Trump

2018 Meltdown and What to Think of 2019?

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Good Morning,
 

Santa Claus rally? No Santa Claus rally? Naughty or nice? One thing is for sure the last two weeks on Wall Street have been gut wrenching. Not for the faint of heart. During that time, the major U.S. stock indexes have suffered losses that put them on track for their worst December performance since the Great Depression. Investors have also been gripped by volatile swings in the market as they grapple with a host of issues.
 

The S&P 500 has logged six moves of more than 1 percent over the period, three of which were of more than 2 percent. For context, the broad index posted just eight 1 percent moves in all of 2017.
 

The Dow Jones Industrial Average, meanwhile, has seen seven days of moves greater than 1 percent. Its intraday points ranges also widely expanded. The 30-stock index has swung at least 548 points in eight of its past nine sessions, and also posted its first single-day 1,000-point gain ever on Wednesday. The index ended down 76 points Friday after vacillating throughout the session.
 

These moves are remarkable and what has been equally remarkable has been the fact that many pundits and astute market veterans haven’t had much of a satisfying explanation; fears of the Fed after Chairman Jerome Powell said he did not anticipate the central bank changing its strategy for trimming its massive balance sheet, a U.S. federal government shutdown, disfunction in Washington (almost every part of Trump's life is now under investigation), slowing global growth, weaker data coming out of the U.S., “end of cycle”, and thus fears of a recession. All of which seem convincing as a root cause of this vicious selling. Watching CNBC has been almost comical with pundits like Jim Cramer recommending gold one day only to recommend nibbling on stock as markets move higher the next.
 

2018 was the year nothing worked: In fact, in 2018, just about every single asset class one can invest in — from stocks around the globe to government debt to corporate bonds to commodities — have posted negative returns or unchanged performance year to date.
 

Even during the financial crisis in 2008, government bonds and gold worked...
 

What gives?


Our Take

While any 20 percent sell-off hurts (both the Russell 2000 and Nasdaq led the way into bear market territory. The S&P 500 (-19.8%) and the Dow 30 (-18.8%) did manage to fall just short of the 20% threshold yet the average stock is down far more than that) the one happening now is far from unheard of in terms of depth or velocity. Over the past 100 years, there are almost too many examples to count of stocks tumbling with comparable force.
 

THIS IS INEVITABLE AND NORMAL. WELCOME TO THE STOCK MARKET.

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Investors over the Holidays have time to reflect on history, now that stocks have avoided a fourth straight down week via the biggest one-day rally since 2009. After coming within a few points of a bear market on Wednesday, the damage in the S&P 500 stands at 15 percent since Sept. 20.
 

This is normal but seems abnormal because we are all talking about it from morning to night.
 

As we are reminded by a recent article in Bloomberg: “A fair amount of complaining has gone on in recent months about the role of high-frequency traders and quantitative funds in the drubbing that reached its peak around Christmas. Perhaps. Those groups are big, and in the search for villains, they make easy targets. Treasury Secretary Steven Mnuchin is among the people who have made the connection.
 

One thing that makes it tough to lay blame for the meltdown on machine-based traders is the many past instances when markets fell just as hard without their help. The Crash of 1929 is one big example. However bad this market is, it’s a walk in the park compared with then.”
 

This pattern holds for the Dot-com Bust (S&P 500 lost 35 percent over the course of two months), Black Monday of 1987 (S&P 500 rose 36 percent between January and August 1987 in what was set to be the best year in almost three decades. Then the October sell-off pushed the S&P into a 31 percent correction over just 15 days), 1974 Sell-Off (the S&P 500 saw the index fall 33 percent in 115 days as a weakening economy, rising unemployment and spiking inflation pushed investors to head for the exits. Stocks subsequently rebounded, surging more than 50 percent between October 1974 and July 1975), 1962 Rout (S&P 500 Index lost a quarter of its value between March and June 1962), Not so Fat ‘57 (20 percent correction over 99 days in 1957).
 

Last I checked there were no high frequency traders then BUT there were equally dysfunctional administrations and equally irrational humans…
 

The selling is likely overdone. When the SP 500 peaked in late September '18, the forward 4 quarter estimate was $168.72; today, that same estimate is $169.58. The point is with the S&P 500 index falling some 15%, the forward estimate on which it's valued is actually slightly higher. The question is will these estimates hold. Clearly the stock market is not so sure despite the fact that the U.S. economy is in a good position to sustain a 2.5-3 percent growth rate in 2019.
 

With the selling frenzy pushing stock prices lower, investors are now pricing in zero growth in earnings for 2019. Is this reasonable? 2018 earnings will come in at around $162 for the year. Clearly, the market has lost a lot of confidence in the staying power of earnings and the health of the economy. If we apply a conservative 14-15 multiple to that, it yields a range for the S&P at 2,268-2,430. So with the index closing at 2,488 Friday, we are just above that range. The issue is that the stock market generally overshoots in either direction when it sees change. Emotion takes over and causes the rapid move.
 

Despite existing negativity, the market’s valuation has changed for the better. The S&P 500 is actually heading into 2019 with a P/E ratio right in line with its historical average going back to 1929. And if you look just at the last 30 years going back to 1990, it is actually undervalued.
 

Unless one sees another financial crisis upon us (which at this time we do not), the probability is high that this could also mark a near term low.
 

As for investor sentiment, bearishness sits at record highs. In fact, half of individual investors now describe themselves as “bearish” for the first time since 2013. The latest AAII Sentiment Survey shows greater polarization, with neutral sentiment falling to an eight-year low.
 

On December 24 73% of financial stocks hit 52-week lows. That exceeds all days from the worldwide financial crisis…
 

In the past 28 years, there have been 2 times when every stock in the 2&P 500 Energy sector was below their 10-, 50-, and 200 day average and more than half were trading at 52 week lows.
1) During the depths of the 2008 financial crisis
2) Now

The pendulum of the market may be set for a swing in the other direction.


