Amor Fati

Good Morning,
 

Stocks closed at record highs on Friday to end the first trading week of the year as traders weighed the prospects of new fiscal aid as well as disappointing U.S. jobs data.

Stocks started off the new year with a slump on Monday, but the market churned higher as expectations of more government aid increased with Democrats winning two key Senate races in Georgia, according to NBC News projections.

The U.S. economy lost 140,000 jobs in December, the Labor Department said. Economists polled by Dow Jones expected a gain of 50,000.

The unexpected drop in employment came as the recent surge in COVID-19 cases across the country has forced state and local governments to re-take stricter measures to mitigate the outbreak. More than 21.5 million coronavirus cases have now been confirmed in the U.S., according to data from Johns Hopkins University. The U.S. reported more than 4,000 COVID-19 deaths Thursday -- the most virus-related deaths the country has reported in one day since the pandemic's start.

It's the third day in a row of record daily deaths from the disease, according to data from Johns Hopkins University. 

Still markets surged higher the weaker-than-expected employment print raised the possibility of more government aid from the incoming Biden administration.

Our Take
 

What a year: a global pandemic, continuous shutdowns, unparalleled government and central bank intervention, the fastest 30% drop in market history, the shortest bear market ever, followed by the quickest recovery on record!

Reflecting back on 2020, the qualities of water go far to describe what surprisingly turned out to be a great year for the bullish investor who was able to stay disciplined despite the chaos. 

Why did the markets end the year in a resounding crescendo of all-time record highs? The primary reason the rebound was so swift was due to overwhelming government and central bank intervention which allowed most business entities to keep the lights on during even the darkest of COVID-19 days. Many vulnerable “old economy” businesses were never forced to close their doors while COVID-19 made it apparent to investors that “disruptive innovation” based businesses (such as DNA sequencing, robotics, energy storage, artificial intelligence, digitization and blockchain technology) form the backbone of economies all around the globe.

The message from the stock market was clear. It saw and continues to see an economy that is fundamentally changed due to technology and is resilient enough to recover. Both the investor who was positioned in “disruptive innovation” before COVID-19 struck, and the investor who quickly recognized this theme and repositioned their portfolio, did extraordinarily well in 2020.

When it came to our portfolio at Logos LP, coming into 2020, its composition reflected an early recognition of how fundamental the above theme of “disruptive innovation” and technological change was becoming, but in the depths of March as markets plunged “limit down” and lockdowns began to grip the globe, we felt that the global economy had likely entered a period of convulsive changes, some positive and others devastating, that would shape financial markets for years to come.

As such, our portfolio’s composition has shifted to reflect our core belief that revolutionary technological changes are creating not only exponential growth opportunities but also black holes in global economies and financial markets.

Contrary to the popular discourse which pits “growth against value”, we believe that 2020 has shown us a way to synthesize the two seemingly opposite investment approaches.

In modesty, just as in the 1930s and 1940s when Benjamin Graham argued that the old investing framework which was dominated by railway bonds and insider dealing had become obsolete, we believe that the classical “value investing” doctrine can be updated.

Just as Graham provided a much-needed overhaul of investment doctrine, we believe that value investors today can improve their frameworks by incorporating into their analyses the rise of intangible assets and the importance of externalities ie. costs that firms are responsible for but avoid paying. 

From 2020 on, it has become apparent that innovation is evolving at such an accelerated pace that traditional equity and fixed-income benchmarks are being populated increasingly by so-called value traps, stocks and bonds that are "cheap" for a reason. As such, we believe that future investment success will require a certain amount of “adapting to the course of the river” in order to find oneself on the right side of disruptive change and innovation.

In John Templeton’s timeless 16 rules for Investment Success (published in 1933) he states:

“The investor who says, ‘This time is different,’ when in fact it’s virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing.”

For those who may suggest that all this talk about “disruptive innovation” amounts to the same old “This time is different” story, it is important to remember a quote by Blogger Jesse Livermore at Philosophical Economics: 

“Not only is this time different, every time is different.  That’s why so many investors are able to outperform the market looking backwards, using curve-fitted rules and strategies. But when you take them out of their familiar historical data sets, and into the messiness of reality, where conditions change over time, the outperformance evaporates.”

