Haters Gonna Hate

Good Morning,
 

The Dow Jones Industrial Average fell sharply on Friday, weighed down by steep losses in Boeing and Johnson & Johnson. The broader market was also pressured by a decline in Netflix shares that led other Big Tech stocks lower.

The 30-stock index ended the day down 255.68 points, or 0.95% to close at 26,770.20. Boeing dropped 6.8% — its biggest one-day drop since February 2016 — on news that company instant messages suggest the aerospace giant misled regulators over the safety systems of the 737 Max. Johnson & Johnson slid 6.2% after the company recalled some baby powder upon finding traces of asbestos.

Friday’s losses wiped out the Dow’s gains for the week. The index closed down 0.2% week to date. 

Meanwhile, S&P 500 pulled back 0.4% to end the day at 2,986.20 while the Nasdaq Composite slid 0.8% to 8,089.54. Netflix shares dropped more than 6%. Facebook, meanwhile, slid 2.2% while Amazon fell 1.6%. Alphabet shares pulled back 0.4%.

Both indexes were able to post solid gains for the week despite Friday’s decline. The S&P 500 rose 0.5% week to date while the Nasdaq gained 0.4% as enthusiasm around the first batch of corporate earnings lifted market sentiment.

More than 70 S&P 500 companies reported calendar third-quarter earnings this week. Of those companies, 81% posted better-than-expected results, FactSet data shows.

It was also a brutal week for the software/cloud technology sector. The worst in recent memory. 

Our Take

We are currently in the middle of deflationary period for many once popular software stocks which began in late July/early August and certain names have dropped anywhere from 40-60% in a matter of months. Investing can be a popularity contest and the most dangerous thing is to buy something at the peak of its popularity. As such, we are now evaluating this group as the safest and most potentially profitable thing is to buy something no one likes.

What can be made of this selloff? There are likely a variety of reasons for this repricing tied to the overall pessimistic “macro” narrative that continues to dominate “popular” discourse (more on this below) yet a more simple explanation is that their valuations have gotten ahead of themselves in a market that is maturing.  

A quick review of the charts of several cloud computing and software focused ETFs suggest incredible outperformance vs. the S&P 500 since around 2016 until about August of this year with many popular software names (Okta (OKTA), Veeva (VEEV), ServiceNow (NOW), Twilio (TWLO), Coupa (COUP)) still up between 20-100% for the year. To boot, most of the cloud computing and software focused ETFs are still up between 15-25% for the year despite the selloff.

Not exactly a “blood bath”. Instead, we see this repricing as perhaps a welcome reversion to the mean as well as a maturation of the sector. A swinging of the pendulum back to reality as all new great growth stories tend to do. The reality is that many of these businesses are more economically sensitive than once thought and many are running out of runway. Competition is now fierce and so the multiples must come down. Look at history and this is nothing new.

Many of these names continue to generate impressive amounts of recurring revenue, maintaining breathtaking rates of growth while solving real problems for customers.  All things considered, the weakness in the space along with the weakness in demand for such issue in the IPO market (think WeWork, AirBnB, Uber, Lyft, SmileDirect, Slack etc.) all point to the other side of the “can’t lose investment idea” coin.

This is healthy and rational. The greater fool theory works only until it doesn’t (think WeWork). Valuation eventually comes into play, and those who are holding the bag when it does have to face the music.

"Attractive at any price” in relation to the sector is steadily morphing into simply “attractive” on a more company specific basis. This is why we are beginning to get excited about opportunities in the space and have begun considering increasing our portfolio weighting in software and technology related services. Our focus has been on companies in the sector in the small to mid-cap arena with strong secular growth stories with real free cash flow. As such, we have started to initiate positions in companies like the following:

1. New Relic (NEWR): Company provides analytic and data monitoring software for DevOps teams. Company is trading a little over 6x sales with ~80% gross margin. Stock is down 47% from 2018 and FCF has nearly quintupled since then. New Relic has more FCF than companies like Zscaler with a similar growth profile is trading at nearly half the market cap.

2. Zuora (ZUO): Company provides software to utilities, industrials and other technology firms that are developing subscription services. Trading under 5.99x sales with growth in enterprise accounts over 100k at 20% and overall growth at over 40% since 2018, the company blew past quarterly earnings and raised guidance last quarter. Stock is down 61% since 2018.

3. Upland Software (UPLD): Marked as the U.S. version of Constellation Software, the company trades at 14x next year’s earnings, a little over 4x sales with FCF quadrupling since 2016. Company has been on an acquisition spree and has raised full year guidance. This is a name that may become a core.

Not all technology stocks or software stocks are created equal. We believe the market has unfairly treated many SaaS providers with strong growth and cash flows by lumping in real software companies at reasonable valuations with companies that are either tremendously overvalued or that are not even technology focused to begin with. Why should Okta, which is an Oauth replacement trading at over 24x sales, be in the same conversation with some of these other high growth sticky software companies trading below 15x sales? Why is Slack, which seems to have its hands full with MSFT Teams, trading at 26x sales? 

While some professional investors may have an answer to these questions, we prefer to wait for compelling valuations to match compelling growth stories. In the meantime, we welcome further multiple compression among highly recurring software businesses as they will provide for interesting upside in the future. Let the baby get thrown out with the bathwater…

Musings

Pessimism and frustration are the words that best describe the popular sentiment at present. It has become necessary for the majority (the "Haters Gonna Hate" crowd) to portray every data point and every headline as negative, in the hopes of confirming their views. The facts are that we are roughly 2% off of record highs YTD for the S&P 500. These majority views thus haven’t proven to be particularly profitable.

It has been said that there are four phases in every bull market: 1) Despair 2) Disbelief (of initial rally) 3) Acceptance 4) Euphoria. We think it is safe to say that we have been through the despair phase. Next we have the disbelief phase in which a few begin to believe that things will get better but most question everything and maintain a pessimistic view holding large swathes of their portfolio in bonds, gold, utilities, non-cyclicals and even cash. Have we really moved out of this phase to acceptance?