A Few Things We Like for 2019 That We Have Been Nibbling On During The 2018 Rout

Cerner Corp. (CERN:NASDAQ): major player in the healthcare IT industry as its software is highly integrated into the operations of several large provider networks. The firm has internally developed much of its software, which makes its product lineup close to seamless and effective within the healthcare IT sector. The secular demand tailwinds for Cerner’s products are robust given ACA mandates that require providers to upgrade their health records management systems. This highly positive trend will be enhanced over the next several years by changing payer reimbursement structures. Trading at a roughly 30% discount to intrinsic value (earnings based DCF), 10 year low P/E, P/S and P/FCF.

CGI Group Inc. (GIB.A:TSX): deeply embedded in government agencies across North America and Europe. Gained greater scale with its acquisition of Logica in 2012. This scale will allow the firm to better meet the needs of global clients. The firm has a backlog of signed contracts of more than CAD 21 billion, with an average duration of approximately five to seven years. Growing IT complexity is expected to support long-term demand for IT services as companies look to simplify and streamline their IT landscape. Trading at a roughly 20% discount to intrinsic value (earnings based DCF), attractive 10 year low P/E, PEG ratio and EV/EBIT.


Chart(s) of the Month 

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“Equity prices are said to have far outpaced earnings during this bull market. In fact, better profits accounts for about 70% of the appreciation in the S&P over the past 8 years. Of course valuations have also risen, that is a feature of every bull market, as investors transition from pessimism to optimism. But this has been a much smaller contributor. In comparison, 75% of the gain in the S&P between 1982-2000 was derived from a valuation increase (that data from Barry Ritholtz).”
 

Musings

I began reading a fantastic book over the break which I highly recommend entitled “The Laws of Human Nature” by Robert Greene. The book takes as its fundamental premise that we humans tend to think of our behaviour as largely conscious and willed. To imagine that we are not always in control of what we do is a frightening thought, but in fact is the reality. We live on the surface, reacting emotionally to what people say and do. We settle for the easiest and most convenient story to tell ourselves.
 

Greene writes: “Human nature is stronger than any individual, than any institution or technological invention. It ends up shaping what we create to reflect itself and its primitive roots. It moves us like pawns. Ignore the laws at your own peril. Refusing to come to terms with human nature means that you are dooming yourself to patterns beyond your control and to feelings of confusion and helplessness.”
 

These principles are all the more relevant in light of 2018’s market action. What is interesting is that like this sell off (including the cryptocurrencies sell off), when we look back at other selloffs like that of 2008, most explanations emphasize our helplessness. We were tricked by greedy banking insiders, mortgage lenders, poor government oversight, computer models and algorithmic traders etc.
 

What is often not acknowledged is the basic irrationality that drove these millions of buyers and sellers up and down the line.
 

They became infected with the lure of easy money. The taste of wealth and the envy of their fellow market participants appearing to make effortless gains.
 

This made even the most rational, experienced and educated investor emotional. Hungry for his own slice of the action. Ideas were rounded up to fortify such behaviour such as “this is game changing technology, this time it is different and housing prices never go down”. A wave of unbridled optimism takes hold of the mind and panic sets in as reality clashes with the story most people have accepted.
 

Once “smart people” start looking like idiots, fingers begin to get pointed at outside forces to deflect the real sources of the madness. THIS IS NOTHING NEW. IT IS AS OLD AS THE HUMAN RACE.
 

Understand: Bubbles/corrections/bear markets “occur because of the intense emotional pull they have on people, which overwhelm any reasoning powers an individual mind might possess. They stimulate our natural tendencies toward greed, easy money, quick results and loss aversion."
 

It is hard to see other people making money and not want to join in. It is also equally hard to watch one’s assets drop in value day after day. THERE IS NO REGULATORY FORCE ON THE PLANET THAT CAN CONTROL HUMAN NATURE.
 

As demonstrated above, the occurrence of these selloffs will continue as they have until our fundamental human nature is altered or managed.
 

As such, it is important during these periods that we look inward to acknowledge and understand the true causes of these phenomenon and even take advantage of them as they occur. The most common emotion of all being the desire for pleasure and the avoidance of pain. The most meaningful experiences of pleasure typically follow the most most meaningful experiences of pain…

 

Logos LP November 2018 Performance

November 2018 Return: 0.15%

2018 YTD (November) Return: -11.06%

Trailing Twelve Month Return: -7.60%

CAGR since inception March 26, 2014: +14.06%


 

Thought of the Month


"If you have trouble imagining a 20% loss in the stock market, you shouldn't be in stocks."

-- John Bogle



Articles and Ideas of Interest

  • 2018: The Year of the Woeful World Leader. Trump, May, Macron, Merkel. Italy, Spain, Sweden, Latvia. Even the dictators stumbled. So much bad governing, so little time.   

  • What the Fall of the Roman Republic can teach us about America. The bad news is that the coming decades are unlikely to afford us many moments of calm and tranquillity. For though four generations stand between Tiberius Gracchus’ violent death and Augustus’ rapid ascent to plenipotentiary power, the intervening century was one of virtually incessant fear and chaos. If the central analogy that animates “Mortal Republic” is correct, the current challenge to America’s political system is likely to persist long after its present occupant has left the White House. 

  • Low fertility rates aren’t a cause for worry. AI, migration, and being healthier in old age mean that countries don’t need to rely on new births to keep growing economically.  

  • Start-Ups aren’t cool anymore. A lack of personal savings, competition from abroad, and the threat of another economic downturn make it harder for Millennials to thrive as entrepreneurs.

  • This McKinsey study of 300 companies reveals what every business needs to know about design for 2019. In a sweeping study of 2 million pieces of financial data and 100,000 design actions over five years, McKinsey finds that design-led companies had 32% more revenue and 56% higher total returns to shareholders compared with other companies.
     

  • What do we actually know about the risks of screen time and digital social media? Some tentative links are in place, but many crucial details are fuzzy.

  • Start-up economy is a 'Ponzi scheme,' says Chamath Palihapitiya. Tech investor Chamath Palihapitiya addressed concerns about his investment firm, Social Capital, while also calling the start-up economy "a multivariate kind of Ponzi scheme.”

