A Tough Short But An Interesting Long

Good Morning,
 

U.S. stocks closed slightly lower Friday, with financials lagging, following some renewed concern of geopolitical tension.

Reuters reported in late morning trade that a Chinese Navy warship has seized an underwater drone deployed by an American oceanographic vessel in international waters in the South China Sea, triggering a formal diplomatic protest from the United States and a demand for its return, a U.S. defense official told the newswire.

 
Our Take
 
We talked a bit about Grey swan risks last week. With U.S./China relations in a bit of slump since Trump was elected, it is worth remembering that life, like markets operates in cycles. If you find yourself in a high, begin preparing yourself for the next low. Without fail it is coming.
 
Nevertheless, this rally is tough to short. Investors are facing a swift transition to an activist and all-business American government. Trump has kept his cards close to his chest but the new strategy is set with a firm focus on jobs, incomes, infrastructure, and a desire to put an end to humiliating declines in the quality of American education and healthcare.
 
As Dr. Michael Ivanovitch for CNBC has stated: “These are the things that markets are betting on. Rest assured that Mr. Trump and his Wall Street appointees fully understand the conditionality of that welcome mat.”


Musings

As we prepare our best ideas and outlook for 2017 we came across this interesting long opportunity in Europe:
 
CRH PLC (ADR): Although industrials and construction have been the story in North America of late, could there be opportunity in Europe? In this name we see strength in construction materials, concrete and plumbing units. This company experienced rapid growth in 2015 and is trading at nearly 16.5 times forward earnings, only 1x sales and 2x book value. The company is in a cyclical industry yet has managed to growth revenue by 50% since 2006 and during the bull run of 2006-2008 saw a revenue increase of over 11%. Interestingly, the company generates more revenue and profit today but is trading below its 2006 levels and has a low price to cash flow ratio of 10x. Look for a dip below $30 as a good entry point. As for the macro infrastructure tailwind, we believe it has about 3 good years to play out before the sector reaches fair value. 
 

Thought of the Week

 

"What was scattered gathers. What was gathered blows away." -Heraclitus

 


Stories and Ideas of Interest

 

  • Contrarian indicator? Could hoarding be a sign of a healthy economy? The boom in self-storage units suggests Americans are buying more than ever.  

     

  • Trump’s cabinet picks have more money than a third of all Americans combined. The most affluent cabinet ever boasts $9.5 billion in total wealth. This is actually incredible. Talk about flair…
  • Sometimes disruption is staring you right in the face and you can’t help but look the other way. That’s doubly true when you’re the head of a legacy business desperate to stay relevant. Small players have historically changed the business landscape when the older guys aren’t aware enough or nimble enough to respond. Cb Insights puts together some great examples of big CEOs and executives who minimized disruptive threats when they appeared. When asked about these smaller players at the time (and even now) some companies have remained woefully dismissive.

 

  • Excuses Excuses. Or realism at work? America’s largest pension fund: A 7.5% annual return is no longer realistic. Probably smart to temper expectations...Although stocks do tend to rise....
  • Investing is maybe 60% science, the rest art. Yes, it has numbers and formulas and rules. But the soft stuff you can’t measure or hardly even describe – the art of the business – makes all the difference in the world. Building a valuation model is a science. Calibrating it to reflect the psychology of uncertainty is an art. Morgan Housel offers an interesting look at the art of investing.

 

All the best for a productive week,

Logos LP

Should The Trump Rally Concern You?

Good Morning,
 

U.S. equities closed at all-time highs on Friday, as the major indexes posted their best week since the election.

The Dow Jones industrial average rose about 130 points heading into the close, with 3M and Apple contributing the most gains.

All major indexes have been hitting record highs since the election. In fact, the Dow has notched 14 record closes since then and gains in 20 of the past 24 sessions.


Our Take


Although this rally is impressive, one should always pause and take the temperature of the market. Think of it as tying oneself to the mast as Odysseus did when the seductive Sirens attempted to lull his crew to destruction. What songs are the sirens singing now? What they seem to be chanting is a pro growth Trump administration. Is there logic to their songs? 

 

Considering Trump’s potential to spend on infrastructure I read a great piece this week in Quartz which took a sober look at this hypothesis.

 

The author pointed out that markets are anticipating a big increase in spending and thus interest rates will begin to rise quite soon (they already have with news of a Trump victory as reflected by the yield on the 10 year). Higher interest rates will make all kinds of investment more expensive and can dampen growth. Meanwhile, the benefits of the infrastructure projects won’t appear for several years.

