Mistakes Happen

Good Morning,
 

Stocks fell on the final day of a busy week that included the U.S.-North Korea summit, major central bank meetings and escalating trade tensions between Washington and Beijing.
 

The S&P 500 Index declined in heavy trading on a quadruple-witching last Friday, a quarterly event when futures and options contracts on indexes and individual stocks expire. The U.S. and China spent the day exchanging tariff threats, which drove down tech and industrial stocks, while a drop in the price of oil hit energy shares. Consumer staples and telecoms advanced, offsetting some of the drop, and the index finished with a weekly gain, if only barely.

Our Take
 

Value strategies continue to underperform while momentum strategies lead the market. In fact, while broad benchmarks sit relatively still, speculative shares are soaring, among them companies that recently went public, stocks favored by short sellers, and firms with weaker balance sheets. A seven-week rally was preserved in the Russell 2000, which was joined in record territory by an index of microcaps.

Gains in the third category, companies with shakier finances, breathed new life into a trade that had prevailed for most of the bull market before deterioratingas investors sought safety. Known as the low-quality rally, its revival may signal indiscriminate buying pressure is building again for equities.

Fundamentals look to be less important right now as high flying IPO’s have been surging. Technology companies that went public recently soared. Dropbox Inc., which began trading on March 23, climbed 32 percent. Cloud-based software company Zuora Inc. surged 18 percent, topping off gains of more than 50 percent since the start of the month. An exchange-traded fund that tracks newly public companies, the Renaissance IPO ETF, posted its second-best weekly gain this year. Avalara Inc., a Seattle-based company that provides sales tax-management solutions, started trading on the NYSE Friday and nearly doubled. There have been 22 technology companies to go public so far this year in the U.S., and they’ve gained an average of 70 percent, weighted by offer size, according to data compiled by Bloomberg.

Investors are no doubt chasing returns and to juice performance but this recent “risk-on” trend may also evidence investor belief that the future looks bright. A recent comment sums up the climate: “Why would you invest in a company where the balance sheet is stressed? You would do it if you felt that either the company or because of the economic situation that they’re going to grow into a more satisfactory fundamental balance sheet.”

Chart of the Month


An inverted yield curve as measured by the 10-year yield less than the two-year yield has occurred ahead of every recession in the past 40 years. The time interval between inversion and recession averages 10 months.

The chart above, courtesy of Urban Carmel, suggests we aren’t there yet.

Musings

Great article by Barry Ritholtz exploring the topic of failure and why we all as investors should learn to fail better. We should all cultivate the ability to be self-critical and implement a “standardized review process” when things go wrong.

As Ritholtz reminds us in contrast to equity investors: “Silicon Valley, technology and the venture-capital business model do a better job. Entrepreneurs and venture funders alike wear their failures like a badge of honor. Many venture capitalists even post their biggest misses on their websites. They recognize their model is to make a lot of losing bets in pursuit of finding the next big winner. Equity investors don’t have quite the same model, but they would benefit from a similar approach to recognizing their own limitations.”

The stigma that surrounds failure in asset management needs to be revisited as even juggernauts such a Buffett and Druckenmiller make big mistakes. As always, the way to avoid future failure is to embrace and learn from past failures. This piece hit home as during the month of May we exited our position in Luxoft and realized we had made a mistake. We were reminded of a few things: 1) turnarounds can take much longer than anticipated no matter how bullish one can be about the business’s prospects 2) more time means a larger opportunity cost 3) sometimes being too early is the equivalent to being wrong.

What investment mistakes have you made lately?

Logos LP May 2018 Performance
 

May 2018 Return: 0%

2018 YTD (May) Return: -3.79%

Trailing Twelve Month Return: +4.38%

CAGR since inception March 26, 2014: +17.99%

Thought of the Month


 

"You know what Kipling said? Treat those two impostors just the same — success and failure. Of course, there’s going to be some failure in making the correct decisions. Nobody bats a thousand. I think it’s important to review your past stupidities so you are less likely to repeat them, but I’m not gnashing my teeth over it or suffering or enduring it. I regard it as perfectly normal to fail and make bad decisions. I think the tragedy in life is to be so timid that you don’t play hard enough so you have some reverses.” -Charlie Munger
 

Articles and Ideas of Interest

 

• World Cup players to watch (not named Messi or Ronaldo). The diminutive Argentine and the preening Portuguese are the most recognizable players in the global tournament now under way in Russia. Oliver Staley details why eight other all-stars also deserve your attention over the next month. Apparently machine learning has come to a conclusion about which team will win. Place your bets. Mine is one France.

