 2000 which is still down around 20% YTD. 

If investors were “foolishly optimistic” there is a high probability that these stocks would have participated more in the rally. 

Instead, the Nasdaq is positive for the year though roughly 75% of the stocks in the index are down in 2020. But the Nasdaq, like the S&P 500, is weighted by market capitalization, and larger companies count for more.

These days, the top 10 stocks, which include tech behemoths Apple (AAPL), Amazon.com (AMZN), and Microsoft (MSFT), account for about 44% of all the value in the 2,700-stock index. 

But this is no dot-com Nasdaq. The group of tech giants that dominate the index are quite different from those of the past. For starters, many companies in the tech sector today are money printing machines growing top line revenue at double digits with remarkable consistency.  

Big tech and select smaller enterprise B2B tech (subscriptions, e-commerce, business infrastructure) also looks less economically sensitive than energy and industrial firms that were market giants long ago. A rising tide has not lifted all boats. 

Is the rally so illogical in light of the above? We think not. The market is simply showing us how the economy has changed and what a post-pandemic economy may look like. 

Nevertheless, we believe that March was the time to buy in drag as these post-pandemic economy “winners” are becoming a crowded “flight to safety” trade. If the assumptions about the path of Covid-19 and the trajectory of the economy’s rebound prove to be wrong, chasing these winners today could prove costly in the short to medium term. 

Finally, it is important to be aware of historical precedent. Recessions typically follow bear markets making the disconnect between markets and the real economy quite common. Scott Clemons notes that in the last recession in the USA "the labor market didn't start to show signs of improvement until the end of 2009, at which point the market was already up 44%." 

Stock prices encompass the news of today with sentiment about the future and thus the worst may be over for the major indexes (for now) while the pain in the real economy may last a while longer. 

 
Stock Ideas
 

We rarely buy IPOs but any IPO listing during a depression/recession should be considered as the decision to list suggests significant buyer demand and thus potentially attractive business models. Two such opportunities of interest have presented themselves of late.   

Gan PLC (GAN): Gan provides a SaaS solution to US casinos and online sports betting operations, which is currently a greenfield space as the US is only starting to open up to online sports betting and iGaming nationally. Their end-to-end solution is focused on everything from account management to payment processing to setting up betting lines. The company is growing at a pretty rapid clip (+145% YoY revenue growth in 2019) and has a high single digit take rate on every dollar won by casino operators. Gross margins are around 64% and we expect this to shoot up as revenue starts to materially increase into 2025. It is really one of the only providers in software and development services, and also has a US patent for their US casino management platform.

Draftkings (DKNGW): One of the largest US operators in online betting and owner of SBTech which is a B2B online betting platform is still in early days with a huge TAM (over $20bn for online sports book in the US alone). Disney recently bought a 6% stake in the company (presumably to position iGaming with ESPN in some capacity). Company is trading at around 3.4x EV/Estimated 2021 revenues which is less than internet consumer companies with less growth and smaller TAMs. Interestingly, SBTech and Gan have already made a strategic partnership once US states start legalizing online sports betting en masse. We expect 30%+ revenue growth and roughly 30% contribution margin at least into 2025 as it continues to lead in market share in the US (currently owns 35% market share of online sports bookmaking in New Jersey).

Musings

Was putting together a list of “Market Crash” Investing Rules inspired by March’s turbulent markets and came across a timeless list from 1990 Marty Zweig:

1. The trend is your friend, don’t fight the tape. 

2. Let profits run, take losses quickly. 

3. If you buy for a reason, and that reason if discounted or is no longer valid, then sell. 

4. If the values don’t make sense, then don’t participate.

5. The cheap get cheaper, the dear get dearer.

6. Don’t fight the FED (less valid than #1)

7. Every indicator eventually bites the dust. 

8. Adapt to change.

9. Don’t let your opinions of what should happen, bias your trading strategy.

10. Don’t blame your mistakes on the market. 

11. Don’t play all the time. 

12. The market is not efficient, but is still tough to beat. 

13. You’ll never know all the answers. 

14. If you can’t sleep at night, reduce your positions or get out. 

15. Don’t put too much faith in “experts”.

16. Don’t focus too much energy on short-term information flows. 

17. Beware of “New Era” thinking ie. it’s different this time because…

We couldn’t have put it better. Those wild evenings and mornings when futures were limit up / limit down seem to be a distant memory now, yet having emerged on what we hope to be the other side, we stress the importance of having a clear long term investment strategy. This will provide a framework to stick to as you adapt to what Mr. Market offers during turbulent times. Decisive action becomes easier and the probability of making a mistake is reduced.

Charts of the Month

Where is the pain?

Consumer borrowing plummeting.

How is Covid-19 consumer spending impacting industries?

A history of Black Swan events.