Our best wishes for a fulfilling 2019, 

Logos LP

The Art of The Deal

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Good Morning,
 

Stocks closed little changed on Friday as solid quarterly results from some of the largest U.S. companies, including Microsoft, Capital One and Honeywell, counterbalanced threats made by President Donald Trump stating that he is willing to up the ante in the trade war with Beijing and could slap tariffs on every Chinese good imported to the U.S. "I'm ready to go to 500," he told CNBC, referencing the $505.5B of American imports from China in 2017, compared to the $129.9B the U.S. exported to the country last year. (an interesting blow by blow look at global trade here)

 

In other news, President Trump sat down with Russian counterpart Vladimir Putin in Helsinki. Crimea, Syria and election meddling were likely on the summit's agenda, but no aide or official from the U.S. delegation were present during the meeting's initial stages. A controversial press conference ensued (in which Trump seemed to prefer Putin’s story suggesting Russia’s non-involvement in the US election rather than the opinion of U.S. intelligence), coming on the tails of a tense NATO summit during which Trump lambasted allies for not meeting their defense spending commitments.

 

The 10-year yield ended the week at 2.90% and the two-year yield finished up at 2.60%. Some analysts saw the increased 2-10 spread as a sign that investors believe President Trump's criticism of the Fed could slow down the pace of rate hikes.

 

Finally, Amazon reached a $900B market value for the first time, nipping at Apple's) heels as Wall Street's most valuable. The news comes after the company announced it sold more than $100M in products during its annual Prime Day sale. Shares are up over 57% so far this year, bringing Amazon's increase to over 123,000% since it listed on the Nasdaq in 1997.


Our Take
 

As perplexing as Trump’s actions can be, instead of spilling more ink on his diversions from “accepted” presidential behavior, it may be best to try and understand his approach by attempting to apply a different mental model. The seeds of Trump’s mental model can be found in his book “The Art of the Deal”. (His approval ratings also hold other clues)

 

Jim Rickards points out that the book is a window on Trump’s approach to every challenge he confronts, including economic and geopolitical challenges as president.

 

What is Trump’s process as described in the book?

 

  1. Identify a big goal (tax cuts, balanced trade, the wall, etc.).

  2. Identify your leverage points versus anyone who stands in your way (elections, tariffs, jobs, etc.).

  3. Announce some extreme threat against your opponent that uses your leverage.

  4. If the opponent backs down, mitigate the threat, declare victory and go home with a win.

  5. If the opponent fires back, double down. If Trump declares tariffs on $50 billion of good from China,and China shoots back with tariffs on $50 billion of goods from the U.S., Trump doubles down with tariffs on $100 billion of goods or perhaps even $505.5 billion etc. Trump may keep escalating until he wins. (or loses)

  6. Eventually, the escalation process can lead to negotiations with at least the perception of a victory for Trump (North Korea) — even if the victory is more visual than real.

 

This approach is abnormal from a historical perspective but to the astute observer this far into his Presidency should be looking more predictable.

 

What should we expect moving forward in light of this mental model? Likely more dramatic policy shifts and extreme threats. The key is not to overreact and hope that all escalations lead to fruitful negotiations in step 6….

 


Chart(s) of the Month
 

The S&P 500 PE ratio is right in line with historical norms.

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J.P. Morgan: “High yields spreads and defaults are low and not rising. Mr. Bond is not yet sniffing a potential economic problem.”
 

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The Big 5 tech companies together are worth more than the bottom 282 companies in the S&P 500 yet this level of concentration is not unprecedented. In 1965 AT&T and GM represented 14.5% of the S&P 500. What is wild is that these 5 companies are all in the same industry.

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Courtesy of Michael Batnick.
 

Musings



This month we released our 2nd quarter letter to our investors. Included is a discussion of portfolio changes as well as a more detailed description of a new position we’ve initiated in Industrial Alliance and Financial Services (TSX: IAG). Please contact us if you would like to see a copy of this letter.


 

Logos LP May 2018 Performance

 

June 2018 Return: 4.29%

 

2018 YTD (June) Return: 0.34%

 

Trailing Twelve Month Return: +11.86%

 

CAGR since inception March 26, 2014: +18.77%


 

Thought of the Month


 

"Do you have the patience to wait till your mud settles and the water is clear? Can you remain unmoving till the right action arises by itself?– Lao-Tzu, Tao-te-Ching




Articles and Ideas of Interest

 

  • These 10 stocks account for all the S&P 500’s first half gains.David Kostin, chief U.S. equity strategist at Goldman Sachs, highlighted that more than 100 percent of the S&P 500’s total return of nearly 3 percent in the first half is attributable to just 10 equities. Amazon.com Inc. alone accounts for roughly two-fifths of the benchmark gauge’s advance. Find out which they are here.

           

  • The average age of a successful startup founder is 45. HBR explores why and also why vc investors often bet on young founders.

 

  • YOLO. A Boston College study has found that half of companies raising through ICOs die within four months after finalizing token sales. Is Blockchain even a revolution?

 

  • Longer lives mean a single marriage may not be enough. More couples are wondering if the relationship they had in their first phase of adulthood is worth continuing.

 

 

  • Can the cult of Berkshire Hathaway outlive Warren Buffett? Centuries from now, historians piecing together the narrative of this stretch of America’s existence will have to explain the curious four-decade (and counting) run in which an arena in an otherwise modest midwestern US city filled to capacity once a year for two aging billionaires talking about the stock market, life, and whatever else tickled their fancy. The annual meeting of the Omaha, Nebraska-based holding company Berkshire Hathaway has no analog in US business or culture. Buffett is 87. Munger is 94. And Berkshire Hathaway’s returns over the S&P 500 are slowing, as Buffett has warned for decades they would. Interesting article in Quartz exploring his legacy as well as his adage that America will always remain a safe bet...

 

  • Google is building a city of the future in Toronto. Would anyone want to live there? It could be the coolest new neighborhood on the planet—or a peek into the Orwellian metropolis that knows everything you did last night. Politico magazine explores the tradeoffs and debates involved.

 

  • In praise of being washed. Has a life of ambition and striving gotten the best of you? Do you sometimes wish you could give up a little—stop chasing so many pointless goals you probably won’t hit anyway? It’s time you got washed. A refreshing summer read in GQ.

