Older, Slower and Entitled

Good Morning,
 

Major U.S. stock averages rebounded Friday, but closed the week in the red amid fears of the Federal Reserve pulling back its stimulus as well as concern regarding the delta variant. 

Minutes from the Fed’s July meeting released this week showed the central bank is willing to start reducing its monthly asset purchases this year. Investors sold equities and commodities this week buying bonds on fears that a “backwards looking” move by the Fed could upend the global economy already under stress by the delta variant.


Our Take


With investors considering a Fed tapering while the delta variant keeps spreading, the transition away from liquidity/policy regime to more mid-cycle markets means volatility is likely set to continue.   

Policy error represents the most obvious risk for markets. For weeks, changes in the economic data suggest that economic growth is slowing, rates have been heading lower, the dollar has headed higher, and commodities have by and large corrected. According to the bears, this picture seems to suggest that any Fed tapering this fall - just as the global economy's growth is normalizing - could create a growth scare, and as a result, that theFed would have begun taperingat the wrong moment leading to further economic weakness and eventually a stock market rout.

This may or may not occur. Corrections are inevitable and although we do think that it would be unwise to chase many major index components as future returns from these levels appear unattractive, we do believe that the strength of this bull market is remarkable. 

This year alone the S&P has hit 48 new highs. Since we finally broke through the 2007 pre-GFC highs in the summer of 2013 we’re now looking at more than 320 new highs in this bull market. The gains are smaller, befitting a less extreme year as when the S&P 500 Index has risen in 2021, the daily increase has been half what it was in 2020. But in terms of persistent, day-after-day gains, these seven months in the U.S. stock market have few historical precedents.

Interestingly, as Nir Kaissar points out for Bloomberg, the past 30 years may not be an anomaly but a new normal. 

For about 120 years from the 1870s to the 1980s, the U.S. stock market reliably reverted to its long-term average valuation, and just as important, it spent roughly equal time above and below that average. Investors could therefore expect an expensive market to become cheaper and a cheap market to become more expensive, a useful assumption when estimating future stock returns. 

Since 1990, however, the market has rarely dipped below its long-term average valuation, the notable exception being the period around the 2008 financial crisis. Neither the dot-com bust in the early 2000s nor the Covid-induced sell-off last spring managed to subdue it.

Accordingly, with volatility moderate and the uptrend persisting, any trading tools that told investors to do anything but buy are failing. When applied to the S&P 500, half of the 22 charts-based indicators tracked by Bloomberg have lost money since the end of March, back-testing data show. All of them are doing worse than a simple buy-and-hold strategy, which is up 12%. 

Over the past 10 years, the S&P 500 is up almost 360% while gold is down 2%. That’s a lost decade for gold, even after it was up 25% in 2020 and 18% in 2019.

It has been incredibly profitable to adhere to the classic mantras of “don’t fight the fed” and “the trend is your friend”. Investors buying virtually every dip have been rewarded. 

Most non-recession 10%+ corrections over the past 25 years began with certain conditions. They all typically start with wildly overbought conditions and excessive optimism. We can’t predict when the party will end, but we do believe that “wildly overbought” and “excessive optimism” are not at present characteristic of the prevailing sentiment. Furthermore, for many high quality companies, multiples have been contracting and fundamentals have been improving. You just need to know where to look….

 Musings
 

Humans are creatures of habit and easily susceptible to conditioning. From childhood we learn (the hard way) to avoid touching a hot stove and alternatively, we learn that certain behaviours such as doing our chores will earn us rewards from our parents. We learn (or are supposed to learn) that by working hard and developing the right skills and habits we will get ahead and unlock a more “pleasant” life. 

Our environment influences us. We react to the incentives and disincentives we are presented with attempting to reduce pain and maximize pleasure and this process of conditioning shapes our behaviours and attitudes. 

The economy and markets work similarly because after all, they are composed of humans. Given the incredible shock Covid-19 represented (which we are still dealing with), we’ve been thinking a lot about the conditioning it has precipitated or perhaps accelerated. How have our brains/habits and thereby societies and economies been re-wired? 

Aware of the seemingly endless amount of time one could spend on this topic, one thing in particular has caught our attention. 

The fact that the labor force in the US has shrunk (this is a phenomenon that is also  affecting most developed economies). The US economy has been creating jobs at a rapid clip. Employment has risen by an average of about 617,000 people per month so far this year.

While the total number of Americans who are working is still more than 5 million short of 2019 levels, there is work available. The number of open positions surged to a record 10 million-plus in June.

Nevertheless, many employers say they’re having trouble filling those jobs, even with the unemployment rate still relatively high.

That points to one big question-mark around the recovery. Americans have dropped out of the labor force.

More than half of the unemployed have been out of work for 15 weeks or longer and, on average, it’s taking people 29.5 weeks to find a job -- even with all those openings.

Why? Common explanations fall into three categories. 

1. Disruption owning to the spread of Covid-19

2. The Impact of welfare policy

3. Changes to attitudes wrought by the pandemic 

When it comes to the first bucket it is believed that school closures have made it impossible for parents, particularly mothers to take a job. The evidence of this is more mixed and less compelling. Furthermore as restrictions ease, Covid-19 recedes and children head back to school, such issues should correct. 

The second bucket is of particular interest as welfare policy (ie. entitlements) is something policy makers can control. Where do we stand on this front? There was an interesting article in the WSJ recently entitled “Hooked on Federal Checks”. The author Nick Stehle wrote: 

“My family is receiving the new Advance Child Tax Credit Payments, passed by Congress and signed into law by President Biden in March. Under this policy, I’m going to make more than $11,000 by the time I file my 2021 taxes. I “earned” this extra cash by having four children between 5 and 13.