What pundit can you think of that is optimistic? There isn’t a day that goes by without David Rosenberg at Gluskin Sheff calling for a recession. Don’t forget Ray Dalio at Bridgewater suggesting that we are headed for the 1930s all over again. What person do you know who loves stocks right now and is suggesting that you buy? At a recent Thanksgiving celebration we were informed by most at the party that they had completely exited the markets as a recession was “right around the corner”.  We couldn't help but think that at least if these views prove to be incorrect one wouldn’t be lonely... 

This is not indicative of acceptance or euphoria. Instead, we believe the door to the acceptance phase began to open in 2017. For some, there was renewed optimism with a pro-business agenda in play. That crack in the door has been abruptly shut. Negativism is back en vogue and is pervasive anywhere you look.

Just last week The American Association of Individual Investors who runs a weekly sentiment poll where participants express their view on which direction the U.S. stock market will be headed over the next six months reported that 20.3% were bullish, 35.7% were neutral and 44% were bearish. Roughly 80% of market participants are not bullish…This is a huge number. 

In other news, investors are flocking to the relative safety of money market funds at the highest level since the financial crisis-era collapse of Lehman Brothers in 2008. The industry has pulled in $322 billion over the past six months, the fastest pace since the second half of 2008, bringing assets to nearly $3.5 trillion, according to data from FactSet and Bank of America Merrill Lynch. Total money market assets are now at their highest level since September 2009! 

Today, it’s all about what is going wrong, and the positives are nowhere to be found. The negative rhetoric coming from ALL political candidates across the spectrum is shocking. Watching the Democratic primary debates on TV, listening to Trump at his rallies or on Twitter or watching the Canadian Federal election debates is enough to make you lose hope for the future. Any positive data is being thrown under the rug and the person/party that can say the most shocking and negative thing appears to be the one that gets the most attention. 

Quite frankly the political discourse is so uninspirational that we feel confident in saying that the disbelief phase is still in progress today, and the “haters gonna hate” sentiment presented week after week confirms that. The fearful have been joined by the frustrated, and that angry mob has grown to proportions seen during times of crisis. 

What to do? We have chosen to accept this market for what it is: it hasn’t gone anywhere for almost 2 years, “safety assets” are leading the market, US household financial burdens today are lower than at any time since the early 1980s, US household leverage (total liabilities as a % of total assets) has declined almost 35% since the mid 1980s, the five largest money center banks in the USA have beaten earnings estimates this quarter, the commentary from just about every Bank CEO was that: "The consumer is ''strong”, the S&P 500 earnings yield stands at +5.90%, growth remains at a moderate pace, inflation is tame, the Fed is dovish and so we will stay the course looking out for opportunities during the acceptance and euphoria phases.

At the end of the day, if this cycle is anything like the others, the currently hyper-valued defensive stalwarts like consumer staples, interest rate sensitive investments, including REITs and utilities, and the heavily embraced bond market, are all poised to underperform dramatically, as a historic capital rotation occurs. As such, looking out into the final 2 phases of the bull market, embracing shunned economically-sensitive assets, when almost all market participants are bidding up the price of “quality”/“safe” assets preparing for a downturn, is perhaps the perfect storm of a contrarian opportunity. As history has taught us, there is no such thing as a good investment regardless of price…

Charts of the Month

Apparently many think we have another 2008 situation brewing as cash has become king now.

Logos LP September 2019 Performance

September 2019 Return: -5.13%
 

2019 YTD (September) Return: 24.62%
 

Trailing Twelve Month Return: 4.67%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014:+14.48%

Thought of the Month

"When the thumb of fear lifts we are so alive.” – Mary Oliver

Articles and Ideas of Interest

• Why many smart women support president Trump. Interesting piece in the WSJ. "I, too, am a college-educated, suburban woman. I am retired, and during President Trump’s term my retirement fund has increased. I live in a heavily populated border state and am happy to see he is addressing the overabundance of people living here illegally. He has reduced my taxes, reduced government regulations thereby improving the business environment and giving my children and grandchildren more access to better, high-paying jobs, and he is protecting my health plan from a government takeover."

• The 'Glass Floor' is keeping America's richest idiots at the top. Elites are finding more ways to ensure that their children never run out of chances to fail. In 2014, Zach Dell launched a dating app called Thread. It was nearly identical to Tinder: Users created a profile, uploaded photos and swiped through potential matches. The only twist on the formula was that Thread was restricted to university students and explicitly designed to produce relationships rather than hookups. The app’s tagline was “Stay Classy.” Zach Dell is the son of billionaire tech magnate Michael Dell. Though he told reporters that he wasn’t relying on family money, Thread’s early investors included a number of his father’s friends, including Salesforce CEO Marc Benioff. The app failed almost instantly. Perhaps the number of monogamy-seeking students just wasn’t large enough, or capping users at 10 matches per day limited the app’s addictiveness. It could also have been the mismatch between Thread’s chaste motto and its user experience. Users got just 70 characters to describe themselves on their profiles. Most of them resorted to catchphrases like “Hook ’em” and “Netflix is life.” After Thread went bust, Dell moved into philanthropy with a startup called Sqwatt, which promised to deliver “low-cost sanitation solutions for the developing world.” Aside from an empty website and a promotional video with fewer than 100 views, the effort seems to have disappeared.And yet, despite helming two failed ventures and having little work experience beyond an internship at a financial services company created to manage his father’s fortune, things seem to be working out for Zach Dell. According to his LinkedIn profile, he is now an analyst for the private equity firm Blackstone. He is 22.

• Why are rich people so mean? Call it Rich Asshole Syndrome—the tendency to distance yourself from people with whom you have a large wealth differential.