Thought of the Month

 

"The pessimist sees difficulty in every opportunity. The optimist sees the opportunity in every difficulty.” -Winston Churchill

Articles and Ideas of Interest

 

• Is Warren Buffett a bear? The legendary Buffett has been eerily silent during the selloff. No acquisitions, liquidating his holdings in the four major airlines and no additions to any positions. A net seller. In short, there was no greed while others were fearful. What to make of this? Some suggest that Buffett has been spending too much time with Bill Gates, others like Josh Brown suggest that the world has changed and the Oracle may no longer be the same. Either way, Buffett may  end up having the last laugh yet investors should be cautious when attempting to look to Buffett for guidance on their portfolios. Buffett sits at the head of a massive conglomerate composed mainly of old economy businesses which have their own issues and problems. Using commentary from him and extrapolating that into an investment strategy or some sort of a “warning” is perilous.

• Social Security and Medicare funds at risk even before virus. The financial condition of the government’s two biggest benefit programs remains shaky, with Medicare expected to become insolvent in just six years, while Social Security will be unable to pay full benefits starting in 2035, the government said Wednesday. And that’s before factoring what officials acknowledge will be a substantial hit to both programs from the coronavirus pandemic, which has shut down large parts of the U.S. economy and put millions of people out of work.

• Why Sweden has already won the debate on COVID 'Lockdown' policy. As Europe and North America continue suffering their steady economic and social decline as a direct result of imposing ‘lockdown’ on their populations, other countries have taken a different approach to dealing with the coronavirus threat. You wouldn’t know it by listening to western politicians or mainstream media stenographers, there are also non-lockdown countries. They are led by Sweden, Iceland, Belarus, Japan, South Korea and Taiwan. Surprisingly to some, their results have been as good or better than the lockdown countries, but without having to endure the socio-economic chaos we are now witnessing across the world. Patrick Henningsen suggests that for this reason alone, Sweden and others like them, have already won the policy debate, as well as the scientific one too.

• What the coronavirus crisis reveals about American medicine. Medicine is a system for delivering care and support; it’s also a system of information, quality control, and lab science. All need fixing. Given the resolve and the resources the New Yorker suggests that, much is within the U.S.A’s grasp: a supply chain with adequate, accordioning capacity; a C.D.C. that can launch pandemic surveillance within days, not months; research priorities that don’t erase recent history; an F.D.A. that serves as a checkpoint but not as a roadblock; a digital system of medical records that provides an aperture to real-time, practice-guiding information.

• How much should it cost to contain a pandemic? Interesting piece in the Financial Times suggesting that assigning an economic value to a life is taboo - but we must confront the trade-offs to properly face the challenge. What if pandemics occur more frequently? Will a full out economic shut down be feasible each time? Are rolling shut downs possible?

• From pipe dream to prospect: the pandemic is making a case for a universal basic income. Before the pandemic hit, the idea of a universal basic income was fringe policy in much of the developed world. But now that the economy is on life support and both Americans and Canadians are being paid to stay away from work, the idea is looking more like common sense to many.

• The lockdowns were the black swan. Great article in the WSJ considering how and why we went from ‘flatten the curve’ to choosing between our economy and the virus.

• The harsh future of American cities. How will the pandemic alter our urban centers, now and maybe forever?  

• Why are some people better at working from home than others? In a world of telework, some people just take better to working from home. Does this productivity come naturally, or can you learn it? The BBC digs in.

• Experts knew a pandemic was coming. Here’s what they’re worried about next. You might feel blindsided by the coronavirus, but warnings about a looming pandemic have been there for decades. Government briefings, science journals and even popular fiction projected the spread of a novel virus and the economic impacts it would bring, complete often with details about the specific challenges the U.S. is now facing. It makes you wonder: What else are we missing? What other catastrophes are coming that we aren’t planning for, but that could disrupt our lives, homes, jobs or our broader society in the next few years or decades? Politico outlines nine that may be coming for us.

• Long after “stay-at-home” measures are gone, we probably won’t stray too far from our backyards. This summer’s vacation plans, if they happens, will be mostly local. But a huge boom in domestic travel won’t affect every country evenly. A report from Bernstein analyst Richard Clarke, which he cautions is a “thought exercise” more than a forecast, looks at which nations stand to benefit, or suffer, “if international travel demand was redirected domestically.”

• State of the cloud 2020. Bessemer Venture Partners rounds up cloud macro trends, growth strategies for founders, 2020 predictions, and they we believe the future is forged in the cloud. We agree, and after two decades of growth it’s only just the beginning... 

All the best for a month filled with joy and gratitude,  


Logos LP

Market Cycles

Good Morning,
 

Bit behind on this July update but better late than never!
 

Stocks fell on Friday for the fourth straight day, capping off a volatile week for investors as rising trade fears and a tech sell-off led to broad weekly losses. The Nasdaq Composite fell 0.3 percent to 7,902.54, led by declines in Apple, Amazon and Alphabet. The tech-heavy index posted its fourth straight loss — its first since April — and is worst start to September since 2008.

The S&P 500 pulled back 0.2 percent to close at 2,871.68 as utilities and real estate both dropped more than 1 percent.

President Donald Trump, speaking from Air Force One, said Friday the U.S. is ready to slap tariffs on an additional $267 billion worth in Chinese goods. His remarks come after a deadline for comments regarding tariffs on another $200 billion in Chinese goods had passed last night.