 

Thus, it seems how well Trump’s infrastructure plan will work will depend on how patient he is. Given the state of the economy, boosting economic growth will require picking useful infrastructure projects. These projects will have to have the potential to boost America’s productive capacity for years to come. As such, they might also leave a powerful legacy (imagine the Trump dam or Donald Trump bridge). But odds are those kinds of projects won’t confer much economic benefit, only cost, during his reign as president. And just how comfortable will Trump and his administration be with delayed gratification? How comfortable will the struggling white working class be?

 

In fact, U.S. President-elect Donald Trump’s future policy stance poses “the single largest risk to the global economy,” according to a client survey by forecasting firm Oxford Economics Ltd. More than half of respondents said that the probability of a sharp slowdown has increased over the past three months, according to the firm’s Nov. 14-21 survey on global risk perceptions conducted among about 180 clients and contacts. The main fear is a potential trade war with China. 

 

What would this even look like? Interesting article in Quartz highlighting which US companies would suffer most if a trade war broke out: 

 

Based on some these concerns should we be skeptical of the “Trump Rally”? Well the same study above also sited Trump as the most likely source of faster global growth, with 38 percent citing the potential for the U.S. economy to surge on new fiscal stimulus he has proposed…Does anyone know anything? If things do improve look to increase exposure to small caps as they will benefit the most from potential regulatory reforms. 

 

Interestingly another view can also be argued. Although the Trump phenomenon can be viewed as a lesson in the laws of power, it can also be viewed as a challenge to traditional economics. Mark Buchanan for Bloomberg argues that although Trump’s move to bully companies into keeping jobs in the U.S. can be viewed as foolish or populist, they do raise some important questions about how we should define economic success. 

 

Significant changes are often preceded by small actions. Could Trump’s "nativist' actions be construed as a promotion of a new set of values? The current economic view - that it is acceptable for businesses to move manufacturing jobs to areas where profitability and competitiveness can be enhanced - may simply be outdated….

 

Have Trump voters hinted that companies should have a different set of values? Perhaps an allegiance to their communities and employees? Given the stagnant economic position the vast majority of people find themselves in, how strange is it to suggest that economic purism may have lost its shine?



Either way the Shiller CAPE market valuation ratio is now over 27, which is near the level we saw before the market crashes in 1929, 2000, 2008… Two decades after then-Federal Reserve Chairman Alan Greenspan fretted about asset prices reaching unsustainable levels -- a pronouncement that caused a brief interruption in the U.S. stock rally -- his successors might be tempted to warn again markets are getting ahead of themselves... 



Funnily enough the latest figures from FactSet, a financial-data provider, show that 49% of firms in the S&P 500 index of leading companies are currently rated as “buy”, 45% are rated as “hold”, and just 6% are rated as “sell”. In the past year, 30% of S&P 500 companies yielded negative returns. Keep calm and compound on....LOL



Expect the rally to continue at least into the new year as 90%+ of hedge fundsare trailing their benchmarks and will look to play catch up yet remember that bull markets die of euphoria not pessimism. 

 

Thought of the Week

 

"MASTER THE ART OF TIMING - Never seem to be in a hurry- hurrying betrays a lack of control over yourself, and over time. Always seem patient, as if you know that everything will come to you eventually. Become a detective of the right moment; sniff out the spirit of the times; the trends that will carry you to power." -Robert Greene

 

Stories and Ideas of Interest

 

  • What risks does the global economy face in 2017? Apart from Donald Trump’s administration as outlined above Nomura has come out with a list of grey swans (“These are the unlikely but impactful events that, in our opinion, lie outside the usual base case and risk scenarios of the analyst community”). 
     

    Potential shock 1: U.S. productivity might boom

    Potential shock 2: China might float its currency

    Potential shock 3: The European Union (EU) could reform, leading the U.K. to re-join

    Potential shock 4: Japan inflation might surge

    Potential shock 5: The U.S. Federal Reserve could be muzzled

    Potential shock 6: Russia may flex its muscles

    Potential shock 7: A clearing house may fail

    Potential shock 8: Japan Prime Minister Shinzo Abe loses power

    Potential shock 9: Emerging market capital controls may return

    Potential shock 10: Paper money may disappear

 

  • It is too early to say the era of low yields is over. The Economist explores how the market has begun pricing in three factors which are usually drivers of higher bond yields —faster growth, rising short-term rates and higher inflation. Nevertheless, this bond-market sell-off needs to be set in context. During the “taper tantrum” of 2013, when the Fed signalled a slowing of its quantitative-easing programme, the ten-year yield reached 3%. It was as high as 2.47% in June last year. Furthermore, it is not clear how much of Mr Trump’s programme will be implemented, nor indeed whether economic growth or inflation will actually rebound. In addition, a rise in bond yields may play a part in choking off economic growth. The ratio of total debt (governments and private sector combined) to GDP has risen in both developed and developing economies since the 2008 crisis. “A large stock of debt needs a low interest rate to make it tolerable. 