He continues:

“Now, in hearing this suggestion, readers will scoff: “So you’re saying this time is different?” Of course I am.  Of course this time is different.  By suppressing this conclusion, even when the data is screaming it in our faces, we hinder our ability to adapt and evolve as investors.  Reality doesn’t care if “this time is different” will upset people’s assumptions and models for how things are supposed to happen. It will do whatever it wants to do.”

This is the problem with many more “traditional” value investors who for years now have found themselves on the wrong side of disruptive change and innovation. The process of learning and growing as an investor is never over. It is a lifelong pursuit.

Alternatively, investors that blindly follow valuation metrics based purely on past averages are falling prey to their own psychological issues even though they think they are acting rationally by following their models.

To simply look back historically at a few classic valuation metrics and say prices are below average, so buy or prices are above average so sell is a recipe at best for mediocrity and at worst for disaster.

It’s never that black and white. If investors would have simply followed those easy models, they would have likely sat on the sidelines for the bulk of this market cycle. It’s far too difficult to use one or even a handful of classic indicators to know exactly when a cycle is at a major inflection point and about to change directions because at the end of the day they are driven by irrational human emotions.

Perhaps our biggest investment takeaways from 2020 is that markets will:

1) always be different in terms of their current state and what factors are contributing to the prices of certain securities. We believe that moving forward, avoiding industries and companies in the clutches of "creative destruction" and embracing those creating "disruptive innovation" will prove lucrative; and

2) never be different when it comes to our inherent irrational human emotions and biases: manias and panics won’t be disappearing any time soon.

Musings

Investors ended one of the market’s wildest years on record by piling into everything from bitcoin to emerging markets, raising expectations that a powerful economic comeback will fuel even more gains.

The breadth of this rally is remarkable. It can be thought of as an “everything rally” which has sent most assets to record highs. It was a good year for those who held assets and a painful year for those with few skills, little education and no assets. The result is a financial chasm between the have and the have-nots which is much deeper than what existed prior to the onslaught of COVID-19.

We expect the chasm to widen even further in the coming years as disruptive innovation wreaks havoc on any individual or company not investing aggressively in innovation. In harm's way are companies that have spent the last 10-20 years engineering their financial results to satisfy the short-term demands of short-sighted investors and individuals who are unwilling to update their playbooks and skillsets. We believe the winners will win big and the losers, particularly those that have levered balance sheets (often companies who employ many low skilled workers) to satisfy certain stakeholders, and those who refuse to upskill will be dislocated leading to even greater levels of permanent unemployment.

Nevertheless, we believe there is reason for optimism.

1) The economy and markets have a history of finding a way through unprecedented challenges. It is important to reflect on the historical ability of humankind to adapt and innovate in the face of hurdles, even those that seemed insurmountable. We created a vaccine in record time, avoided what could have been an economic depression and will continue to push on in 2021.
 

2) There are still compelling reasons to invest in 2021. There's still much work to be done, but the U.S. and global economies are on a trajectory of recovery, which provides a favorable environment for risk assets. On the whole, U.S. economic data is still coming in better than expected, even if momentum has slowed. Manufacturing activity, initial unemployment claims and consumer activity have all rebounded impressively off lows. The Federal Reserve is unlikely to deviate from its accommodative course especially with so many still unemployed. Economies are getting massive liquidity injections, cash in circulation is soaring and annual growth of U.S. cash in circulation typically peaks at the start of economic cycles. The world is positioned for synchronized global growth and companies are positioned for impressive earnings growth. Inflation may ramp up a bit, but we think that the probability that it will upend markets in any meaningful way is low as policy makers and central banks are well aware of the disastrous consequences of any sudden rise in inflation (asset prices at all time highs supporting the “wealth effect” underpinning the recovery, a plethora of overleveraged zombie firms and perhaps most importantly most states’ vastly expanded balance sheets-both governments’ debt and central banks’ liabilities). 
 

3) A business-friendly approach to taxes and regulation has been a key driver of markets over recent years and there is little reason to believe this will change as there is little appetite to derail the fragile recovery and instead, there is appetite for major infrastructure spending. With neither political party having a significant majority in the Senate, this will likely mitigate the scale of fiscal policy shifts.

The real question is how much of the above 3 factors have investors already priced into markets? To what extent have investors pulled forward future returns to the present?