• Not all millennials are woke. In Europe, young people’s political views have shifted right rather than left. Under-30s in Europe are more disposed than their parents are to view poverty as a result of an individual’s choice.

• Australia’s three rate cuts are making consumers even gloomier. Australian consumers are feeling their gloomiest in more than four years, signaling that the Reserve Bank’s three recent interest-rate cuts are having the reverse intended effect. Consumer confidence dropped 5.5% to 92.8 in October, with pessimists again outweighing optimists in the monthly Westpac Banking Corp. survey. The index sunk to its lowest level since July 2015 and is down 8.4% since the central bank started cutting rates in June. “This result will be of some concern to the monetary authorities,” said Westpac Chief Economist Bill Evans. “Typically, an interest-rate cut boosts confidence, particularly around consumers’ expectations for and assessments of their own finances. In this survey, these components of the index fell by 3.7% and 4.9% respectively.” Maybe politicians will eventually realize that they will have to make some hard decisions as monetary policy has run its course and fiscal policy will need to be relied upon.
   

• You now need to make $350,000 a year to live a middle-class lifestyle in a big city. Here’s a sad breakdown of why. 
  
   

• Empty hair salons can’t be saved by a central bank. Struggling businesses in rural Japan show the limits of the BOJ’s massive easing. There’s a lesson for other economies facing demographic decline.

• Time can make you happier than money. It’s true for all ages and stages - even for recent college grads according to a new study. “People who value time make decisions based on meaning versus money,” says study leader Ashley Whillans, an assistant professor of business administration at Harvard Business School. “They choose to do things because they want to, not because they have to.”

• VC Withering? Aggregate valuations of venture-backed companies are still at an all-time high.  But CB insights quarterly deep dive MoneyTree report — created in partnership with PwC — shows deals and funding down almost across the board (in the geographical and industry-specific sense). Looks like the money and dealmaking is pulling back. What does it mean? 

  Our best wishes for a fulfilling October,

  Logos LP
  

Man’s Inability To Sit Quietly In A Room Alone

Good Morning,
 

Stocks were little changed on Friday as investors took a breather following a wild month of trading and Trump tweeting (nowadays they seem to go hand in hand). 

The equity market entered the week in an oversold condition. Eight of the eleven S&P sectors were oversold, with four of the eight coming in extremely oversold. Only Staples, Real Estate and Utilities remained in “neutral”.

The major indexes posted their worst monthly performance since May. The Dow fell 1.7% in August while the S&P 500 lost 1.8%. The Nasdaq pulled back 2.6%. U.S.-China trade relations intensified this month, rattling investors. 

The Cboe Volatility Index (VIX), widely considered to be the best fear gauge on Wall Street, traded as high as 24.81 in August before pulling back to around 18. Investors also loaded up on traditionally safer assets such as gold and silver this month. The SPDR Gold Trust (GLD) rose 8% in August while the iShares Silver Trust (SLV) surged 12.8%.

Choppy intraday market action continued during the month as traders stayed fixated on the 2/10 Treasury spread and the Trade/Tweet situation.

Last week, China retaliated against U.S. tariffs by unveiling levies of its own that target $75 billion in U.S. products. President Donald Trump then said the U.S. would hike tariffs on a slew of Chinese products. 

Our Take

In our view, despite signs of global economic weakness markets want to go higher. Nevertheless, without proof of actual movement towards a trade ‘truce, in addition to a cooling of Trump rhetoric lambasting the Fed, American Business as well as China, the probability of a self inflicted recession is growing. 

Charles Schwab sees leading indicators flashing limited recession warning:

Although the levels of the leading and coincident indicators remain mostly green (strong) and yellow (fair); there has been a pickup in the number of red (worsening) trend readings; albeit having improved from the prior month in the case of the LEI.

Although the tariffs in place remain a drop in the bucket of this 20 Trillion dollar Amercican economy, the onset of a downturn is as much a matter of mood as of money. Although recessions can be linked to the after effects of shocks, they can also be linked to periods of time when people and firms fail to use valuable resources as they become available. In these garden variety slumps, people and firms with the capacity to spend more, who might normally leap at the chance to buy discounted goods or hire overqualified workers, instead allow their cash to pile up. Sound familiar? 

In a recent Economist article, we are reminded that at the heart of this behaviour is a matter of mass psychology, or “animal spirits”, as John Maynard Keynes put it. “Economies are great chains of earning and spending, held together by shared expectations that all will continue as normal. People spend incomes freely, on everything from homes to haircuts, in the belief that their jobs will not disappear and their incomes wither. Faith in economic expansion is self-fulfilling. But it is not invulnerable. Contagious pessimism can flip an economy from one equilibrium to another, in which cautious consumers spend less and hiring and investment fall accordingly. If the mood in markets and on Main Street is sour enough, even a modest nudge may push an economy into a slump.” Is Trump’s frantic leadership style helping or hindering this “faith in economic expansion”? 

Instead, we are witnessing an erosion of such faith as each time consumers or market participants attempt to be optimistic about the outlook for the U.S. economy, they are punched in the gut by a Trump tweet.

Considering the big picture, it is conceivable that China just might be able to doom Trump’s reelection chances—just as Russia helped put him in office in the first place by interfering in the 2016 presidential election in what the Mueller Report called “sweeping and systematic fashion.”

As recently reported in Bloomberg: “China is suffering more from the trade war than the U.S. is, as Trump has accurately observed. The difference is that Chinese President Xi Jinping does not have to worry about an upcoming election. His new strategy seems to be to outlast Trump and hope that the next occupant of the White House will be more reasonable.” 

As the U.S. economy is beginning to show signs of weakness, Trump has reason to fret. He has built his argument for reelection on American prosperity. His hopes for winning the race may hinge in no small part on stopping the U.S. from tumbling into a recession before November 2020.