The policy—which pays $300 a month for each child under 6 and $250 a month for each child between 6 and 17—is set to expire at year’s end, yet the Biden administration and congressional Democrats are pushing to make it permanent. If that happens, I’m looking at more than $10,000 a year for the next four years, then thousands more annually for nearly a decade after that.

Do I need this money? Thankfully, no. I have a good job that puts my family solidly in the middle class. Should I be getting this money? Absolutely not. But will I use the money? Yes. That is why this new entitlement is so dangerous.

The federal government is conditioning families like mine to expect “free” money. When you see that cash in your account, the first thought is how to use it. It becomes a habit to see and spend extra money each month. Like many habits, it is liable to worsen.”

The political discourse in Canada is no different with each challenger party putting forth colossal spending platforms designed to one up the current incumbent Liberal spending bonanza. 

Politicians of all stripes continue to clamour for more spending as they decry that life is getting more expensive. All of this while nearly 61% of U.S. households paid no federal income taxes in 2020 and central banks have spent $834 million an hour for 18 months buying bonds to force down borrowing costs since the pandemic hit (the US Fed alone has put in roughly $4 trillion). 

The question is how much longer can central banks and governments keep the cash spigots flowing at full force? Politicians appear to be openly uninterested in such trivial details.  

Many of the entitlements such as the Advance Child Tax Credit Payments discussed above or the Old Age Security benefits in Canada (only two small examples) are not primarily directed to families in poverty. 

Instead, such entitlements are better understood as an attempt to buy votes from various voting blocks. Once you come to expect an entitlement you are much less inclined to vote for someone who wants to cut off the cash. A similar understanding can be applied to the Canada Emergency Wage Subsidy, CRB, CRCB and the CRSB in Canada. The conditioning has become powerful. 

Nick Stehle points out that the price tag of such measures in terms of expanding the national debt is high yet the human cost of these policies is perhaps even higher. Since many of these benefits are not tied to work/output, people have less reason to try and climb the ladder of opportunity. 

Is this how a social safety net should work? Will such political discourse erode cultural attitudes surrounding “work ethic”? Has irreversible damage already been done? 

This idea dovetails on the third category of common explanations: changes to attitudes wrought by the pandemic. One intriguing possibility is that the pandemic has made people value work less. The pandemic forced us all to take a hard look in the mirror and many surveys suggest that people now treasure time with family more than they once did. A shift in attitudes towards work is hard to pin down yet a recent study from Britain suggests that people want to work fewer hours even if their pay falls.  

By making unemployment insurance schemes (entitlements) competitive with market wage rates in a pandemic, it would come as no surprise if attitudes surrounding work ethic have suffered. Rewards and incentives change habits and behaviour. The longer this dynamic persists, the longer and more difficult it will be to reshape such habits and adjust behaviours. 

It is still too early to tell how much work ethic has suffered yet this potential conditioning accelerated by COVID-19 is not a positive development. 

The economic carnage brought on by Covid-19 induced lockdowns necessitated extraordinary monetary and fiscal intervention. Politicians and Central bankers had to act. The problem we see today is that a potential pandora’s box of entitlement and complacency has been opened. 

When leaders have simply to open the spigot to earn votes, there is little incentive to improve the quality of leadership. Hence, in our opinion, the disastrous state of leadership today. 

Thomas Jefferson and Alexander Hamilton agreed on little publicly, but they did agree that when the public treasury becomes a public trough and voters take notice, they will send to government only those who promise them a bigger piece of the government pie.

There’s an old theory that wealthy democracies follow a socio-economic cycle from slavery to spiritual faith, to great courage, to liberty, to abundance and wealth, to complacency, to apathy, to dependence and back to slavery. Judging from the post Covid-19 socio-economic climate we appear to be on a problematic path to complacency and apathy. 

When entitlement is not linked to output and contribution there is little willingness to accept responsibility for one’s own life - which is the source from which self-respect and thus character, springs. Instead, one develops the perception that the outcomes of one’s life are entirely out of one’s hands. 

And to be without character is perhaps the worst fate of all. 

Charts of the Month

Valuations are certainly in the upper band even when measured against the past 25 years, which has been a time filled with higher-than-average historical valuations. Here’s one that may surprise you though — this year we’ve actually seen multiples on the S&P 500 contract:

JP Morgan also broke out valuations and earnings by the top 10 stocks in the S&P (which also includes Berkshire Hathaway, Tesla, Nvidia, JP Morgan and Johnson & Johnson) and everything else:

The top 10 stocks are now close to 30% of the market. This sounds concerning until you see they contributed 34% of the earnings over the past year. These companies are large for a reason.

They’re also expensive for a reason. You can see once you take away the top 10 holdings, the valuation of the other 490 or so stocks doesn’t look all that bad.

Logos LP July 2021 Performance

July 2021 Return: -1.18%

2021 YTD (July) Return: 7.28%

Trailing Twelve Month Return: 41.47%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 24.39%
 

Thought of the Month

“Enough of this miserable, whining life. Stop monkeying around! Why are you troubled? What’s new here? What’s so confounding? The one responsible? Take a good look. Or just the matter itself? Then look at that. There’s nothing else to look at. And as far as the gods go, by now you could try being more straightforward and kind. It’s the same, whether you’ve examined these things for a hundred years or three.” - Marcus Aurelius


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Articles and Ideas of Interest

• Florida is America's Future: Old, Southern and Retired. Why we should be concerned that the fastest-growing cities in the U.S. are retirement villages in the South. One of the most important trends to emerge from the 2020 Census didn't get much attention last week, but it reveals more about how both the U.S. economy and its politics will look in the coming years than most other details focused on by the news media. Americans' vision of their city of the future typically involves skyscrapers populated by large new technology companies. Yet the 2020 Census didn't point to San Francisco or New York as the fastest-growing city, or even one of the dozens of smaller metros that emulate them. The fastest growing metro area in the U.S. is the Villages, a retirement community in central Florida. And that's indicative of an economy that's older, less dynamic and more reliant on government benefits. It also points to a growing concentration of political and economic power in the south. Why is no one talking about this?  
  
