Older, Slower and Entitled

Good Morning,
 

Major U.S. stock averages rebounded Friday, but closed the week in the red amid fears of the Federal Reserve pulling back its stimulus as well as concern regarding the delta variant. 

Minutes from the Fed’s July meeting released this week showed the central bank is willing to start reducing its monthly asset purchases this year. Investors sold equities and commodities this week buying bonds on fears that a “backwards looking” move by the Fed could upend the global economy already under stress by the delta variant.


Our Take


With investors considering a Fed tapering while the delta variant keeps spreading, the transition away from liquidity/policy regime to more mid-cycle markets means volatility is likely set to continue.   

Policy error represents the most obvious risk for markets. For weeks, changes in the economic data suggest that economic growth is slowing, rates have been heading lower, the dollar has headed higher, and commodities have by and large corrected. According to the bears, this picture seems to suggest that any Fed tapering this fall - just as the global economy's growth is normalizing - could create a growth scare, and as a result, that theFed would have begun taperingat the wrong moment leading to further economic weakness and eventually a stock market rout.

This may or may not occur. Corrections are inevitable and although we do think that it would be unwise to chase many major index components as future returns from these levels appear unattractive, we do believe that the strength of this bull market is remarkable. 

This year alone the S&P has hit 48 new highs. Since we finally broke through the 2007 pre-GFC highs in the summer of 2013 we’re now looking at more than 320 new highs in this bull market. The gains are smaller, befitting a less extreme year as when the S&P 500 Index has risen in 2021, the daily increase has been half what it was in 2020. But in terms of persistent, day-after-day gains, these seven months in the U.S. stock market have few historical precedents.

Interestingly, as Nir Kaissar points out for Bloomberg, the past 30 years may not be an anomaly but a new normal. 

For about 120 years from the 1870s to the 1980s, the U.S. stock market reliably reverted to its long-term average valuation, and just as important, it spent roughly equal time above and below that average. Investors could therefore expect an expensive market to become cheaper and a cheap market to become more expensive, a useful assumption when estimating future stock returns. 

Since 1990, however, the market has rarely dipped below its long-term average valuation, the notable exception being the period around the 2008 financial crisis. Neither the dot-com bust in the early 2000s nor the Covid-induced sell-off last spring managed to subdue it.

Accordingly, with volatility moderate and the uptrend persisting, any trading tools that told investors to do anything but buy are failing. When applied to the S&P 500, half of the 22 charts-based indicators tracked by Bloomberg have lost money since the end of March, back-testing data show. All of them are doing worse than a simple buy-and-hold strategy, which is up 12%. 

Over the past 10 years, the S&P 500 is up almost 360% while gold is down 2%. That’s a lost decade for gold, even after it was up 25% in 2020 and 18% in 2019.

It has been incredibly profitable to adhere to the classic mantras of “don’t fight the fed” and “the trend is your friend”. Investors buying virtually every dip have been rewarded. 

Most non-recession 10%+ corrections over the past 25 years began with certain conditions. They all typically start with wildly overbought conditions and excessive optimism. We can’t predict when the party will end, but we do believe that “wildly overbought” and “excessive optimism” are not at present characteristic of the prevailing sentiment. Furthermore, for many high quality companies, multiples have been contracting and fundamentals have been improving. You just need to know where to look….

 Musings
 

Humans are creatures of habit and easily susceptible to conditioning. From childhood we learn (the hard way) to avoid touching a hot stove and alternatively, we learn that certain behaviours such as doing our chores will earn us rewards from our parents. We learn (or are supposed to learn) that by working hard and developing the right skills and habits we will get ahead and unlock a more “pleasant” life. 

Our environment influences us. We react to the incentives and disincentives we are presented with attempting to reduce pain and maximize pleasure and this process of conditioning shapes our behaviours and attitudes. 

The economy and markets work similarly because after all, they are composed of humans. Given the incredible shock Covid-19 represented (which we are still dealing with), we’ve been thinking a lot about the conditioning it has precipitated or perhaps accelerated. How have our brains/habits and thereby societies and economies been re-wired? 

Aware of the seemingly endless amount of time one could spend on this topic, one thing in particular has caught our attention. 

The fact that the labor force in the US has shrunk (this is a phenomenon that is also  affecting most developed economies). The US economy has been creating jobs at a rapid clip. Employment has risen by an average of about 617,000 people per month so far this year.

While the total number of Americans who are working is still more than 5 million short of 2019 levels, there is work available. The number of open positions surged to a record 10 million-plus in June.

Nevertheless, many employers say they’re having trouble filling those jobs, even with the unemployment rate still relatively high.

That points to one big question-mark around the recovery. Americans have dropped out of the labor force.

More than half of the unemployed have been out of work for 15 weeks or longer and, on average, it’s taking people 29.5 weeks to find a job -- even with all those openings.

Why? Common explanations fall into three categories. 

1. Disruption owning to the spread of Covid-19

2. The Impact of welfare policy

3. Changes to attitudes wrought by the pandemic 

When it comes to the first bucket it is believed that school closures have made it impossible for parents, particularly mothers to take a job. The evidence of this is more mixed and less compelling. Furthermore as restrictions ease, Covid-19 recedes and children head back to school, such issues should correct. 

The second bucket is of particular interest as welfare policy (ie. entitlements) is something policy makers can control. Where do we stand on this front? There was an interesting article in the WSJ recently entitled “Hooked on Federal Checks”. The author Nick Stehle wrote: 

“My family is receiving the new Advance Child Tax Credit Payments, passed by Congress and signed into law by President Biden in March. Under this policy, I’m going to make more than $11,000 by the time I file my 2021 taxes. I “earned” this extra cash by having four children between 5 and 13.