"The $200 billion we're talking about could take place very soon, depending on what happens with them," Trump said. "I hate to say this, but behind that, there's another $267 billion ready to go on short notice if I want." (targeting a sum of goods equal to virtually all imports from China)
 

The selloff pummeling emerging market currencies shifted to stocks as contagion concerns weighed on risk assets. MSCI Inc.’s EM equities gauge entered a bear market on Sept. 6 and had its worst week since mid-August.

The fear also comes after the Wall Street Journal reported, citing U.S. officials, that the possibility of the U.S. and China reaching a trade deal are fading as the Trump administration tries to revamp the North America Free Trade Agreement (NAFTA). Meanwhile, Bloomberg News reports that the U.S. and Canada will likely end the week with no trade deal in place.

Wall Street was also under pressure after strong wage data stoked fears of tighter monetary policy in the U.S. Average hourly earnings rose 2.9 percent for the month on an annualized basis, marking the largest jump since 2009. The U.S. economy added 201,000 jobs in August, more than the expected increase of 191,000.

Treasury yields jumped to their highs of the session following the jobs report release, while the dollar also rose. The Fed has already raised rates twice this year and is largely expected to hike two more times before year-end.

Our Take
 

There is little doubt that the U.S. economy is in a boom. The Conference Board is reporting the highest levels of job satisfaction in more than a decade given a tight labor market — the ratio between the unemployment level and the number of job vacancies is at its lowest level in a half-century. A broader measure, the prime-age employment-to-population ratio, is back to 2006 levels. Meanwhile, real gross domestic product growth for the second quarter was just revised up to 4.2 percent. Corporate profits are rising strongly. And investment as a percentage of the economy is at about the level of the mid-2000s boom.

Wages are still lagging. But all other indicators show the U.S. economy performing as strongly as at any time since the mid-2000s — and possibly even since the late 1990s.

Why? A few reasons present themselves as outlined recently by Noah Smith:

1. Demand Side Explanations:

   1. Low interest rates: lowered borrowing rates for corporations and mortgage borrowers, which tends to juice investment. Fiscal deficits provide an added boost to demand, and deficits have been rising as a result of President Donald Trump’s tax cuts. Typically pumping demand will eventually lead to rising inflation but this hasn’t happened yet.

   2. “Animal spirits” or “sentiment” as small business confidence is at record highs, and consumer/investor confidence also is very strong.

   3. Tail end of the long recovery from the Great Recession — consumers and businesses might finally be purchasing the houses and cars that they waited to buy when the recovery was still in doubt. Housing, traditionally the most important piece of business-cycle investment and consumption, is still looking weak, with housing starts below their 50-year average. But business investment might be experiencing the positive effects of stored-up demand.

2. Supply Side Explanations:

   1. The Trump tax cuts removed distortions that held back business investment, and that fast growth — and the attendant low unemployment — is the result of the economy’s rapid shift to a higher level of efficiency.

   2. Technology: Information technology advances such as machine learning and cloud computing might be driving the investment boom — perhaps also spurring companies to invest in intangible assets such as brands and workers’ skills.

Which one is responsible? It is difficult to say but determining which are responsible matters as it can give insight into how the boom will end and how it can be prolonged. In our view all these factors have played a role, albeit certain ones have played a more crucial role during different stages in the bull market.  

At the current stage of the bull market we see evidence that the demand-side “animal spirits” or “sentiment” factor is doing a lot of the heavy lifting.

It should be remembered that although of late there has been a minor repricing of high multiple/risk assets, the trend is still firmly in place: investors are not put off by unprofitable companies. In fact, the proportion of companies reporting losses before going public in the United States is at its highest since the dotcom boom in 2000.

Last year, 76 percent of the companies that listed were unprofitable in the year before their initial public offerings, according to data compiled by Jay Ritter, a professor at the University of Florida's Warrington College of Business.

That's lower than the 81 percent recorded in 2000, but still far higher than the four-decade average of 38 percent.

Investors are currently keen on “new business models” and are willing to overlook losses. In fact, many are questioning whether “value investing” and classic investing principles even makes sense anymore. The market's euphoria for so-called "growth companies" has even made billionaire hedge fund manager David Einhorn question if classic investing principles that worked for him still make sense today.

As Howard Marks reminds us, in investing as in life, there are very few sure things. Very few things move in a straight line. There’s prograss and then there’s deterioration. We must remain attentive to cycles.

The process/cycle is typically the same: 1) the economy moves into a period of prosperity 2) providers of capital thrive, increasing their capital base 3) because bad news is scarce, the risks entailed in lending and investing seem to have shrunk 4) risk aversion disappears 5) financial institutions and investors move to expand their businesses - that is, to provide more capital 6) they compete for market share by lowering demanded returns (e.g. cutting interest rates), lowering credit standards, lowering prudence, disregarding the linkage between price and value, paying less attention to profits or disregarding them all together and providing more capital for a given transaction.

At the extreme, providers of capital finance borrowers and businesses (investments) that aren’t worthy of being financed. This leads to capital destruction -that is, to investment of capital in projects where the cost of capital exceeds the return on capital, and eventually to cases where there is no return of capital.