 

  • Scientists at a company part-owned by Bill Gates have found a cheap way to convert CO2 into gasoline. A team of scientists has discovered a cheap, new way to extract carbon dioxide from the atmosphere — which could arm humanity with a new tool in the fight against climate change.

 

  • The friend effect: why the secret of health and happiness is surprisingly simple. Our face-to-face relationships are, quite literally, a matter of life or death. “One of the biggest predictors of physical and mental health problems is loneliness,” says Dr Nick Lake, joint director for psychology and psychological therapy at Sussex Partnership NHS Foundation Trust. “That makes sense to people when they think of mental health. But the evidence is also clear that if you are someone who is lonely and isolated, your chance of suffering a major long-term condition such as coronary heart disease or cancer is also significantly increased, to the extent that it is almost as big a risk factor as smoking.”

Our best wishes for a fulfilling month, 

Logos LP

 

What Is The Purpose Of Tax Reform?

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Good Morning,
 

U.S. stocks climbed to records as the latest jobs report boosted optimism in the world’s largest economy, continuing equity rallies that took hold in Asia and Europe. The dollar posted its best week this year.

 

The S&P 500 Index and Dow Jones Industrial Average closed at all-time highs in light volume after data showed hiring increased by more than forecast in November and the unemployment rate held at a 17-year low of 4.1%. The dollar briefly edged lower as investors assessed tepid wage growth that missed estimates, then resumed its fifth consecutive gain. Average hourly earnings — a closely watched component of the report — rose 0.2 percent for November and 2.5 percent for the year. Economists expected a monthly increase of 0.3 percent or 2.7 percent for the year. Ten-year Treasury yields inched higher.

 

The jobs data added to a run of recent news that has been contributing to investor confidence after the U.S. government averted a shutdown and tax reform negotiations made progress.



Our Take
 

This melt-up may have legs as forecasts for U.S. growth have been too pessimistic. Nevertheless, despite a mostly solid run of job growth, 2017 ends pretty much where it began — with wage growth stuck and inflation subdued.

                                               

This nonfarm payrolls report brought with it news all too familiar to the post-crisis economy. The 228,000 jobs created formed a solid foundation, but the pedestrian 2.5 percent average hourly earnings growth left many scratching their heads wondering how a 4.1 percent unemployment rate, the lowest in 17 years, still wasn't producing fatter paychecks.

 

The lack of wage growth at the aggregate level despite the declines in the unemployment rate and strong job gains remain a mystery.

 

Central bankers can control short-term interest rates but as has become glaringly obvious in the post recessionary world, long-term ones are out of their purview.  

 

Ms. Yellen’s Fed has raised rates twice this year and will likely raise a third time this month. In October the Fed began reversing quantitative easing (QE), purchases of financial assets with newly created money. Despite all this monetary tightening, yields on ten year Treasury bonds have fallen from around 2.5% at the start of 2017 to about 2.3% today. As a result the “yield curve” is flattening. The difference between ten year and two year interest rates is at its lowest since November 2007.

 

The yield curve matters as it has inverted- ie. long-term rates have dipped below short term ones-just before each of the past seven American recessions.

 

The yield curve reflects where markets expect Fed Policy to go and what we are seeing is an expectation that rates are not likely to increase.

 

Why? Falling inflation risk may explain the falling yield curve but as the Economist suggests, what is most likely is that markets are losing confidence in the Fed’s ability to raise rates without inflation sagging. This nonfarm payrolls report will only accelerate this loss of confidence.  

 


Musings
 

So what of Trump’s new tax reform package? Despite Trump’s approval ratings hitting a new low, the market appears to be applauding it. From our perspective, although this tax package will likely stimulative in the short term, in the long term a fiscal stimulus through generalized tax cuts is unnecessary, and destabilizing, in an economy running substantially above its 1.5 percent potential (and non-inflationary) growth on the steam of exceptionally loose monetary policy.

 

Furthermore, deep corporate tax-cuts (which have been tried before by Ronald Reagan) don’t seem to work.

 

The Trump team’s argument goes something like this: Cutting taxes on businesses will free up profits they will invest in new factories, research and development, and new equipment. The resulting investment boom will spur growth, as firms hire and as workers harness new ideas and equipment to produce more than they used to.

 

If we look at the Reagan years, investment fell—that was the weakest period of investment in the postwar period.

 

The same is likely to occur today. Firms aren’t cashed constrained. They aren’t asking for more money then and they certainly aren’t asking for more now. In fact, companies don’t even know what to do with their money. Companies today are sitting on record cash piles (roughly $1.84 trillion).

 

When asking the question of what companies will do with a windfall of after tax-profits,  Quartz points out that the odds that it will flow back into the real economy (investment) aren’t looking good. Many major companies are planning to hand that money to their investors through dividends and share buybacks. In fact, when Gary Cohn, Trump’s economic guru, asked a gathering of corporate leaders who was planning to reinvest their tax cuts, few raised their hands, Bloomberg recently reported. What these cuts will likely do is inflate asset prices even further as the bill directs the largest tax cuts as a share of income to the top 5 percent of taxpayers and by 2027, taxes on the lowest earners would go up.

 

This at a time when we find ourselves in what could be argued is an “everything bubble”. At a time when a cool $1 million which has long been considered the gold standard of retirement savings, has become only a fraction of what you will really need.A time when 44 percent of millennials would prefer to live in a socialist country, compared with 42 percent who want to live under capitalism. A time when 41 million Americans officially live in poverty. A time when  bitcoin is the most popular search on Google as well as the most popular news story on virtually every news outlet….

 

What goes up must come down….In this environment, where the balance of risk is likely to the downside, buying EXTRA thoughtfully is warranted.