• We are worrying about the wrong kind of AI. There’s a bigger AI threat than computers achieving consciousness. Rapid progress in lab-grown “mini brains” from human cells brings up huge ethical challenges. Consider that biologists have been learning to grow functioning “mini brains” or “brain organoids” from real human cells, and progress has been so fast that researchers are actually worrying about what to do if a piece of tissue in a lab dish suddenly shows signs of having conscious states or reasoning abilities. While we are busy focusing on computer intelligence, AI may arrive in living form first, and bring with it a host of unprecedented ethical challenges.

• Tudor Jones says his social impact ETF has potential to rival the S&P 500. Paul Tudor Jones said Tuesday that a new exchange-traded fund about investing based on social impact could one day rival the benchmark U.S. stock index. Social impact investing is making a real impact in private markets. Look for it to grow in popularity in public markets.

• Why China 'holds all the aces' in a full-blown US-China trade war. U.S. tariffs on $50 billion of China goods were imposed Friday to protect U.S. intellectual property and technology. It prompted China to retaliate. But before evaluating the policy prescriptions for this problem, we must first consider the starting point, which is flawed. The current $370 billion deficit estimate does not account for value-added. When looking at the value-added content of Chinese exports, the U.S. deficit with China is actually only half of what it seems. And if we then add back the U.S. surplus in "invisibles" and how much money the United States brings back from investments in China, the U.S.–China deficit shrinks from 2 percent of U.S. GDP to 0.8 percent, a report from Oxford Economics revealed. Furthermore, the reality is that many of the Trump administration's articulated demands are things that China is already doing, albeit at a somewhat slower pace. The United States wants China to buy more American goods and services — and so does China. Trump wants to impose stiff tariffs to prevent China from flooding the American market with increasingly less expensive technological products, like smartphones, computers and related accessories, which collectively comprise China's biggest exports to the United States. And China agrees — they want to export higher value-added goods, especially those with a high innovation content. Interests are much more aligned than either country wants to admit.

• You should be sleeping more than eight hours a night. Here’s why. To set the record straight about being horizontal, Quartz spoke to one of the world’s most-talked-about sleep scientists. Daniel Gartenberg is currently working on research funded by the National Science Foundation and the National Institute of Aging and is also a TED resident. (Watch his talk on deep sleep here.) He’s also an entrepreneur who has launched several cognitive-behavioral-therapy apps, including the Sonic Sleep Coach alarm clock. All that with 8.5 hours’ of sleep a night. Some topics covered: why 8.5 hours of sleep is the new eight hours, the genes that dictate if you’re a morning person or a night owl, why you should take a nap instead of meditating, how sleep deprivation can be a tool to fight depression, why sleep should be the new worker’s rights and tips on how to get a better night’s rest (hint: it’s not your Fitbit).  

• Here’s Mary Meeker’s essential 2018 Internet Trends report. A few highlights: Ecommerce vs Brick & Mortar: Ecommerce growth quickens as now 13% of all retail purchases happen online and parcel shipments are rising swiftly, signaling big opportunities for new shopping apps.Amazon: More people start product searches on Amazon than search engines now, but Jeff Bezos still relies on other surfaces like Facebook and YouTube to inspire people to want things. Subscription services: They’re seeing massive adoption, with Netflix up 25%, The New York Times up 43%, and Spotify up 48% year-over-year in 2017. A free tier accelerates conversion rates. Privacy: China has a big opportunity as users there are much more willing to trade their personal data for product benefits than U.S. users, and China is claiming more spots on the top 20 internet company list while making big investments in AI.

Our best wishes for a fulfilling month, 

Logos LP

Do Bull Markets Die Of Old Age?

Good Morning,
 

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

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

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

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

Our Take

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

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

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


Chart of the Month

Source: More Than Never. Less Than Always


Musings
 

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

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

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

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

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

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

So what?

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

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

Logos LP April 2018 Performance



April 2018 Return: -3.84%

2018 YTD (April) Return: -3.79%


Trailing Twelve Month Return: +8.22%


CAGR since inception March 26, 2014: +18.39%

Thought of the Month


 

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

Articles and Ideas of Interest

 

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

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

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

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

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

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

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

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

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

Our best wishes for a fulfilling month, 

Logos LP

Less Is More

Good Morning,


As a special note, this month marks our 4 year anniversary at Logos LP. We appreciate your support and will continue to bring you thought provoking ideas from around the web. 