   

• The Opposite of Toxic Positivity. Countless books have been written on the “power of gratitude” and the importance of counting your blessings, but that sentiment may feel like cold comfort during the coronavirus pandemic, when blessings have often seemed scant. Refusing to look at life’s darkness and avoiding uncomfortable experiences can be detrimental to mental health. This “toxic positivity” is ultimately a denial of reality. Telling someone to “stay positive” in the middle of a global crisis is missing out on an opportunity for growth, not to mention likely to backfire and only make them feel worse. As the gratitude researcher Robert Emmons of UC Davis writes, “To deny that life has its share of disappointments, frustrations, losses, hurts, setbacks, and sadness would be unrealistic and untenable. Life is suffering. Scott Barry Kaufman for The Atlantic suggests that no amount of positive thinking exercises will change this truth.

• The Coronavirus Is Here Forever. This Is How We Live With It. Sarah Zhang for the Atlantic suggests that we can’t avoid the virus for the rest of our lives but we can minimize its impact. The current spikes in cases and deaths are the result of a novel coronavirus meeting naive immune systems. When enough people have gained some immunity through either vaccination or infection—preferably vaccination—the coronavirus will transition to what epidemiologists call “endemic.” It won’t be eliminated, but it won’t upend our lives anymore. Politicians crafting policy based on “Covid zero” are going down a dangerous path…

• Warren Buffett’s Cash Trap Can Snare Big Tech, Too. The Berkshire Hathaway CEO has more cash than he knows what to do with. But Apple, Amazon and other tech giants face a similar dilemma. It may remain one of Buffett’s most memorable lessons. Even as tech company after tech company has joined the $1 trillion and then $2 trillion market-cap club during the pandemic, they all have something in common with Buffett: more cash than they know what to do with. It’s a good problem to have until it isn’t.
  
   

• Companies and Families Are Loading Up on Debt. It Could Be a Dangerous Trend. For folks with finances stretched by inflation, using “buy now, pay later” (BNPL) to help pay for luxuries or even necessities, such as an updated wardrobe to return to work, might be the clincher in the purchasing decision. Square’s ability to provide ready funding to merchants and consumers apparently justifies the $29 billion price tag for Afterpay—equal to an enterprise value of 35 times gross profit for the next 12 months, according to MoffettNathanson analyst Lisa Ellis. But it belies the notion of flush consumers. Or does it?
  
   

• Why Managers Fear a Remote-Work Future. Interesting take on remote work by Ed Zitron in the Atlantic suggesting that like it or not, the way we work has already evolved. Remote work lays bare many brutal inefficiencies and problems that executives don’t want to deal with because they reflect poorly on leaders and those they’ve hired. Remote work empowers those who produce and disempowers those who have succeeded by being excellent diplomats and poor workers, along with those who have succeeded by always finding someone to blame for their failures. It removes the ability to seem productive (by sitting at your desk looking stressed or always being on the phone), and also, crucially, may reveal how many bosses and managers simply don’t contribute to the bottom line.
  
   

• Why is China smashing its tech industry? Noah Smith suggests that it has something to do with what countries consider to be the “Tech Industry”. China may simply see things differently. It’s possible that the Chinese government has decided that the profits of companies like Alibaba and Tencent come more from rents than from actual value added — that they’re simply squatting on unproductive digital land, by exploiting first-mover advantage to capture strong network effects, or that the IP system is biased to favor these companies, or something like that. There are certainly those in America who believe that Facebook and Google produce little of value relative to the profit they rake in; maybe China’s leaders, for reasons that will remain forever opaque to us, have simply reached the same conclusion.

• What’s Holding Back China’s Recovery? The Kids Aren’t Alright. There are many answers, but one important piece of the puzzle is starting to become clear: Young workers and job seekers, who often spend more of their income since they are just starting out, are struggling. Until that is rectified, regaining China’s pre-pandemic consumption-growth trend could be challenging. Online movements springing from youth discontent such as “tang ping” or “lying flat,” which was started by a disenchanted former factory employee and rejects overwork, may be difficult to fully suppress. This problem is affecting most nations globally as policy makers ignore the plight of the next generation…
  
   

• America’s Investing Boom Goes Far Beyond Reddit Bros. Robinhood traders have earned the most attention, but they’re only part of a larger story about class stagnation and distrust. Fascinating account by Talmon Joseph Smith in the Atlantic of the investing craze that has characterized the post pandemic world. In a series of interviews conducted with economic analysts, amateur and professional investors, cryptocurrency lovers, and former hedge-fund managers, several people expressed the view that the subcultures born out of America’s untamed investing boom are many and varied. They’re diverse, if not integrated; some silly, some assiduous—yet all infused with a quiet desperation to reach escape velocity and defeat the gravitational pull of class stagnation that’s lasted decades...

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

Logos LP

The Nature Of Long-Term Shareholding

Good Morning,
 

The Dow Jones Industrial Average jumped to another record high on Friday as reopening optimism continued to encourage the rotation into cyclical stocks. Meanwhile, surging bond yields rekindled valuation fears and took the comeback momentum out of high-growth, high multiple names.

The 10-year Treasury yield jumped another 10 basis points to 1.64% at its session high Friday, hitting its highest level since February 2020. The benchmark rate started 2021 at around 0.92%.