Only two presidents since World War II — Democrats Harry Truman and Jimmy Carter — have run for reelection in the same year as a recession. While Truman won and Carter lost, history suggests an economic slump would damage Trump’s chances in what will already be a tough 2020 race.

Metrics such as the University of Michigan Consumer Sentiment Index help track consumers views’ on and expectations for the economy. The metric typically plummets during recessions. Over the survey’s history back to the mid-20th century, it has “largely” found that “if the index is low, the incumbent doesn’t get reelected,” said Richard Curtin, director of surveys of consumers at the University of Michigan.

What have you done for me lately? 

The longer this trade war drags on the answer for Trump is increasingly trending towards a big: “nothing”...

Musings

In a recent article Michael Batnick reminds us that investors are always told to think long-term, but how are we supposed to do this in a world that gives presidential candidates 30 seconds to make a point?

This point rings more true today than at any other point in my investing career. Multiple daily market moving headlines is the new norm. One worries about how the day will end let alone the month, quarter or decade. 

During a recent conversation with a potential investor I was asked how we at Logos LP handle this seemingly minute by minute investing climate. 

The way we approach this question is through the lens of Pascal’s suggestion that “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” It is in our human nature to want to tinker. Dissatisfaction and unease are inherent parts of human nature as this kind of suffering is biologically useful. 

It is nature’s preferred agent for inspiring change. We have evolved to always live with a certain degree of dissatisfaction and insecurity, because it’s the mildly dissatisfied and insecure creature that’s going to do the most work to innovate and survive. As Mark Manson writes in his book: “This constant dissatisfaction has kept our species fighting and striving, building and conquering. So no- our own pain and misery aren’t a bug of human evolution; they are a feature.” 

Thus, our own human nature can stand in the way of superior investment results ie. thinking long term, tuning out the noise and staying the course. 

If you are willing to accept and maintain a certain faith in long-term sustained economic expansion, thinking long-term when it comes to investing simply means that you maintain an acute awareness of your “human” penchant for dissatisfaction and unease. That you recognize your desire to tinker and don’t act on it. You don’t act out of emotion. You stick to the plan despite your troubles and your insecurities. 

As Aristotle once said: “Knowing yourself is the beginning of all wisdom.”

Charts of the Month

Net worth is at an all-time high, while leverage is down to levels seen in the 1980's. All of this evidence supports the notion that the consumer is well positioned to keep the economy on level footing.

Chart Courtesy of Urban Carmel, Data Source; J.P. Morgan.

J.P.Morgan notes;

Fund flows into equity mutual funds and ETFs was strong before both the 2000-02 and 2007-09 bear markets, and even before the 2015-16 mini-bear market (blue circles). In comparison, fund flows have been negative for 5 of the past 8 quarters (red circle)

Logos LP July 2019 Performance

July 2019 Return: 4.45%
 

2019 YTD (July) Return: 30.93%
 

Trailing Twelve Month Return: 8.33%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014:+16.02%

Thought of the Month

"Everyone thinks of changing the world, but no one thinks of changing himself.”-Leo Tolstoy

Articles and Ideas of Interest

• The next recession will destroy millennials. My generation just can’t catch a break. The trade war is dragging on. The yield curve is inverting. Investors are fleeing to safety. Global growth is slowing. The stock market is dipping. Millennials are already in debt and without savings. After the next downturn, they’ll be in even bigger trouble. In addition low interest rates benefit pensioners not millennials…

• Is our economy in The Upside Down? Something is strange with the economy. Normally, in good times, the government seeks to balance its books a bit, borrowing less, paying off some debt or — gasp — maybe even aiming for a budget surplus. And right now, on some important measures, economic times are good. But the government has been increasing spending and cutting taxes — and the budget deficit is projected to grow to nearly $1 trillion, an increase of over 35% since the Tax Cuts and Jobs Act was passed in 2017. Meanwhile, the Federal Reserve would normally be raising interest rates to make sure the price of everything doesn't get out of control. But high inflation is nowhere to be seen, and the Fed is now cutting interest rates. We're living in the Upside Down. It's an alternate dimension where economic textbooks are being thrown out the window. A scary place where despite big deficits and easy money, the economy is slowing down to a rate below historical averages and wage growth remains disappointing. And it's a place where frightening monsters, or demogorgons, continue to scare away investment and productivity while kids now dream of being YouTubers rather than astronauts.... Slaying these monsters is the key to growth and prosperity, but we seem to be stuck in this new world where investment and productivity will not come roaring back. Can we escape?

• The non-weirdness of negative interest rates. Savers in Europe are having to pay to store their wealth. That’s not so crazy when saving is all too plentiful. We are now at $17 trillion in negative yields globally in addition to certain european banks who are now paying customers to take out mortgages by offering negative interest rates. Banks paying people to borrow money is a bad sign for the global economy as it suggests that a fast-rising share of investors are so nervous about the future they’re willing to actually lose a little money by lending it to a borrower that is almost certain to pay it back, rather than risk betting on something that could go bust. In a healthy economy, investors would put their money to work in profit-making ventures such as factories or office buildings. There’s an obvious, persistent and continuous glut of underutilized capital and there’s no place in the advanced world for that capital to be invested without excess risk. The problem is that such negative rates don’t seem to be having the desired effect of stimulating the creation of profit making ventures and therefore growth. Research shows that negative rates actually CUT lending as they don’t create the right incentives to spend and invest.

• We’ve reached peak wellness. Most of it is nonsense. In Silicon Valley, techies are swooning over tarot-card readers. In New York, you can hook up to a “detox” IV at a lounge. In the Midwest, the Neurocore Brain Performance Center markets brain training for everything from ADHD, anxiety, and depression to migraines, stress, autism-spectrum disorder, athletic performance, memory, and cognition. And online, companies like Goop promote “8 Crystals For Better Energy” and a detox-delivery meal kit, complete with “nutritional supplements, probiotics, detox and beauty tinctures, and beauty and detox teas.” Across the country, everyone is looking for a cure for what ails them, which has led to a booming billion-dollar industry—what some have come to call the Wellness Industrial Complex. The problem is that so much of what’s sold in the name of modern-day wellness has little to no evidence of working.