As for equities, after posting the worst start to April since the Great Depression, U.S. stocks dropped on Friday as several banks weighed down the major indexes on the final day of an otherwise strong week for equities. 


Citigroup, Wells Fargo and J.P. Morgan Chase all reported quarterly earnings and revenue that surpassed analyst expectations. Bank shares initially traded higher before falling, as the strong results were already priced in and guidance was lacklustre. 


This will likely be the case for many other sectors as expectations for this earnings season are sky high with earnings data registering higher growth than ever this late in the cycle. According to FactSet, S&P 500 earnings are forecast to have grown by 17.1 percent last quarter. Financials, meanwhile, are expected to see earnings increase by 24 percent..


2018 has so far been a roller coaster not for the faint of heart with even veterans such as Jack Bogle stating that: "I have never seen a market this volatile to this extent in my career."

Our Take


What should be made of this volatility? 

Although many are quick to point the finger at Trump’s itchy “Twitter Finger” which has lobbed challenges at Russia, China, Syria, Amazon, Robert Mueller etc. there are at least several other matters contributing to the volatility. David Rosenberg has suggested some plausible factors:
 

1. "A new, untested and less dovish Fed" led by Chairman Jerome Powell, who may have a less intense focus on stock market values than some of his predecessors.

2. Budget problems caused by big tax cuts that the Congressional Budget Office projects will lead to a $2 trillion deficit.

3. A possible trade war that will push up interest rates until the next recession hits.

4. An isolationist administration when it comes to trade, which will lead to "disrupted supply chains."

5. The boost markets got last year from tax cuts and a general air of fiscal stimulus has been priced in. Meanwhile, President Donald Trump's attacks on "Big Tech," and Amazon in particular, are leading to policy uncertainty.

6. "Cracks" in the synchronized global growth narrative. Belief that the world was growing together helped fuel the 2017 rally, but Rosenberg sees multiple big economies slowing down.

7. A possible peak in corporate profits that is raising the bar for expectations, meaning it will be tougher for earnings season to impress. Earnings perfection or bust? Both business and consumer optimism has certainly hit rarefied air and thus nothing short of perfection will move the needle or at minimum keep it where it is...

8. Related earnings woes, particularly from a U.S. dollar that may have found a bottom after plunging during the first year of Trump's presidency. Trump has advocated for a weaker greenback as it helps make U.S. multinationals more competitive on the global stage.

9. The wild intraday stock moves. The S&P 500 is on track for 100 days of plus-or-minus 1 percent moves, a trend that Rosenberg says typically happens during bear markets (1974, 2001, 2002, 2008 and 2009 are other years when this occurred).

10. Circling back to the Fed, Rosenberg does not believe the central bank will come to the rescue if the markets correct. Moreover, the Fed is reducing the size of its bond portfolio just as the U.S. will be flooding the market with bonds to fund the burgeoning fiscal deficits.

Another issue we’ve been monitoring lately is a widening of Libor-OIS which is typically associated with heightened credit concerns. This is a metric that measures the difference between Libor (the London interbank borrowing rate where banks lend to each other unsecured) and the overnight interest rate swap (the rate tracking the interest rate set by the central bank) which has shot up to more than 50 basis points. Known as the Libor-OIS, it's now at the widest it has been since the euro zone sovereign debt crisis of 2012. It widened more than 15 basis points in the February alone.


A widening of Libor-OIS is generally associated with heightened credit concerns, however this time analysts are pointing to several structural shifts in money markets (markets that trade in securities with short-dated maturities) rather than banking concerns — as banks are now flooded with liquidity and are generally performing better.


Taken together these factors suggest a concerning picture. A significant wall of worry.


As always we suggest that for the long-term investor it is a fool’s game to try to time markets, yet whether we are in the 6th inning or the 9th, there are an increasing number of signs and signals that the economy may be entering the late stages of economic recovery.


This doesn’t mean a recession is imminent, but some early warning signs are emerging that should encourage us to make preparations for a rainy day. The expansion will likely extend through its ninth year, but is unlikely to accelerate and looks set to slow from here. Are our minds prepared for less? Are we ready and willing to do more with less? To make the most of less?

Musings


Like so many other important principles regarding successful long-term investing, the merits of training oneself to do more with less can be found when considering other disciplines. 

This past month I found some interesting research which suggests that when people severely cut calories, they can slow their metabolism and possibly the aging process.


Clinical physiologist Leanne Redman, who headed the study at Pennington Biomedical Research Center in Baton Rouge used participants that were not overweight and cut their typical plate for breakfast, lunch and dinner by up to 25 percent.