The policy—which pays $300 a month for each child under 6 and $250 a month for each child between 6 and 17—is set to expire at year’s end, yet the Biden administration and congressional Democrats are pushing to make it permanent. If that happens, I’m looking at more than $10,000 a year for the next four years, then thousands more annually for nearly a decade after that.

Do I need this money? Thankfully, no. I have a good job that puts my family solidly in the middle class. Should I be getting this money? Absolutely not. But will I use the money? Yes. That is why this new entitlement is so dangerous.

The federal government is conditioning families like mine to expect “free” money. When you see that cash in your account, the first thought is how to use it. It becomes a habit to see and spend extra money each month. Like many habits, it is liable to worsen.”

The political discourse in Canada is no different with each challenger party putting forth colossal spending platforms designed to one up the current incumbent Liberal spending bonanza. 

Politicians of all stripes continue to clamour for more spending as they decry that life is getting more expensive. All of this while nearly 61% of U.S. households paid no federal income taxes in 2020 and central banks have spent $834 million an hour for 18 months buying bonds to force down borrowing costs since the pandemic hit (the US Fed alone has put in roughly $4 trillion). 

The question is how much longer can central banks and governments keep the cash spigots flowing at full force? Politicians appear to be openly uninterested in such trivial details.  

Many of the entitlements such as the Advance Child Tax Credit Payments discussed above or the Old Age Security benefits in Canada (only two small examples) are not primarily directed to families in poverty. 

Instead, such entitlements are better understood as an attempt to buy votes from various voting blocks. Once you come to expect an entitlement you are much less inclined to vote for someone who wants to cut off the cash. A similar understanding can be applied to the Canada Emergency Wage Subsidy, CRB, CRCB and the CRSB in Canada. The conditioning has become powerful. 

Nick Stehle points out that the price tag of such measures in terms of expanding the national debt is high yet the human cost of these policies is perhaps even higher. Since many of these benefits are not tied to work/output, people have less reason to try and climb the ladder of opportunity. 

Is this how a social safety net should work? Will such political discourse erode cultural attitudes surrounding “work ethic”? Has irreversible damage already been done? 

This idea dovetails on the third category of common explanations: changes to attitudes wrought by the pandemic. One intriguing possibility is that the pandemic has made people value work less. The pandemic forced us all to take a hard look in the mirror and many surveys suggest that people now treasure time with family more than they once did. A shift in attitudes towards work is hard to pin down yet a recent study from Britain suggests that people want to work fewer hours even if their pay falls.  

By making unemployment insurance schemes (entitlements) competitive with market wage rates in a pandemic, it would come as no surprise if attitudes surrounding work ethic have suffered. Rewards and incentives change habits and behaviour. The longer this dynamic persists, the longer and more difficult it will be to reshape such habits and adjust behaviours. 

It is still too early to tell how much work ethic has suffered yet this potential conditioning accelerated by COVID-19 is not a positive development. 

The economic carnage brought on by Covid-19 induced lockdowns necessitated extraordinary monetary and fiscal intervention. Politicians and Central bankers had to act. The problem we see today is that a potential pandora’s box of entitlement and complacency has been opened. 

When leaders have simply to open the spigot to earn votes, there is little incentive to improve the quality of leadership. Hence, in our opinion, the disastrous state of leadership today. 

Thomas Jefferson and Alexander Hamilton agreed on little publicly, but they did agree that when the public treasury becomes a public trough and voters take notice, they will send to government only those who promise them a bigger piece of the government pie.

There’s an old theory that wealthy democracies follow a socio-economic cycle from slavery to spiritual faith, to great courage, to liberty, to abundance and wealth, to complacency, to apathy, to dependence and back to slavery. Judging from the post Covid-19 socio-economic climate we appear to be on a problematic path to complacency and apathy. 

When entitlement is not linked to output and contribution there is little willingness to accept responsibility for one’s own life - which is the source from which self-respect and thus character, springs. Instead, one develops the perception that the outcomes of one’s life are entirely out of one’s hands. 

And to be without character is perhaps the worst fate of all. 

Charts of the Month

Valuations are certainly in the upper band even when measured against the past 25 years, which has been a time filled with higher-than-average historical valuations. Here’s one that may surprise you though — this year we’ve actually seen multiples on the S&P 500 contract:

JP Morgan also broke out valuations and earnings by the top 10 stocks in the S&P (which also includes Berkshire Hathaway, Tesla, Nvidia, JP Morgan and Johnson & Johnson) and everything else:

The top 10 stocks are now close to 30% of the market. This sounds concerning until you see they contributed 34% of the earnings over the past year. These companies are large for a reason.

They’re also expensive for a reason. You can see once you take away the top 10 holdings, the valuation of the other 490 or so stocks doesn’t look all that bad.

Logos LP July 2021 Performance

July 2021 Return: -1.18%

2021 YTD (July) Return: 7.28%

Trailing Twelve Month Return: 41.47%

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: 24.39%
 

Thought of the Month

“Enough of this miserable, whining life. Stop monkeying around! Why are you troubled? What’s new here? What’s so confounding? The one responsible? Take a good look. Or just the matter itself? Then look at that. There’s nothing else to look at. And as far as the gods go, by now you could try being more straightforward and kind. It’s the same, whether you’ve examined these things for a hundred years or three.” - Marcus Aurelius


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Articles and Ideas of Interest

• Florida is America's Future: Old, Southern and Retired. Why we should be concerned that the fastest-growing cities in the U.S. are retirement villages in the South. One of the most important trends to emerge from the 2020 Census didn't get much attention last week, but it reveals more about how both the U.S. economy and its politics will look in the coming years than most other details focused on by the news media. Americans' vision of their city of the future typically involves skyscrapers populated by large new technology companies. Yet the 2020 Census didn't point to San Francisco or New York as the fastest-growing city, or even one of the dozens of smaller metros that emulate them. The fastest growing metro area in the U.S. is the Villages, a retirement community in central Florida. And that's indicative of an economy that's older, less dynamic and more reliant on government benefits. It also points to a growing concentration of political and economic power in the south. Why is no one talking about this?  
  