Is this time any different?

Chart(s) of the Month

JP Morgan shows us that holding cash for too long can be a dangerous proposition. 

Are overall tech valuations overstretched or only certain segments?  Notice the absence of earnings in the dot com bubble years. Valuations do not appear stretched when put into perspective, prices appear to be in line with the underlying earnings picture. The NASDAQ-100’s price to forward earnings ratio is still a little below its longer run average of about 23x. 
 

Musings
 

What of valuation? What of the relationship between price and value? For an investor (whether a “value” investor or not) price has to be the starting point regardless of where we are in the cycle and especially in the last innings. No asset is so good that it can’t become a bad investment if bought at too high a price.

As an example of the current “animal spirits” climate we should consider the following:

Cannabis : the thesis or “story” here is that cannabis, like alcohol, tobacco and other hedonistic instruments, has now achieved positive momentum with policymakers across the world. As such the fragmented industry will consolidate and a few early movers will reap the profits of this new multi-billion dollar industry. But just like investing in the nascent stages of many industries that in essence were revolutions from a status quo, speculation will initially replace prudent financial analysis of price relative to value.

As Easterly points out in a recent article Cronos' (CRON) current valuation is an outright manifestation of "extraordinary delusions" stemming from the madness of crowds.

Cronos trades at about 17.25 forward price to sales (TTM price to sales of 332.97 and TTM price to earnings of 874.69) compared to its peers. For some further clarity, highly valued SaaS stocks prized for their recurrent revenue stream and high gross margins seldom trade at 17.25 forward P/S ratio. The average P/S ratio for stocks in the software application industry is around 6.8, compared to 2.16 for the S&P 500.

Hence, why does an agricultural commodity producer trade at a higher valuation than Shopify and other?

In Deloitte's "A society in transition, an industry ready to bloom" 2018 cannabis report, they expect legal cannabis sales during 2019, the first full year post-legalization to be [CAD]$4.34 billion. This figure is likely inflated when compared against the results of other markets. Further, the study only surveyed a sample size of 1,500 adult Canadians, which is not significant enough to estimate the Cannabis purchase habit of millions of Canadians.

For some perspective, California, which is regarded as the most important Cannabis market on Earth realized sales of [USD]$339 million or [CAD]$444 million (at current spot USD/CAD) during the first two months post-legalization. Extrapolating this across a full year would infer total sales of [USD]$2.01 billion or [CAD]$2.7 billion. Sure there are other factors to consider like a larger Californian black market and a different set of regulations and taxes. However, the Californian market has also not been as stringent on marketing as Canada will be.

Assuming the Canadian market is at least on par with California, the author models the potential market using an optimistic CAGR of 23.54% from 2019 - 2023 which is more optimistic than some market reports. The author also models Cronos' revenue for the years from 2018 - 2022.

Cronos' current market valuation of [USD]$1.75 billion or [CAD]$2.29 billion is around 84.81% of the total Canadian legal cannabis market in FY2019. (And this does not take into account the fact that the total estimated legal cannabis sales [CAD] $4.34 billion number mentioned above represents a total retail sales projection and that will likely be shared between grower, distributor, retailer, and the government through taxes. Taxes will be large, perhaps even 30%. Retail will be handled by government in a few big provinces like BC -- yet the government will still take a retail margin cut. What will be left for growers could be as low as sub $4 CAD / gram.. half or less of that total [CAD] $4.34 billion number…

At a current market valuation of [CAD]$2.29 billion ($2.79 billion at time of writing) which is around 84.81% of the total estimated Canadian legal cannabis market in FY2019, has the fairness of Cronos’ price been considered? Or have people without disciplined consideration of valuation simply decided that they want to own something because the story is good, risk aversion is low and the future looks bright?

Overall, we see current valuation trends in certain growth stocks (cannabis, select tech.) (not to mention that the ratio of bearish option bets to bullish ones is waning as the S&P 500 keeps churning out records. That implies investors may be loading up on derivatives as way to make up for lost ground should 2018 deliver a year-end rally similar to last year’s, when stocks closed with a 6.1 percent fourth-quarter surge) to be evidence that the demand-side “animal spirits”/“sentiment” factor is doing a large portion of the heavy lifting to prolong the current bull market.

As such, we would advise caution before increasing exposure to these “loved” and therefore richly valued businesses. Investing is a popularity contest, and the most dangerous thing is to buy something at the peak of its popularity. For our portfolio, given where we are in the present cycle and overall market conditions we are abiding by the following maxim:
 

“The safest and most potentially profitable thing is to buy something when no one likes it. Given time, its popularity, and thus its price can only go one way: up.” -Howard Marks

Logos LP July 2018 Performance

 

July 2018 Return: -0.34%

2018 YTD (July) Return: 0.00%

Trailing Twelve Month Return: +12.79%

CAGR since inception March 26, 2014: +18.29%

Thought of the Month

 

"The polar opposite of conscientious value investing is mindlessly chasing bubbles, in which the relationship between price and value is totally ignored. All bubbles start with some nugget of truth: 1) Tulips are beautiful and rare 2) The internet is going to change the world 3) Real estate can keep up with inflation, and you can always live in a house.” -Howard Marks

Articles and Ideas of Interest

 

• After Coltrane, there is nothing left to say. The saxophone virtuoso pushed jazz as far as it could go, and it’s been downhill ever since.            