We are certainly flying high yet that doesn’t mean that stocks can’t push higher still. When studying the history of stock market excesses, particularly the excess of the 1999/2000 era what is apparent is that calling the market overextended or spotting a bubble is easy as investors were comparing the internet sector to tulip mania as early as mid-98. What is much more difficult is the ability to time a profitable exit...

As Epictetus in Discourses, 2.5.4-5 reminds us:

“The chief task in life is simply this: to identify and separate matters so that I can say clearly to myself which are externals not under my control, and which have to do with the choices I actually control. Where then do I look for good and evil? Not to uncontrollable externals, but within myself to the choices that are my own…”

2020 so starkly reminded us of the virtues of humility. To be humble in our predictions and forecasts. Humble as to what we believe we can control. Humble as to our talents and abilities. Open to an attitude of “Amor fati” which may be translated as "love of fate" or "love of one's fate".

Willing to embrace an attitude in which one sees everything that happens in one's life, including suffering and loss, as good or, at the very least, necessary.

Charts of the Month

Financial conditions are also the most loose on record.

While many stocks have delivered other worldly performance.

As mania spread to derivatives.

Amazing comeback story.

Last year 54% of all new cars sold in Norway were battery-powered electric vehicles, making Norway the first country in the world where electric vehicles (EVs) outsell traditional petrol, diesel or hybrid vehicles. With new models from Tesla, BMW, Ford & Volkswagen all due to hit the market next year, Norway seems very much on track to meet their target of ending the sale of diesel and petrol cars by 2025. Perhaps the world is next?

Logos LP December 2020 Performance

December 2020 Return: 5.48%
 

2020 YTD (December) Return: 99.71%
 

Trailing Twelve Month Return: 99.71%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +25.43%

Thought of the Month

"Join with those who are as flexible as the wood of your bow and who understand the signs along the way. They are people who do not hesitate to change direction when they encounter some insuperable barrier, or when they see a better opportunity. They have the qualities of water: flowing around rocks, adapting to the course of the river, sometimes forming into a lake until the hollow fills to overflowing, and they can continue on their way, because water never forgets that the sea is its destiny and that sooner or later it must be reached.” — Paulo Coelho “The Archer”

Articles and Ideas of Interest

• The pro-Trump mob was doing it for the gram. But it was also quickly apparent that this was a very dumb coup. A coup with no plot, no end to achieve, no plan but to pose. Thousands invaded the highest centers of power, and the first thing they did was take selfies and videos. They were making content as spoils to take back to the digital empires where they dwell, where that content is currency.

• What Warren Buffett’s losing battle against the S&P 500 says about this market. In 2020, Berkshire Hathaway shares were up, but not by much (2%), against an S&P 500 that gained over 18%, with dividends reinvested, according to S&P Global. Taken together, the two-year stretch of 2019 and 2020 marked one of the biggest gaps between Berkshire and the broader U.S. stock market in recent history, with the Buffett trailing the index return by a combined 37%. What does it mean?

• Does Joe Biden have too much power as he will undoubtedly face pressure from extremist left to use it? Joe Biden has a problem on his hands, other than the man in the White House who refuses to behave himself or go away. Kelly McParland digs in. How concerned should investors be about Biden’s tax proposals? After the Democratic sweep of both Georgia senate seats this week, Goldman Sachs now expects the Fed to raise interest rates in 2024 instead of 2025.
   

• A majority of investors believe the stock market is in a bubble - and many fear a recession, according to an E*Trade survey. A new E*Trade Financial survey of 904 active investors revealed that 66% of them believe the stock market is either fully or somewhat in a bubble. An additional 26% said the stock market is "approaching a market bubble." The survey also revealed that recession fears linger. 32% of investors listed a recession as their top portfolio risk right now. But they remain fully invested with inflows surging and the consensus long…
  
   

• Canadian expert's research finds lockdown harms are 10 times greater than benefits. Finally an honest analysis of ROI from an early proponent of lockdowns. Emerging data has shown a staggering amount of so-called ‘collateral damage’ due to the lockdowns. This can be predicted to adversely affect many millions of people globally with food insecurity [82-132 million more people], severe poverty [70 million more people], maternal and under age-5 mortality from interrupted healthcare [1.7 million more people], infectious diseases deaths from interrupted services [millions of people with Tuberculosis, Malaria, and HIV], school closures for children [affecting children’s future earning potential and lifespan], interrupted vaccination campaigns for millions of children, and intimate partner violence for millions of women. In high-income countries adverse effects also occur from delayed and interrupted healthcare, unemployment, loneliness, deteriorating mental health, increased opioid crisis deaths, and more.

