Temperament Determines Outcomes

Good Morning,
 

This week U.S. stocks climbed to record highs and Treasuries rallied after a core inflation reading slowed, adding to evidence that economic growth continues apace without stoking price increases. The dollar pared losses.

The three major indexes posted slight weekly gains. The S&P 500 and the Dow recorded their fifth consecutive weekly gains, while the Nasdaq has completed three.

Bonds in Europe gained after a report that the European Central Bank may continue asset purchases for at least nine months after it starts tapering in January. The Stoxx Europe 600 Index climbed, led by steelmakers and miners as most industrial metals gained and crude oil rose back above $51 a barrel.

Excluding food and energy, so-called core prices rose 0.5 percent in September, below an estimate of 0.6 percent. At the same time, a Commerce Department report also released Friday showed U.S. retail sales rose in September by the most in more than two years, as Americans replaced storm-damaged cars and paid higher prices at the gasoline pump. Excluding autos and gas, sales still increased at the second-fastest pace since January.

The inflation data bolstered the view that U.S. inflation below the Federal Reserve’s target may be structural rather than transitory, prompting traders to slightly reduce the odds of another rate increase in December. Could the Fed be ignoring actual inflation data?

Our Take
 

As we’ve suggested in the past, inflation is simply not cooperating but the fundamentals continue to look good. The never-ending crazy going on in Washington simply hasn’t stopped the economic expansion.

The International Monetary Fund, echoing increasingly gloomy sentiment in Washington, has concluded that the Donald Trump administration and Congress probably won't succeed in enacting tax reform or even significant tax cuts. The Republican chairman of the Senate Foreign Relations Committee calls the White House "an adult day care center" and says he fears that the president's reckless bluster may lead us into World War III. The president, meanwhile, says he wants to compare IQ test scores with his secretary of state.

No worries. Investors do not appear to be concerned about any of these things. Earnings season has also gotten off to a good start, with 87 percent of the companies that have reported topping bottom-line expectations. The number of companies currently beating estimates, and the margin by which they are doing so, is running at a clip well above what these same 31 companies have recorded, on average, over the past three years.

Even Buffett thinks that stock valuations make sense with interest rates where they are. You measure laying out money for an asset in relation for what you are going to get back. You get 2.30% on the ten year. Seems fair to say that stocks will do better over the long term. In case you missed it Warren Buffett’s full interview on CNBC.

But what of the concept of Ben Graham's “margin of safety” in this "bull market in everything" environment? The idea that the price paid for an asset (stock, bond, real estate etc.) should allow for human error, bad luck or, indeed, many things going wrong at once.

In a problematic world of trade tariffs, nuclear braggadocio, nationalism and inequality such a concept is more prescient than ever. Rarely have so many asset classes -from stocks, to bonds, to gold, to real estate to bitcoins, to wine, to classic cars- exhibited such a sense of invulnerability. And all at the same time to boot! Listen to the temperature of this market. Listen for the all too familiar refrains of “this time it’s different” as they roll in. Timing markets is a fool’s game, but remaining alert to the concept of “margin of safety” is not. It may ensure survival.  

Musings
 

Many great investors suggest that generating above average investment results necessitates above average temperament.

As warren Buffett has stated: “Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

Over the last few weeks in particular I’ve observed this on numerous occasions. Individuals with seemingly above average intelligence making poor decision after poor decision, blinded by ego and jealousy. Weakened by insecurity and contempt. Burdened by an inability to move forward after failure. Influenced by “opinions” when they reach “decisions”. Led astray by their own faulty temperaments.

This week I came across an interesting piece in the Economist that made me think deeply about temperament. Management gurus have poured over a related topic endlessly: is a knack for entrepreneurship something that you are born with, or something that can be taught? In a break with those gurus’ traditions, a group of economists and researchers from the World Bank, the National University of Singapore and Leuphana University in Germany decided that rather than simply concoct a theory, they would conduct a controlled experiment.

Moreover, instead of choosing subjects from the boardrooms of powerful corporations or among the latest crop of young entrepreneurs in Silicon Valley, Francisco Campos and his fellow researchers chose to monitor 1,500 people running small businesses in Togo in West Africa.

As they reported in Science, the researchers split the businesses into three groups of 500. One group served as the control. Another received a conventional business training in subjects such as accounting and financial management, marketing and human resources. They were also given tips on how to formalise a business. The syllabus came from a course called Business Edge, developed by the International Finance Corporation.

The final group was given a course inspired by psychological research, designed to teach personal initiative—things like setting goals, dealing with feedback and persistence in the face of setbacks, all of which are thought to be useful traits in a business owner. The researchers then followed their subjects’ fortunes for the next two-and-a-half years (the experiment began in 2014).

An earlier, smaller trial in Uganda had suggested that the psychological training was likely to work well. It did: monthly sales rose by 17% compared with the control group, while profits were up by 30%. It also boosted innovation: recipients came up with more new products than the control group. That suggests that entrepreneurship, or at least some mental habits useful for it, can indeed be taught. More surprising was how poorly the conventional training performed: as far as the researchers could tell, it had no effect at all. Temperament was the determinate factor. Superior mental habits lead to outperformance.

Focusing on the theme of temperament for our own decision making at Logos LP we’ve made a conscious effort to record instances in which poor temperament has lead to poor outcomes. A record of instances when either we or those around us have let poor temperament wreak havoc upon output. The journal gets re-visited on a monthly basis in order to develop an awareness of trends or patterns. Action items are them developed to alter behaviour.