   

• The Opposite of Toxic Positivity. Countless books have been written on the “power of gratitude” and the importance of counting your blessings, but that sentiment may feel like cold comfort during the coronavirus pandemic, when blessings have often seemed scant. Refusing to look at life’s darkness and avoiding uncomfortable experiences can be detrimental to mental health. This “toxic positivity” is ultimately a denial of reality. Telling someone to “stay positive” in the middle of a global crisis is missing out on an opportunity for growth, not to mention likely to backfire and only make them feel worse. As the gratitude researcher Robert Emmons of UC Davis writes, “To deny that life has its share of disappointments, frustrations, losses, hurts, setbacks, and sadness would be unrealistic and untenable. Life is suffering. Scott Barry Kaufman for The Atlantic suggests that no amount of positive thinking exercises will change this truth.

• The Coronavirus Is Here Forever. This Is How We Live With It. Sarah Zhang for the Atlantic suggests that we can’t avoid the virus for the rest of our lives but we can minimize its impact. The current spikes in cases and deaths are the result of a novel coronavirus meeting naive immune systems. When enough people have gained some immunity through either vaccination or infection—preferably vaccination—the coronavirus will transition to what epidemiologists call “endemic.” It won’t be eliminated, but it won’t upend our lives anymore. Politicians crafting policy based on “Covid zero” are going down a dangerous path…

• Warren Buffett’s Cash Trap Can Snare Big Tech, Too. The Berkshire Hathaway CEO has more cash than he knows what to do with. But Apple, Amazon and other tech giants face a similar dilemma. It may remain one of Buffett’s most memorable lessons. Even as tech company after tech company has joined the $1 trillion and then $2 trillion market-cap club during the pandemic, they all have something in common with Buffett: more cash than they know what to do with. It’s a good problem to have until it isn’t.
  
   

• Companies and Families Are Loading Up on Debt. It Could Be a Dangerous Trend. For folks with finances stretched by inflation, using “buy now, pay later” (BNPL) to help pay for luxuries or even necessities, such as an updated wardrobe to return to work, might be the clincher in the purchasing decision. Square’s ability to provide ready funding to merchants and consumers apparently justifies the $29 billion price tag for Afterpay—equal to an enterprise value of 35 times gross profit for the next 12 months, according to MoffettNathanson analyst Lisa Ellis. But it belies the notion of flush consumers. Or does it?
  
   

• Why Managers Fear a Remote-Work Future. Interesting take on remote work by Ed Zitron in the Atlantic suggesting that like it or not, the way we work has already evolved. Remote work lays bare many brutal inefficiencies and problems that executives don’t want to deal with because they reflect poorly on leaders and those they’ve hired. Remote work empowers those who produce and disempowers those who have succeeded by being excellent diplomats and poor workers, along with those who have succeeded by always finding someone to blame for their failures. It removes the ability to seem productive (by sitting at your desk looking stressed or always being on the phone), and also, crucially, may reveal how many bosses and managers simply don’t contribute to the bottom line.
  
   

• Why is China smashing its tech industry? Noah Smith suggests that it has something to do with what countries consider to be the “Tech Industry”. China may simply see things differently. It’s possible that the Chinese government has decided that the profits of companies like Alibaba and Tencent come more from rents than from actual value added — that they’re simply squatting on unproductive digital land, by exploiting first-mover advantage to capture strong network effects, or that the IP system is biased to favor these companies, or something like that. There are certainly those in America who believe that Facebook and Google produce little of value relative to the profit they rake in; maybe China’s leaders, for reasons that will remain forever opaque to us, have simply reached the same conclusion.

• What’s Holding Back China’s Recovery? The Kids Aren’t Alright. There are many answers, but one important piece of the puzzle is starting to become clear: Young workers and job seekers, who often spend more of their income since they are just starting out, are struggling. Until that is rectified, regaining China’s pre-pandemic consumption-growth trend could be challenging. Online movements springing from youth discontent such as “tang ping” or “lying flat,” which was started by a disenchanted former factory employee and rejects overwork, may be difficult to fully suppress. This problem is affecting most nations globally as policy makers ignore the plight of the next generation…
  
   

• America’s Investing Boom Goes Far Beyond Reddit Bros. Robinhood traders have earned the most attention, but they’re only part of a larger story about class stagnation and distrust. Fascinating account by Talmon Joseph Smith in the Atlantic of the investing craze that has characterized the post pandemic world. In a series of interviews conducted with economic analysts, amateur and professional investors, cryptocurrency lovers, and former hedge-fund managers, several people expressed the view that the subcultures born out of America’s untamed investing boom are many and varied. They’re diverse, if not integrated; some silly, some assiduous—yet all infused with a quiet desperation to reach escape velocity and defeat the gravitational pull of class stagnation that’s lasted decades...

Our best wishes for a month filled with joy and contentment,

Logos LP

A Crisis Of Intelligence

Good Morning,
 

Stocks fell on Friday, led by major tech shares, as Wall Street wrapped up a difficult week in which coronavirus cases rose, U.S. fiscal stimulus talks broke down and traders braced for next week’s presidential election.

The Dow and S&P 500 fell 6.5% and 5.6%, respectively, and posted their biggest weekly losses since March. The Nasdaq lost more than 5% over that time period and also had its worst one-week performance since March.