The rapid rise in bond yields prompted investors to dump the high-growth, high-multiple long-duration Nasdaq (QQQ) names again after a brief rebound earlier this week. Sharp increases in interest rates can put outsized pressure on such high-growth long-duration stocks as they reduce the relative value of future profits.

February and March saw the biggest market sell-off since September 2020. The recent sell-off predominantly affected the QQQ with a rotation out of high-growth, high-multiple technology companies and into businesses that have taken a beating throughout the pandemic (energy, banks, live events, brick-and-mortar retailers, hotels or travel to name a few). 

For those in more traditional S&P 500 (SPY) components, with little exposure to the high-growth complex, the “sell-off” was barely noticeable. Whereas, for those with significant exposure to such long duration assets, the drawdown was more pronounced than the move in the index would suggest, with many names reaching extremely oversold levels (average drawdowns of 30%-40% across the board):

Many analysts and so-called market pundits have since rushed in and declared that the bubble is popping. That the high-growth technology trade is dead. The refrain is now: 

“I think the story is becoming very, very clear in the tech sector. We have incredibly high valuations and yields that have tripled from the low last year,” said Robert Conzo, CEO of The Wealth Alliance. “You are going to see a lot of volatility in the tech sector. There’s a better trade out there in the cyclicals.”

Or even more bold calls such as:


“2020 marked the secular low point for inflation and interest rates; new central bank mandates, excess fiscal stimulus including UBI, less globalization, fading deflation from disruption, demographics, debt…we believe inflation rises in the 2020s and the 40-year bull market in bonds is over… BofA Global Research’s Inflation Survey shows 61% of analysts saw their companies raise prices in recent months. AA [asset allocation] implications bullish real assets, commodities, volatility, small cap value, and bearish bonds, US$, large cap growth.”

There is no doubt that the rapid sharp increase in U.S. government-bond yields is pressuring certain pockets of the stock market and forcing investors to confront the implications of both rising inflation and interest rates.

Yet the rotation referenced above has been playing out for at least 6 months now as energy, financials, industrials and materials (stocks whose fortunes are closely tied to economic growth) have greatly outperformed technology:

Same goes for growth vs. value with traditional value stocks (those which trade at low multiples of their book value, or net worth) beating growth stocks by the widest margin in TWO DECADES! 

This year, the Russell 1000 Value Index is up 11% and the Russell 1000 Growth Index has edged up 0.2%.

That gap is the largest lead for value stocks at this time of year since 2001, according to Dow Jones Market Data, when the bursting of the tech bubble led to a resurgence in value shares. At this point last year, during the coronavirus-induced downturn, growth stocks held a wide lead.

Oh what a difference a few months can make...

Our Take

So, should one abandon high-growth technology/innovation and chase the hot hand, piling into cyclicals/value names even as they reach new highs? Should one chase the trend and shift to low quality, high volatility, weak balance sheet names with little profitability? 

What should we make of the rotation?

Value investing and growth investing are two different investing styles.Traditionally, value stocks are thought of as an opportunity to buy shares below their actual value (although most investing can be conceptualized this way), and growth stocks exhibit above-average revenue and earnings growth potential.

Wall Street attempts to categorize stocks neatly as either growth or value stocks. The truth is a bit more complicated, as some stocks have elements of both value and growth. Nevertheless, to answer the questions posed above, it is important to step back and think about what’s going on and how investors should approach the current market. 

The pandemic has caused a massive acceleration for digital/innovation businesses. This isn’t likely to be temporary. The pandemic has now lasted long enough for consumers and companies to form new habits and ways of doing business, many of which will last even as the pandemic fades into history.

The digital/innovation acceleration is real. The long-term implications are likely larger than currently envisioned by even the most optimistic forecasters. Yet as we have warned before, many stocks leveraged to these trends, especially those that appear to be pure plays, were likely overvalued coming into 2021 and remain overvalued now. Mistaking such individual investments as a "no-brainer" way to capture long-term mega trends like digital acceleration, AI, solar, cloud, blockchain, EV is fraught with risk as stock price moves in such names can be extreme. 

At a high level, as long-term investors (more on this below), we believe that although the declines discussed above can be painful given their speed and unpredictability, investors must be willing to pay this price in the pursuit of above-average long-term returns. 

Such drawdowns should not be a catalyst for panicked portfolio rebalancing, as well as significant rotations/reallocations towards the “investment theme du jour”. Instead, they should prompt diligent reflection on one’s portfolio:  

1. How do I understand market, sector and company risk? 

2. How much drawdown can I cope with?

3. Do I have the cash I need and a cash deployment strategy?

4. Does my portfolio fit my risk profile?

5. Do I have a list of stocks I want to buy and a strategy for allocating to them?

6. Do I have a strategy that is written down?

In addition to this, the recent drawdowns in high-growth/high-innovation names should remind us that it isn’t enough to recognize a big innovation/investment trend and throw money at it. 

As QQQ names were melting down earlier this month, there was real fear that this could be a Dot Com moment. The knife could continue to fall. 

Intrinsic Investing reminds us that if we look at the Dot Com crash for guidance we can find at least two important lessons: 1) people at the time were too conservative about their big mega trend outlooks and; 2) they were too optimistic in how they expressed those views in individual stock selection. 

Despite the internet being vast, only a handful of the companies capitalized on the mega trends of the times. Some of the biggest winners of the internet age weren’t even public (i.e. Google) or founded yet (i.e. Facebook) until well after the Dot Com bubble crashed.