• It has gotten too hard to strike it rich in America. Many of the traditional ways of accumulating wealth are out of reach. In a free-market economy everyone is supposed to have the chance to get rich. The dream of making it big motivates people to take risks, start businesses, stay in school and work hard. Unfortunately, in the U.S., that dream seems to be dying. There are still plenty of rich people in the U.S., and their wealth is increasing. But people outside that top echelon are having a tougher time breaking in. A 2017 study by the Federal Reserve Bank of Cleveland found that the probability that a household outside the top 10% made it into the highest tier within 10 years was twice as high during 1984-1994 as it was during 2003-2013.
  
   

• Want to beat venture capitalists’ returns? Invest in publicly listed innovators through the NASDAQ. Everyone has heard that story about an angel or vc fund that invested in a start-up company at seed or early stage and reaped 100-1000 times returns. Investors hear about such stories and, wanting to reap the same returns for themselves, start exploring angel and venture capital investments. The above instances are exceptions, but given the extraordinary returns generated, they get talked about. However, for every such exceptional investment, there are at least a 100 or possibly 1000 investments where the capital is completely destroyed. Once you account for those, what are the returns to Venture Capitalists? According to a study by Cambridge Associates, the US Venture Capital investors got compounded annual returns of 12.83 per cent (net) over the 10 years from 2008 to 2018, in USD terms. Now, that is not something small. However, over the same period the Nasdaq composite returned 15.45 per cent annually with full liquidity...Headlines sell, facts deliver.

• Evidence shows you’re not open-minded. Do you think of yourself as open-minded? For a 2017 study, scientists asked 2,400 well-educated adults to consider arguments on politically controversial issues — same-sex marriage, gun control, marijuana legalization — that ran counter to their beliefs. Both liberals and conservatives, they found, were similarly adamant about avoiding contrary opinions. The lesson is clear enough: Most of us are probably not as open-minded as we think. That is unfortunate and something we can change. A hallmark of teams that make good predictions about the world around them is something psychologists call “active open mindedness.” People who exhibit this trait do something, alone or together, as a matter of routine that rarely occurs to most of us: They imagine their own views as hypotheses in need of testing.

Our best wishes for a fulfilling August,

Logos LP

The Disciplined Pursuit of Less

Good Morning,
 

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

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

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

Our Take

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

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

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

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

Musings

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

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

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

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

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

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

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

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

The clarity paradox can be summed up in four phases: 

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

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

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

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

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

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

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

When faced with too many choices: 

1. Quality of decision making goes down

2. Satisfaction with choices goes down 

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

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

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

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

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

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

Charts of the Month

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

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

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

Logos LP June 2019 Performance

June 2019 Return: 5.57%
 

2019 YTD (June) Return: 25.35%
 

Trailing Twelve Month Return: 3.25%
 

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

Thought of the Month


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

Articles and Ideas of Interest

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

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

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

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

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

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

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

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

Our best wishes for a fulfilling July,

Logos LP

These Halcyon Days

Good Morning,
 

Stocks closed lower on Friday after it was reported that trade talks between China and the U.S. had stalled and tit-for-tat tariffs soured the process. The late-day sell-off underscored the fragile mood in financial markets destabilized by concerns that the escalating trade war will undermine global growth.

President Donald Trump took steps toward calming nerves by postponing any tariffs on Japanese and European cars, while agreeing to end levies on Canadian steel and aluminum imports. But the status of talks with China remained unclear as investors headed into the weekend.

It was also the fourth straight weekly drop for the Dow.

Earlier this week, under the banner of a threat to the “national security” of the U.S., the administration made it harder for U.S. companies to do business with Huawei, a giant telecommunications company in China. U.S. firms that want to do business with Huawei must now have a license.

On the positive side, U.S. consumer confidence sentiment gauge reached a 15-year high with stocks near records and A Wells Fargo/Gallup survey found small business confidence rebounded strongly in the second quarter, matching a record, as current conditions posted a new high and recession concerns diminished. Top worries were attracting customers and new business, followed by hiring and retaining staff.


Our Take

Take a deep breath, these are halcyon days. Enjoy. The data coming out of the U.S. is for the most part still supportive of the view that things are pretty good (For a nice overview see here). Let's remember that the S&P 500 is still up about 14% YTD.

With stocks struggling to find direction amid heightened volatility over increased tariffs and threats of new ones as the White House and China battle over trade, many investors are overreacting and trading headline noise. *(Interestingly Trump’s China fight/tariffs has enjoyed broad support from American business, the Democrats and the Republicans)

They would be better served if they recalibrated their expectations on the outcome and timing of any future agreement on the China/U.S. tariff issue.
 

We’ve heard murmings that this is a Trump powerplay: a mastery of the art of timing. A sniffing out of the right moment to strike a deal with China to save the day just as Americans head to the polls. Vanquishing a saviour who has adroitly played on what voters hold dear and what they fear would certainly be a difficult task for the Democrats...

The above narrative may or may not be accurate but regardless, to expect a quick deal is to completely misunderstand the deep differences in the two countries economic models (state capitalism vs. free-market capitalism). These differences ensure that their trading relations will likely be unstable for years to come.

It should be remembered that the Chinese government allocates capital through a state-run banking system with $38trn of assets. Attempts to bind China by requiring it to enact market-friendly legislation are unlikely to work given that the Communist Party is above the law.

These are issues that have been around for decades. Stable trade relations between countries require them to have much in common such as how commerce should work, what role the state should have and a commitment to the enforcement of rules. Look no further than the (for the most part successful) renegotiation of NAFTA (Mexico, USA, Canada).