53 healthy volunteers were recruited and one-third ate their regular meals. The rest were on the severe calorie reduction plan for two years.


Redman noticed that for those on the restricted diet, their metabolism slowed and became more efficient.

"Basically it just means that cells are needing less oxygen in order to generate the energy the body needs to survive; and so the body and the cells are becoming more energy efficient," Redman explains. And if less oxygen is needed to burn energy, then dangerous byproducts of that burning — free radicals — can be reduced.

"Oxygen can actually be damaging to tissues and cells, and so if the cells have become more efficient, then they've got less oxygen left over that can cause this damage," she says. And that damage can accelerate aging.


Now, these findings don't directly prove that drastic calorie-cutting will actually help people live longer. People would have to be followed for their lifetimes to prove that. But the study did find that blood pressure, cholesterol and triglycerides were lower in the group on severe calorie restriction. When those numbers are high, they can lead to life-shortening diseases.

What can this research teach us when it comes to investing? 


For the last 5 years or so, returns have been for the most part high, low hanging investment fruit plentiful, central banks accommodative and volatility low.


Calorie intake (as represented by stock returns) has been high. Breakfasts, lunches and dinners have been large and our “investor metabolisms” have slowed, their efficiency impaired. We’ve been lulled into ease by excess. Our expectations inflated. 


Instead, as storm clouds gather on the horizon, we should proactively prepare for less by re-setting expectations. This "mental" cutting of calories can lead to improvements in the efficiency of our investor metabolisms. Ultimately our ability to prepare for less will enable us to do more with less. As our physiology suggests, doing more with less may not only determine our long-term success as investors, but also our longevity as humans. 

Logos LP March 2018 Performance



March 2018 Return: 2.34%

2018 YTD (March) Return: 0.05%


Trailing Twelve Month Return: +17.80%


CAGR since inception March 26, 2014: +19.95%

Thought of the Month


 

"Without frugality none can be rich, and with it very few would be poor.” -Samuel Johnson

Articles and Ideas of Interest

 

• Most people have a really tough time understanding compound interest. It isn’t intuitive so its systematically overlooked and underappreciated. More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact: Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child. $80.7 billion of Warren Buffett’s $81 billion net worth was accumulated after his 50th birthday. Seventy-eight billion of the $81 billion came after he qualified for Social Security, in his mid-60s. Start early. Be invested. Repeat.

• Lessons on Bubbles From Bitcoin. Until there is a way to bet against an asset, its price will be set by the most upbeat buyer. This suggests that there’s a good and easy way for regulators to reduce the incidence of bubbles. Whenever a new asset is created or a bunch of new investors enters the market, allow more futures trading and other exchanges that let pessimists publicly register their pessimistic beliefs. That won’t totally prevent all bubbles -- the late 1990s technology stock bubble, for instance, happened in spite of the existence of stock futures markets. But it would certainly help. Keeping pessimists out of the market is a recipe for repeated bubbles and crashes, as overoptimistic speculators rampage unchecked. Given a level playing field, the bears can restrain the bulls.

• At this rate, it’s going to take us nearly 400 years to transform the energy system. Here are the real reasons we’re not building clean energy anywhere fast enough. Beyond the vexing combination of economic, political, and technical challenges is the basic problem of overwhelming scale. There is a massive amount that needs to be built, which will suck up an immense quantity of manpower, money, and materials. There’s simply little financial incentive for the energy industry to build at that scale and speed while it has tens of trillions of dollars of sunk costs in the existing system. Should we just give up? MIT digs in.

• Why is it so hard to invest with a social conscience? For those so inclined, the good news is this: There are more opportunities than ever to invest with a conscience. One firm, Wealthfront, will even let you strip individual American companies that rub you the wrong way from one of the index-fund-like portfolios it creates for you. But with all these choices comes a fair bit of confusion. To land the biggest blow with whatever investing dollars you have, you’ll first need to confront at least seven challenges.

• There is a lot of hype surrounding blockchain. Could it be crappy technology and also a bad vision for the future? Anti Futurist Kai Stinchcombe goes so far as to say that “Eight hundred years ago in Europe — with weak governments unable to enforce laws and trusted counterparties few, fragile and far between — theft was rampant, safe banking was a fantasy, and personal security was at the point of the sword. This is what Somalia looks like now, and also, what it looks like to transact on the blockchain in the ideal scenario.”

• The Richest 1% are on target to own 2/3rds of all wealth by 2030. Will anger over inequality ever reach a tipping point?