• These Fake Islands Could Spell Real Economic Trouble. Glitzy property projects and financial crises tend to go hand-in-hand.

• U.S. Household wealth is experiencing an unsustainable bubble. Jesse Colombo suggests that Since the dark days of the Great Recession in 2009, America has experienced one of the most powerful household wealth booms in its history. Household wealth has ballooned by approximately $46 trillion or 83% to an all-time high of $100.8 trillion. While most people welcome and applaud a wealth boom like this, research suggests that it is actually another dangerous bubble that is similar to the U.S. housing bubble of the mid-2000s. In this piece, he explains why America's wealth boom is artificial and heading for a devastating bust.

• Who needs democracy when you have data? Here’s how China rules using data, AI and internet surveillance.

• How tourists are destroying the places they love. Travel is no longer a luxury good. Airlines like Ryanair and EasyJet have contributed to a form of mass tourism that has made local residents feel like foreigners in cities like Barcelona and Rome. The infrastructure is buckling under the pressure. Great 2 part expose suggesting that travel has almost become a human right yet it has become predatory - devouring all the beautiful places which drive it. Has nature itself come to be viewed as merely one more good to be consumed? ; Have we developed a shallow, modern need to present a life free from the tyranny of a nine-to-five office job in the tight frame of Instagram? No wonder you are not original or creative on instagram. Everyone on Instagram is living the same life.  
  
   

• Peak Valley. The Bay Area’s primacy as a technology hub is on the wane. Don’t celebrate. Although capital is becoming more widely available to bright sparks everywhere yet unfortunately the Valley’s peak looks more like a warning that innovation everywhere is becoming harder.  

• Americans live in the ruins of the 2008 financial crisis. Prosperity is undercut by broken institutions, from health care to law enforcement. NYT presents some astonishing facts. Is the American dream dead?

Our best wishes for a fulfilling month, 

Logos LP

The Most Precious Resource Of Our Era: Data

Good Morning,
 

U.S. equities closed mostly lower on Friday as investors digested a tough week for retailers as well as mixed economic data.

Several retailers, including Macy's and Nordstrom, saw their stocks tank this week after reporting weaker-than-expected quarterly results, putting the sector under pressure.

The dollar fell while Treasuries rallied after tepid data on retail sales and inflation in the U.S. economy rekindled concern that growth won’t accelerate to levels economists project.

Consumer prices rebounded last month, though at a slower pace than expected, while retail sales advanced after an unexpected drop in March. That was enough to support the case for Federal Reserve tightening in June, though not enough to push stocks higher or dislocate bonds. Investors cast a wary eye on Washington, where President Donald Trump escalated his war with fired FBI director James Comey at the same time his cabinet attempted to move forward on trade and regulatory reforms.

While that was a slowdown from March's 2.4 percent increase, the year-on-year gain in the CPI was still larger than the 1.7 percent average annual increase over the past 10 years.

Overall markets were pretty quiet this week as the CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, closed below 10 earlier this week, raising concerns about complacency in the market.

In addition, with valuations at record levels many investors and commentators are still actively seeking to identify the next “boogeyman” that will tank markets.

Our Take
 

In light of fears surrounding the low VIX reading in addition to bearish sentiment I want to highlight two things:

1. Since September 2001, the S&P has secured 311% of its gains when volatility is as low as it is now.

2. The first step of a corporate earnings rebound is now in the books with a 13%+ increase in year over year profits being reported in Q1.

Moving to the political front, I’m tired of the attention this man continuously garners, but Donald Trump’s dismissal of FBI Director James Comey on Tuesday merits attention for all the wrong reasons. This is the third time he’s fired someone involved in an investigation of him or his associates.

The bureau has been probing Russian involvement in the U.S. election and possible involvement of Trump associates since the summer. Earlier, former acting U.S. Attorney General Sally Yates was dismissed after she refused to defend Trump’s first travel ban. And former Manhattan U.S. Attorney Preet Bharara was initially asked to stay on in his role before being fired in March.

Bloomberg’s helpful graphic shows how, in each of these cases, the justification for dismissal was inconsistent with prior actions, or immediately followed events related to investigations.

How can we interpret this dismissal? As Timothy L. O’Brien for Bloomberg View opines: self-preservation. There is no point trying to analyze Trump's motives and actions as rational and long-term oriented.  He clearly doesn’t care about policy or process. So searching for "strategy" or "deal-making prowess" in the president is usually a “fool's errand”.

What drives Trump today, and what has always driven him, are twin forces: self-aggrandizement and self-preservation. Most of his public actions can be understood as a reflection of one or both of those needs.

Comey’s firing was a manifestation of the second force: self-preservation. He came for the FBI, what’s next? The rule of law? Nevertheless, while unnerving for world leaders, citizens and investors, at the end of the day the firing is unlikely to lead to previously unforeseen problems in enacting health care and tax reform.