For the next six months try and keep track of all of your major decisions and thoughts in a journal. This will help to build an awareness of the way your decisions are made and their associated outcomes. What you may find is that you develop more control over yourself and your decision making. Education comes from within; you get it by personal struggle, effort and thought. Live in the process…

Thought of the Week

"If you do not conquer self, you will be conquered by self.” - Napoleon Hill

Articles and Ideas of Interest

• There’s nothing old about this bull market. Claims that it’s the second-longest ever don’t hold up. Barry Ritholtz makes a convincing case that the current bull market is only four and a half years years old. The best starting date of a new bull market is when the prior bull-market highs are eclipsed. That is how we get a date like 1982 as the start of the last secular long-term bull market. And it is also how we get to March 2013 as the start date of this bull market, when the S&P 500 topped the earlier high of 1,565 set in October 2007. Could we just be approaching the middle of the run?

• Debt keeps rising and nothing bad happens. Economists are stumped. As the Republicans prepare for their big tax reform push, the issue of deficits and debt is once more coming to the fore. Many economists realize that tax cuts, especially income tax cuts, tend to increase deficits, which over time lead to increases in the national debt. The GOP plan, if adopted, probably would pump up both deficits and debt. So the question is: Is more debt good, bad or does it even matter? But if it’s bad, how serious a problem is it?

• Ideas aren’t running out, but they are getting more expensive to find. The rate of productivity growth in advanced economies has been falling. Optimists hope for a fourth industrial revolution, while pessimists lament that most potential productivity growth has already occurred. This must read piece argues that data on the research effort across all industries shows the costs of extracting ideas have increased sharply over time. This suggests that unless research inputs are continuously raised, economic growth will continue to slow in advanced nations.

• Bitcoin resumed its climb. After tearing past $5,000 on Thursday, the cryptocurrency soared above $5,800 on Friday. JPMorgan CEO Jamie Dimon, who told investors last month that bitcoin was a bubble “worse than tulip bulbs,” said Thursday he doesn’t want to talk about it anymore.  But on Friday, Dimon responded to a question about bitcoin by saying if people are "stupid enough to buy it," they will pay the price for it in the future. The craze rolls on with hedge funds flipping ICOs and receiving preferential discounts and terms. Here’s the deal with an ICO: You can buy entry in a computer ledger issued by a start-up company on the basis on an unregulated prospectus. It is called an ICO (“Initial Coin Offering”) but though the ledger entry is called a coin, you cannot spend it at any shop. And whereas the use of the term ICO makes it sound like an IPO (initial public offering), the process whereby a firm lists on the stockmarket, coin ownership does not necessarily get you equity in the company concerned. The Economist points out that this is the kind of bargain that would only appeal to people who reply to emails from Nigerian princes offering to transfer millions to their accounts. There is a serious side to the craze as there was with the dotcom boom. The technology that underpins digital currencies- the blockchain- is an important development. The problem is that it is not easy to draw a line between financial innovation and reckless speculation.

  
   

• Dating apps are reshaping society. There’s been a big uptick in interracial and same-sex partners who find each other online. Interesting research presented in the MIT Tech Review which tends to support that there is some evidence that married couples who meet online have lower rates of marital breakup than those who meet traditionally. That has the potential to significantly benefit society. And it’s exactly what new data models predicts. Perhaps online dating isn’t all bad. Important to think about as Berkshire Hathaway CEO Warren Buffett recently stated that making money means nothing without having another person, such as a spouse, to share the wealth with. Who you marry, which is the ultimate partnership, is enormously important in determining the happiness in your life and your success. A study published by Carnegie Mellon University found that people with supportive spouses are "more likely to give themselves the chance to succeed."

• The loneliness epidemic. This may not surprise you. Chances are, you or someone you know has been struggling with loneliness. And that can be a serious problem. Loneliness and weak social connections are associated with a reduction in lifespan similar to that caused by smoking 15 cigarettes a day and even greater than that associated with obesity. But we haven’t focused nearly as much effort on strengthening connections between people as we have on curbing tobacco use or obesity. Loneliness is also associated with a greater risk of cardiovascular disease, dementia, depression, and anxiety. At work, loneliness reduces task performance, limits creativity, and impairs other aspects of executive function such as reasoning and decision making. For our health and our work, it is imperative that we address the loneliness epidemic quickly.

Our best wishes for a fulfilling week, 
 

Logos LP

• Asset Management 4
• Ideas 19
• Macro 9
• Newsletter 87
• Psychology 4
• Strategy 7

Our Institutions Are Breaking

Good Morning,
 

Last week the S&P 500 Index pushed past 2,500 for the first time, notching its third round-number milestone of the year as the bull market in U.S. equities rages on. With a gain of 10.4% through the end of August, this year ranks as the fourth best start to a year in the last ten years, behind 2013 (+14.5%), 2009 (+13.0%) and 2012 (+11.8%).

The benchmark gained 0.2 percent to 2,500.23 last Friday, capping its biggest weekly advance since January, as technology shares rebounded and banks climbed with Treasury yields. Up 12 percent since January, the S&P 500 is on course for its best annual gain in four years.

Equities broke out of a month long trading range after the worst-case scenarios from Hurricane Irma and North Korea failed to materialize. As geopolitical fears subsided, investors shifted focus back to fundamentals, where economic growth remains stable and corporate earnings are expected to increase every year through at least 2019.