Logos LP November Performance


 

November 2017 Return: +7.33%

 

2017 YTD (November) Return: +28.83%

 

Trailing Twelve Month Return: +35.67%


CAGR since inception March 26, 2014: +20.65%


 

Thought of the Week 

 

"Do you wish to rise? Begin by descending. You plan a tower that will pierce the clouds? Lay first the foundation of humility.” -Saint Augustine



Articles and Ideas of Interest
 

  • Collective intelligence can change the world. Combining the minds of humans and machines to avoid confirmation bias. A group with a more autonomous intelligence will fare better than one with less autonomy. It will fall victim less often to the vices of confirmation bias or functional fixedness. It is more likely to see facts for what they are, interpret accurately, create usefully or remember sharply. Knowledge will always be skewed by power and status as well as our pre-existing beliefs. We seek confirmation. But these are matters of degree. We can all try to struggle with our own nature and cultivate this autonomy along with the humility to respond to intelligence. Or we can spend our lives seeking confirmation. Over the Holidays -- give yourself the freedom to explore, think and imagine without constraint.

          

  • There’s an implosion of early-stage VC funding, and no one’s talking about it. Amid record amounts of capital raised by VCs worldwide, and a sharp rise in the number of private “unicorns” valued at $1 billion-plus, therehas been a quiet, barely noticed implosion in early-stage VC activity worldwide. This is now a three-year trend, so cannot be “blamed” on macro or short-term factors. More worryingly, it comes at a time of unprecedented stock market valuations worldwide. Whether the early-stage VC implosion is healthy or disastrous for the tech ecosystem remains to be seen. This is likely healthy over the long run in order to break Silicon Valley’s never-ending startup cycle: Startup employees get rich quick and quit to become venture capitalists.

 

  • Mysterious object confirmed to be from another solar system.Astronomers have named interstellar object ’Oumuamua and its red colour suggests it carries organic molecules that are building blocks of life. Interestingly, NASA has also found another 20 promising planets for humans to colonize.

 

  • Net neutrality: catastrophe or a non-event?  Some suggest that the internet is dying and that repealing net neutrality hastens that deathOthers suggestthat concerns over net neutrality are overblown as public blowback in past cases of service providers blocking sites that are competitive has been fierce, scaring other providers from following suit. Second, blocking competitors to protect your own services is anticompetitive conduct that might well be stopped by antitrust laws without any need for network neutrality regulations.

     

  • Will BlackRock and Vanguard own everything by 2028? Imagine a world in which two asset managers call the shots, in which their wealth exceedscurrent U.S. GDP and where almost every hedge fund, government and retiree is a customer. It’s closer than you think. BlackRock Inc. and Vanguard Group  — already the world’s largest money managers — are less than a decade from managing a total of $20 trillion, according to Bloomberg News calculations. Amassing that sum will likely upend the asset management industry, intensify their ownership of the largest U.S. companies and test the twin pillars of market efficiency and corporate governance.

 

  • Robots aren’t killing jobs fast enough-and we should be worried.Interesting perspective on this. In fact, data show that the US labor market is the calmest it has been in more than 160 years. The problem is there is not enough disruption. If anything, we need more jobs destroyed. That argument, made by Robert Atkinson and John Wu of the Information Technology and Innovation Foundation, a think tank promoting policies that spur innovation, is a novel one. Their belief that we are in an age of stagnation, not disruption, is based on a decade-by-decade analysis of how quickly occupations have been appearing and disappearing since 1850. No wonder Google, Amazon have found that not everyone is ready for AI.

 

  • How high will bitcoin go? Should you buy in? What is next for cryptocurrencies? Well ladies and gents even the most staunch haters arethrowing in the towel with Jamie Dimon recently suggesting a reversal of his position stating that “I'm open-minded to uses of cryptocurrencies if properly controlled and regulated." Make no mistake this is a frenzy much like the dot-com bubble in 1995. Perhaps even larger as bitcoins appear to be at least 4 times as expensive as dot-com stocks were at their height. Interestingly, few are talking about its energy use implications: By July 2019, the bitcoin network will require more electricity than the entire United States currently uses. By February 2020, it will use as much electricity as the entire world does today. Is this sustainable? The cryptocurrency’s price is completely unreal. Then again so is money...The problem is that it is clear that this is not a currency. Most are buying and holding in hopes of future gains. This is an asset class and as seen many times before, when lots of investors buy an illiquid asset, the price can rise exponentially yet at some point the urge to turn all those digital zeros into cars and iPhones will prove too great. Getting out of an illiquid asset can be much harder than getting in. When that rush inevitably happens, people are going to get hurt. Rule number 1: don’t lose money. Rule number 2: don’t forget rule number 1.

 

  • Me, myself and iPhoneFascinating research presented in the Economistsuggesting what we already know (subconsciously): the many hours young people spend staring at their phones is having serious effects. Adolescents who spent more time on new media-using Snapchat, Facebook or Instagram on a smartphone were more likely to agree with remarks such as: “The future often seems hopeless” or “I feel like I can’t do anything right.” Those who used screens less, spending time playing sport, doing homework, or socialising with friends in person, were less likely to report mental troubles.

 

Our best wishes for a fulfilling week,  
 

Logos LP

Be Boring Not Bored

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Good Morning,
 

U.S. stocks closed higher on Friday as Wall Street assessed the likelihood of tighter monetary policy following a weaker-than-expected jobs report.


The Dow Jones industrial average rose 39.46 points, to close at 21,987.56. The index also rose above 22,000 earlier in the session for the first time since mid-August.

                                               

The S&P 500 gained 0.17 percent to end at 2,475.77, with energy leading seven sectors higher. The Nasdaq composite rose 0.1 percent to 6,435.33, a record close.   

 

The U.S. economy added 156,000 jobs in August, according to the Bureau of Labor Statistics. Economists polled by Reuters expected 180,000 jobs to have been added last month.


The BLS also said, however, that wages grew at an annualized rate of 2.5 percent, less than expected.

 

On the Canadian side, the economy unexpectedly accelerated at a 4.5 percent pace in the second quarter -- tops among Group of Seven countries -- led by the biggest binge in household spending since before the 2008-2009 global recession.

 

Annualized growth was the fastest in six years and topped the 3.7 percent average forecast from economists. This isn't just a win for Canada. This print is further evidence of a strong global recovery.



Our Take
 

August's nonfarm data in the US was disappointing but should be viewed the context of solid U.S. and global economic growth, strong earnings, low inflation and still-ample global liquidity which will likely allow the US rally to continue.