On a more positive note, the election of Emmanuel Macron in France is a clear repudiation of populism as represented by Marine Le Pen. This is a remarkable accomplishment at 39 years old. Macron has managed to triumph over the two parties that have dominated the presidency since 1958 “potentially” heralding in a new era of forward thinking politics.

I say “potentially” as now comes the hard part: turning his political movement into a vehicle capable of winning a majority, or at least garnering enough seats in parliament to govern or form a coalition. We predict that he will win a majority.

Musings
 

More and more buzz is being generated about those who control the most precious resource of our era: data. Like the oil majors of days past when oil was the most precious resource on the planet, the wise are turning their gaze to the giants that deal in data, the oil of the digital era.

And so they should.

These behemoths: Alphabet (Google’s parent company), Amazon, Apple, Facebook and Microsoft- look to be unstoppable. They are (unsurprisingly) the most valuable firms in the world the likes of which even Warren Buffett and Mark Cuban Marvel over. Buffett this week went so far as to say that he was “dumb” not have have recognized their brilliance sooner and Marc Cuban stated that these companies are still undervalued. I would agree.

Few would wish to live without the products/services of any of these companies which underpin both our personal and professional lives. On their face these companies do not appear to transgress antitrust rules yet their control of our data gives them tremendous power.

As data proliferates, those who control it are better able to compete by developing better products, services and experiences thereby creating an even stronger protective moat.

Furthermore as the Economist points out, the possibility of these incumbents being blindsided by a startup in a garage in data age is becoming increasingly slim. They explain that “The giants’ surveillance systems span the entire economy: Google can see what people search for, Facebook what they share, Amazon what they buy. They own app stores and operating systems, and rent out computing power to startups. They have a “God’s eye view” of activities in their own markets and beyond. They can see when a new product or service gains traction, allowing them to copy it or simply buy the upstart before it becomes too great a threat.”

A current and obvious example is Snapchat. If the business does not collapse under its own unprofitability, Facebook will continue to bleed it out by successfully mirroring its most attractive features.

Interestingly, The Economist suggests that antitrust authorities should move into the 21st century by not considering size as the deciding factor in a merger but rather take into account the size of a firm’s “data assets” when assessing the impact of deals. They also suggest that regulators could loosen the grip that providers of online services have over data and give more control to those who supply them with the data aka: consumers. They prescribe more transparency and more data sharing.

These are novel ideas but highly unlikely to be implemented absent significant public outrage. Will that public outrage be forthcoming? I think not.

Perhaps the most underappreciated fact of internet-age capitalism is that we are all in the inescapable clutch of these companies and we like it that way.

We are already living in a world in which our own human “feelings” are no longer the best algorithms in the world. We are developing superior algorithms which use unprecedented computing power and giant databases. The algorithms of these 5 giants not only know exactly how you feel, they also know a million other things you hardly suspect. When a non-human algorithms knows us better than we know ourselves we are likely to stop listening to our “feelings” and defer decision making to these external algorithms instead. I would argue that this is already happening and we adore it. We are coddled by our conveniences, entertained and comforted by our personal echo chambers of self-importance. 

Be honest, if some anti-tech dictator forced you to drop all five companies, how would you do so? In what order? What would your life look like? Strip each away and take a moment to look at your life and how it would change. Is it one you yearn to return to? I doubt it. 

Power has shifted. As both the volume and speed of data increase, classic institutions like elections, parties and parliaments might simply become obsolete - not because they are corrupt but simply because they don’t process data fast enough.

By the time the cumbersome government bureaucracy makes up its mind about regulating data or the big 5 for that matter (it can’t even pin down immigration, tax, healthcare, and trade reform) the internet/digital world will have morphed ten times. As Yuval Harari states: “The government tortoise cannot keep up with the technological hare.”

Thus, it should come as no surprise that In March, Trump’s Treasury secretary, Steve Mnuchin, said the problem of job displacement by robots is “not even on our radar screen” since it will only come “in 50 to 100 more years.” This is a government completely out of touch. The big 5 will continue their supreme control of today’s most powerful resource: data.
 

*(The above is inspired from a conference I am giving this weekend at MENSA about the societal effects of AI and emerging technologies. Contact me if you wish to see the slides)

Logos LP April Performance
 

April 2017 Return: 4.57%

2017 YTD (April) Return: 18.98%

Trailing Twelve Month Return: 38.16%

Annualized Return Since Inception March 26, 2014: 27.06%

Cumulative Return Since Inception March 26, 2014: 85.70%

Thought of the Week
 

"“What will happen to society, politics and daily life when non-conscious but highly intelligent algorithms know us better than we know ourselves?- Yuval Harari

 

Articles and Ideas of Interest

• Populism is great for stock returns. If the last two decades of anti-establishment rule are any guide, the world may be on the brink of some monster stock rallies as it takes a turn toward populism. A look at 10 of the 21st century’s most recognized populist leaders shows that in the three years after their election, local equities soared an average of 155 percent in dollar terms. And the rallies often continued as long as a decade after the vote.