Another piece of good news last week: America's middle class had its highest earning year ever in 2016, the U.S. Census Bureau reported Tuesday. Median household income in America was $59,039 last year, surpassing the previous high of $58,655 set in 1999, the Census Bureau said.

Our Take
 

Strength is appearing to beget strength. In each of those three years above (2013, 2009, 2012) where the S&P was up significantly in the first eight months of the year, the remainder of the year saw further upside with a median gain of 9.3%.

In addition to those three years, the last four months of each calendar year has been strong throughout the entire bull market. The S&P 500 has been up every time for a median gain of 3.4%.

On a total return basis, the the index was up an impressive 16.2% over last year through the end of August. The historical average is 11.7% going back to 1928. Can things continue?

The trend may be up but either way we subscribe to a more reserved view well described in a note entitled “Yet Again?” released last week by Howard Marks. In this memo, which served as a follow up to his other recent memo entitled “There They Go Again” released on July 26, Marks suggests that investors are no longer being offered value in the market at cheap prices and thus should pull back and be less aggressive. Marks suggested that the market is not currently a “nonsensical bubble” but rather is simply high and therefore risky.

Risk may have increased as prices have risen yet the interesting question then is: “So what should we do?” At our 2017 high this year our fund was up roughly 25%. We have since come off this high and are in the process of re-calibrating our expectations in what we believe to be a more “low-return” environment. What does this mean?

As Marks reminds us in his memo the options are limited:

1. Invest as you always have and expect your historic returns.

2. Invest as you always have and settle for today’s low returns.

3. Reduce risk to prepare for a correction and accept still-lower returns.

4. Go to cash at a near-zero return and wait for a better environment.

5. Increase risk in pursuit of higher returns.

6. Put more into special niches and special investment managers.

#1 would make no sense.

#2 is difficult.

#3 makes sense if you think a correction is coming but could cost you.

#4 is tough as zero-returns are rarely ever acceptable.

#5 is deceptive as high risk does not assure higher returns. It means accepting greater uncertainty with the goal of higher returns and the possibility of substantially lower (or negative) returns.

#6 is good as they can offer higher returns without proportionally more risk. That is if they can be identified.  

Like Marks, we believe that none of these options is perfect but that there are no others. Thus, as we re-set expectations in an environment promising lower returns we will do the things we have always done remaining largely fully invested and accept that returns will be lower than they traditionally have been (#2). While we do what we have always done we will employ more caution than usual especially with regards to price (#3) and we will work diligently to find special opportunities that lie “off the beaten track” (#6).

Musings
 

I attended a conference this week in Toronto called Elevate TO. The purpose of the conference was to showcase the City as a growing hotbed of innovation. The presenters ranged from local politicians, to start-up founders to Canadian technology luminaries. One talk by Salim Ismail the technology entrepreneur and best-selling author of Exponential Organizations really stood out. (for a youtube video see here)

The crux of his talk is that society needs to shift from linear thinking to exponential thinking in order to adapt to a world which is changing faster than our institutions and minds can keep pace with.

But what is linear bias? We’ve seen consumers and companies fall victim to linear bias in numerous real-world scenarios. Although there are many such examples, a nice one relates to intangibles like consumer attitudes.

In a recent HBR article the author suggests looks at consumers and sustainability. We frequently hear executives complain that while people say they care about the environment, they are not willing to pay extra for ecofriendly products. Quantitative analyses bear this out. A survey by the National Geographic Society and GlobeScan finds that, across 18 countries, concerns about environmental problems have increased markedly over time, but consumer behavior has changed much more slowly. While nearly all consumers surveyed agree that food production and consumption should be more sustainable, few of them alter their habits to support that goal.

What’s going on? It turns out that the relationship between what consumers say they care about and their actions is often highly nonlinear. But managers often believe that classic quantitative tools, like surveys using 1-to-5 scales of importance, will predict behavior in a linear fashion. In reality, research shows little or no behavioral difference between consumers who, on a five-point scale, give their environmental concern the lowest rating, 1, and consumers who rate it a 4. But the difference between 4s and 5s is huge. Behavior maps to attitudes on a curve, not a straight line.

Companies typically fail to account for this pattern—in part because they focus on averages. Averages mask nonlinearity and lead to prediction errors. For example, suppose a firm did a sustainability survey among two of its target segments. All consumers in one segment rate their concern about the environment a 4, while 50% of consumers in the other segment rate it a 3 and 50% rate it a 5. The average level of concern is the same for the two segments, but people in the second segment are overall much more likely to buy green products. That’s because a customer scoring 5 is much more likely to make environmental choices than a customer scoring 4, whereas a customer scoring 4 is not more likely to than a customer scoring 3.

This illustration does a great job to outline the problem. The current climate of rapid technological development and change is rooted in exponential thinking. If you look at the biggest problems in the word such as the climate change, economic growth, pandemics and sociopolitical upheaval etc. they are rooted in exponential accelerators and factors. The problem is that many of us (including our leaders) don’t understand this phenomenon and this is the fundamental cognitive gap that we are facing. This gap is causing immense stress as evidenced by the increasing failure of our institutions (Occupy Wallstreet, the Arab Spring, the election of Donald Trump, the surge in nationalism, racism and authoritarianism) which were created in a fundamentally linear world.