 

The disconnect between modest economic growth and low inflation continues to support equities here. Not to hot. Not to cold. Perhaps central banks search for inflation has turned Sisyphean and should be abandoned...

 

A good way to think about the present equity market is as follows:

 

  1. Valuation compared to alternatives – positive

  2. Valuation compared to inflation – positive

  3. Risk of recession – extremely low

  4. Financial stress – extremely low

  5. Market skepticism – high



Musings

 

This week, throughout my conversations and observations about the market I couldn’t help but notice a common theme: boredom. The last 2 weeks have been relatively quiet in the markets as investors return from vacation while others gear up for the long weekend.

 

Nevertheless, the punditry and financial media have soldiered on doing their best to whip up stories suggesting that danger is lurking around every corner: The Fed, North Korea, Trump, China’s CDS market etc.

 

What these times of “boredom” acutely remind me of is a principle eloquently presented by Christoper Mayer: “Boredom can explain a lot. It can explain all kinds financial behavior. And there is definitely a “boredom arbitrage” to take advantage of in the markets.

 

People get bored. Most of life for most people is “boring”. Most jobs require just enough concentration to prevent one from drifting off into a dream but not enough to really occupy the mind. As a result, we have boredom on a massive scale. As such, people will do all kinds of strange things to alleviate that boredom.

 

They will act like fools. Dress like idiots and make all kinds of decisions to sabotage their lives. Anything to kill the boredom.

 

The financial markets are still primarily composed of the results of people’s decision making and thus are influenced by boredom. People get bored and just want to make something happen.

 

In the financial markets, people wind up sabotaging their own portfolios out of sheer boredom.

 

Why else throw money at fly by night unregulated Initial Coin Offerings (ICOs)? Or put money in “pre-revenue” tech startups with unproven founders? Or chase hyped up tech companies that trade at absurd levels with questionable prospects? Or go to cash or gold because Donald Trump is in the White House or “the market” looks overvalued?

 

They are bored!

 

It seems exciting to churn your money in this way. People buy and sell stocks so frequently because they are bored. They feel they have to do something.

 

This is the fundamental lesson to remind oneself of during these “boring” times. When asked in an interview this week why he hasn’t spoken out about Donald Trump, Warren Buffett reminded us that:

 

"Forty-five presidents of the United States and I lived under a third of them," he said. "I bought stocks under 14 of the 15. The first one was [President Herbert] Hoover. I was only 2 when he left so I hadn't gotten active at that point. But [ Franklin Delano] Roosevelt was next. And I bought stocks under him, even though my dad thought it was the end of the world when he got elected."

 

My goodness how boring. Yet how profitable. Furthermore, at a time when most investors are bored with anything that isn’t tech, artificial intelligence, blockchain or Alibaba, Warren Buffett's Berkshire Hathaway has invested more money in financial stocks. Berkshire Hathaway reported a 17.5 million share stake in Synchrony Financial, in its June quarter 13F filing as well as converting warrants into 700 million shares of Bank of America (BAC) common stock.

 

This is a prime example of “boredom arbitrage”. Often what is out of favor is priced as such and thus offers the best prospects for outsized returns over the long-term.

 

Furthermore, people get bored of holding the same stock for long periods of time. They want action. But consider the classic 100 bagger Monster Beverage.

 

This company became a 100 bagger in 10 years and yet during that period there were over 10 occasions that the stock fell more than 25%. In three separate months, it lost more than 40% of its value. Yet if you focused on the business and not the stock price, putting $10,000 in, you would have ended up with $1 million at the end of ten years.

 

Be a reluctant seller. Hold for the long-term. Be boring not bored.

 

Hundredfold returns are unlikely to induce boredom...

 


Thought of the Week
 

"All men’s miseries derive from not being able to sit in a quiet room alone.” -Pascal



Articles and Ideas of Interest

 

  • The free economy comes at a cost. Facebook, whose users visit for an average of 50 minutes a day, promises members: “It’s free and always will be.” It certainly sounds like a steal. But it is only one of the bargains that apparently litter the internet: YouTube watchers devour 1bn hours of videos every day, for instance. These free lunches do come at a cost; the problem is calculating how much it is. Because consumers do not pay for many digital services in cash, beyond the cost of an internet connection, economists cannot treat these exchanges like normal transactions. The economics of free are different.

 

  • Too much power lies in tech companies’ hands. A libertarian case for caution after the Daily Stormer is booted off the public internet. Libertarians tend to worry about concentrations of power in the hands of the state. There is no consensus about the danger of concentrations of power in private hands. But when the private hands in question control access to the principal media of communication in the world, one has to hesitate when they decide that not everyone should be granted entree. For the power they are exercising is almost state-like. 

 

  • Silicon Valley isn’t special. Tech has plenty of reasons to believe that it is an industry of upstarts but the facade is crumbling.

 

  • Contrarian view of Amazon. Moody’s contrarian view is especially notable because it makes the intriguing argument that Amazon, while it may be an online juggernaut, is actually the weakest of the large U.S. retailers. Although the Seattle-based company does capture about half of all online retail sales, that’s a tiny share of all retail sales; about 90 percent of all sales are made offline.

 

  • How the next quant fund crisis will unfold and why quant strategies are underperforming. Almost everyone knows that this month marks the 10th anniversary of the start of the biggest financial crisis since the Great Depression. There was another significant event back then that gets overlooked but was still very significant. I’m referring to the quant equity crash of August 2007. Institutional quant hedge funds have addressed the risk issues that caused 2007 losses, but the newer retail products cannot. Another interesting piece looking at the recent underperformance of quant funds. The space is getting crowded.

 

  • Finding the root cause of recessions. Two things bear most of the blame: external shocks and economic volatility.

 

  • Robots will not take your job. Wired magazine paints a compelling picture as to why the fear and hype is overblown.

 

  • Millennial Americans are moving to the ‘burbs, buying big SUVs. Wait I thought it was the gig economy and consumption was dead? Millennials are finally starting their own baby boom and heading for the suburbs in big sport utility vehicles, much like their parents did. Americans aged about 18 to 34 have become the largest group of homebuyers, and almost half live in the suburbs, according to Zillow Group data. As they shop for bigger homes to accommodate growing families, they’re upsizing their vehicles to match. U.S. industry sales of large SUVs have jumped 11 percent in the first half of the year, Ford Motor Co. estimates, compared with increases of 9 percent for midsize and 4 percent for small SUVs. Guess they just want to be like their parents after all.