 

  • Do you make less than an entry level employee in Silicon Valley?Competition for engineering talent remains fierce in Silicon Valley. The megaplayers offer recruits lavish offices and gourmet cafeterias along with all the usual corporate perks, such as gym memberships and expense accounts. But there's nothing like good, old-fashioned money to entice top talent. An unscientific survey in Bloomberg tries to put a price on some of the hottest jobs in tech. 

 

  • Some of the apparent income mobility in places like Canada or Scandinavia is something of an illusion. Income mobility is a problem for everyone. Most people, in most countries, dream of a world where birth does not limit your status in society. No country has achieved this happy end, though some of them do better than others. Income mobility statistics are created, worried over, analyzed for some sign of possible cures. A new paper out of Sweden suggests that we should perhaps be worrying even more than we do, and that the cures may be harder to come by than we thought. What is interesting here is that if family history is such a major component of financial success then this weakens some of the evidence for supposed present day discrimination…Is redistribution the only way???

 

  • Upset with your government and feeling disillusioned? Move to a seastead. Imagine, for instance, autonomously governed sea platforms, with a limited number of citizens selling health and financial services to the rest of the world. Advances in robotics and artificial intelligence might make the construction and settlement of such institutions more practical than it seemed 15 years ago. Technocratic utopianism or path to greater human companionship?

 

All the best for a productive week,

Logos LP

2 Opportunities With Potentially Explosive Value

Good Morning,

U.S. stocks closed mostly flat on Friday, with financials falling around 1 percent, as investors braced themselves for a key constitutional referendum in Italy while digesting a stronger-than-expected jobs report. In economic news, the U.S. economy added 178,000 jobs last month, the Labor Department said, with the unemployment rate falling to 4.6 percent. Economists polled by Reuters expected a gain of 175,000 with the unemployment rate holding steady at 4.9 percent. Wages, however, slumped to 2.5 percent.
 
While Friday's jobs data will not deter the central bank from raising rates, it was not a good report as record numbers of workers are no longer looking for work and part-time job creation is far outpacing full-time.
 

Our Take

It is always best not to be caught in the crowd. Take the temperature of the market. This violent Trump rally may not be all that it is perceived to be. Commentators such as Bill Gross warned this week that the Trump rally is built on a false promise of growth. Some of his points are worth considering.
 
Specifically his concerns about US productivity. Gross pointed out that future growth is primarily a function of productivity, which has flat lined for the last several years and shows little promise of accelerating. Gross wrote that “A strong dollar and continuing structural headwinds including aging demographics, de-globalization trade policies, and accelerating debt-to-GDP in almost all countries at now higher interest rates, promise to contain productivity at perhaps 1 percent annual growth rates and therefore real GDP growth at 2 percent.”
 
In addition, analysts at Bank of America Corp. suggested this week that we may be approaching the market’s last hurrah. The crux of the argument is that the firm’s contrarian sell side indicator, which measures Wall Street’s bullishness on equities, jumped to a six-month high in November, its biggest gain in more than a year. Right now, the index is pointing toward a rally of almost 20 percent for U.S. stocks over the next 12-months, but the analysts believe that a rally of that magnitude could mark the end of the bull run. Remember that market euphoria is typically what we see at the end of bull markets and that has been glaringly absent so far in the cycle.

 
Musings
 
Recently, we have been looking at companies with explosive book value that have been selling off in this market. After careful analysis, we have noticed that significant book value growth over the last 10 years (over 2.5x), coupled with sustained high returns on capital over the past 5 years, can provide a glimpse into up-and-coming quality enterprises that may propel higher over the medium term.
 
Some picks of interest:           
 
CGI (TSE: GIB.A): Book value per share nearly quadrupled since 2007 as revenue tripled. Average ROE is above 14% over the last ten years. Company has strong tailwinds going forward and stock is below 200 MA and is down 4% last 3 months. Look for the stock to dip below its 50 MA.
 
Luxoft (NYSE:LXFT): Roaring book value per share growth, more than doubling over past 2 years. Return on Invested Capital has averaged over 35% since 2011. Price to sales is at 2.5, which lower than some consumer non-cyclicals growing at less than inflation, and revenue is expected to hit $1 billion by end 2018 (TTM at $716MM). Stock is down 33% YTD despite record growth and no debt.