When you have an information based environment it goes into an exponential growth path and it starts doubling in price performance every 1 to 2 years. Now we have whole industries and livelihoods like music, newspapers, retail, manufacturing etc. caught up in this vortex of exponential creative destruction as our world is not set up for this.

When you think about all the mechanisms we use to run the world: our social structure, our civics, our politics, our legal systems, our patent systems, our monetary policy systems, our financial systems, our healthcare systems, our education systems they are all geared for the linear world of 100 or 200 years ago when information was scarce. Lets remember that marriage was invented about 15 000 years ago when lifespans were about 25. You grew up, had kids and you died. Was it really designed to last 50-60 years? What happens when lifespans hit 120-150 years?

These mechanisms are all breaking or are already broken. We simply aren’t set up for the exponential world of today and certainly not for the world of tomorrow.

Most of the changes that set this exponential world in motion happened about 25 years ago with the advent of the internet yet now we have moved into the world of 3D printing, AR/VR, synthetic biology, blockchain technologies, advanced robotics and artificial intelligence.

We have a forcing problem with technology. Moore’s law has been doubling computing power for over 60 years and now we have over 12 technologies operating at that same pace: neuroscience, drones, biotech, and even solar cells are doubling in their price performance every 22 months and have been for over 40 years. At this pace we will hit 100% world energy supply that can be delivered by solar in less than 2 decades...Energy that has been scarce for most of human history is about to become abundant...

These exponential and thus highly disruptive technologies will only increase the stress that currently characterizes our world absent the ability of our leaders and I would argue ourselves to learn how to navigate these technologies and update the mechanisms which run our world grounding them in exponential thinking.

The problem is that if you attempt disruptive innovation in any organization or perhaps mind, its immune system will attack you. All of our organizations and mechanisms we use to run the world are built to resist change and withstand risk. Try and change education: teachers unions attack, try to update transportation:  taxi drivers attack, try and marry/date someone outside of your accepted circle: your parents or friends attack, try and actually reform the French economy: the unions attack and your approval ratings tank etc.

We’ve got to solve our immune system problem and the future will belong to those people, those leaders, those businesses and those countries that can do so. Can we scale as fast as technology?

Logos LP August Performance

August 2017 Return: -4.55%

2017 YTD (July) Return: +13.27%

Trailing Twelve Month Return: +13.01%

CAGR since inception: +17.84%

Logos LP in the Media

ValueWalk has done a special feature on us and some of our best ideas that will be released this month. For a teaser please click here.

Thought of the Week

"I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.” -Jimmy Dean

Articles and Ideas of Interest

• Robots and AI may not take our jobs after all. Liz Ann Sonders posted the graphic below showing how e commerce has created more jobs that it has taken away.

• Furthermore, automation commonly creates more, and better-paying, jobs than it destroys. Greg Ip for the WSJ explains. Stop pretending you really know what AI is and read this instead.

• What goes up must come down for cryptocurrencies. The summer of bitcoin looks to be ending badly. The biggest cryptocurrency dropped as much as 40 percent since reaching a record high of $4,921 on Sept. 1, cutting about $20 billion in market value. The collapse extended to as much as 30 percent this week since China began sending stronger signals of a clampdown on Sept. 8, making this the biggest five-day decline since January 2015, when it traded at around $200. JPMorgan Chase CEO Jamie Dimon took a shot at bitcoin, saying the cryptocurrency "is a fraud" but can you really blame him given Bitcoin’s status as “the most crowded investment in the world”? Don’t believe the hype about the tremendous returns on “initial coin offerings”. Great piece on ICOs and the promise and perils of global capital markets for everyone. Canada also poured cold water on ICOs in a notice last week, in which regulators there warned that the "coins" in "Initial Coin Offerings"—a popular new way for companies to raise money using cryptocurrency—are likely to be securities. What’s interesting is that with the changing of the tides it hasn’t just been bitcoin tanking. Virtually all cryptocurrencies have taken a beating. Nevertheless, the coins already appear to be recovering...

• In world of supposed bubbles here’s what investors fear most. From Alan Greenspan and the current Federal Reserve staff to fund managers hoarding cash, people feel queasy about asset prices. Euro high-yield debt is trading in line with U.S. Treasuries for the first time ever. Tajikistan is selling Eurobonds as yields on the junkiest emerging markets drop below 6 percent. An exchange-traded fund for betting on low volatility has more than doubled in size this year. And let’s not get started on the bitcoin rally.

• Making money during the apocalypse. Bryan Menegus reports for Gizmodo from a conference whose attendees envisage a future where capitalism is under siege. “The machinery of freedom” apparently will include floating sea colonies, special economic zones, and stateless cryptocurrencies. And it’s up to these elite techno-libertarian attendees to ensure that future happens—whether it benefits the rest of the world or not.

• How Warren Buffett broke American Capitalism. Provocative piece in the FT time suggesting that the investment style of Warren Buffett may have had disastrous effects on the economy. Are “high moats” not simply “monopolies”? Can an investment philosophy have negative effects on an economy?

• Mind control isn’t sci-fi anymore. 2017 has been a coming-out year for the Brain-Machine Interface (BMI), a technology that attempts to channel the mysterious contents of the two-and-a-half-pound glop inside our skulls to the machines that are increasingly central to our existence. The idea has been popped out of science fiction and into venture capital circles faster than the speed of a signal moving through a neuron. Facebook, Elon Musk, and other richly funded contenders, such as former Braintree founder Bryan Johnson, have talked seriously about silicon implants that would not only merge us with our computers, but also supercharge our intelligence.