Those weekly losses came as the seven-day average of new coronavirus cases in the U.S. hit an all-time high this week, according to data from Johns Hopkins University. In Europe, Germany, France and the UK announced new lockdown measures to curb the virus’ spread.

Our Take

Massive policy stimulus, positive medical developments, a belief that lockdowns were discredited and high hopes for a return to pre-pandemic economic activity levels have provided solid support for equity markets yet with each passing day, they each seem to be on increasingly shaky ground. Stimulus is now likely stalled until the new year, new economic restrictions in the form of lockdowns, particularly in Europe, in response to the re-acceleration in COVID-19 infections, are now catching investors attention triggering a re-evaluation of downside risk. 

Investors had been betting on both sides reaching a stimulus deal before Tuesday’s vote and now recent data is suggesting that the recovery may continue to lose momentum without new aid just as governments face pressure to re-lockdown. 

On a more positive note, we are now halfway through a spectacular third-quarter earnings season. So far, 85% of companies have beat expectations by an astounding 19% on average, well above the historic average of 3% to 5%, according to The Earnings Scout.

But the market has shrugged. The S&P 500 is 8% below where it started on the day earnings season began Oct. 13.
 

Why? It’s simple: markets don’t live on past earnings reports, however good they may be. They live on future earnings projections, and they are now in danger of plummeting. Markets are being hit with a quadruple whammy: The reopening narrative is in trouble, with politicians opting for fresh lockdowns despite clear evidence of their disastrous economic effects; stocks are richly priced, even for an economic recovery; strong earnings reports are not moving stocks up; and some CEOs are again, declining to provide guidance, leaving analysts to themselves.

The reopening story is in jeopardy. Investors were betting that the reopening would continue to proceed without lockdowns, and that additional stimulus would be coming to bridge the gap to a vaccine that would be widely available sometime in the second quarter. In other words, investors priced in rational political leadership that was data driven and awake to the long term economic and social health of their nations. 

Then Europe happened. Germany, France and the UK decided to re-lockdown, closing bars and restaurants for at least a month. More lockdowns, more of the same failed policies, instead of learning from our failures and the successes of other eastern nations. The strategies pursued by South Korea, Vietnam, China and others do still seem to be paying off. While the total Covid-19 death toll is between 500-700 per million people in France, the U.K., Spain and the U.S., in China and South Korea it is below 10 per million. 

If the key to avoiding more lockdowns is finding a way to “live with the virus” — through widespread testing, investment in health infrastructure, protecting the vulnerable, tracing of contacts and isolating positive cases to slow transmission — Western countries have made structural, not cultural, errors.


The problem is that even if outright lockdowns do not happen in the U.S., a widespread slowdown in economic activity — with many simply refusing to go out regardless of whether stores and restaurants are open or not — is increasingly likely given the following reality:

Third-quarter numbers have been great, but Wall Street had been betting that the following three quarters (Q4, Q1, and Q2) will also see sequential improvement as the reopening story proceeds. The lockdown story likely kills all of this and companies know it as many have declined to provide guidance to analysts. 

The prospects of renewed economic slowing, if not the outright onset of a new recessionary phase in 2020 Q4 and 2021 Q1, due to lockdowns would also likely result in meaningful downward revisions to corporate earnings forecasts that were until recently getting revised marginally higher but remain depressed below pre-COVID levels.

If politicians choose to go down this road, U.S. stocks are likely set up for meaningful disappointment as these earnings forecasts increasingly fall apart. Will investors want to own stocks at 60 times or 80 times earnings, if not more?

Put this ugly package together, and you have a high degree of macro uncertainty, with stimulus doubts, lockdown threats, uncertainty on the timing of the vaccine, and the election.

It’s a potentially explosive combination that on its face, appears to be a nightmare for investors. On top of such worries you have hedge fund gurus lining up to call a top as well as calling for “a lost decade” for stocks. 
 

So what to do in the face of the above? 

Musings

We do believe that the current climate does represent accumulating potential downside risk, yet we prefer to remain cautiously optimistic and focus on “what is” rather than “what if”. 

Leadership in the west is abysmal yet we are not surprised. Leadership is simply a reflection of those who elect such leaders and studies show that people in the West are getting “dumber” by the year. 

A recent study found that 19 percent of young New Yorkers — millennials and Gen Z — believe Jews caused the Holocaust. A shocking 58 percent of New York state adults between 18 and 39 could not cite the name of any concentration camp, death camp or ghetto. 

A survey in 2013 by the Public Religion Research Institute found that 27 percent of Americans think God helps determine the outcome of football games. A 2012 survey by the National Science Foundation found that 26 percent of Americans believe the sun goes around the Earth instead of the other way around, which indicates people haven’t been keeping up with the newspapers since about 1532. As for Democrats, 67 percent of them said (in a 2018 YouGov poll) that Russia “tampered with vote tallies in order to get Donald Trump elected.” There is no more evidence for this than there is for the existence of vampires. A survey last year found that the majority of residents in every state except Vermont would have failed a citizenship test. 

In another recent study it was found that the IQ scores of young men have plunged below previous generations for the first time in nearly a century. For the past 90 years, the IQ levels of young people were believed to have steadily increased by about three points per generation in a phenomenon dubbed the Flynn effect. But the selfie generation’s empty-headedness may be linked to the way math and language are now taught — along with more time spent on TV and cell phones/computers researchers said. This is the most convincing evidence yet of a reversal of the Flynn effect. 

Given the above, should we really be surprised by the intellectually vacuous debates we’ve witnessed in the run up to November 4? Should it shock us that politicians aren't learning and improving their responses to the pandemic? 

