Where Is "The Crowd"?

Good Morning,

U.S. equities rose on Friday on better-than-expected employment data. The Dow Jones industrial average hit a record high and closed 66.71 points at 22,092.81. Goldman Sachs contributed the most gains. The index also posted its eighth straight record close.


Banks, including Goldman Sachs, outperformed the market, with the SPDR S&P Bank exchange-traded fund (KBE) advancing 0.81 percent. The space received a boost from a jump in interest rates, which followed strong U.S. employment data. The U.S. economy added 209,000 jobs last month, according to the Labor Department, well above the expected gain of 183,000.


On the Canadian side, Canada’s labor market continued its stellar performance in July, with the jobless rate falling to the lowest since before the financial crisis. The unemployment rate fell to 6.3 percent, the lowest since October 2008, as the labor market added another 10,900 jobs during the month, Statistics Canada reported from Ottawa. The total increase over the past year of 387,600 is the biggest 12-month gain since 2007. These jobs figures will likely bolster confidence that the country is quickly running out of economic slack and higher Bank of Canada interest rates may be needed to cool off growth...


Our Take

The US report was very strong. Timing couldn’t be better as we are moving into the tail end of Q2 earnings as well as into August and September which are typically weak months for the market. This was a beat and raise guidance jobs number and the second month in a row the U.S. has come in above 200,000 and above expectations.


Furthermore, although lower wage Americans are still reeling from the great recession, they are finally getting some relief in the jobs market. Underneath a 209,000 gain in July payrolls, significant shares of job growth were in lower-wage industries such as restaurants and home health-care services. As the overall labor-force participation rate ticked up 0.1 percentage point, the level for people age 25 or older without a high school degree surged to the highest since 2011. In leisure and hospitality, which typically carries lower pay, annual wage gains of 3.8 percent outpaced the average. (For a breakdown of who is hiring see here)


Other indicators suggest that even with the tightening job market, some slack still remains. That leaves room for additional gains that would back up President Donald Trump’s drive to bring people back into the workforce as well as support the Federal Reserve’s go-slow approach to tightening credit. This is good news and suggests that perhaps we haven’t yet reached the peak of this economic cycle.


U.S. equity indexes have been on a roll lately with the Dow notching eight straight record closes.


Nevertheless, all is not rosy. Amid the talk of new highs and record levels, one section of the equity market is having trouble keeping up. Small-cap stocks, on track for their second weekly decline with a loss of 1.7 percent, are falling further behind benchmark equity gauges.


In addition, underneath what was another up week for the S&P 500 Index, things were a little more complicated. An equal weight version of the S&P 500 that strips out market value biases just posted its biggest weekly drop since May, and its worst week versus the regular S&P 500 all year. The reason: while enough megacap stocks rose to keep the S&P 500 afloat, single-stock blowups were far more common than single-stock rallies.


Perhaps we haven’t quite reached euphoria just yet…


During these summer months I’ve gotten the opportunity to reconnect with old friends and learn a few new things whilst doing so. Of great interest have been several conversations with those in the corporate sector.


Among many other enlightening insights, I was startled to hear of a new phenomenon in current deal making circles: deal quality has been decreasing. Deals are getting done that just 1-3 years ago would have been laughed at for their overvaluation, shoddiness, and/or high risk. Interesting data tending to support that risk-taking may be on the rise...


If not by coincidence one of our favorite investors Howard Marks put out a cautionary memo last week entitled “There they go again...Again” suggesting that “they” are “engaging in willing risk-taking, funding risky deals and creating risky market conditions.


Marks suggests 4 attributes of today’s investment environment: 1) uncertainties are unusual in number and scale 2) prospective returns for the vast majority of asset classes are about the lowest they have ever been 3) asset prices are high across the board 4) pro-risk behaviour is commonplace


These attributes support his overall suggestion that in this environment one should move forward with caution. As always, the memo is worth a close read.