• The healing power of nature. The idea that immersing yourself in forests and nature has a healing effect is far more than just folk wisdom. Blood tests revealed a host of protective physiological factors released at a higher level after forest, but not urban, walks. Among those hormones and molecules, a research team at Japan’s Nippon Medical School ticks off dehydroepiandrosterone which helps to protect against heart disease, obesity and diabetes, as well as adiponectin, which helps to guard against atherosclerosis. In other research, the team found elevated levels of the immune system’s natural killer cells, known to have anti-cancer and anti-viral effects. Meanwhile, research from China found that those walking in nature had reduced blood levels of inflammatory cytokines, a risk factor for immune illness, and research from Japan’s Hokkaido University School of Medicine found that shinrin-yoku lowered blood glucose levels associated with obesity and diabetes. GET OUT THERE.

Our best wishes for a fulfilling week, 
 

Logos LP

• Asset Management 4
• Ideas 19
• Macro 9
• Newsletter 87
• Psychology 4
• Strategy 7

Stealth Bear Markets

Good Morning,
 

U.S. equities managed to stage a comeback from their session lows on Friday after Steve Bannon, one of President Donald Trump's top advisors, left the administration. Traders at the New York Stock Exchange literally cheered the news that Bannon was out of the administration.

The Dow and the S&P fell 0.8 percent and 0.7 percent for the week, respectively, marking their first two-week losing streak since May. The Nasdaq, meanwhile, posted a four-week losing streak, its longest of the year.

In Europe, stocks extended their declines after a horrific terrorist attack in Barcelona added to unease about U.S. policy paralysis and lingering tensions over North Korea.

Tension between Bannon and other top advisors to Trump, including Chief Economic Advisor Gary Cohn and National Security Advisor H.R. McMaster, had been intensifying inside the White House. On Wednesday, Reuters reported that disagreement between Bannon and McMaster is destabilizing Trump's team.

As volatility picked up this week with the VIX rallying roughly 44% from its lows only a month ago, investors grew worried that Trump's economic agenda, which includes tax reform and fiscal stimulus, will not get through Congress. These concerns only grew as backlash multiplied from Trump's remarks following the violent protests in Charlottesville, VA.

This led to Trump dissolving two CEO advisory forums, one of which included JPMorgan Chase's Jamie Dimon. Rumors also started circulating Thursday that Cohn, Trump's top economic advisor, could resign amid the fallout.

Investors pulled $1.3 billion from equity funds in the week ending Aug. 16 as tensions over the Korean peninsula escalated, according to EPFR Global data. Outflows from U.S. stock funds were triple that, suggesting a growing risk off attitude.

Our Take
 

Largely lost in the debate over how much credit President Donald Trump should or should not get for the performance of U.S. stocks this year is that perhaps the biggest reason for the rally is strong earnings. With more than 90 percent of the S&P 500 members having reported second-quarter results, earnings growth is tracking at a 12.2 percent pace year-over-year, much better than the 8.4 percent expected, according to Bloomberg Intelligence.

All sectors of the benchmark are on pace to beat projections, except energy, where less than 40 percent of companies topped earnings forecasts. Technology and healthcare continue to lead upside surprises, with more than 85 percent of tech companies and 75 percent of health companies posting better-than-expected earnings per share.

This is all great news yet markets are forward looking, so it stands to reason that what happens next in earnings should have a big influence on the direction of stocks.

That’s where things may be looking a bit less tremendous. Despite the positive earnings surprises in second-quarter results, S&P 500 profit estimates for the next four quarters continue to edge lower. Earnings per share forecasts for the index through mid-2018 have been reduced by 0.7 percent since the end of June, with the fourth-quarter bearing the brunt of downward revisions, according to Bloomberg Intelligence. But should this worry the prudent long-term investor?

FactSet this week presented a nice overview of the charts/data that tell the story of 2017 so far. A few interesting trends which we believe are likely to continue through Q3 and Q4 were:

1) Consumer spending is not keeping up with consumer sentiment (not a good thing)

2) Consumer price inflation is slowing even as the Fed is planning to tighten (also not good)

3) Companies in the S&P 500 with more global revenue exposure are projected to report higher earnings and revenue growth in 2017 relative to companies in the index with less global revenue exposure. (perhaps a source of opportunity)
 

At the sector level, the Information Technology sector is expected to be the largest contributor to earnings and revenue growth in 2017. No wonder the Russel 2000 is up a measly 0.05% YTD while the Dow is up 9.67% and the S&P 500 is up 8.33%.

Absent any significant changes in foreign exchange rates and global GDP growth in the second half of 2017 which could alter these expected earnings and revenue growth rates for the full year, it is unlikely that David Tepper’s bold call that technology stocks "look cheaper than any other part of the market even though they moved” will prove foolish.  

So what are the opportunities? Well, we have spotted one such opportunity that recently took a dive after an earnings miss: Priceline Group Inc. (NASDAQ: PCLN).

This online travel reservation business has been growing pre-tax earnings over the last decade at a compound annual rate of 42% per year. That is faster than Apple, Amazon, Netflix, Alphabet and Expedia (Expedia has been growing EBITDA over the last decade at around 7%).