The Dot Com bubble and crash teaches us not to get out of the market when speculative activity surges as it is today. Rather, the takeaway is to “avoid those specific stocks that are speculatively valued and to be highly skeptical of unproven businesses that claim they are sure to capitalize on exciting new trends.” It is during periods like these - and where we find ourselves today - that stock selection (knowing what you own) becomes extremely important. The last few weeks have been a stark reminder of this principle. 

So, as we manage our portfolio at a time when speculative activity is rampant, we will do our best to keep an open mind when it comes to the significance of the big fundamental changes at play, while remaining very skeptical about which companies will capture those trends and the valuation of those companies we believe will be the long-term winners. In short, we will not be rotating into low quality, high volatility, weak balance sheet names with little profitability. 

Musings

It’s important to realize that as an investor in an increasingly digital world in which investment information is ubiquitous, no matter what innovations we see in the financial industry, patience will always be the great equalizer in the financial markets. In fact, one of the biggest advantages investors have over the pros and even the machines is the ability to be patient. 

Charlie Munger nailed it when he remarked: 

“We've really made the money out of high quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money's been made in the high quality businesses. And most of the other people who've made a lot of money have done so in high quality businesses.

Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result.”

Individual investors have the luxury of thinking (and hopefully acting) in terms of decades which is virtually impossible on Wall Street. A buy and hold strategy is by no means perfect, yet for it to work, you need to do both the buying and the holding during a drawdown. Of late, it has been much easier to do the buying and holding when markets are rising. Yet we must remember that on the journey to making large returns, there will be detours accompanied by poor returns.  

For example, Morgan Housel looked at one of the best-performing stocks of the last 20 years (Monster Beverage) and found that it spent the majority of that time with returns that would make make most investors hit the sell button. 

Housel looked at the 10 best stocks to own over the past 20 years which were all cherry-picked for their stellar returns, and would represent the stocks you would probably choose to own if you had a time machine. On average they increased more than 28,000%.

But they all spent a majority of the time well below their previous high mark. They all had multiple declines of 50% or more. A few had multiple 70% drops.

Investors underestimate how common and severe volatility is, especially among individual stocks. If stocks with the cherry-picked best returns spend a third of their time down at least 30%, you can imagine what the long-term losers look like. 

In 2009, Charlie Munger was asked how concerned he was that Berkshire Hathaway shares — which made up most of his net worth — dropped more than 50%. He quickly interrupted the interviewer and responded:

“Zero. This is the third time that Warren [Buffett] and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%. I think it's in the nature of long-term shareholding that the normal vicissitudes in markets means that the long-term holder has the quoted value of his stocks go down by, say, 50%.

In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50% two or three times a century you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get compared to the people who can be more philosophical about these market fluctuations.”

Investing is work. Stock picking is work. There are no shortcuts that provide easy money for an extended period of time.
 

For long-term investors like us, there is no scenario where we will be meaningfully selling out of high quality businesses in order to buy and hold low-quality businesses or sit in cash. Why not now?

1. We don’t know how to time the market: We don't know when the market will crash or even correct. It could be next week; it could be a decade from now. Unpredictable geopolitical, environmental, and biological events, coupled with people's emotional response to them, will determine this. 

2. What matters is time in the markets: If you wait for ideal conditions before investing, you never will. Time in the market is what is important. Productively and diligently allocating capital creates far more wealth than timing its allocation perfectly.

3. Stocks are a wonderful hedge against inflation: Since 1928, the U.S. stock market is up 9.8% per year while inflation has averaged 3% per year. So stocks have grown at nearly 7% more than the rate of inflation. One of the reasons for this is the fact that earnings and dividends also grow at a healthy clip above inflation. Over the past 93 years, earnings have grown at roughly 5% per year. Stocks also have perhaps the greatest income stream of any asset. Dividends have grown at roughly 5% per year. So earnings and dividends both have a history of growing above the rate of inflation.

4. Real interest rates are likely to remain negative over the long term: We aren’t economists, yet we believe that the rise in inflation and interest rates will be a temporary diversion from a clear downward trend. The fiscal stimulus is all transitory and the economic effects on demand will be short-lived. Zombie firms (those that cannot cover their fixed expenses with operating income and thus continuously rely on the capital markets to survive) are proliferating all over the developed world causing disinflation. We are also going through a productivity boost (technology) at a time when real wage growth is depressed and that is no prescription for durable inflation from a unit-labour cost perspective. In addition, aging demographics and a catastrophic collapse in birth rate (which no one is talking about) across the developed world are disinflationary, while governments are arguably the most anti free-market and least business friendly ever. How will the investor holding a portfolio of low quality, high volatility, weak balance sheet names with little profitability fare if the reflation thesis flames out? 

There will always be another narrative to worry about. A reason to sell your holdings or rotate into the “investment theme du jour”. A good long-term investment strategy will not produce desired returns year in and year out. 

Rather, it will be tested as it makes progress toward some long-term goal over time as winning years more than offset losing years. Investors who keep their investment strategy consistent regardless of volatility set themselves up for success over the long-term. 

Embrace the grind. How can you know what your investment strategy is made of if its never been tested? 

Charts of the Month


How does the market perform when interest rates rise?

Back drop: Why the big picture is critical – especially now:

(1) Three YEARS of non-stop Stock selling.

(2) All the money went into Bonds.

If the rally continues, where does the money go? Is the current equities market a bubble? This chart offers some perspective. Look at where money has been invested since the March 2009 bottom. The bets on equity funds and ETFs are dwarfed by the inflow for bonds.

Where are the jobs? Where is the growth?

The big boost China experienced post Covid-19 looks like it has already come to an end. China's economy was the first to recover from the Covid-19 collapse due to trillions of credit pumped into the economy at home, as well as Americans rushing out to buy imported goods using stimulus money. With China again showing signs of economic weakness, the story that it takes more and more stimulus to create the same kick each time we play this game is playing out. Will the story somehow be different for America or Canada?