• The end of scale. New technology driven business models are undercutting the traditional advantages of economies of scale. But large companies have strengths to exploit if they move quickly. Is big business really that bad? The Atlantic argues that large corporations are vilified in a way that obscures the innovation they spur and the steady jobs they produce. After all, entrepreneurship isn't for everyone. 

• The grim conclusions of the largest ever study of fake news. Falsehoods always beat out the truth on Twitter, penetrating further, faster and deeper into the social network than accurate information. Extremism pays. That’s why Silicon Valley isn’t shutting it down. The tech giants’ need for ‘engagement’ to keep revenues flowing means they are loath to stop driving viewers to ever-more unsavoury content. The show must go on! Unless Facebook’s Cambridge Analytica problems are nothing compared to what's coming for all of online publishing.

• Private Equity: Overvalued and Overrated? America is in the grips of a speculative frenzy. Investment bankers, private investment firms, and even a few dozen recently graduated MBAs labelling themselves “searchers” are calling, emailing, wining, and dining small business owners. Their goal is to translate prosaic small businesses into the poetry of private equity. This consensus has led institutional investors to flood private markets with capital, about $200 billion per year of new commitments. The result is soaring prices for private companies of all shapes and sizes. Just before the financial crisis, in 2007, the average purchase price for a PE deal was 8.9x ebitda (earnings before interest, taxes, depreciation, and amortization—a commonly used measure of cash profitability). Deal prices reached 8.9x again in 2013 and are now up to nearly 11x ebitda. But asset prices are going up everywhere. What makes private equity dangerous is the use of debt—and the use of phony accounting to conceal the riskiness of these leveraged bets. Great piece suggesting that all the glitter is not gold.

Our best wishes for a fulfilling month, 

Logos LP

Everything Has Been Done Before

Good Morning,
 

U.S. stocks rocketed higher on Friday, seeing the Nasdaq composite hit a new record, after February jobs growth far exceeded expectations.

The Dow Jones industrial average rose 440.53 points to close at 25,335.74, with Goldman Sachs among the biggest contributors of gains to the index. The 30-stock index also closed above its 50-day moving average, a key technical level.

The S&P 500 gained 1.7 percent to end at 2,786.57, with financials as the best-performing sector. It also closed above its 50-day moving average.

The jobs report which came out Friday was nothing short of extraordinary. The U.S. economy added 313,000 jobs in February, according to the Bureau of Labor Statistics. Economists polled by Reuters expected a gain of 200,000.

Wages, meanwhile, grew less than expected, rising 2.6 percent on an annualized basis. Stronger-than-expected wage growth helped spark a market correction in the previous month.

Our Take
 

The jobs report was impressive. For all that can be said about Trump’s unconventional decision making (his big deficits may actually make sense by spurring productivity and his “tariffs” may in fact be good for free trade) this report confirmed the underlying strength of the economy, and also diminished some of those inflationary concerns and the potential that there could be more than three rate hikes this year.

Many question how you can create this many jobs and not have wages go up more but we maintain that this phenomenon is due to a unique interplay of several factors: demographics, labour force participation and technology.

The basic formula is as follows: as labor becomes more scarce based on demographics, it constrains supply, triggering inflation. But labor scarcity, in turn, should speed the adoption of automation and trigger an investment boom. Automation investments are likely to generate supply growth just as demographics and investment both spur demand growth, creating a reasonable balance (despite rising inequality). Once the investment boom ends, however, the negative effects of automation will become more visible—namely, high levels of unemployment, wage suppression and slowing demand.
 

We may have progressed further along this matrix than some may think. Regardless, we are a long ways from the sort of wage inflation of the 1990s . . .

Musings

I shared an interesting chart in the Economist with some friends this week which sparked a spirited discussion:

The debate focused on whether or not such historical data offers the investor anything of value. Certain friends suggested that the world in 1900 was vastly different than the world today and thus such data was of limited use.

What struck me most about the discussion wasn’t the comparison between what the world looks like today vs. what it looked like over 100 years ago, it was the ease with which we are able to overlook history in an effort to justify the perceived novelty and uniqueness of whatever appears to be relevant in the moment.

Think cannabis, blockchain, bitcoin, AI, cryptocurrency and whatever else is hot right now. This isn’t to say that these “new” things aren’t relevant.

But it is to say that broadly speaking everything has been done before as human nature hasn’t changed all that much. As Morgan Housel reminds us: The scenes change but the behaviours and outcomes don’t.