Average ROE is about 28.4% and long-term prospects also look favorable. Last year travel accounted for roughly 10% of global GDP or $7.6 trillion and only about ⅓ of it is booked online. This share is expected to grow by a few percentage points per year and thus although rivals such as AirBnB, Tripadvisor, Expedia, Ctrip and perhaps Google are circling, the future looks bright indeed.

Sitting roughly 12% off its 52 week high Priceline is getting attractive. A move under 1600 or another 12% down from current levels and we would look to initiate a position.

Musings

Came across a pretty interesting chart this week from Michael Batnick which painted a nice picture of how the market has scaled the “wall of worry” in defiance of a plethora of doomsday predictions of an imminent selloff.

As the graph shows, since stocks bottomed in March 2009, the S&P 500 index has soared 271% to multiple records, meandering higher through the European debt crisis, Brexit, and the U.S. presidential election.

Political upheaval certainly does not necessarily translate to market volatility. But more importantly, the chart got me thinking about a common refrain these days: “things can’t keep going up like this”. Is that true? Are “things” bound to collapse? What may be more relevant to consider is what we mean by “things”?

Looking at this current market as a "market of stocks" rather than as a "stock market" it is clear that “things” most certainly cannot keep going up and in fact “things” most certainly are not continuously going up: The average Russell 2000 stock is already in a bear market, falling 22.42% from its 52-week high. The median Russell 2000 stock is 17.38% from its 52-week high. Likewise, the average and median S&P 500 stock are 8.04% and 11.77% from their 52-week highs.

What of this record bull market then? Well it may be that we have experienced several “stealth” bear markets within the current long-term uptrend.

It should be remembered that market crashes of over 30% are incredibly rare events. Could the bear market that so many people are predicting these days have already happened?

I think this an argument worth considering given the fact that research has shown that in 189 years of stock returns only 3 times since 1825 did the market finish a calendar year down 30% or worse. That’s about once every 63 years...recency bias is a hell of a drug...
 

Logos LP July Performance

 

July 2017 Return: -1.16%

2017 YTD (July) Return: +18.67%

Trailing Twelve Month Return: +21.59%

3-Year Annualized Return: +22.55%

Thought of the Week

"After seeing a movie that dramatizes nuclear war, they worried more about nuclear war; indeed, they felt that it was more likely to happen. The sheer volatility of people's judgement of the odds--their sense of the odds could be changed by two hours in a movie theater--told you something about the reliability of the mechanism that judged those odds.” -Michael Lewis

Articles and Ideas of Interest

• Ten years ago from August 9, people weren’t that worried about impending financial doom. Ten years ago August 9, all was not well with the global financial system. On Aug. 9, 2007 BNP Paribas froze more than $2 billion in funds, barring investors from withdrawing their money due to a “complete evaporation of liquidity in certain market segments.” This marked the beginning of a dangerous new phase in what eventually developed into the worst economic downturn since the Great Depression. What did we learn? Reuters puts together a decade in charts. Financial Times suggests that there were clear warnings that Wall Street ignored.

• Time to focus on return of capital strategies? Is there anybody left recommending risk assets? It sure seems like if there are, they are few and far between. The number of influential pundits warning about the risk of investing in assets such as corporate bonds and equities is growing exponentially. Recently it was Oaktree Capital Group co-Chairman Howard Marks and former Federal Reserve Chairman Alan Greenspan. Last week, it was the likes of DoubleLine Capital Chief Executive Officer Jeffrey Gundlach, HSBC Holdings’ head of fixed-income research Steven Major and Pantheon Macroeconomics Chief Economist Ian Shepherdson. Have we reached the point in the investment cycle where you’ve got to start thinking the return on capital is rather less important than the return of capital…Luckily for doomsday preppers, the end of the world is good for business.

• Is passive investing “devouring capitalism”? Billionaire Paul Singer is warning of a growing and menacing threat: passive investing.“Passive investing is in danger of devouring capitalism,” Singer wrote in his firm’s second-quarter letter dated July 27. “What may have been a clever idea in its infancy has grown into a blob which is destructive to the growth-creating and consensus-building prospects of free market capitalism.” Almost $500 billion flowed from active to passive funds in the first half of 2017. The founder of Elliott Management Corp. contends that passive strategies, which buy a variety of securities to match the overall performance of an index, aren’t truly "investing" and that index fund providers don’t have incentive to push companies to change for the better and create shareholder value. Cranky underperforming manager (Singer’s Elliott Associates fund rose 0.4 percent in the second quarter, bringing gains for the first half to 3.5 percent) or luminary? The Atlantic explores the growing chorus of experts that argue that index funds are strangling the economy. I would agree. Diversification has brought undeniable benefits to large numbers of Americans. If recent scholarship is right, it has brought hidden costs to many more. For the opposing view see Gadfly.

• Forget robots — “super-workers” may be coming for your job. According to a report from PwC, one outcome of technology and automation could be the rise of the medically-enhanced “super-worker” by 2030. These workers will combine man, machine, and medical enhancements (like pharmaceuticals to boost cognition) to secure employment and guarantee performance in an increasingly competitive labor market. 70% of those surveyed by PwC said they’d undergo treatments to improve their bodies and minds if it would help their job chances. On a small scale, some of this is already happening: A Wisconsin firm recently made headlines for microchipping employees.