Zombies are taking over the world.

If you think that is a lot, consider the entire globe. An International Monetary Fund report from October 2019, fretted that global zombie debt could soon rise to $19 trillion and amount to 40% of all corporate debt in major economies...

Logos LP February 2021 Performance

February 2021 Return: 2.89%

2021 YTD (February) Return: 14.95%

Trailing Twelve Month Return: 133%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 27.29%

 

Thought of the Month

“I judge you unfortunate because you have never lived through misfortune. You have passed through life without an opponent- no one can ever know what you are capable of, not even you.” -Seneca

Logos LP Services


Looking for help with your investments? Unsure about how to achieve your financial goals? We would be happy to chat. Please book an intro call here.



Articles and Ideas of Interest

• The Gig Economy Is Coming for Millions of American Jobs. California’s vote to classify Uber and Lyft drivers as contractors has emboldened other employers to eliminate salaried positions—and has become a cornerstone of bigger plans to “Uberize” the U.S. workforce. This while Long-term unemployment is close to a Great Recession record and the unemployment rate for the bottom quartile of Americans is 23%.

• Canada's balance sheet is deteriorating and the consequences could be significant for investors. Canada is spending in places that may not directly repair the damage that has been done by the virus. No wonder a job in the public sector has never looked better. The long-running rivalry between the two services — public versus private — has been settled by COVID-19. Why would anyone risk the dangers and uncertainty of free enterprise when they could have the safety and security of a large and ever-expanding government? The bottom line is that the cachet that once went with private employment has gone the way of the Dodo bird, which coincidentally never had a government to protect it either. Public pay is better, the benefits top-of-line, it’s almost impossible to be fired, you know the date you can retire, and the amount you’ll be paid. If you don’t get along with your manager you can call the union and grieve 13 ways from Sunday. You don’t have to worry about the business going under, and can live in confidence that terror-stricken politicians will opt to buy peace at contract time, rather than challenge the latest set of demands. This reality is a major problem for the future of Canada’s economy.

• Move over GameStop, hockey cards are emerging as the hottest bull market on the planet: Blame it on the pandemic, but cards are seeing a 'parabolic boom' with values up 300% to 400%. All this while people are paying millions for video clips that can be viewed for free. Welcome to the world of ‘NFTs’.
  
   

• Microdosing study shows placebo effect of taking psychedelics. UK research into LSD consumption reveals expectation of improved wellbeing drives transformation rather than the drug itself. The mind is more powerful than the sword. 
  
   

• YOLO investing still appears healthy. 37% of Americans in a recent online survey say they've made trades based on an Elon Musk tweet and half of respondents in a recent survey between 25 and 34 years old plan to spend 50% of their stimulus payments on stocks. Bless their hearts.

• The long-term economic costs of lost schooling. Students who are falling behind now because of Covid restrictions may never catch up in their skills, job prospects and income.
  
   

• SPACs are becoming less of a sure thing as the deals get stranger, shares roll over. Faced with intense competition, deadline pressure and a volatile market, some SPACs had to settle for less ideal targets, and in some cases, throw their entire blueprint out the window.The proprietary CNBC SPAC 50 index, which tracks the 50 largest U.S.-based pre-merger blank-check deals by market cap, dropped more than 15% in the past two weeks, giving up all of its 2021 gains. Most are problematic, but there is one we find attractive: IonQ (DMYI) which promises to be the leader in quantum computing. 

• What happened to gold? If you went into a laboratory to build a gold price optimizer, you would want a couple of things: A falling dollar, Rising inflation expectations, Money printing, Central bank balance sheets expanding, Fiscal deficits increasing and Political turmoil. All of these things were in place over the last few months, and yet gold has done the opposite of what you expected it to do. It’s down 9% over the last 6 months, and it’s 15% below its highs in August. Gold could rally on any one of the items I mentioned. All six were in place at the same time, and it couldn’t get out of its own way. Michael Batnick digs in.  
  
   

• How Much Longer Can This Era Of Political Gridlock Last? Democrats may have a narrow majority in both the House and the Senate for the next two years, but it’s nothing near the margin they hoped for. And the likelihood that Democrats keep both the House and the Senate in 2022 are low, as the president’s party almost always loses seats in the midterm elections. That means more divided government is probably imminent, and the electoral pattern we’ve become all too familiar with — a pendulum swinging back and forth between unified control of government and divided government — is doomed to repeat, with increasingly dangerous consequences for our democracy.

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

Logos LP

The Market Will Crash [Insert Percentage]

Good Morning,
 

U.S. stocks finished slightly higher on Friday to set another round of record closes.

The major averages finished with modest gains for the week, as the strong rally which opened February has now taken a little breather. 

The market ground higher to notch records this month as investors remained hopeful for a smooth economic reopening as well as additional Covid stimulus. The Dow has gained 4.9% in February, while the S&P 500 and the Nasdaq have rallied 5.9% and 7.8%, respectively. The S&P 500 has raked in ten record closes in 2021.

Cyclical sectors, those most sensitive to an economic rebound, led the rally in February. Energy is up more than 13% month to date, with financials and materials also among the leading sectors. Nevertheless, while the "other" segments of this market garner the attention, it is important to acknowledge that this is a very broad based rally. 

Our Take

The medical and economic picture is improving and investors seem to be taking notice. Additionally, fourth-quarter earnings are rolling in well ahead of expectations, and analysts are now adjusting their 2021 earnings estimates upwards. Furthermore, if you take the time to look beyond the headlines - dominated by Reddit speculation stories (many of which have since sold off mercilessly) or “everything is a bubble” stories - investors have appeared to react rationally to underwhelming earnings prints from high-multiple “darling” stocks selling them off aggressively.  