 

  • To come up with a good idea. First try and come up with the worst idea possible. There are many creative tools a designer uses to think differently, but none is more counter-intuitive than “wrong thinking,” also called reverse thinking. Wrong thinking is when you intentionally think of the worst idea possible — the exact opposite of the accepted or logical solution, ideas that can get you laughed at or even fired — and work back from those to find new ways of solving old problems. Nice piece in HBR looking at innovation and discovery.

 

  • The cryptocurrency phenomenon is gaining further traction. The world’s biggest banks aren’t immune from cryptocurrency euphoria, with a range of projects underway to explore how traditional financial firms can benefit from the innovation. Swiss banking giant UBS and 10 other companies say that they plan to use the technical idea behind bitcoin—a distributed ledger called a blockchain—for their own digital currency (paywall). This could show the way for the world’s biggest central banks to do the same.

 

Our best wishes for a fulfilling week, 
 

Logos LP

Blind Spots, Power and Decision Making

Good Morning,
 

U.S. stocks steadied Friday after a three-day slide, while Treasury yields and the dollar edged lower. The week was largely dominated by crude’s tumble into bear market territory yet all three major American assets didn’t seem to care.

The S&P 500 Index finished the week virtually where it began, as rallies in health-care and tech shares offset a rout in energy producers. Small caps rallied Friday to end higher on the week.

Also of interest this week was Warren Buffet’s Berkshire Hathaway Inc., buying a 38 percent stake in Home Capital for about C$400 million ($300 million) and providing a C$2 billion credit line to backstop the Toronto-based lender.

With the deal, the billionaire investor is wading into a housing market that’s been labeled overvalued and over-leveraged, with home prices in Toronto and Vancouver soaring as household debt hits record levels.

Warren Buffett’s deal to back Home Capital Group Inc. was quickly interpreted by Toronto real estate pundits as a vote of confidence for a housing market that everyone from investors to global ratings companies say is a bubble ready to burst. Nevertheless, before getting too jubilant about Canadian real estate one should consider the terms of the deal. 

Buffett is no stranger to taking advantage of dark times to opportunistically turn need into an attractive investment (famously investing $5 billion in Goldman Sachs right after the 2008 collapse of Lehman Brothers). Securing Buffett’s participation came at a high price for the Canadian company, including giving Berkshire Hathaway a large stake at a steep discount to a recent trading average. Based on Friday’s closing price Buffett appears to have already have nearly doubled his initial $153 million investment in Home Capital’s equity, on paper...

A classic example of: “be greedy when others are fearful.”
 


Our Take

 

Weakness in energy prices were the theme of the week, yet few signs of contagion emerged leaving everything from gold to the dollar to U.S. equities to stay range bound as the traditionally slow summer season began.

As Bloomberg remarked, the bear market in crude in many ways resembles its more severe predecessors from 2014 and 2016: oil prices plummeting, non-U.S. producers floundering to keep supply at bay and concerns swirling around the impact of energy companies on high-yield bonds.

The correlation between daily swings in the S&P 500 Index and crude has been roughly zero in the past month, the lowest since January and far below the five-year highs reached in 2016 as the oil prices bottomed near $26 before staging a rebound.

Why? Perhaps the industry’s impact on the overall market is simply low. Today, energy stocks account for less than 6 percent of the S&P 500, compared with 11 percent three years ago. Or perhaps investors see little possibility of systemic risk.

One thing is evident: that falling energy prices will likely further subdue inflation.

Treasury yields have fallen from their 2017 highs recently, with the benchmark 10-year yield trading around 2.15 percent. In March, it traded around 2.6 percent. The bond market doesn't appear to see inflation coming in the near term, and so far it's been right.

The consumer price index fell 0.1 percent in May, raising questions about whether the Fed will be able to raise rates once more this year. The next rate hike isn't fully priced in until March 2018, according to the CME Group's FedWatch tool.

In addition, Amazon’s CEO Jeff Bezos may be single handedly killing inflation. As recently pointed out on CNBC, at a time when central banks are starting to prepare for an expected rise in inflation ahead, Bezos' move to acquire Whole Foods looks to be a significant counterweight.

The entire food retailing industry is an $800 billion market and it is likely that the the supermarket wars are only just beginning. Food makes up about 14.6 percent of the consumer price index, a widely used inflation index…

In addition, this move will likely put greater pressure on other chains such as Target and Wal-Mart to lower prices. Neil Irwin for the NY Times goes so far as to say that the Amazon-Walmart showdown has come to explain the modern economy as in the short term consumers will benefit from lower prices but in the long term will have worrying implications for jobs, wages and inequality.

Interestingly, few are following the Federal Reserve’s lead to raise interest rates. In fact, inflation appears to slowing worldwide and a broad measure of rich-world monetary conditions implied by Morgan Stanley, which incorporates short-term interest rates, bond yields, share prices and other variables suggests monetary policy is becoming looser, if anything…

In this environment further tightening presents asymmetric risk to the downside. Much better to let the economy run a bit hot and raise rates than exacerbate a deflationary environment...low inflation and thus low interest rates will likely remain the “only game in town”...

 

Musings
 

This week I read an interesting piece in the Atlantic which suggested that power causes brain damage. Many leaders actually lose mental capacities - most notably for reading other people - that were essential to their rise.

Is it perhaps useful to think of power as a prescription drug which comes with side effects? After 2 decades of lab research, Dacher Keltner, a psychology professor at UC Berkeley, found that subjects under the influence of power acted as if they had suffered a traumatic brain injury—becoming more impulsive, less risk-aware, and, crucially, less adept at seeing things from other people’s point of view.

Sukhvinder Obhi, a neuroscientist at McMaster University, in Ontario, recently described something similar.

When he put the heads of the powerful and the not-so-powerful under a transcranial-magnetic-stimulation machine, he found that power, in fact, impairs a specific neural process, “mirroring,” that may be a cornerstone of empathy.