• Why you should have (at least) two careers. It’s not uncommon to meet a lawyer who’d like to work in renewable energy, or an app developer who’d like to write a novel, or an editor who fantasizes about becoming a landscape designer. Maybe you also dream about switching to a career that’s drastically different from your current job. But in my experience, it’s rare for such people to actually make the leap. The costs of switching seem too high, and the possibility of success seems too remote. Harvard Business Review suggests that the answer isn’t to plug away in your current job, unfulfilled and slowly burning out. I think the answer is to do both. Two careers are better than one. And by committing to two careers, you will produce benefits for both.

• There’s no Canadian crisis in sight despite downgrade hitting assets. Moody’s downgrade of Canada’s biggest banks beat down assets in a market already rattled by woes of mortgage lender Home Capital Group Inc. Yet analysts say this isn’t evidence of an impending crisis. We would agree. Sentiment will help to cool an overheated housing market but do not expect any kind of 2007 style housing bust.

• How homeownership became the engine of American inequality. Interesting piece in the NY Times looking at the perverse effects of the mortgage interest deduction (MID). Important in light of the current real estate situation in Toronto. Poverty and homelessness are political creations. Their amelioration is within American grasp and budget. But those Americans most likely to vote and contribute to political campaigns are least likely to support (MID) reform — either because it wouldn’t affect their lives or because it would, by asking them to take less so that millions of Americans could be given the opportunity to climb out of poverty.

• A roadmap to investing for the next 100 years. The University of California looks at where we have been and how we can invest for the long-term. What will work: Less is more, risk rules, concentrate, creativity pays, build knowledge, team up,

Our best wishes for a fulfilling week, 
 

Logos LP

You're Leaving Value On The Table

Good Morning,

U.S. equities closed down on Friday — the last day of the first quarter and of the month — as investors digested a slew of economic data.                                  

The Dow Jones industrial average fell about 65 points, with Goldman Sachs and Exxon Mobil contributing the most losses. The S&P 500 slipped 0.23 percent, with financials lagging.                       

The Nasdaq composite closed just below breakeven.                                                                           

The three major U.S. indexes posted quarterly gains of at least 4.6 percent. The Nasdaq also recorded its best quarterly performance since 2013 as tech stocks rose more than 12 percent in the period.
 

Our Take

Last week there were some jitters about whether or not Trump’s potential pro growth policies would be delayed, but the market has since remained resilient. March marked the 8th anniversary of the bull market and we hold that the show will go on despite Trump’s bumblings.

There are pockets of value despite repeated calls that “stocks are overvalued” and furthermore for the first time in 6 years double digit earnings growth looks real. Focus on the fundamentals. While stocks have been ascending ever since the election, it’s unlikely the rally would’ve gotten this far without the contemporaneous improvement in earnings, which last year ended one of the longest streaks of declines ever in a U.S. bull market.

Despite oil’s slump to skepticism over Trump’s growth agenda, Wall Street analysts have been standing firm on forecasts that represent almost twice the profit growth seen in 2013, a year when the S&P 500 rose 30 percent.

S&P 500 operating income will rise 12 percent to $130.20 a share this year, estimates compiled by Bloomberg show.

For the health of your investments, earnings are what matters. Long-term fundamentals drive stock prices. Short-term the political noise can impact sentiment but time and time again over the last 8 years buying the dips has worked…

Musings

A focus on the long-term matters. It has a determinate impact on our investment outcomes but more importantly on whether our lives will be remarkable or simply average.

More on that later. First I wanted to highlight the incredible outcomes reserved to those who think long-term. This week I read an excellent research report produced by a team from McKinsey Global Institute in cooperation with FCLT Global which found that companies that operate with a true long-term mindset have consistently outperformed their industry peers since 2011 across almost every financial measure that matters.

The differences were dramatic. Among the firms the team identified as focused on the long term, average revenue and earnings growth were 47% and 36% higher, respectively, by 2014, and market capitalization grew faster as well. The returns to society and the overall economy were equally impressive. By their measures, companies that were managed for the long term added nearly 12,000 more jobs on average than their peers from 2001 to 2015.

In addition, they calculated that U.S. GDP over the past decade might well have grown by an additional $1 trillion if the whole economy had performed at the level their long-term stalwarts delivered — and generated more than five million additional jobs over this period.

What indicators were studying? 1) Investment 2) Earnings Quality 3) Margin Growth 4) Earnings Growth 5) Quarterly Targeting

After running the numbers on these indicators, two broad groups emerged among those 615 large and midcap U.S. publicly listed companies: a “long-term” group of 164 companies (about 27% of the sample), which were either long-term relative to their industry peers over the entire sample or clearly became more long-term between the first half of the sample period and the second half, and a baseline group of the 451 remaining companies (about 73% of the sample).

What is clear from the performance gap between these two groups is the massive relative cost of short-termism.

From 2001 to 2014 those managing for the long term cumulatively increased their economic profit by 63% more than the other companies. By 2014 their annual economic profit was 81% larger than their peers, a tribute to superior capital allocation that led to fundamental value creation.