• After embracing remote work in 2020, companies face conflicts making it permanent. Although the pandemic forced employees around the world to adopt makeshift remote work setups, a growing proportion of the workforce already spent at least part of their week working from home, while some businesses had embraced a “work-from-anywhere” philosophy from their inception. But much as virtual events rapidly gained traction in 2020, the pandemic accelerated a location-agnostic mindset across the corporate world, with tech behemoths like Facebook and Twitter announcing permanent remote working plans. Not everyone was happy about this work-culture shift though, and Netflix cofounder and co-CEO Reed Hastings has emerged as one of the most vocal opponents. “I don’t see any positives,” he said in an interview with the Wall Street Journal. “Not being able to get together in person, particularly internationally, is a pure negative.” Very interesting expose in Venture Beat. 

• The Life in The Simpsons Is No Longer Attainable. The most famous dysfunctional family of 1990s television enjoyed, by today’s standards, an almost dreamily secure existence that now seems out of reach for all too many Americans. I refer, of course, to the Simpsons. Homer, a high-school graduate whose union job at the nuclear-power plant required little technical skill, supported a family of five. A home, a car, food, regular doctor’s appointments, and enough left over for plenty of beer at the local bar were all attainable on a single working-class salary. Bart might have had to find $1,000 for the family to go to England, but he didn’t have to worry that his parents would lose their home.

• mRNA vaccines could vanquish Covid today, cancer tomorrow. The incredible progress made in developing the Covid vaccines should not be understated as we may be on the edge of a scientific revolution in human health. It looks increasingly plausible that the same weapons we’ll use to defeat Covid-19 can also vanquish even grimmer reapers — including cancer, which kills almost 10 million people a year.

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

Logos LP

Laugh Now Cry Later

Image Source: From Drake's Laugh Now Cry Later music video, 2020.Courtesy of UMG / Republic / OVO

Good Morning,
 

Stocks rose on Friday, lifted by strong U.S. economic data, to end a week that saw the broader market reach a record level. 

The bull market was strong before the virus and it has now regained its stride. This week's price action confirmed that. A 55% move off the lows in five months is the quickest and strongest recovery after a BEAR market low. The comeback rally appears to be the beginning of a new bull market. 

On Friday the Nasdaq hit its 35th new high in 2020 while the S&P recorded its 15th high with a close at 3,397. Both of those indices posted their fourth straight week of gains. The Dow 30 and the Dow Transports were both unchanged on the week, while the small caps as measured by the Russell 2000 fell 1.5%. 

This week, concerns over a new coronavirus stimulus bill kept the market’s gains in check as party representatives appeared unable to come to an agreement on the terms of a package. 

Washington continues to bicker while markets hit fresh record highs as we experience the strongest start to any month of August in 20 years. 

What to make of the haters who are still singing the “too much complacency” / “a total disconnect from the real economy” / “only a handful of stocks are rising” tune?

Our Take
 

Below I will get into why we, as investors, are predisposed to looking out for dangers that may upset our investment plans, but first I want to point out what is being lost in neverending gloom and doom of the popular financial media. 

For those who wonder why we are hitting new highs or who fear that the risk-reward is most certainly now skewed to the downside I would recall the following FACTS:

-Retail Sales hit a record high last week, and now Housing Starts and Building Permits are back to pre-pandemic levels.

-Airline passenger traffic has continued to improve off its lows from April, and the seven-day average traffic is the strongest since March 22nd.

-Adjusted for seasonal factors, the IHS Markit Flash U.S. Composite PMI Output Index posted 54.7 in August, up from 50.3 at the start of the third quarter, and signaled a strong increase in output (18-month high). Moreover, it marked the sharpest upturn in private sector business activity since February 2019.

-U.S. Services Business Activity Index at 54.8 (50.0 in July). 17-month high.