• Lego-Like brain balls could build a living replica of your brain. The human brain is routinely described as the most complex object in the known universe. It might therefore seem unlikely that pea-size blobs of brain cells growing in laboratory dishes could be more than fleetingly useful to neuroscientists. Nevertheless, many investigators are now excitedly cultivating these curious biological systems, formally called cerebral organoids and less formally known as mini-brains. With organoids, researchers can run experiments on how living human brains develop—experiments that would be impossible (or unthinkable) with the real thing.

• Digging for digital gold in Inner Mongolia. The crypto currency mania shows no sign of abating. Consider the case for $5000 bitcoin (why not $10000?). Yet also consider that at the heart of bitcoin are miners running massive computing operations to earn the $7 million up for grabs each day for solving complex mathematical equations. Zheping Huang and Joon Ian Wong got access to one of the world’s largest bitcoin mines, Bitmain, and offer a rare look at the lives of its workers, as does a photo essay for Quartz by Aurelien Foucault. I see bitcoin as here to stay. Perhaps grandpa had a pension and this generation has cryptocurrency. Great piece in the New York Times suggesting that “as traditional paths to upper-middle-class stability are being blocked by debt, exorbitant housing costs and a shaky job market, these investors view cryptocurrency not only as a hedge against another Dow Jones crash, but also as the most rational — and even utopian — means of investing their money."

Our best wishes for a fulfilling week, 
 

Logos LP

How To Make Better Decisions

Good Morning,
 

U.S. stocks limped into the weekend on a sluggish final day of trading, while the dollar fluctuated with oil as investors assessed data showing the U.S. economy on solid footing.

The S&P 500 Index moved between gains and losses before closing higher by less than a point -- good enough for a seventh straight gain and fresh record in trading 25 percent below the 30-day average.

The U.S. economy’s first quarter GDP came in this Friday and it wasn’t so miserable after all, as consumption contributed more to growth and business investment was even stronger than thought.

Our Take
 

The S&P 500 and Nasdaq indexes both hit record highs this week, and the Dow flirted with its own all-time high. Investors seem to be signalling that everything is honky-dory even as the political headlines remain concerning. Tax and healthcare reform appear to be even further out of reach as the investigations into the Trump administration (now Jared Kushner under scrutiny) deepen.

But are these headlines so concerning? In the short-term political events can trigger short term buying opportunities but research has shown that political crises rarely have a lasting impact on markets. There is an abundance of liquidity in this market with a lot of cheap money chasing a returns. This is no doubt one factor contributing to the rally, but more importantly investors are focusing on the strengthening economy, signs from the central bank that interest rates will continue to rise, and the best quarter of corporate-earnings growth in five years.

Furthermore, there still exists a record amount of bearishness. The S&P 500 Index has climbed 7.9 percent since January, including its biggest gain since April in the just-completed week. At the same time, short interest as a proportion of total shares outstanding has also expanded, rising by 0.3 percentage point to 3.9 percent. Never before has an equity advance as big as this year’s occurred simultaneously with more short sales, according to exchange data compiled by Bloomberg that goes back to 2008.

There is no euphoria!

Bloomberg this week reported that investors are pulling money out of stocks after the initial rush to buy faded along with the optimism over Trump’s pro-growth policy. They have withdrawn $20 billion from exchange-traded funds and mutual funds this quarter, reversing about one third of the inflows seen between November and March, according to data compiled by Bloomberg and Investment Company Institute.  

Bullish bets are also shrinking in the futures market. Net long positions in S&P 500 contracts held by large speculators fell in seven of the last eight weeks and were closer to turning net short than any time since December, data compiled by Commodity Futures Trading Commission show.

The challenge for short sellers is how long they can stay solvent before being forced to buy back the shares that they have borrowed and sold. And the pressure to cover is building. The potential for a swift melt up is increasing…..

Musings
 

Last weekend I was on vacation and had the opportunity to read a wonderful book “Charlie Munger: The Complete Investor” by Tren Griffin. Munger is one of the world’s most successful investors better known as Warren Buffett’s partner at Berkshire Hathaway.

What is most interesting about Munger is not his success as an investor but the way he thinks and keeps his emotions under control.

The book offers a great overview of Munger’s ideas and methods which can help us make better decisions, be happier and live a more fulfilling life. Why? Because investing, like life is about decision making. Everyday we are faced with a spectrum of possible decisions which will set us along one path or another.

As such, misjudgement can wreak havoc upon the outcomes of our lives.

What is the psychology of human misjudgement?

Humans have developed simple rules of thumb called heuristics, which enable them to efficiently make decisions. Heuristics are essential as without them humans would be unable to process the vast amount of information they face on a daily basis.

The problem is that these shortcuts can sometimes result in tendencies to do certain things that are dysfunctional.

The upside is that we can learn to identify these dysfunctional tendencies and overcome them. This is the key to better decision making. What are some of the most common of these tendencies? There are over 20 explained in the book but these are those that stood out most:

1. Liking/Loving Tendency

   1. People tend to ignore or deny the faults of people they love and also tend to distort the facts to facilitate love.

2. Inconsistency-Avoidance Tendency

   1. People are reluctant to change even when they have been given new information that conflicts with what they already believe. The desire to resist any change in a given conclusion or belief is particularly strong if a person has invested a lot of effort in reaching that conclusion or belief.

3. Kantian Fairness Tendency

   1. Humans will often act irrationally to punish people who are not fair. In other words they may act irrationally when presented with a situation that they feel is unfair. Some would rather lose money in an investment than see another person benefit from “perceived” unfairness.