Now this makes me think of the countless examples I encounter on an almost daily basis of short-termism. It is not simply corporations that favor these costly short-termist agendas. It is the average human or at least 73% of the population…..that chooses the easy money vs. the long money. The easy choice or the choice that seemingly brings the most juice today. Nevertheless, real change is possible. This is one of the key messages from the research.

The proof lies in a small but significant subset of the long-term outperformers identified in the study — 14%, to be precise — that didn’t start out in that category. Initially, these companies scored on the short-term end of the index. But over the course of the 15-year period they measured, leaders at the companies in this cohort managed to shift their corporations’ behavior sufficiently to move into the long-term category.

As an investor it is best to develop the ability to identify such long-term value creators, as well as those companies who are shifting their behavior.

As a human it is best to look at ourselves in the mirror and ask what short-termist behaviors we are exhibiting and how we can change such habits. Upon honest reflection, what we will undoubtedly find is that we are leaving a considerable amount of “value” and long-term “fulfillment” on the table….

Thought of the Week
 

"The most important quality for an investor is temperament, not intellect.” -Warren Buffett
 

Stories and Ideas of Interest

• A world without retirement. The population is getting older and the welfare state can no longer keep up. After two months of talking to people in Britain about retirement, it’s clear that old age is an increasingly scary prospect. The Guardian digs in.  
   

• Compelling new evidence that robots are taking jobs and cutting wages. In a recent study (pdf), economists Daren Acemoglu of MIT and Pascual Restrepo of Boston University try to quantify how worried we should be about robots. They examine the impact of industrial automation on the US labor market from 1990 to 2007. They conclude that each additional robot reduced employment in a given commuting area by 3-6 workers, and lowered overall wages by 0.25-0.5%. A central question about robots is whether they replace human workers or augment them by boosting productivity. Acemoglu and Restrepo’s research is a powerful piece of evidence on the side of replacement. Furthermore, automation is set to hit workers in developing countries even harder. The fourth industrial revolution looks set to cause global mass unemployment. Could we tax robots as Bill Gates has proposed? The Economist suggests that this idea is misguided.

• Silicon Valley’s quest to live forever. Can billions of dollars of high-tech research succeed in making death optional? Forget retirement. Some are actively working on finding a cure for death. The New Yorker digs in and considers the incredible amount of money and effort being deployed towards achieving eternal life. I’ve always looked at this through the following prism: does the present moment really have any significance if it isn’t fleeting or precious?

• Your animal life is over. Machine life has begun. The road to immortality. In California, radical scientists and billionaire backers think the technology to extend life - by uploading minds to exist separately from the body is only a few years away. Yes that’s right. Forget the problems with robots replacing humans, when we will be able to achieve “morphological freedom” – the liberty to take any bodily form technology permits. “You can be anything you like,” as an article about uploading in Extropy magazine put it in the mid-90s. “You can be big or small; you can be lighter than air and fly; you can teleport and walk through walls. You can be a lion or an antelope, a frog or a fly, a tree, a pool, the coat of paint on a ceiling.” No wonder Elon Musk is founding another company called Neuralink which will focus on merging man and machine through the “neural lace”...talk about thinking long-term...

• Given the circumstances our existence, shouldn’t we just kill ourselves? French philosopher Albert Camus did an excellent job describing those moments in our lives when our ideas about the world suddenly don’t work anymore, when every daily routine — going to work and back — and all our efforts seem pointless and misdirected. When one suddenly feels foreign and divorced from this world. In these frightening moments of clarity we feel the absurdity of life. Luckily, his interpretation of the myth of Sisyphus offers us salvation. Sisyphus was sentenced to push a boulder up a hill, just to see it roll down again, and keep doing so forever and ever and ever. Camus offers a bold statement: “One must imagine Sisyphus happy.” He says, Sisyphus is the perfect model for us, since he has no illusions about his pointless situation and yet revolts against the circumstances. With every descent of the rock he makes a conscious decision to give it another go. He keeps pushing that rock and recognises that this is what his existence is all about: to be truly alive, to keep pushing.

• A dearth of I.P.O.s but it’s not the fault of red tape. Nice piece in the NY Times exploring possible explanations yet finding that while there might be rational reasons to reduce regulation on capital raising — to make it easier and less expensive — we are kidding ourselves if we think that simply deregulating will bring back initial public offerings.

• Not leadership material? Good. The world needs followers. The NYT suggests that the glorification of leadership skills, especially in college admissions, has emptied leadership of its meaning. I love this. Very contrarian. “Perhaps the biggest disservice done by the outsize glorification of “leadership skills” is to the practice of leadership itself — it hollows it out, it empties it of meaning. It attracts those who are motivated by the spotlight rather than by the ideas and people they serve. It teaches students to be a leader for the sake of being in charge, rather than in the name of a cause or idea they care about deeply. The difference between the two states of mind is profound. The latter belongs to transformative leaders like the Rev. Dr. Martin Luther King Jr. and Gandhi; the former to — well, we’ve all seen examples of this kind of leadership lately.”

All the best for a productive week,

Logos LP