-U.S. Manufacturing PMI at 53.6 (50.9 in July). 19-month high.

-U.S. Manufacturing Output Index at 53.9 (51.7 in July). 19-month high.

Siân Jones, Economist at IHS Markit noted a strong expansion in U.S. private sector output in August:

"August data pointed to a further improvement in business conditions across the private sector as client demand picked up among both manufacturers and service providers. Notably, the renewed increase in sales among service sector firms was welcome news following five months of declines."

"Encouragingly, firms signalled an accelerated rise in hiring, as greater new business inflows led to increased pressure on capacity. Some also mentioned that time taken to establish safe businesses practices had now allowed them to expand their workforce numbers."

"However, expectations regarding output over the coming year dipped slightly from July due to uncertainty stemming from the pandemic and the upcoming election. Meanwhile, cost burdens surged higher amid reports of greater raw material prices. Although manufacturers increased their selling prices at a faster rate to help compensate, service sector firms noted that competitive pressures and discounting to attract customers had stymied their overall pricing power."
 

Furthermore when we move from the macro backdrop to the company level we see similar green shoots: 

-We continue to see extremely strong beat rates, especially for bottom-line EPS numbers. Overall, 82% of companies have reported earnings better than expected with an aggregate earnings surprise of ~22%.

-Forward guidance continues to be as positive as investors have ever seen it, but not many analysts are talking about it. 

Today, the haters state that technology stocks are in a new bubble, but the data may suggest otherwise. When compared to other sectors,  the Technology sector easily has the strongest EPS beat rate this season at 87%. Industrials, Consumer Staples, and Materials have the next strongest beat rates, while Energy and Real Estate have the weakest beat rates in the 50s. Do these numbers suggest that the market is irrational?

What of the claim that technology is doing ALL of the heavy lifting and this can’t go on? Is this even accurate? 

This may sound hard to believe, but the Technology sector ETF is just the sixth best performing sector in the third quarter and underperforming the S&P 500.

Industrials, Consumer Discretionary, Materials, and Communication Services are all posting double-digit percentage gains this quarter. With Consumer staples posting a 9+% gain, that is also higher than the 8.8% gain for the Technology sector in Q3.

The S&P is also up 9+% for the quarter. Let's not forget that Small Cap Growth, Small Cap Value, and Mid Cap value are also posting double-digit percentage gains in Q3 as well…

What about the general claim that the market is overpriced? The S&P 500 is trading at 10% above its 200-day moving average, similar to where it traded in February and at other previous market highs so there isn’t much new to see here yet what of the claim that the market is overvalued?

This appears to be a popular opinion as cash on the sidelines continues to to hit record highs. The double dip narrative appears to be gaining steam with every new fresh record high. Are stocks overvalued? The following tweet offers some insight:

Barry’s tweet is a reminder that classic “quick and dirty” valuation tools such as PE multiple should be relied upon with caution. What “expert” truly has any idea how high the PE multiple should be with an unlimited level of monetary stimulus and backstop of credit from the Fed? What investor has been here before? 

At minimum, it isn’t unreasonable to assume that the multiple should NOT be in line with historical norms. Therefore, the overvaluation “models” many investors and classical “value investors” cling to simply cannot hold the same weight they did with the 10-year Treasury at 0.68% when the historical norm is well above 5.0% (see Morgan Housel’s article below on Expiring Skills vs. Permanent Skills).

In fact, Kai Wu of Sparkline capital has put together an interesting research report which suggests that classical “value investing” has a long and distinguished pedigree but is currently in a deep thirteen-year drawdown as its “models” have rotated such investors into a massive losing bet against technological disruption. 
 

This is not the time for dogma. The old playbooks should at minimum be questioned. More than ever before, espousing a flexible approach is required. Inspiration from the old and appreciation for the new is a must as the “New” economy becomes THE economy.  

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Musings

I recently heard Drake’s new hit single “Laugh Now Cry Later,” on which Drake and Lil Durk rap about the high-life they live hoping to live in the moment and deal with pain and troubles later. As usual, Drake has aptly captured the spirit of the moment at a time when it appears that governments and central banks around the world are engaging in ever increasing monetary and fiscal stimulus that favors immediate pleasure, pushing pain and troubles to some future date for some future generation. 