 

Thought of the Week
 

"The herd instinct among forecasters makes sheep look like independent thinkers." - Edgar Fieldler


Stories and Ideas of Interest

 

  • Silicon Valley has an empathy vacuum. The New Yorker suggests that Silicon Valley’s biggest failing is not poor marketing of its products, or follow-through on promises, but, rather, the distinct lack of empathy for those whose lives are disturbed by its technological wizardry. Living in a bubble can mean different things to different people.

 

  • Tech was supposed to crash in 2016. It got real instead. Sure money isn’t as easy to get as it used to be but the unicorn reckoning expected in 2016 was nigh. Wired magazine looks into a year in tech which looked more like air leaving a balloon rather than a sudden pop.

 

  • An incubator for (former) drug dealers. Amid calls for more job training, less automatic background searching, and other changes that would make it easier for ex-felons to become employees, an alternative idea has slowly taken hold: Encourage them to start their own businesses. Bloomberg takes a look at the largest nonprofit pushing entrepreneurism of this kind: Defy Ventures, based in New York. Over the past six years it has trained more than 500 formerly incarcerated people and incubated more than 150 successful startups.

 

  • Corporate executives have opinions about Donald Trump. Bloomberg has a look at what they’ve been saying. On balance it is safe to say that they are optimistic but most believe that it is too early to speculate about what changes in Washington are going to mean for business. We tend to agree, despite the incredible rotation we have been witnessing in the markets into financials, basic materials and industrials. Be weary of premature herd following. Nevertheless, here’s an interesting look at how the new president might change rules that have made the financial system safer since the 2008 crisis, from most likely to least.

 

 

All the best for a productive week,

Logos LP

 

The Greatest Wealth Transfer In History Has Begun

Good Morning,
 

U.S. equities closed higher on Friday, posting weekly gains, as investors monitored retailers during Black Friday as the post-election rally moved forward. The three major indexes were up more than 1 percent for the week ripping to new record highs on optimism that President-elect Donald Trump's proposed policies will stimulate economic growth.

U.S. Treasury yields and the dollar have also risen sharply since the election, with the benchmark 10-year note yield skyrocketing above 2 percent and the greenback trading around levels not seen since 2003, putting euro/dollar parity within reach. Gold prices, in turn, have turned sharply lower, hitting nine-and-a-half month lows.

Also of interest this week was consumer confidence, which rose more than previously reported to a six-month high in November, showing Americans became more optimistic about their finances and the economy after Donald Trump won the presidential election.

Despite this encouraging news, the U.S. is still home to a working class suffering from stagnant incomes and declining job prospects—widespread struggles that helped elect Republican Donald Trump. The relative wealth of Americans in all age groups keeps falling, compared with previous decades.

Nevertheless, 1700 millionaires are minted every day in the US of A…

In fact, today, more than 8 million households have financial assets of $1 million or more, not including homes or luxury goods, according to Boston Consulting Group. Yet before your faith in upward mobility is renewed, consider this: The very oldest Americans hold a disproportionate chunk of all those trillions, and they’re handing it off to their already well-off kids in what is the largest generational transfer of wealth in history.

Fundamentally inheritance is an increasingly significant driver of wealth in America. Be sure to check out this very interesting read in Bloomberg this week exploring the wealth picture in America.

Interestingly, the top 3 factors cited by the richest investors are encouraging:

1)     Hard Work

2)     Education

3)     Smart investing (Does Index Investing Really Count?)

Thought of the Week

 

"All life demands struggle. Those who have everything given to them become lazy, selfish, and insensitive to the real values of life. The very striving and hard work that we so constantly try to avoid is the major building block in the person we are today.” –Pope Paul VI
 


Stories and Ideas of Interest

 

  • Self-control is a myth.  "There’s a strong assumption still that exerting self-control is beneficial…and we’re showing in the long term, it’s not.” Interesting piece here in Vox suggesting that willpower can’t be strengthened, so we should try to avoid situations that call for it…

 

  • The buybacks aren’t working. Here's a sign it's time for CEOs to stop spending on buybacks and start reinvesting in their business: an index tracking European share buybacks is underperforming the broader market. Time to think seriously about R&D…

 

  • Working for a big company is the new chic. When he started thinking about leaving Apple Inc. this year, Darren Haas briefly contemplated Uber Technologies Inc., where many friends worked. Instead, the cloud-computing engineer pursued an opportunity he considered more exciting: General Electric Co. Workers are now flocking to older and larger tech firms…Go figure.

 

  • Don’t just lower corporate tax rates. Abolish them. Enlightening piece in Bloomberg View arguing that corporate tax rates should be done away with altogether.