Compounding the friction between these competing economic visions is that fact that many in the U.S. are suffering from a lack of self-confidence (“bullying behaviour”) as they witness China’s rise.

The problem with this administration's heavy handed approach is that it has made it difficult for China’s leadership to frame the trade spat domestically as anything other than an effort to undermine China’s rise. The shift toward a nationalist tone coincides with Beijing’s hardened trade negotiating position.

The problem is that an intensified conflict over trade and nationalism that results in harm to U.S. interests will make China less appealing to foreign investors, something Beijing can ill afford at a time when its economy is already slowing. Moreover, previous protests have shown that promoting nationalism can boomerang on the Chinese state and lead to unwanted social disruptions.

As such, the probability of some kind of a resolution is high.

For the investor, it is important to come to terms with any pervasive “fear” of “losing money” and  corresponding unwillingness to take a long-term view. Making rash decisions each time there is a change in the short-term trend due to a headline is a recipe for the investor to realize low returns on capital or worse: no return on capital.

Musings

This month we were featured/interviewed by two wonderful organizations.

ValueWalk: https://valuewalkpremium.com/2019/05/eter-mantas-and-matthew-castel-general-partners-of-logos-lp-talk-small-cap-investing/

MOI Global: https://moiglobal.com/peter-mantas-2019/

Only a short note this week on portfolio concentration. This month we fielded several questions regarding the concentration of our portfolio and thought it may be useful to explain our view that concentration as a strategy is more attractive than diversification.

Why?

1. Better information increases the probability of superior returns, so a concentrated fund allows the investor to conduct thorough research and understand the intricacies of the business in order to take advantage of mispricings in the market. Instead, lack of concentration leads to making investment decisions based on superficial reasons or worse: emotion.

2. If the target range of holdings is narrow, the investor is setting a higher hurdle rate for investment quality and return. Investors can be more discriminating, avoiding stocks or sectors that are not high quality and focus on a smaller group of companies that meet their strict metrics.

3. There is also the issue of cost. With low to no-cost ETFs, there is simply no justification for an active investor/manager to construct a portfolio with a large number of holdings that mimics the benchmark. Better to own the benchmark in a low cost way.

Charts of the Month


According to a new survey by Charles Schwab, almost half of millennials (49%) say their spending habits are driven by their friends bragging about their purchases on social media vs. around one-third of Americans in general. link

Tech bubble all over again?


Logos LP April 2019 Performance
 

April 2019 Return: 10.08%
 

2019 YTD (April) Return: 23.87%
 

Trailing Twelve Month Return: 6.60%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014:+15.58%

Thought of the Month

"Knowledge is learning something new every day. Wisdom is letting go of something every day.”-Zen Proverb

Articles and Ideas of Interest 

 

• Why we’ll never be happy again. Ben Carlson suggests that there are two things people need to understand about humanity:(1) Things are unquestionably getting better over time. (2) People assume things are unquestionably getting worse over time. Is there a silver lining?

• Inflated credit scores leave investors in the dark on real risks. Consumer credit scores have been artificially inflated over the past decade and are masking the real danger the riskiest borrowers pose to hundreds of billions of dollars of debt. That’s the alarm bell being rung by analysts and economists at both Goldman Sachs Group Inc. and Moody’s Analytics, and supported by Federal Reserve research, who say the steady rise of credit scores as the economy expanded over the past decade has led to “grade inflation.”

• What makes a great business? Great article by Travis Wiedower regarding what makes a great business. In summary, there’s no getting around that businesses have to invest capital at high rates of return to be successful. To do so, they probably need several strong competitive advantages that keep potential competitors away. Finally, organic growth of new products usually outperforms other types of growth, especially large acquisitions. Those are the base rates of what makes a great business.

• Putting your phone down may help you live longer. By raising levels of the stress-related hormone cortisol, our phone time may also be threatening our long-term health.

• If this is a tech bubble in stocks, it’s the expansionary phase. Is this the tech bubble part two? It’s fair to ask, given how big that index is getting versus the rest of the market. At about 36 percent of the S&P 500, it’s creeping up on 1999-style dominance. Arguing against the comparison is the share of overall earnings its companies generate. Going by the quarter they just reported, it’s four times as much as 20 years ago. 

• The Age of the influencer has peaked. It’s time for the slacker to rise again. It’s hard to remember a time when scrolling through Instagram was anything but a thoroughly exhausting experience. Where once the social network was basically lunch and sunsets, it’s now a parade of strategically-crafted life updates, career achievements, and public vows to spend less time online (usually made by people who earn money from social media)—all framed with the carefully selected language of a press release. Everyone is striving, so very hard- #nevernotworking. And great for them....But sometimes one might pine for a less aspirational time, when the cool kids were smoking weed, eating junk food, and… you know, just chillin’. Quartzy suggests that the slackers are back…

• Getting rich vs. Staying rich. Fantastic article by Morgan Housel in which he explores the following pattern: Getting rich can be the biggest impediment to staying rich. It goes like this. The more successful you are at something, the more convinced you become that you’re doing it right. The more convinced you are that you’re doing it right, the less open you are to change. The less open you are to change, the more likely you are to tripping in a world that changes all the time. There are a million ways to get rich. But there’s only one way to stay rich: Humility, often to the point of paranoia. The irony is that few things squash humility like getting rich in the first place.

• Private equity’s allure poses big risks for the stock market and its investors in the next recession. Private equity is becoming the go-to for active investors — a trend which AllianceBernstein expects to continue for the next decade. The shift, which is well underway, could have implications for the stock market and its investors, especially in a recession. “It throws a spotlight on the resilience of the liquidity of public markets and even questions the point of a public stock market,” Bernstein senior analyst Inigo Fraser-Jenkins says. No wonder Buffett has also sounded the alarm suggesting that private equity returns have been inflated and bondholder covenants have “really deteriorated”.