For all the unprecedented events and unforeseen consequences of the past year, all the fear mongering of bubbles and exuberance, market conditions today actually resemble quite closely to those of mid-February 2020, when stocks peaked right before the Covid crash. Interestingly, the S&P 500 (since its pre-Covid peak February 10, 2020) is only about 15% higher one year on. Is that euphoria? 

Much of the discourse around the market is also similar; worries that too much of the market is dominated by a few large growth stocks (the top five S&P stocks were 20% of the index then and are 22% today) and that investor sentiment had grown complacent or even euphoric.  

Back then, and like today, the S&P was at a 20-year high in terms of valuation, the forward price/earnings ratio then just above 19 and now surpassing 22 – yet for those who choose to compare equity earnings yields to Treasury yields, the gap is pretty close: 3.7 percentage points then versus 3.3 now.

Nevertheless, there are some key differences. The economic collapse brought on by government induced lockdowns reset the clock on the economic cycle and accompanying policy stances. 

Michael Santoli reminds us that from 2019 into 2020 Wall Street was caught in a late-cycle set-up, with the economy near peak employment, the Treasury yield curve flat, corporate profit margins near peak, and earnings projected to be flat.

Short rates were higher at 1.5-1.75%, the Fed was on hold indefinitely yet certain Fed officials were projecting a rate hike in 2021.

The flash recession and profit collapse led to one of the greatest deficit-financed fiscal support binges in history ($5 trillion and counting) and turned the Fed maximum accommodative focused on a return to full employment coupled with a lasting rise in inflation before any whisper of normalization. 

So, yes, valuations are higher now and investor expectations could be growing more willy nilly yet corporate America just refinanced itself for years to come at ultra low rates with a Fed and government who have gone all in on the “Wealth Effect”. 

The "Wealth Effect" is the notion that when households become richer as a result of a rise in asset values, such as corporate stock prices or home values, they spend more and stimulate the broader economy. 

Asset Price Increases = Spending Increases = Employment Increases

Now in 2021, earnings will be back above their prior peak, government is eager to run the economy hot and policy makers (arguably) just pulled off a repeatable process for sidestepping a recession. 

For us, we do believe certain themes and stocks are running hot and that the major indexes look tired. As such, we maintain a focus on individual names. We expect divergences to emerge across sectors with higher volatility for the rest of the year. We see opportunities in individual small-caps particularly in names that are under-the-radar and still have long-runways and thus real value. Think bio-tech, health-tech, clean-tech and certain basic materials. We also like smaller emerging markets (Asia) that can benefit from a weaker U.S. dollar and still have upside to historical valuations.
 

Musings

So are we in a "different " investment world today? Have the old rules changed? Or will all the “pundits” pointing to history (South Sea bubble, 1929, and 2000) calling for an epic crash be vindicated? 

The short answer is they might, as the future is unknowable. Yet today we believe that one should be cautious when applying investment history to the present in order to predict the future. 

The further back in investment history you go the more likely you are viewing a world that no longer applies to the present moment. 

As Morgan Housel reminds us in his fabulous book, investment history matters, yet if one relies too heavily on it, one will likely miss the outlier events that have the greatest impact.

It is important to remember that most of what is happening at any given moment in the global economy can be linked to a handful of past events that were nearly impossible to predict.

Think: the invention of the printing press, the first passenger plane, penicillin, the integrated circuit, the internet, the Great Depression, WWII, September 11th and Covid-19 to name a few.

The most common denominator of economic history is the role of surprises. The danger investors face is taking the worst and best events of the past and assuming they will occur again in the future. They make the assumption that a history of unprecedented events doesn’t apply to the future. This isn’t a failure of analysis but a failure of the imagination.

Instead, we believe that the future might not look anything like the past and this need for imagination grounds our approach to investing. We understand that the things that will move the needle the most are the things history gives us no guide to understanding or necessarily predicting.

We also understand that history can be a misleading guide to the future of economies and stock markets as it has difficulty accounting for unique structural changes that are key to today’s world.
 

Historical theories about recessions, interest rates, inflation and purchasing stock often look tired when applied to today’s world. We take cues from the past, but believe in the power of adapting such learnings to the present.

Constant experimentation, retesting of assumptions and adaptation is crucial for lasting investment success. Tethering to past events, patterns and ideas can bring comfort but it can also lead to destructive blind spots.

Human nature and human behaviours tend to be stable over time, yet specific investment trends, causal relationships and strategies are constantly evolving. 

Regardless of whether the pundits are at some point proven correct, those who can free their minds and evolve their ideas and biases tilt the odds of outperformance in their favour.

Charts of the Month

County-level data on U.S. stock market holdings suggest that rising share prices induce consumer spending, which raises employment and wages.

Cross-border investment fell off a cliff in 2020, dropping 42% to $859 billion from 2019's $1.5 trillion, according to official UN figures.