Marks supports his 4 overarching attributes of the current market environment with several fascinating vignettes each showcasing “willy nilly risk taking” in a variety of asset classes.


  1. U.S. equities: Many metrics such as average p/e, Shiller p/e and the “Buffett yardstick” and record low interest rates suggest stock prices are at lofty levels.

  2. The VIX: The VIX is at record lows and this suggests that investor sentiment is largely positive.

  3. Super-stocks: Bull-markets are marked by a single group of stocks that are “the greatest” and the FAANGs are having their moment. When the mood is positive multiples rise as one “can’t lose” in these names.

  4. Passive investing/ETFs: These approaches are on the rise and in the current up-cycle, over-weighted, liquid, large-cap stocks have benefitted from forced buying on the part of passive vehicles, which don’t have the option to refrain from buying a stock just because its overpriced. Investors are thus turning capital over to a process in which neither individual holdings nor portfolio construction is the subject of thoughtful analysis and decision-making, and in which buying takes place regardless of price…

  5. Credit: Low grade credit instruments are proliferating. Junk bond offerings are over subscribed and offer weak investor protections.

  6. Emerging market debt: For only the third time in history, emerging market debt is selling at yields below those on U.S. high yield bonds.  

  7. Private equity: PE firms will probably add more than a trillion dollars to their buying power this year.  Where will it be invested at a time when few assets can be bought at bargain prices? Too much money is chasing too few good deals. Standards are relaxing.

  8. Venture capital: SoftBank’s recent raising of $93 billion for its Vision Fund for technology investments – presumably on the way to $100 billion. Can one wisely invest $100 billion in technology?

  9. Digital currencies: digital currencies are nothing but an unfounded fad (or perhaps even a pyramid scheme), based on a willingness to ascribe value to something that has little or none beyond what people will pay for it.  The same description can be applied to the Tulip mania that peaked in 1637, the South Sea Bubble (1720) and the Internet Bubble (1999-2000).

This is a fascinating selection of examples yet perhaps the most interesting thing in the memo was his acknowledgement that many market participants are aware of these issues and agree that things can’t go well forever – that the cycle is extended, prices are elevated and uncertainty is high.


These cautious beliefs are what makes calling a top in this market so hard. Just this week CNBC ran a poll which asked readers “Is the stock market about to suffer an epic crash?”


11,736 readers voted and 44% of them said yes, 33% said no and 26% said not sure.


Think about that.


The poll didn't ask, "Is the stock market overvalued?" or "Will the stock market decline for the rest of the year?" (or in the next year, or anything like that). It asked about "an epic crash," and not just any time, but specifically about whether the market is about to crash. "About to" means that it's going to happen very soon.


It is rather incredible that such a large proportion of people say they expect such an extreme and rare event to happen within such a narrow time frame.


Not to mention, as Josh Brown reminded us in response to the Marks memo, that we’ve got an entirely lost generation of investors, the millennials, who prefer to hold cash and even bonds than own stocks.


Could the behaviour of the crowd (as Brown defines it) be telling a different story than the anecdotes in the Marks memo? A story of caution and bearishness?


Without a doubt, as Josh Brown points out, it is as good a time as any to be cautious as caution should be the default orientation for any serious investor.


But I believe this debate highlights something else of great importance that has plagued the pundit, the asset manager and the individual investor throughout this epic bull run: the consensus or “crowd” has been incredibly hard to pin down. Each of these groups seems unable to agree upon what the “consensus view” is.


Timeless investment wisdom suggests that avoiding the crowd is a good bet for beating the stock market but this is difficult for most as there is ample evidence to support one’s own definition of “the crowd”.


The crypto currency trader believes his asset class is misunderstood and unloved. He sees himself as ahead of the curve and thus ahead of the crowd while the value investor looks upon him with disdain. “Just another herd follower chasing returns with the crowd…”


As such, rather than expending excessive energy on the identification of “the crowd” it may be best to humbly return to first principles: What do I understand and what is my sphere of investment competence? What do I reasonably believe is valuable and can be acquired for less than it should be? Am I being skeptical enough? Do I accept that there is no free lunch?