Which gives a neurological basis to what Keltner has termed the “power paradox”: Once we have power, we lose some of the capacities we needed to gain it in the first place.

These findings are concerning as we look to those in our societies who have power including perhaps ourselves.

What blind spots has our power generated in ourselves and our leaders? Do these findings help to explain current political events and leadership styles? How much do they contribute to trends in income distribution, social stratification and investment returns?

What I found most interesting and perhaps most alarming about these findings is to set them in the context of another ill which society is currently suffering from: an inability to acknowledge error.

In a wonderful piece in The Economist a few weeks ago it was posited that humanity is getting worse at owning up to its gaffes.

Few enjoy the feeling of being outed for an error but real damage can be caused when the desire to avoid reckoning leads to a refusal to grapple with contrary evidence.

People often disregard information that conflicts with their view of the world. Why? Roland Bénabou, of Princeton, and Jean Tirole, of the Toulouse School of Economics posit that: “In many ways, beliefs are like other economic goods. People spend time and resources building them, and derive value from them. Some beliefs are like consumption goods: a passion for conservation can make its owner feel good, and is a public part of his identity, like fashion. Other beliefs provide value by shaping behaviour.

Because beliefs, however, are not simply tools for making good decisions, but are treasured in their own right, new information that challenges them is unwelcome. People often engage in “motivated reasoning” to manage such challenges. Mr Bénabou classifies this into three categories. “Strategic ignorance” is when a believer avoids information offering conflicting evidence. In “reality denial” troubling evidence is rationalised away: house-price bulls might conjure up fanciful theories for why prices should behave unusually, and supporters of a disgraced politician might invent conspiracies or blame fake news. And lastly, in “self-signalling”, the believer creates his own tools to interpret the facts in the way he wants: an unhealthy person, for example, might decide that going for a daily run proves he is well.”

These tendencies/biases linked to the desire to avoid acknowledging error are relatively harmless on a small scale but can cause major damage when they are widely shared or exhibited by those in power.

It is no wonder that motivated reasoning is a cognitive bias which better-educated people are especially prone. This takes us back to the research on how power can cause the brain to become more impulsive, less risk-aware, and, crucially, less adept at seeing things from other people’s point of views.

As investors, but more broadly as humans we would do well to recognize how these tendencies cross-pollinate and threaten to wreak havoc on our decision making and its outcomes.

Particularly as we accumulate success and thus power we become more vulnerable. Blinded by our own righteousness, increasingly unable to consider differing narratives, facts, perspectives, ideas and at times even reality.

What can be done to avoid these blind spots? Research finds that humility can go a long way to counter such tendencies. Yet to build humility, experiences of powerlessness may be key.

By experiencing or at minimum recounting moments of powerlessness, you maintain a connection or “groundedness” in reality.

When was the last time you felt powerless? The last time you made an error? Hold onto those moments. They may more important than you think.



Ideas from Logos LP

Huntington Ingalls Industries (NYSE: HII) 

 

Logos LP in the Media

Our 2016 Annual Letter to Shareholders Published by ValueWalk
 


Thought of the Week 

 

"It is impossible for a man to learn what he thinks he already knows." -Epictetus
 


Articles and Ideas of Interest
 

  • My algorithm is better than yours.  Just 10% of trading is regular stock picking estimates JPMorgan. The majority of equity investors today don't buy or sell stocks based on stock specific fundamentals. No wonder the world’s fastest growing hedge funds are quant funds and robots are eating money managers lunches.

 

  • Finland tests a new form of welfare. An experiment on the effect of offering the unemployed an unconditional income. Interesting piece in The Economist chronicling Mr Jarvinen who was picked at random from Finland’s unemployed (10% of the workforce) to take part in a two-year pilot study to see how getting a basic income, rather than jobless benefits, might affect incentives in the labour market. He gets €560 ($624) a month unconditionally, so he can add to his earnings without losing any of it. Finland’s national welfare body will not contact him directly before 2019 to record results. I see this happening more often in the developed world. Something to keep an eye on.

 

  • Stop fooling yourself about 8% returns. Nice piece in Gadfly suggesting that There's an amazing amount of denial going on right now. Investors are simply ignoring current market dynamics and are still expecting average annual returns of 8.6 percent, according to a Legg Mason Inc. survey of income investors released this week. Those who were employed expected more than 9 percent gains, with retirees expecting less. Actual returns have come in markedly lower of late, but hopes remain high. It is important that investors become realistic. If they're not, fund managers will try to serve their hopes and dreams, making the financial system all the more fragile for it.

 

  • The web makes it harder to read market sentiment. The internet swept away the old-school financial pundits, turning the public forum into the Wild West. Inflammatory click bait filled with extreme opinions has found its way into ordinary discourse. Not too long ago, anyone who held radical opinions about markets, individual stocks (or even politics) could freely opine about them, just as today. But it was local and contained; those with idiosyncratic opinions could only scare their friends and neighbors, one at a time, at backyard BBQs and school plays. That is no longer the case as “crash”, “hyperinflation”, “monetary debasement” are becoming more common than “value investing”, “long-term” and “prudence” ;).

 

  • The cheapest generation. Why millennials aren’t buying cars or houses and what that means for the economy. Younger generations simply haven’t started spending yet….But what if this assumption is simply wrong? What if Millennials’ aversion to car-buying isn’t a temporary side effect of the recession, but part of a permanent generational shift in tastes and spending habits? It’s a question that applies not only to cars, but to several other traditional categories of big spending—most notably, housing. And its answer has large implications for the future shape of the economy—and for the speed of recovery. After all the old are eating the young. Around the world, a generational divide is worsening.

 

  • The older we get, the person we spend the most time with is the one we see in the mirror. QZ reports that time with friends, colleagues, siblings, and children diminishes over the course of a lifetime. One doesn’t have to be alone to be lonely. More than half of the lonely respondents in the UCSF study lived with a partner. To feel connected to others, it seems, the number of hours spent on relationships is less important than the quality of the relationship itself.

 

Our best wishes for a fulfilling week,  

Logos LP