• Is CBD the cure-all it’s touted to be? The cannabis derivative is being tested as a treatment for everything from brain cancer to opioid addiction to autism-spectrum disorders. Whether it can live up to the hype is still an open question, writes Moises Velasquez-Manoff in the New York Times Magazine. Meanwhile Americans can expect to bombarded by ever more CBD-infused products as Green Growth Brands Inc. is partnering with Abercrombie & Fitch Co. to sell its CBD-infused bath bonds and other body care products in a limited number of stores.

Our best wishes for a fulfilling May,

Logos LP

Stocks Have Become Cheaper Today Than 4 Years Ago

Good Morning,
 

The S&P began April on the right foot on the first day of trading. The sustained strength into the end of the week suggested that it was no April Fools' joke as investor sentiment was boosted by better-than-expected jobs data and progress on the U.S.-China trade front. As is, the S&P stands at a gain of 15+% for the year, and 1.5% from the all-time highs. Not too shabby given the calls of “this is the end” and “earnings have peaked” which led the market lower in December.

After a brief pause, global markets have resumed their up trends. Even if we look at the MSCI Emerging Markets ETF (EEM) it also remains in a healthy uptrend after the December sell-off with a series of higher highs and higher lows. Interestingly, this pattern is the same just about everywhere one looks around the globe. Worldwide equity markets are rallying, which may be signaling a re-setting of expectations from fear and gloom to cautious optimism.

The U.S. economy added 196,000 jobs in March, according to data released on Friday by the Bureau of Labor Statistics. Economists polled by Dow Jones expected a print of 175,000. The U.S. unemployment rate, meanwhile, remained at 3.8%. However, wage growth expanded 3.2%, below an expected gain of 3.4%.

Overall, however, the March employment report has become the latest in a series of better data this week, including stronger home sales and a pickup in ISM manufacturing activity. Recession fears have been fading as economists have been nudging up their expectations for GDP growth, with some seeing over 2% in the first quarter from earlier forecasts closer to 1% or lower.

Our Take
 

The demise of the U.S. economy has been greatly exaggerated. The unemployment rate is low, so that should have a positive impact on consumer confidence, but it’s not so low that wages are growing quickly. From the shareholder’s perspective, margins are expected to remain high. In fact, earnings expectations for Q1 2019 are low and upside surprises are likely to push equities higher. With 23 companies in the S&P 500 having reported actual results for the quarter, 19 have already reported a positive EPS surprise and 13 have reported a positive revenue surprise.

Funnily enough the pundits who were screaming recession in December are still beating their drums albeit less aggressively stating instead that there “is a risk of a recession next year.”  

At the end of the day there is always “a risk of recession” in any given year, the question for an investor is whether the current investment environment and where a number of elements stand in their cycles suggest a re-positioning of one’s portfolio? Does the current environment demand a re-calibration along the continuum that runs from aggressive to defensive?
 

Musings

In our view, the current environment does not warrant excessive defensiveness. If we define risk as the likelihood of permanent capital loss (downside risk) as well as the likelihood of missing out on potential gains (opportunity risk) we should also view the future as a range of possibilities rather than as a fixed outcome.

Thus, investors - or anyone wishing to grapple successfully with the future - need to form probability distributions with regards to future outcomes. What are the range of possible future outcomes and what probability can we assign to each?

As Howard Marks has suggested: “it is useful to think of investment success as choosing a lottery winner. Both are determined by one ticket (the outcome) being pulled from a bowlful (the full range of possible outcomes). In each case, one outcome is chosen from among the many possibilities. Superior investors are people who have a better sense for what tickets are in the bowl, and thus for whether it is worth participating in the lottery. In other words, while superior investors - like everyone else - don’t know exactly what the future holds, they do have an above average understanding of future tendencies.”

As such, what sense do we have for what tickets are currently in the bowl? What insights do we have about future tendencies? Can we tilt the odds in our favor?

In last month’s newsletter we put out a call suggesting that we saw an opportunity in this market. We had put this call out to our limited partners in December. What did we see?

In short, we saw that global equity markets actually appeared to be cheaper, or less risky (downside risk) today than they’ve been over the last four years.

Without diving too deeply into the other factors we had been observing about the cycle/investment environment and are still observing today, the nature of the lottery (the tickets and bowl) as we saw it then and as we see it now are summed up nicely by Andrew Macken, Chief Investment Officer at Montaka Global Investments.

This perspective begins with the understanding that over the last 4 years global equities have delivered a real return of approximately zero.

The MSCI World Net Total Return Index has delivered +4.5 percent per annum over the four-year period to 31 December 2018. On its face this return above any global average rate of inflation suggesting real global equity returns have been positive over the period.

The problem is that the most substantial contributor to the MSCI World’s return was the +7.2 percent per annum return generated by US equities – as measured by the S&P 500, in this case. Now, the US accounts for approximately 54 percent of the MSCI World Net Total Return Index, so this substantial return drove more than 80 percent of the total return of the MSCI World over this four-year period.

What is sometimes forgotten is that US domiciled businesses benefited from a significant reduction in their corporate tax rate, from 35 percent to 21 percent, as part of President Trump’s Tax Cuts and Jobs Act of 2017. This reduction in the corporate tax rate effectively provided a one-time rebasing of US corporate earnings upwards.

The question is what US equities would have delivered absent the Trump tax cut? Montaka’s analysis suggests that approximately 70 percent of US equity returns over the last four years was driven by the Trump tax cut. Absent this tax cut, US equities would likely have delivered an average return of 1.9 percent per annum – exactly the same as the average yield of the five-year US Treasury Bond over the same period.

Now, upon adjusting the MSCI World Net Total Return Index for the Trump tax cut, the four-year annual return of +4.5 percent reduces to just +1.6 percent per annum. Arguably this return is in line with global inflation suggesting real global equity returns over the period have been approximately zero.

What are we to make of this? The implication of the above is: “as earnings grow without commensurate growth in total shareholder return, then equities are essentially becoming cheaper, absent some material change to the trajectory of future growth or cost of capital.”