We are facing nothing short of an intelligence crisis in the West from the bottom right up to the top, which is undermining our problem-solving capacities and leaving us ill-equipped to tackle the complex challenges posed by pandemics, AI, global warming and developments we have yet to imagine.

Investors should be aware of these shortcomings (think of it as a cognitive decline risk or ignorance risk) and take them into consideration as they price risk and make decisions as to where and with whom they will allocate capital. 

So what to do? If technology and complex challenges are on the rise while IQ is on the decline, we believe that the best opportunities for long-term growth and capital appreciation will be found in disruptive innovation. We believe such opportunities have the ability over time to transcend cognitive decline risk/ignorance risk. 

And they have. In a recent piece in Bloomberg, Sarah Ponczek found that if you took all the physical assets owned by all the companies in the S&P 500, all the cars and office buildings and factories and merchandise, then sold them all at cost in one giant sale, and they would generate a net sum that doesn’t even come out to 20% of the index’s $28 trillion value. Much of what’s left comes from things you can’t see or count: algorithms and brands and lists. This is, in the broadest sense, a new phenomenon. Intangible assets make up more than 84% of S&P 500 firm value. 

So, for all the stress and worry about how the pandemic run-up in tech stocks bespeaks a bubble that’s bound to burst, what if the bigger concern is that it doesn’t?

If you work at a company riding this wave or better yet own one, you’re doing well. For everyone else, the news is less good. One loose way of thinking of the impact is that while intellectual property tends to create a small set of well-to-do workers and investors, it often displaces a larger set of non-innovation focused ones. 

This helps explain why many American workers have recently had it so rough, with wages stagnating and benefits disappearing. Demand for certain intangible linked skills is rising while it is dropping for almost every other skill set. 

The market’s appetite for earnings based not on plants and machinery, but ideas -- feeds itself. The share of business investment targeted at intangible assets is now rising 1 1/2-times faster than it did during the financial crisis, itself a record period of hyper-investment in intangibles, estimates Jason Thomas, the head of global research at Carlyle Group.

Such spending tends to be motivated by a desire to do more with less. Our bet is that this continues. Unfortunately, if it does, it implies an uncomfortable projection for a labor market still destroyed from the shutdowns, with close to 8% of people in the U.S. unemployed and the prospect of further shutdowns looming. 

In fact, the Covid-19 induced economic shutdowns should be thought of as the worst assault on the working class in half a century. Economic recoveries that focus more on intangible investments have increasingly been met with slower labor market bounce-backs and this rebound will be no different. 

Innovative ideas are becoming more hard to come by and thus, we believe that big idea-based companies - those who are the leaders, enablers, and beneficiaries of disruptive innovation - will be the epicentre of attractive future returns. 

Despite lockdowns, the absence of a vaccine, the presence of a Republican or Democrat in the White House, cognitive decline in the West, we are confident that remaining long big ideas will reward the patient long-term investor. 

 
Charts of the Month

The number of business bankruptcies and insolvencies in most countries has declined this year through the coronavirus pandemic as the world is seeing far fewer bankruptcies than it did in 2019. But that is largely thanks to assistance from central banks and government measures restricting things like foreclosures.

What it means: When the smoke clears the world is likely to be looking at a sizable increase in the number of zombie companies — firms that owe more on debt than they generate in profits but are kept alive by relentless borrowing.

Why it matters: "Zombie firms are smaller, less productive, more leveraged and invest less in physical and intangible capital," the Bank for International Settlements concluded in a report last month.

• "Their performance deteriorates several years before zombification and remains significantly poorer than that of non-zombie firms in subsequent years."

In other words: More zombies will lead to a slower, less efficient and less productive global economy.

Logos LP September  2020 Performance

September 2020 Return: 0.76%
 

2020 YTD (September) Return: 51.51%
 

Trailing Twelve Month Return: 67.44%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +21.31%

Thought of the Month

"Where there is no vision, the people perish." —Proverbs 29:18

Articles and Ideas of Interest

• The role of luck in life success is far greater than we realized. Are the most successful people in society just the luckiest people? The importance of the hidden dimension of luck raises an intriguing question: Are the most successful people mostly just the luckiest people in our society? If this were even a little bit true, then this would have some significant implications for how we distribute limited resources, and for the potential for the rich and successful to actually benefit society (versus benefiting themselves by getting even more rich and successful). Fascinating article in the Scientific American. 

• Researchers gave thousands of dollars to homeless people. The results defied stereotypes. Researchers gave 50 recently homeless people a lump sum of 7,500 Canadian dollars (nearly $5,700). They followed the cash recipients' life over 12-18 months and compared their outcomes to that of a control group who didn't receive the payment.

• Trump boasts the economy reached historic heights during his first term. Here are 9 charts showing how it stacks up to the Obama and Bush presidencies.
  
   

• Biden, Democratic victories would be the best outcome for the economy, Moody’s says. Biden would be allowed to enact more wide-sweeping economic policy changes such as spending trillions on infrastructure, education and social safety, while also boosting trade and immigration. “Greater government spending adds directly to [GDP] and jobs,” Zandi said, while also arguing that the higher taxes Biden has proposed to fund some of these plans have an “indirect impact” and would not slow the economy. Moody’s analysis found that a Trump victory would be a worse outcome for the economy because of his smaller proposals for fiscal stimulus and the increased likelihood of deeper trade tensions and cuts to immigration. Trump has proposed “much less expansive support to the economy from tax and spending policies,” Moody’s said, adding that his planned immigration cuts are a “significant impediment to longer-term economic growth” as it slows both the job market growth and labor productivity.

• Either way, on Nov. 3, China wins. Mary Hui and Jane Li explain why Beijing is in an “enviable position” going into this US presidential election. A Joe Biden administration would likely bring some cooperation and less confrontation while a Donald Trump win might mean more short-term pain, but would also reduce America’s ability to overcome internal divisions and forge a global strategy to counter China.