The deficit spending for the U.S. is over $3 trillion so far this year and for Canada, close to $75 billion. While the costs are clear, the benefits are less so. Financial relief for millions of Americans and Canadians furloughed or unemployed has certainly been a short-term humanitarian gift but what about the future? 

As both governments in the USA and Canada look to additional government spending they must acknowledge the fact that monetary and fiscal spending have not generated ​significant growth ​over the past decade. 

As Michael Farr suggests, “our current efforts continue to make the same mistakes.  There are two primary mistakes: one, while surges of liquidity can stave off economic collapse​, and provide needed relief, they have little ability to stimulate ​sustained growth.  When growth doesn’t come, policy makers add more stimulus.  Two, cheap money has increased supply and done little to increase demand.”

The injections over the past ten years of QE haven’t created any multiplier effect. A trillion dollar injection results in a one-time trillion dollar surge and another trillion in debt because the U.S. doesn’t have an extra trillion lying around somewhere (the USA hasn’t run a surplus since the 1990s). 

Instead, the dollars should be funnelled to things that will grow and create jobs and increase over time. In short, there needs to be a clear ROI on future spending beyond the payment of another month’s rent or mortgage. This is the kind of investment that successful private industry and individuals would make. 

Unfortunately, policy makers have chosen to continue on a kind of willfully blind panglossian adventure in which they take the recipients of stimulus to an amusement park only to have them return to their same old same old. While at the park they feel pretty good. They temporarily forget their struggles and pain as they live the highlife only to return out another trillion in cash. When the high fades, a weak business pre-pandemic is still a weak business, a poor/precarious skill set/job is still a poor/precarious skill set/job. 

Instead, policy makers will need to have the courage to confront the harsh realities of this “Laugh Now Cry Later” economy. The rapid adoption of remote work and automation is accelerating inequalities which were in place well before the pandemic. The resulting ‘K’ shaped recovery has been and will continue to be good for professionals with the right skills who are largely back to work, with stock portfolios approaching new highs—and bad for everyone else.

The stimulus dollars as they are currently being deployed are not addressing this reality. Over the past ten years to today, the economy has no longer been creating steady jobs for low-skilled, low-wage workers as fast as it once was. Things will not go back to the way they were. No amount of protectionism or taxation of the hyper-rich will make it so. 

Alternatively, if policy makers are to have a chance at stimulating the kind of sustained growth we need, they will need to acknowledge that not all skills, jobs and businesses are created equal. Certain uses of capital and certain skills have higher ROIs than others. 

They will need to be more discerning capital allocators if they wish to stimulate a generation of producers, earners, consumers, tax payers, creative innovators and problem solvers that would better the future for generations to come. 

Sadly, looking at the sorry state of the current political discourse, such courage appears to be in short supply. 

After all, perhaps given how uncertain the future now looks and how much harder it will be for most to make a buck, many may be satisfied with what they can get. Even if it’s just a free trip to Wonderland…

Charts of the Month

After slowing to a trickle in March, public listings roared back and are now on pace to reach their highest levels since the peak of the dot-com boom in 2000.

Robot subsidy: Payroll and related taxes have held steady over the past 40 years, but the effective tax rate on automation has fallen. Translation: Economists argue we are now subsidizing the replacement of humans with robots, even when robots aren't as productive.  

Logos LP July 2020 Performance

 
July 2020 Return: 4.77%
 

2020 YTD (July) Return: 51.44%
 

Trailing Twelve Month Return: 59.30%
 

Compound Annual Growth Rate (CAGR) since inception March 26, 2014: +21.91%
 

Thought of the Month

"“The worst loneliness is to not be comfortable with yourself.”– Mark Twain

Articles and Ideas of Interest

 

• Even a global pandemic can’t slow the US IPO market down. After slowing to a trickle in March, public listings roared back and are now on pace to reach their highest levels since the peak of the dot-com boom in 2000.

• After tapping the bond market at a record-shattering pace in recent months, Corporate America is more indebted today than ever before. And while much of that fresh cash -- more than $1.6 trillion in total -- helped scores of companies stay afloat during the pandemic lockdown, it now threatens to curb an economic recovery that was already showing signs of sputtering. Many companies will have to divert even more cash to repaying these obligations at the same time that their profits sink, leaving them with less to spend on expanding payrolls or upgrading facilities in months ahead. Leverage ratios have never been higher for U.S. companies.