4. Envy/Jealousy Tendency

   1. Very primal emotions are triggered when humans see someone with something they don’t have often causing dysfunctional thoughts and actions. In this world of abundance there is nothing but unhappiness to be gained from envy.

5. Reciprocation Tendency

   1. The urge to reciprocate favors and disfavors is so strong that people will feel uncomfortable until they can extinguish the debt.

6. Simple, Pain-Avoiding Denial

   1. People hate to hear bad news or anything inconsistent with their existing opinions and conclusions. If something is painful people will work to even deny the reality.

7. Excessive Self-Regard Tendency

   1. People tend to vastly overestimate their own capabilities. The most effective way to reduce risk in any situation is to genuinely know what you are doing.

8. Deprival Super-Reaction Tendency

   1. Loss aversion- we irrationally avoid risk when we face the potential for gain, but irrationally seek risk when there is a potential for loss.

9. Social Proof Tendency

   1. Humans have a natural tendency to follow a herd of other humans. We view a behaviour as more correct to the degree we see others performing it. This is how bubbles form. The herd is rarely correct.

10. Authority-Misinfluence Tendency

    1. People tend to follow people who they believe are authorities or have the right credentials. Especially when they face risk, uncertainty or ignorance.

Think independently!

Thought of the Week
 

"“The best thing a human being can do is help another human being know more.” - Charlie Munger

Articles and Ideas of Interest

• The meaning of life in a world without work. As technology renders jobs obsolete, what will keep us busy? Sapiens author Yuval Noah Harari examines ‘the useless class’ and a new quest for purpose. Could playing virtual reality games be the answer? But what about truth? What about reality? Do we really want to live in a world in which billions of people are immersed in fantasies, pursuing make-believe goals and obeying imaginary laws? Well, like it or not, Harari suggests that may be the world we have been living in for thousands of years already...

• Why you should learn to say no more often. The NYT suggests that humans are social animals who thrive on reciprocity. It’s in our nature to be socially obliging, and the word no feels like a confrontation that threatens a potential bond. But when we dole out an easy yes instead of a difficult no we tend to overcommit our time, energy and finances. Do you have the ability to communicate ‘no’ and reflect that you are actually in the driver’s seat of your own life?

• The cryptocurrency mania may just be starting. Practically this entire week on CNBC the top 5 most popular articles were bitcoin related with bitcoin more than doubling in price this year alone and its closest rival Ether up over 2,300 percent! Yes 2,300 percent. There are a few theories for why the currencies have been rallying so much the most convincing being that bitcoin has been getting support from certain governments and investors and that the ethereum blockchain has been getting serious backing by major corporations wishing to use the technology for smart contract applications. I have no interest in trading currency or speculating on its price action but what worries me about products like Ether is that they can be cloned. The people buying Ether are buying a specific blockchain while the technology underlying it is what is most valuable. Cryptocurrencies are proliferating with new currencies being launched at record speeds. Canada-based Kik's cryptocurrency, Kin just launched this week which is also based on the ethereum blockchain. If I were to invest in a crypto currency I would look at bitcoin and take 1% or less of what I own, buy bitcoin with it, and then forget about it for at least the next five years; ideally the next decade. The way I see it you will either lose 1% of your net worth or make incredibly large sums. You can find the ways to buy it here.

• Toronto homeowners are suddenly in a rush to sell. Toronto’s hot housing market has entered a new phase: jittery. After a double whammy of government intervention and the near-collapse of Home Capital Group Inc., sellers are rushing to list their homes to avoid missing out on the recent price gains. The new dynamic has buyers rethinking purchases and sellers asking why they aren’t attracting the bidding wars their neighbors saw just a few weeks ago in Canada’s largest city. Interestingly, a Canadian regulator this week said it disciplined two mortgage brokers who funneled business to Home Capital Group Inc., marking the first disclosure of action taken against dealers who submitted fraudulent loan applications to the embattled mortgage lender. The Financial Services Commission of Ontario conducted its own review into Home Capital in relation to the company severing ties in 2015 with 45 brokers who used falsified client income on applications. This is a big deal….this means that many Canadians may be delinquent or be under real stress in affording their home since who knows what they put down as income. According to Equifax, mortgage fraud jumped 52 percent last year from 2011, showing the issue may only be growing. House of cards? No wonder a recent Manulife study indicated that a mere 10% hike to mortgage payments would sink almost ¾ of Canadian homeowners. Robert Shiller for the NYT reminds us how tales of “flippers” led to the last housing bubble.

• The phrase “late capitalism” is suddenly everywhere. The Atlantic suggests that “Late capitalism,” in its current usage, is a catchall phrase for the indignities and absurdities of our contemporary economy, with its yawning inequality (new research suggests that your financial fate is sealed by the time you turn 25) and super-powered corporations (new research also suggests that employers often implicitly, and sometimes explicitly, act to prevent the forces of competition from enabling workers to earn what a competitive market would dictate, and from working where they would prefer to work) and shrinking middle class. Interesting read chronicling the perverse ways our “developed” economy is progressing. What do growth and productivity even mean in an economy that has moved from manufacturing (whose products can be counted) to services (which can't be)? Do economies driven by information and software need new metrics for progress? And what, if anything, can an economy at the technological frontier do to make living standards rise faster?

Our best wishes for a fulfilling week, 
 

Logos LP