Logos LP in the Media


Commentary from Logos LP on investment opportunities in the defense sector in Forbes Magazine.

Thought of the Week


"Anyone can hold the helm when the sea is calm.” -Publilius Syrus

Articles and Ideas of Interest


  • How bond markets can predict moves in stocks. Interesting research suggesting that high-yield bonds moving with the ebbs and flows of U.S. earnings announcements tend to predict stock returns for a slew of issuers -- particularly firms with a modest level of institutional equity ownership. So perhaps stock investors seeking an informational edge should keep their eyes on junk-bond prices on the heels of earnings reports.


  • Commodities are a losing bet. Over the past 10 years, the Bloomberg Commodities Index is down 6.5 percent per year for a total loss of almost 50 percent. Over that same time frame, the S&P 500 is up a total of close to 100 percent, or a 7 percent annual return. This difference in performance has led to a huge divergence in the ratio of commodities to stocks, which has compelled some investors to ask whether there is a buying opportunity in commodities. There is also no financial reason that dictates that commodities must exhibit mean reversion. They provide no dividends or income. They don’t have earnings. Commodities are more of an input than a financial asset. In many ways, a bet for commodities is a bet against technology and innovation. Commodities have shown lower returns than cash equivalents with higher volatility than stocks. This is a poor risk-return relationship.


  • There is no U.S. wage growth mystery. Economists are puzzled over U.S. wage growth, wondering why it has been so slow despite a labor market that is allegedly back to or close to full employment. Nice piece in Moody’s suggesting that if you look at the right wage growth and the right measure of employment slack there is no mystery: Wage gains are right where they should be. And it indicates the labor market has room to improve.


  • Is productivity growth becoming irrelevant? As we get richer, measured productivity may inevitably slow, and measured GDP per capita may tell us ever less about trends in human welfare. Measured GDP and gains in human welfare eventually may become entirely divorced. Imagine in 2100 a world in which solar-powered robots, manufactured by robots and controlled by artificial intelligence systems, deliver most of the goods and services that support human welfare. All that activity would account for a trivial proportion of measured GDP, simply because it would be so cheap. Conversely, almost all measured GDP would reflect zero-sum and/or impossible-to-automate activities – housing rents, sports prizes, artistic performance fees, brand royalties, and administrative, legal, and political system costs. Measured productivity growth would be close to nil, but also irrelevant to improvement in human welfare.


  • Why aren’t Americans moving anymore? In the 1990s, 3% of Americans moved out of state each year. Now the rate is half that, with US mobility hitting the lowest level since World War II. “The lack of mobility in the American workforce is a huge blocker of our economic growth,” says Ryan Sager, editorial director for Ladders. It's "definitely hurting Main Street,” writes business analyst Thanh Pham, who says there’s a mismatch between cities with abundant jobs and areas with potential workers. There are myriad reasons for the slowdown in mobility, from lack of job stability to the prohibitive expense of actually moving. Aeon suggests we are living in the quitting economy where employees are treated as short-term goods and thus market themselves as goods, always ready to quit.


  • A highly successful attempt at genetic editing of human embryos has opened the door to eradicating inherited diseases. This is huge and ushers in a new era. Shoukhrat Mitalipov has performed the first highly successful use of the gene-editing technique called Crispr to improve human health: his team was able correct a genetic mutation that causes a life-threatening cardiac disease. None of the embryos were allowed to come to term. But if Mitalipov has his way, future projects could eradicate a disease that affects millions—one in 500 people carry the mutation—and even kills unsuspecting, seemingly fit adults.          


  • Best summer reads 2017. Great list out of The Guardian. My favorite I revisit each summer: Herman Hess - Sidhartha.


Our best wishes for a fulfilling week, 

Logos LP