Logos LP January 2021 Performance

January 2021 Return: 11.71%

2021 YTD (January) Return: 11.71%

Trailing Twelve Month Return: 116.73%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 27.10%
 

Thought of the Month

“In general I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook was first published. But the situation has changed a great deal since then.” -Benjamin Graham

Articles and Ideas of Interest

• Why a dawn of technological optimism is breaking. The 2010s were marked by pessimism about innovation. The Economist suggests that is giving way to hope. For much of the past decade the pace of innovation underwhelmed many people—especially those miserable economists. Productivity growth was lacklustre and the most popular new inventions, the smartphone and social media, did not seem to help much. Their malign side-effects, such as the creation of powerful monopolies and the pollution of the public square, became painfully apparent. Promising technologies stalled, including self-driving cars, making Silicon Valley’s evangelists look naive. Security hawks warned that authoritarian China was racing past the West and some gloomy folk warned that the world was finally running out of useful ideas. Today a dawn of technological optimism is breaking. The speed at which covid-19 vaccines have been produced has made scientists household names. Prominent breakthroughs, a tech investment boom and the adoption of digital technologies during the pandemic are combining to raise hopes of a new era of progress: optimists giddily predict a “roaring Twenties”. Just as the pessimism of the 2010s was overdone—the decade saw many advances, such as in cancer treatment—so predictions of technological Utopia are overblown. But there is a realistic possibility of a new golden era of innovation that could lift living standards, especially if governments help new technologies to flourish. Opportunities abound. The future is bright.

• Canadians’ wealth is tied to their parents’ more than ever, StatCan finds. A new study has found that the likelihood of Canadians staying within the same income and wealth class as their parents has increased significantly. The report, released Wednesday by Statistics Canada, measured the incomes of five different cohorts of children born between the 1960s and 1980s, as well as that of their parents. It found that intergenerational income mobility — the degree to which a person’s income and wealth could move further from that of their parents — had declined across all of the cohorts.

• As Vaccines Raise Hope, Cold Reality Dawns: Covid-19 Is Likely Here to Stay. Governments and businesses are starting to accept that the coronavirus isn’t a temporary problem and instead will lead to long-term changes enabling society to co-exist with Covid-19, as it does with flu, measles and HIV.
  
   

• 'Alarming' numbers show Canadian business investment has plunged to just 58 cents for every dollar spent in the U.S. Canadian business investment numbers out today ‘tell a bleak story’ of a nation that will struggle to compete when it emerges from the COVID-19 pandemic. The pace of business investment’s decline over the past five years has been alarming, says the C.D. Howe Institute report, entitled “From the chronic to the acute: Canada’s investment crisis.” After “slipping badly” since 2015, it has now plunged in 2020 to the lowest since the beginning of the 1990s, widening the gap between us and the United States and other OECD countries.

• While the world is in the midst of a tech revolution, Canadians (as usual) bet on real estate. Now, the addiction is simply embarrassing. The world is in the midst of a transformative shift to a digital and carbon-neutral economy, a once-in-a-lifetime investing opportunity, and where are Canadians placing their bets? Houses, for the most part. We’ve resumed, after a brief cooldown, plowing a ridiculous amount of money into assets that do nothing to improve the country’s ability to generate wealth. Housing accounted for 37 per cent of overall investment, while business spending on machinery and equipment and intellectual property dropped to 28.2 per cent, the highest and lowest levels, respectively, since early 1993.

• GameStop may not have been the retail trader rebellion it was perceived to be. The prevailing narrative of a retail investor revolution or a David vs. Goliath battle seems flawed. Data shows institutional investors as drivers of a large portion of the wild price action in GameStop. GameStop was not even in the 10 most-bought names by retail investors that month, according to JPMorgan.

• Markets that are definitely NOT in a bubble. If it feels like we’ve been debating a stock market bubble in the U.S. for a decade it’s because we have. LOL Ben Carlson suggests that the longer this goes the louder the chorus of bubble-callers will get. And maybe they’ll be right eventually. Bubbles are basically an American past-time. We can debate all we want about whether we’re in a bubble or not and there are compelling arguments on each side. But there are plenty of other markets that are certainly not in a bubble. Ben puts together a compelling list. Emerging markets representing the most interesting opportunity.

• SPACs are red-hot—but they’ve been a lousy deal for investors. For the dealmakers who put SPACs together, the upsides are obvious. For investors, not so much. For the dealmakers who put SPACs together, the upsides are obvious. They can skip the headache of a road show—in which a company’s top executives make the same pre-IPO presentation over and over to would-be investors—as well as avoid the customary 7% fee normally paid to underwriters. Meanwhile, the organizers typically pocket 20% of the SPACs, a reward known as the “sponsor promote” for their trouble. In other words, the SPAC has plenty of upside and almost no downside. Well, no downside for the SPAC organizers that is. For ordinary investors, though, SPACs have often proved to be a rotten deal. For 107 SPACs that have purchased companies since 2015, the average return on common stock has been a putrid negative 1.4%. That compares with a 49% return for companies that went public via the traditional IPO route during the same period, according to data cited by the Wall Street Journal.

• Tom Lee says rising retail interest won’t mark a market top, could be the start of a long-term trend. The previous decade has been characterized by large inflows in bonds despite the bull market in stocks. This could be the first year out of ten years where there’s real inflows into stocks.

• Social-Media algorithms rule how we see the world. Good luck trying to stop them. What you see in your feeds isn’t up to you. What’s at stake is no longer just missing a birthday. It’s your sanity—and world peace. Fascinating article in the WSJ outlining how computers are in charge of what we see and they’re operating without transparency.

• The battery is ready to power the world. After a decade of rapidly falling costs, the rechargeable lithium-ion battery is poised to disrupt industries. The WSJ digs in. We like MP Materials as a long term benefactor of this disruption.

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

Logos LP

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

How did we do in 2019? Sell in 2020?

Good Morning,
 

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

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

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

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

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

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

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

Our Take

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

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

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

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

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

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

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

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

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

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


Stock Ideas
 

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

Musings

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

Charts of the Month

Logos LP December 2019 Performance
 

December 2019 Return: -0.06%
 

2019 YTD (December) Return: 37.62%
 

Trailing Twelve Month Return: 37.62%
 

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

Thought of the Month


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


Articles and Ideas of Interest

 

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

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

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

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

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

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

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

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

Our best wishes for a fulfilling January,

Logos LP