Over the last four years, global equities have basically drifted sideways (absent the one-time Trump tax cut the effects of which will likely fade very soon); but pre-tax earnings have been increasing!

In the US, for example, S&P 500 pre-tax earnings have increased by 16 percent over the last four years. Said another way: global equity markets have actually become cheaper, or less risky (downside risk), over the last four years. The tickets in the bowl suggest participation in the lottery. Being overly defensive now suggests opportunity risk at a time when downside risk appears less pronounced.

As equity prices fall, the probability that they will be higher in the future rises.

But the conventional wisdom is that equities are heading for a prolonged “bear market” similar to the drawdown at the beginning of the century. Lets remember that recessions are relatively rare, so constantly forecasting them and positioning portfolios to prepare can be a risky proposition (opportunity risk). Furthermore, between 2000 and 2002, the S&P 500 Total Return Index roughly halved and we should note that the forward P/E ratio of the S&P 500 TODAY is the same as where it was at the bottom of the 2002 bear market – and roughly half of where it was at the top, in the year 2000...

Charts of the Month

Logos LP March 2019 Performance
 

March 2019 Return: 3.88%
 

2019 YTD (March) Return: 12.61%
 

Trailing Twelve Month Return: -6.94%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014:+14.34%

Thought of the Month

"To be a warrior is to learn to be genuine in every moment of your life.”-Chogyam Trungpa

Articles and Ideas of Interest 

 

• MTY Food Group: There’s Still Value In Food. An article by us looking at MTY one of our best ideas.   

• Picking stocks is hard. Josh Brown and Michael Batnick discuss diversification and portfolio concentration. In a recent study, Vanguard took a look at the last 30 years worth of data for the Russell 3000 index, which represents the total stock market. They found something remarkable - over the last 30 years, 47% of stocks were unprofitable investments and almost 30% lost more than half their value. They also found, and this is the big one, that 7% of stocks had cumulative returns over 1,000%.But imagine how hard it would have been to identify that winning 7% and concentrate only on those holdings in advance?

• Is the yield curve inversion important? The 10Y-3M yield curve recently inverted, and market pundits are running around like their hair is on fire. Should we care? Contrary to popular belief, there is little theoretical or conceptual support for using inversion of the 10Y-3M Treasury yield curve as a leading indicator of recessions. Contrary to popular belief, there is little theoretical or conceptual support for using inversion of the 10Y-3M Treasury yield curve as an asset allocation signal to sell stocks.

• The happiness recession. Today’s young adults are replacing church and marriage with friendships. But there’s one thing for which they have no substitute….the sex recession is in full swing.

• Reality is delicious all on its own. A Zen teacher and chef says that the secret to appreciating life lies in accepting that nothing is perfect, but everything is useful. No food or experience should ever go to waste. Just as he saves the remains of today’s dishes for tomorrow’s meals, the chef suggests we relish everything life brings our way, or at least learn to resist less. Instead of always trying to control things, which is impossible, the chef argues that we can get better at dealing, making delicious recipes in the kitchen and in our lives by using limited ingredients and learning to savor the flavors that arise naturally.

• How digital technology is destroying our freedom. Douglas Rushkoff, a media theorist at Queens College in New York, is the latest to push back against the notion that technology is driving social progress. His new book, Team Human, argues that digital technology in particular is eroding human freedom and destroying communities.

• Andreessen Horowitz Is Blowing Up The Venture Capital Model (Again). Andreessen and Horowitz, who rank 55th and 73rd, respectively, on this year’s Forbes Midas List, intend to be disagreeable themselves. They just finished raising a soon-to-be announced $2 billion fund (bringing total assets under management to nearly $10 billion) to write even bigger checks for portfolio companies and unicorns the firm missed the first time. More aggressively, they tell Forbes that they are registering their entire firm—a costly move requiring reviews of all 150 people—as a financial advisor, renouncing Andreessen Horowitz’s status as a venture capital firm entirely. Why?
  

• Different kinds of information. The amount of raw, accessible information we have is orders of magnitude more than it was 15 years ago, let alone 129 years ago. Yahoo has historical financial statements of every public company; 20 years ago you had to ask each company to mail you hard copies. Twitter spits out 200 billion tweets a year; it barely existed a decade ago. The firehose makes it easy to mirror the poor Oxford boy: since information is free and ubiquitous but adding context has a mental price, the path of least resistance is to know facts without a clue where they go or whether they’re useful. Morgan Housel suggests that one step to dealing with this firehose is acknowledging different types of information. When you come across a piece of information – any kind of information – I’ve found it useful to bucket it into different groups.

• This Negative-Fee ETF Will Pay Investors to Invest. While the biggest exchange-traded fund shops such as BlackRock and Vanguard battle for fresh money by undercutting each other on fees, small and relatively new entrants of ETF-land are going whole hog. Salt Financial, an ETF shop with less than two years under its belt, filed on Tuesday to launch an ETF that will actually pay investors for investing in it, at least at the start. The negative-fee ETF is finally here, making online lender Social Financial or SoFi’s zero-fee ETFs old news.

• It's not just corruption. Entrance into elite US colleges is rigged in every way. An FBI sting revealed that wealthy parents are buying their children a place in top universities. But they’re not the only problem: the whole system is rigged. But here’s the thing: the whole system is “rigged” in favor of more affluent parents. It is true that the conversion of wealth into a desirable college seat was especially egregious in this case – to the extent that it was actually illegal. But there are countless ways that students are robbed of a “fair shot” if they are not lucky enough to be born to well-resourced, well-connected parents. The difference between this illegal scheme and the legal ways in which money buys access is one of degree, not of kind. The mistake here was to do something illegal. Meanwhile, much of what goes on in college admissions many not be illegal, but it is immoral.

  Our best wishes for a fulfilling April,

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