"Historian Niall Ferguson’s plug for his profession is that “The dead outnumber the living 14 to 1, and we ignore the accumulated experience of such a huge majority of mankind at our peril.”

The biggest lesson from the 100 billion people who are no longer alive is that they tried everything we’re trying today. The details were different, but they tried to outwit entrenched competition. They swung from optimism to pessimism at the worst times. They battled unsuccessfully against reversion to the mean.

They learned that popular things seem safe because so many people are involved, but they’re most dangerous because they’re most competitive.

Same stuff that guides today, and will guide tomorrow. History is abused when specific events are used as a guide to the future. It’s way more useful as a benchmark for how people react to risk and incentives, which is pretty stable over time.”

Logos LP February 2018 Performance

February 2018 Return: -3.75%

2018 YTD (February) Return: -2.24%

Trailing Twelve Month Return: +21.02%

CAGR since inception March 26, 2014: +19.72%

Thought of the Month


 

"The way to outperform over the long haul typically isn’t done by being the top performer in your category every single year. That’s an unrealistic goal. A better approach is to simply avoid making any huge errors and trying to be more consistent. The top performers garner the headlines in the short-term but those headlines work both ways. The top performers over the long-term understand that’s not how you stay in the game over the long haul.” -Ben Carlson

Articles and Ideas of Interest
 

• When value goes global. Interesting piece in Research Affiliates magazine suggesting that the value premium that is traditionally associated with stock selection and market timing works just as well when applied globally across major asset classes. The alternative value portfolios studied are typically uncorrelated with their underlying asset classes, traditional value approaches, and each other, thereby offering meaningful diversification benefits alongside attractive excess return potential. The success of global value portfolios hinges on their design, which allows investors to gain better exposure to desired risk premia not easily available when investing in a single market.

• Rational Irrational Exuberance. We tend to be uncomfortable with the notion that an economy’s fundamentals do not determine its asset prices, so we look for causal links between the two. But needing or wanting those links does not make them valid or true.

• If you’re so smart, why aren’t you rich? Turns out it’s just chance. The most successful people are not the most talented, just the luckiest, a new computer model of wealth creation confirms. Taking that into account can maximize return on many kinds of investment.

• Why doesn’t more money make us happy? Dan Gilbert, social psychologist and author of Stumbling on Happiness showed that people who recently became paraplegics are just as happy one year later as people who won the lottery. Relative to where we thought our happiness would be after winning the lottery, we adjust downward, and relative to where we thought our happiness would be after losing our legs, we adjust upward….Interesting piece from Michael Batnick that suggests that this concept makes sense in theory, but not in practice. Like many things in life, it’s an idea that is hard to truly believe until we experience it for ourselves.

• The town that has found a potent cure for illness- community. What a new study appears to show is that when isolated people who have health problems are supported by community groups and volunteers, the number of emergency admissions to hospital falls spectacularly. While across the whole of Somerset emergency hospital admissions rose by 29% during the three years of the study, in Frome they fell by 17%. Julian Abel, a consultant physician in palliative care and lead author of the draft paper, remarks: “No other interventions on record have reduced emergency admissions across a population.” No wonder what causes depression most of all is a lack of what we need to be happy, including the need to belong in a group, the need to be valued by other people, the need to feel like we’re good at something, and the need to feel like our future is secure.

• Could capitalism without growth build a more stable economy?New research that suggests – that a post-growth economy could actually be more stable and even bring higher wages. It begins with an acceptance that capitalism is unstable and prone to crisis even during a period of strong and stable growth – as the great financial crash of 2007-08 demonstrated.

• Is it time to say it? That retirement is dead? What will take its place? The numbers are startling: Thirty-four percent of workers have no savings whatsoever; another 35 percent have less than $1,000; of the remaining 31 percent, less than half have more than $10,000. Among older workers between 50 and 55, the median savings is $8,000. And this is total savings, including retirement accounts. Contrast that with the fact that experts say you should have eight times your preretirement annual salary saved in order to retire by 65 and continue a reasonable quality of life, commensurate with what you have become accustomed to.  

• Blockchain is meaningless. People keep saying that word but does it really mean?

Our best wishes for a fulfilling month, 

Logos LP

Market Meltdown: Correction or Destruction?

Good Morning,
 

Oh how fast things can change. After a big January, U.S. equities ended their worst week in two years as rate-hike fears pushed markets into a correction.

The recent turmoil in equities began last Friday, when the Dow fell 666 points after a better-than-expected jobs report ignited inflation fears. That fall was exacerbated Monday after the yield on the benchmark 10-year Treasury note hit a 4-year high, sending the Dow tumbling another 1,175 points as investors grew more nervous about an overheating economy.