• Shallower pools, emptier pockets. Back in June, Donald Trump temporarily halted the H-1B visa program, which companies use to recruit highly skilled foreign workers, especially in computer science. Ananya Bhattacharya lays out how shutting 200,000 top employees out of the country shaved $100 billion off of Fortune 500 companies’ returns.

• The loneliness of the long-distance employee. It takes effort to maintain camaraderie while working from home. The Great Work From Home Experiment of 2020 has gone on for nearly eight months, and preliminary results are coming in. Overall, surveys suggest that most of us like it most of the time, except for one thing: We feel lonely. “Camaraderie” is the No. 1 thing people look forward to about an eventual return to the office. “Loneliness” is often at the top of the list of downsides to remote work.

• The GOP’s demographic doom. Millennials and Gen Z are only a few years away from dominating the electorate. Given that the younger generations align much more closely with Democratic ideological views on almost all policy questions, this shift underscores the stakes in the generational roulette Trump has played by defining the GOP so narrowly around the priorities and preferences of his core groups: older, nonurban, non-college-educated, and evangelical white people. If Democrats can not only express the values of younger Americans, but also advance their material interests, they will have a substantial advantage in building electoral majorities through the decade ahead, says Ruy Teixeira, a veteran Democratic election analyst and co-founder of the States of Change project, which is a joint research collaboration between three liberal-leaning groups and the centrist Bipartisan Policy Center.

• Stocks typically climb, regardless of who’s in the White House. For investors worried about how the stock market will fare in the event of a divided government or a sweep by either party in next month’s elections, history offers an important lesson.  
  
   

• Machines to 'do half of all work tasks by 2025'. Millions more jobs will be lost to robots with Covid accelerating the trend, says the World Economic Forum.

• How do pandemics end? In different ways, but it’s never quick and never neat. Just like the Black Death, influenza and smallpox, Covid-19 will affect almost every aspect of our of lives – even after a vaccine turns up.

• Psyche, an asteroid believed to be worth $10,000 quadrillion, is observed through Hubble Telescope in new study. The exact composition of Psyche is still unclear, but scientists think it's possible the asteroid is mostly made of iron and nickel. It's been hypothesized that a piece of iron of its size could be worth about $10,000 quadrillion, more than the entire economy on our planet. LOL “Wealth” is such a relative concept...

• Now that more Americans can work from anywhere, many are planning to move away. An astonishing 14 million to 23 million Americans intend to relocate to a different city or region as a result of telework, according to a new study released by Upwork, a freelancing platform. The survey was conducted Oct. 1 to 15 among 20,490 Americans 18 and over. The large migration is motivated by people no longer confined to the city where their job is located. The pandemic has shifted many companies' view on working from home. Facebook announced plans for half of its employees to work from home permanently. The company even hired a director of remote work in September to ease the transition. Big cities will see the largest outmigration, according to the survey. Meanwhile, Bruce Flatt the CEO of Brookfield believes things will go right back to normal. With COVID-19 cases reaching new records in the U.S. and spiking around the world, Flatt’s confidence in a return to pre-pandemic norms stands out, and it may be wishful thinking...

  Our best wishes for a month filled with discovery and contentment,

  Logos LP

Everything is F*cked But Hope Springs Eternal

Good Morning,
 

U.S. stocks rose on Friday, recovering some of their losses for the week, as tech shares clawed back some of their big September declines. Nevertheless, despite Friday’s rally both the Dow and S&P 500 posted four-week losing streaks, their longest slides since August 2019.

The major averages have had a tough month, with the S&P 500 falling 5.8% in September. The Dow has dropped 4.4% over that time period and the Nasdaq is down 7.3% month to date.

Our Take

It is important to remember that there are always two ways to view the stock market at any given time. From an optimistic perspective, there is the potential for favorable results from the Phase III clinical trials as early as the end of October, the elections could be decided in an orderly manner, large institutions and investors could put their record cash piles to work, earnings growth could take off as governments and central bankers continue to support the economy and holiday shopping could be impressive with limited disruption from COVID-19.

From a pessimistic perspective, one could say that all of those developments above are unlikely. No vaccine at all, the election results could be delayed and contested thus resulting in complete turmoil, as a second wave of COVID-19 prompts further economic shutdowns leading to economic collapse.

Whatever camp you fall into, it is important not to get swallowed by emotion as the reality will likely lay somewhere in between. 

Absent additional full economic shutdowns by governments in response to a second wave of COVID-19 (if this happens again all bets are off as the damage would likely be irreversible) we believe the recovery will continue albeit extraordinarily unevenly across industries and countries.  

The Economist recently revisited their “90% economy” prediction and found that economies certainly have begun to recover, yet the world is still a long way from normal. Governments continue to enforce social-distancing measures to keep the virus at bay. These reduce output—by allowing fewer diners in restaurants at a time, say, or banning spectators from sports arenas. People remain nervous about being infected. Economic uncertainty among both consumers and firms is near record highs—and this very probably explains companies’ reluctance to invest.

Calculations by Goldman Sachs, suggest that social-distancing measures continue to reduce global GDP by 7-8% and such measures are set to continue in most countries. Yet The Economist found that although the global economy is operating at about nine-tenths capacity, there is a lot of variation between industries and countries. Some are doing relatively—and surprisingly—well, others dreadfully.

When considering the respective performance of goods and services, goods have bounced back fast while services activity is a lot further below its pre-pandemic level. This is understandable as services require person to person interaction and thus when confidence is lacking, consumption of services wanes. 