• Scientists discover a major lasting benefit of growing up outside the city. As the recession is predicted to slam cities and many rush to leave them, the data seems to support the move. Using data from 3,585 people collected across four cities in Europe, scientists from the Barcelona Institute for Global Health (also called IS Global) report a strong relationship between growing up away from the natural world and mental health in adulthood. Overall, they found a strong correlation between low exposure to nature during childhood and higher levels of of nervousness and feelings of depression in adulthood. Co-author Mark Nieuwenhuijsen, Ph.D., director of IS Global’s urban planning, environment and health initiative, tells Inverse that the relationship between nature and mental health remained strong, even when he adjusted for confounding factors.

• What if we could live for a million years? Past generations used to say that even though we cannot postpone natural death, we can control how we live. They also believed that there is “nothing new under the sun.” Both statements are inaccurate from our current perspective. With advances in bioscience and technology, one can imagine a post-COVID-19 future when most diseases are cured and our life span will increase substantially. If that happens, how would our goals change, and how would this shape our lives? Fascinating article in the Scientific American outlining what a post-death world could look like.

• Is inflation really what we should be worrying about? With many pundits pushing gold as their investment of choice, deflation remains the bigger danger from the collapse in global demand, rather than a surge in inflation.

• Delisting Chinese Firms: A cure likely worse than the disease. Interesting article by Jesse Friend suggesting that if the proposed legislation becomes law, its cure could be worse than the disease. Both Chinese controlling shareholders and the Chinese government are likely to exploit such a trading ban to further their own objectives, at the expense of Americans holding shares in these firms.

• The unstoppable Damian Lillard is the NBA superstar we deserve. He’s lifted his game to new heights inside the NBA bubble, but what sets the Trail Blazers’ point guard apart is the fierce loyalty and outsider spirit that’s driven him from the start. His unwillingness to run from “the Grind” is an inspiration.

• The unravelling of America. Interesting perspective (albeit a bit depressing) on America by anthropologist Wade Davis in the Rolling Stone in which he suggests that COVID has reduced to tatters the illusion of American exceptionalism. At the height of the crisis, with more than 2,000 dying each day, Americans found themselves members of a failed state, ruled by a dysfunctional and incompetent government largely responsible for death rates that added a tragic coda to America’s claim to supremacy in the world. Using compelling data and the historical context of other great empires, he paints a picture of a country in decline. Nothing lasts forever - perhaps America’s best days are behind it?

• Expiring vs. Permanent Skills.  Morgan Housel knocks it out of the park with this one in which he explains that every field has two kinds of skills: Expiring skills, which are vital at a given time but prone to diminishing as technology improves and a field evolves. Permanent skills, which were as essential 100 years ago as they are today, and will still be 100 years from now. Both are important. But they’re treated differently. Expiring skills tend to get more attention. They’re more likely to be the cool new thing, and a key driver of an industry’s short-term performance. They’re what employers value and employees flaunt. Permanent skills are different. They’ve been around a long time, which makes them look stale and basic. They can be hard to define and quantify, which gives the impression of fortune-cookie wisdom vs. a hard skill. But permanent skills compound over time, which gives them quiet importance. Morgan provides an excellent list of certain key permanent skills applicable to many fields.

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

Logos LP

2018 Meltdown and What to Think of 2019?

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.

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 


“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

Temperament Determines Outcomes

Good Morning,
 

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

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

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

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

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

Our Take
 

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

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

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

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

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

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

Musings
 

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

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

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

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

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

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

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

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

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

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

Thought of the Week

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

Articles and Ideas of Interest

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

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

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

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

  
   

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

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

Our best wishes for a fulfilling week, 
 

Logos LP

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

Stealth Bear Markets

Good Morning,
 

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

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

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

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

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

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

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

Our Take
 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Musings

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

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

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

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

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

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

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

Logos LP July Performance

 

July 2017 Return: -1.16%

2017 YTD (July) Return: +18.67%

Trailing Twelve Month Return: +21.59%

3-Year Annualized Return: +22.55%

Thought of the Week

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

Articles and Ideas of Interest

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

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

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

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

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

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

Our best wishes for a fulfilling week, 
 

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