 

 

All the best for a productive week,

Logos LP

What So Many People Get Wrong About The White Working Class

Good Morning,

U.S. equities closed slightly lower on Friday, led by health care, as investors digested Federal Reserve officials' remarks on monetary policy and falling oil prices.
 
Entering Friday's session, the Dow, S&P 500 and Nasdaq composite were all within half a percent of their previous all-time highs. The Dow had reached a record intraday high of 18,934.05 on Monday — on the back of a sharp post-election rally — while the S&P last set a record high of 2,193.81 on Aug. 15.
 
Fed Chair Janet Yellen's testimony in Congress on Thursday all but assured the central bank would raise interest rates next month. According to the CME Group's FedWatch tool, market expectations for a rate hike in December were above 90 percent Friday morning.

13Fs came out this week and they shed some light on the incredible rotation we have seen post Trump from tech/utilities/REITS/consumer staples into financials and industrials. Why? Consumer staples and tech were the 2 largest sector weightings amongst the top 50 hedge funds. Easy come easy go on the return chasing band wagon….
 

Musings
 
Last bit about the election I promise. Read a great article this week in the Harvard Business review that outlines what so many people don’t get about the U.S. working class. As a broad theme the white working class (WWC) resents professionals but admires the rich.
 
Professional people are viewed as suspect and managers are college kids “who don’t know shit about how to do anything but are full of ideas about how I have to do my job”.
 
The WWC aspires to be independent and give their own orders and not have to take them from anybody else. Owning one’s own business — that’s the goal. That’s another part of Trump’s appeal.
 
Joan Williams writes that “Hillary Clinton, by contrast, epitomizes the dorky arrogance and smugness of the professional elite. The dorkiness: the pantsuits. The arrogance: the email server. The smugness: the basket of deplorables. Worse, her mere presence rubs it in that even women from her class can treat working-class men with disrespect. Look at how she condescends to Trump as unfit to hold the office of the presidency and dismisses his supporters as racist, sexist, homophobic, or xenophobic.”
 
Several other key points she makes are:
 
Understand that working class means middle class, not poor
 
Understand working-class resentment of the poor
 
Understand how class divisions have translated into geography
 
If you want to connect with white working-class voters, place economics at the center
 
(My favorite) Avoid the temptation to write off blue-collar resentment as racism
 
Defending this last one is bold yet perhaps one of the biggest risks facing America today is how out of touch the elite is with the rest of the country. This election has placed the spotlight on the gross amount of class cluelessness that exists today. As Joan indicates: “If we don’t take steps to bridge the class culture gap, when Trump proves unable to bring steel back to Youngstown, Ohio, the consequences could turn dangerous.”
 

Thought of the Week

 

" The state is nothing but an instrument of oppression of one class by another - no less so in a democratic republic than in a monarchy." -Friedrich Engels
 


Stories and Ideas of Interest

 

  • We just don’t want to face the brutal facts. Came across an interesting piece this week in the Guardian highlighting the “fact” that “post-truth” has been named the word of the year by Oxford Dictionaries. This adjective was popularized as both the US election and EU referendum unfolded to describe a situation ‘in which objective facts are less influential than appeals to emotion”. Despite the incredible increase in data are we in fact living in a “post truth” world?

 

  • But trust your gut. “Gut reactions” — subtle bodily sensations that result from risky behavior — have long been the stuff of financial market lore. Some successful stock market gurus, billionaire George Soros included, have claimed they pay attention to bodily pains and other sensations to gain valuable insight into how they should trade on the markets. A new paper published in Scientific Reports suggests some truth could be lurking behind these stories. Where can we find the delicate balance between reason and emotion?

 

  • Don’t fear AI. Humans and AI will be inextricably linked in less than a decade. “Symbiotic autonomy” will forever change the decision making process.

 

  • Short-term gain for long-term pain? That's the view of economists at Goldman Sachs Group Inc., who argue that while some of President-elect Donald Trump's proposals could boost U.S. economic growth in the near future, his other policies would offset those positive impacts over the long-run. Specifically higher inflation and unemployment?

 

  • Debt crisis? A group of online consumer loans that were packaged into bonds is going bad faster than lenders and bond underwriters had expected, the latest sign that some startups that aimed to revolutionize the banking industry underestimated the risk they were taking.

 

  • Renewables? A contrarian buying opportunity? Investors have been selling off companies that specialize in producing renewable energy. Bloomberg suggests that fears of a negative impact of Trump are really overblown. We would agree.

 

All the best for a productive week,

Logos LP