Trouble with securities called exchange-traded notes that decline in value when volatility increases likely helped create more turmoil in the markets this week. The Cboe Volatility index (VIX) — the market's best fear gauge — shot above 40 again Friday after jumping as high as 50 earlier in the week. At the end of January, the VIX was below 14.

Traders are now focusing on next week’s U.S. consumer-price data after a week in which the 10-year yield pushed as high as 2.88 percent. Equity investors took the signal to mean interest rates will rise as inflation gathers pace, denting earnings and consumers’ spending power.

In only a week the S&P 500 has tumbled 5.2 percent, its steepest slide since January 2016. At one point yesterday before a furious rally, stocks had fallen as low as 12 percent from their latest highs. The volatility Friday was impressive: the Dow jumped 349 points in morning trading, fell 500 points later in the session, before closing 330 points higher.

Still, the selloff has wiped out gains for the year and signs have mounted which suggest that  jitters have spread to other assets, with measures of market unrest pushing higher in junk bonds, emerging-market equities and Treasuries.
 

Our Take
 

Hindsight being 20/20 it was easy to see this coming: record high valuations, record high returns (the S&P’s risk adjusted return was close to the world’s best in 2017), a strengthening economy, synchronized global growth, signs that inflation is picking up, risk-on behaviour gaining ground, massive equity inflows, monetary policy normalization, the shift from a monetary driven economy to a fiscal driven economy...the list goes on.

U.S. stocks have enjoyed a nearly uninterrupted bull market since late 2009. Two factors have helped create a Goldilocks scenario driving this surge. First, the shock administered by the 2008-2009 financial crisis left stocks significantly undervalued, creating plenty of room for equity prices to recover. Second, U.S. inflation has consistently held below the Federal Reserve’s 2 percent target, leaving the central bank with little reason to tighten monetary policy.

Finally conditions are now changing.

Stocks are richly valued and at the same time, inflation looks set to overshoot the Fed's target in the medium term. The overshoot won't be large, but it could ultimately trigger faster rate hikes than presently are being priced by the market. That could cause the bond market's yield curve to invert, as short-term rates rise above those for longer-term maturities. Fiscal stimulation is hitting the gas, which is driving the economy forward into the capacity constraints, which is triggering interest rate increases that are hitting the brakes, first in the markets and later in the economy.

This confluence of circumstances will make it difficult for the Fed to get monetary policy exactly right. As Ray Dalio has pointed out, this is classic late-cycle behavior (when it’s difficult to get monetary policy exactly right, which leads to recessions), though it is more exaggerated because the durations of assets are uniquely long, which means that when interest rates are low, prices of assets are more sensitive to changes in interest rates than when interest rates are high.

A yield curve inversion is normally a clear signal the economy is heading for a recession. We're not there yet, but the risks are rising.

Caution is warranted and longer term return expectations should be lower. Nevertheless, what so far looks like a purge of sorts, will likely be long-term positive; flushing out the excess and re-calibrating investor psychology. For now we see this pullback a potential opportunity to dollar cost down in existing positions as well as to initiate new positions at more attractive multiples. Nevertheless, a watchful eye should be set on volatility as measured by the VIX. For if the VIX continues to rise sustainably as the stock market rallies and retests its lows, more meaningful trouble may lie ahead.

Some things to consider:

The S&P 500 would have to fall an additional 52 percent to reach its long-term average valuation. Bulls have nothing to panic about yet, and bears have not been vindicated.

The return of major volatility is unpleasant for many, but does give some much-needed negotiating power to investors in IPOs and stock sales. As stock volatility jumps -- as in recent days -- so the risk of loss rises and discounts should widen. The problem is that US startups don’t want to go public anymore and that's bad news for investors.

The current market rout -- which is occurring smack dab in the middle of a nice earnings season -- may put a damper on the recent trend towards record-high takeover valuation.

Musings

After a year of abnormally low volatility, this past week has been particularly gut wrenching. But these types of selloffs should be expected in the stock market from time to time. Let's remember that although the raging bull of the 1980s and 1990s which is likely the greatest of all time in U.S. stocks, investors were forced to deal with the 1987 crash, when stocks fell more than 33 percent in the span of a week. In addition, most investors forget there was an emerging-markets crisis in 1997 and 1998 that caused the S&P 500 to fall just shy of 20 percent. Stocks still charged afterward, reaching highs in 1999 and early 2000 before crashing after the tech bubble popped.