Additionally, the magazine found that the huge gap between countries’ economic recovery can be attributed to: 1) industrial composition (countries which rely on retail and hospitality and laggards) 2) confidence (countries who had good leadership under lockdown) and 3) stimulus (countries that put in place large rescue package ie. America may still not be able to agree on a new one, yet still has ALREADY enacted the world’s largest package relative to the size of its economy). 

In light of the above, and the fact that most developed countries seem to be hovering around a “90% economy”, should we opt for the pessimistic view of markets or the optimistic view? 

In our view, absent further draconian lockdowns, we believe that a 90% economy - one which could trend towards 95% if countries can better calibrate social-distancing measures without jeopardizing output - is certainly not a good enough reason for the patient long-term investor to significantly reduce equity exposure and move to cash or gold.

There will be scars to the economy and the recovery will take time, there will be more short term volatility in markets as political headlines and a record amount of derivatives trading foster instability, yet we remain hopeful and confident that holding quality businesses with unique secular tailwinds for the long-term, remains the right strategy.

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Musings
 

Over the course of the month of September it has struck me how emotional the last 6 months have been for most. How difficult it has been to wake up 6 months into the pandemic and read a variety of news headlines which are basically the same as those featured 5 months ago, 4 months ago 3 months ago etc.: 

-“Terrified’: Bar, restaurant, gym owners say they won’t make it if forced to close again”

-”New-York State Tops 1,000 New Daily Coronavirus Cases for First Time Since Early June”

-”Stock market crash: David Rosenberg warns of a dot-com-bubble, IPO mania”

-”The Death of the American Dream” 

The mood is sombre. Hope appears to be slipping away as pandemic fatigue sets in and this is precisely what we as a society need to combat: hopelessness. 

Flirting which such feelings myself over the last six months, I picked up a book this month with a title that unsurprisingly caught my attention: “Everything is Fucked: A Book About Hope” by Mark Manson (ironically written pre-Covid-19) 

While the book covers a lot of ground, what resonated with me was his explanation that “the human psyche needs hope to survive the way a fish needs water.”

He furthers that: 

“Hope is the fuel for our mental engine. It’s the butter on our biscuit. It’s a lot of cheesy metaphors. Without hope, your whole mental apparatus will stall out or starve. If we don’t believe there’s any hope that the future will be better than the present, that our lives will improve in some way, then we spiritually die. After all, if there’s no hope of things ever being better, then why live- why do anything?” 

Without hope for the future one sinks into indifference and nihilism- the sense that there is no point, no broader “why?”. Without hope for the future, without a hope narrative that gives us a sense of purpose, we pursue the pure indulgence of desire. Success for the sake of success. Pleasure for the sake of pleasure. Power for the sake of power. Protest for the sake of protests. Shut downs for the sake of shut downs. Hysteria for the sake of hysteria. 

Manson reminds us that, hopelessness is the root of anxiety, mental illness and depression. It is the source of all misery and the cause of all addiction. Chronic anxiety is a crisis of hope. It is the fear of a failed future. Depression is a crisis of hope. It is the belief in a meaningless future. Should we be surprised that such mental illnesses are on an eighty year upswing among young people and a twenty year upswing among the adult population? 

The problem with COVID-19 six months in, is that it has exacerbated the crisis of hope which was plaguing the rich developed world well before the pandemic struck. Although a serious public health issue, we now have nothing short of a COVID-19 national hysteria. We’ve allowed the virus to take over our economy, our small businesses, our schools, our social lives, our quality of life and most importantly our hope for the future. 

This irrational sense of hopelessness is growing and those in power should carefully consider its effects when they set out to combat a second wave of COVID-19 and put policies in place to aid in the recovery. 

The human mind/human nature is the most powerful force on earth. Left misunderstood by those in power as well as by those acutely suffering from a lack of hope themselves, any recovery will be challenged. 

The rich developed world has made incredible progress in health, safety, material wealth and quality of life yet those are facts about the past, not the future. Hope doesn’t care about these things. Hope only cares about the problems that still need to be solved. Hope must be found in our visions for the future. 

We as individuals and as a society need to find our “why” again. Our personal hope narratives which give us a reason to believe that our tomorrows will be better than our todays. Our inspirational vision which gives us purpose. Which makes us smile, grounds us, helps us stay on course, joyful in the face of adversity and suffering.  

Somewhere along the way as we argue about whether everything is “rigged”, or whether we will “accept” to leave office, or what we are entitled to by virtue of our birth, or about how much we wish to take from others who have earned it to give to ourselves, or as we continue to surrender our economies and our lives to the virus, we’ve become lost. 

My hope is that we succeed in finding hope again. That will be the true recovery. 

Charts of the Month

Where is hope trending? 

In Canada, the Covid-19 mortality rate is 0.024% and the chance of not dying from Covid-19 is 99.975% yet in a survey conducted on behalf of Global News, Ipsos found that 75% of respondents would approve of quickly shutting down non-essential businesses in the event of a second wave???

Why isn’t the media talking about this? That’s also what TIS Group asks in the USA, citing revised Centers for Disease Control statistics that say Covid-19 is only directly responsible for 6% of the reported Covid deaths in the U.S., or around 10-11,000 people. The rest of deaths reflect Covid as a contributing factor to existing illnesses, particularly among the elderly...

Logos LP August  2020 Performance

August 2020 Return: -0.71%
 

2020 YTD (August) Return: 50.36%
 

Trailing Twelve Month Return: 57.65%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +21.46%

Thought of the Month


 

"Fearlessness is not the absence of fear, but the willingness to walk into it. When I walk into my fear, practice there, sit upright in the middle of it, completely open to the experience, with no expectation of the outcome. Anything is possible. When our circumstances look impossible or terrifying, there is a way.” -Judith Randall

Articles and Ideas of Interest

 

• Interactive Brokers braces for election volatility by telling clients to put up more cash. Market action around the election is expected to be so volatile that Interactive Brokers is forcing clients to put up more money in order to trade using leverage. The retail broker is increasing margin requirements — how much money an investor using leverage and derivatives has in their brokerage account after a stock purchase — heading into the November presidential election, according to a clients letter obtained by CNBC.