The stock market should not be mistaken for the economy. Fundamentals are still solid and while double-digit losses should be expected when investing in equities, investors must also realize that human beings tend to panic more often when money evaporates before their eyes. In the short-term, emotion rules. In the long-term, fundamentals prevail.

Bull markets end when economies go into recession, not because of high valuations or old-age. At present, there appears to be little on the horizon to suggest the economy is on anything but stable ground as the best-known recession triggers -- asset bubbles, oil-price spikes and interest-rate hikes -- all look reasonably unlikely.

Continue to buy and hold quality at a discount, shut off the screens, get some air and be grateful.

Logos LP January 2018 Performance

January 2018 Return: 1.57%

2018 YTD (January) Return: +1.57%

Trailing Twelve Month Return: +39.19%

CAGR since inception March 26, 2014: +21.33%

Thought of the Month


 

"Then the flood came upon the earth for forty days, and the water increased and lifted up the ark, so that it rose above the earth.” -Genesis 7:17-20

Articles and Ideas of Interest

• Investors may want to calm down since history shows rising rates have been good for stocks. Using Kensho, a hedge fund analytics tool, CNBC looked at what happens during major periods of rising interest rates. The findings show there were six periods with major rises in interest rates in the last three decades. The market rose big during five of those instances and only fell slightly during the one lagging period.

• 35 steps to a market bottom by Michael Batnick. Where are we and where are you?

  -1% Mock the permabears

  -2% Meh

  -3% Yawn

  -4% Off the highs

  -5% Pullback

  -6% Healthy correction

  -7% Buying opportunity

  -8% Stay the course

  -9% This too shall pass

  -10% Correction territory

  -11% I’m a long-term investor

  -12% Stocks always come back

  -13% Don’t panic

  -14% Draw lines on a chart

  -15% Look for attractive valuations

  -16% I knew this was coming

  -17% Blame Cramer

  -18% This sucks

  -19% I should buy some downside protection

  -20% Bear market

  -21% I should have listened to my gut

  -22% Buy when there’s blood in the streets

  -23% I was early

  -24% Is this the bottom?

  -25% This sucks

  -26% Uggggh

  -27% I can’t take this much longer

  -28% I sold my stocks

  -29% I’m never buying stocks again

  -30% Good thing I sold

  -31% I should buy gold

  -32% And silver

  -33% I don’t even care anymore

  -34% Glad I stopped looking

  -35% Bottom

  
   

• President Trump’s first year in 14 metrics. A year ago, we chose benchmarks for his administration's progress. The results are in.

• Gene editing - and what it really means to rewrite the code of life. We now have a precise way to correct, replace or even delete faulty DNA. Ian Sample explains the science, the risks and what the future may hold.

• Post-work: the radical idea of a world without jobs. Work has ruled our lives for centuries, and it does so today more than ever. But a new generation of thinkers insists there is an alternative.

• It’s the (democracy-poisoning) golden age of free speech. Here’s how this golden age of speech actually works: In the 21st century, the capacity to spread ideas and reach an audience is no longer limited by access to expensive, centralized broadcasting infrastructure. It’s limited instead by one’s ability to garner and distribute attention. And right now, the flow of the world’s attention is structured, to a vast and overwhelming degree, by just a few digital platforms: Facebook, Google (which owns YouTube), and, to a lesser extent, Twitter. Yes, mass discourse has become far easier for everyone to participate in—but it has simultaneously become a set of private conversations happening behind your back. Behind everyone’s backs. Not to put too fine a point on it, but all of this invalidates much of what we think about free speech—conceptually, legally, and ethically. The most effective forms of censorship today involve meddling with trust and attention, not muzzling speech itself. As a result, they don’t look much like the old forms of censorship at all. No wonder our political future is hackable.

• Most unhappy people are unhappy for the exact same reason. In other words, every activity that didn’t involve a screen was linked to more happiness, and every activity that involved a screen was linked to less happiness. Perhaps the formula for phone addiction might double as a cure. Happiness is a skill you can build with consistent practice.

• The driverless revolution isn’t coming anytime soon. Self-driving cars have come a long way, but still have a long way to go. We’ve all heard the story at some point in the past few years. The tech and auto industries are on the cusp of rolling out vehicles that can drive themselves and will forever transform the way we move. We’ll be able to summon driverless pods that will whisk us to our destinations, making personal vehicles unnecessary and freeing up all the space wasted on parking to be used for parks and public gathering spaces — or so they tell us.

Our best wishes for a fulfilling month, 

Logos LP