• Is Covid to blame for business closures or is it helping new startups? The answer may be both. A report found that more than 100,000 restaurants have closed this year, but another says new business applications are up by 19%. Everyone has their narrative about the plight of small business because it’s a political issue. The right wants to make it out that small businesses are suffering and state governments need to relax the shutdowns. The left says that not only small businesses, but their employees, are feeling pain and therefore significant stimulus is still needed. Both sides agree on some form of a more targeted round of the Paycheck Protection Program. Everyone’s right. Everyone’s wrong. The fact is that no one really knows for sure about the effects Covid has had on small businesses ... yet. We won’t know until this whole thing is over and researchers can comb through the data and that’s going to take a few years. I’m sure they’ll find that many businesses did close permanently because of the pandemic. But then again, how many of these businesses would have closed anyway? And how many were previously buoyed by a strong economy until that facade disappeared?

• America divided by education. The gulf between the party identification of white voters with college degrees and those without is growing rapidly. Trump is widening it. One of the most striking patterns in yesterday’s election was years in the making: a major partisan divide between white voters with a college degree and those without one. According to exit polls, 61 percent of non-college-educated white voters cast their ballots for Republicans while just 45 percent of college-educated white voters did so. Meanwhile 53 percent of college-educated white voters cast their votes for Democrats compared with 37 percent of those without a degree. The diploma divide, as it’s often called, is not occurring across the electorate; it is primarily a phenomenon among white voters. It’s an unprecedented divide, and is in fact a complete departure from the diploma divide of the past. Non-college-educated white voters used to solidly belong to Democrats, and college-educated white voters to Republicans.

• Covid grows less deadly as doctors gain practice, drugs improve. For those who develop dangerous cases of the infection, advances in medical care and the growing experience of doctors are improving the chances of survival. Since the first case arrived in the U.S. at the start of the year, medical professionals have gone from fumbling in the dark to better understanding which drugs work -- such as steroids and blood thinners, and the antiviral medicine remdesivir. Allocation of intensive medical resources have improved. And doctors have learned to hold off on the use of ventilators for some patients, unlike with many other severe respiratory illnesses. Governments are also learning lessons from Europe’s lockdowns and finding that they simply can’t lock down again.

• Why we shouldn’t have unrealistic expectations regarding COVID-19 vaccines. Among pharmaceutical, medicinal and drug products, vaccines are by far the most complex. They are also life-saving. In times of devastating disease outbreaks such as the COVID-19 pandemic, it is not uncommon to foster hopes that an effective vaccine, a magic bullet, could somehow be quickly made and administered to people. Unfortunately, reality can be very different because vaccines can take a long time to be developed (4-5 years typically), longer than most pharmaceutical, medicinal or drug products. Bottom line: there may never be a magic bullet. We need to get better living with the virus. Furthermore trust in Covid-19 vaccines could turn on a knife edge. The race to remove regulatory and legal roadblocks to secure a vaccine could blow the whole vaccine hope wide open. Will you line up to take a vaccine which has been rushed through development without large scale patient trials from a vaccine maker that has been given full legal immunity from personal injury lawsuits?

• 52% of young adults are living with their parents. That's higher than any prior measure on record, even surpassing the Great Depression's peak. Millennials will likely continue to pay the price for their parents’ luck and self-indulgence. According to a new report by Deutsche Bank the consequences of this dynamic will be so severe this widening generational divide should be a key source of alarm for investors, financial markets and society as a whole. “Investors can expect an abrupt, and significant upheaval in housing and asset markets, tax systems, climate policy, and many other areas,” Allen wrote. “This scenario becomes more likely towards the end of this decade as Millennial and younger voters start to exceed those in older generations.” (This year millennials have surpassed baby boomers as the country’s largest adult population.)

• How China is preparing its economy for a future where the U.S. isn’t the center of global demand. In a world rocked by the coronavirus pandemic and tensions with the U.S., the Chinese government is stepping up focus on the domestic market with the pronouncement of a “dual circulation” policy. Increased public discussion in the last few weeks has helped crystallize some of the implications for global trade. “The ‘dual circulation’ policy demonstrates China’s recognition that it won’t be able to rely on trade as much for the next two decades, as it did for the previous two,” Stephen Olson, research fellow at the nonprofit Hinrich Foundation, said in an email this week. China is focused squarely on a post U.S.centric world in which China leads in technology innovation. 

• Remote work is killing the hidden trillion dollar office economy. From airlines to Starbucks, a massive part of our economy hinges on white-collar workers returning to the office. As companies in cities across the U.S. postpone and even scrap plans to reopen their offices, they have transformed once-teeming city business districts into commercial ghost towns comprised of essentially vacant skyscrapers and upscale complexes. A result has been the paralysis of the rarely remarked-upon business ecosystem centering on white-collar workers, who, when you include the enterprises reliant on them, account for a pre-pandemic labor force approaching 100 million workers. 

• Japanese doctor who lived to 105-his spartan diet, views on retirement, and other rare longevity tips. 1) Don’t retire. But if you must, do so a lot later than age 65, 2) Take the stairs (and keep your weight in check). 3) Find a purpose that keeps you busy. 4) Rules are stressful; try to relax them. 5) Remember that doctors can’t cure everything. 6) Find inspiration, joy and peace in art.

Our best wishes for a month filled with discovery and contentment,

Logos LP