equities

Where Is "The Crowd"?

Good Morning,
 

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

 

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

 

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

 


Our Take
 

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

 

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

 

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

 

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

 

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

 

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

 

Perhaps we haven’t quite reached euphoria just yet…
 



Musings
 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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


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

 

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

 

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

 

Think about that.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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


Logos LP in the Media

 

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


Thought of the Week

 

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



Articles and Ideas of Interest

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Our best wishes for a fulfilling week, 
 

Logos LP

Can Sci-Fi Help Us Become Better Investors?

Good Morning,
 

U.S. equities fell along with the dollar (which has dropped to an 11-month low as measured by the Bloomberg Dollar Spot Index) on Friday as investors assessed an investigation into U.S. President Donald Trump that may stall his economic agenda. Nevertheless, the three major indexes notched record highs this week as quarterly earnings from S&P 500 companies largely outperform expectations. Microsoft, Honeywell and Morgan Stanley are just a few of the companies that reported earlier this week.

 

Next week will be the busiest one this earnings season, with about 170 S&P 500 components scheduled to report.This remains an earnings-driven market and there have not been any major surprises yet. If earnings continue to grow, stocks should keep going higher.

 

Calendar second-quarter earnings have mostly exceeded expectations this far. With 20 percent of S&P 500 companies having reported, 73 percent have beaten expectations and 77 percent have beaten on sales, according to John Butters, senior equity analyst at FactSet.

 

Our Take
 

Interestingly, for all the fear associated with the gridlock and incompetence in Washington research actually suggests that stocks may like government gridlock as much as they like potential tax reform. Investment research firm Ned Davis Research found that when the Philadelphia Federal Reserve's Partisan Conflict Index — a measure of political disagreement in the United States — rises above 100, the S&P 500 has risen at a 11.7 percent annual rate. In contrast, the S&P rises just 5.8 percent when the index is below 100, according to analysis published on June 27.

 

On Wednesday, the Philly Fed said the index reached 201.15 in June, one of only seven times it has been above 200, and close to March's record of 271.29. In this case, traders may actually like the Trump-Russia headlines causing D.C. gridlock because they don't want politicians to mess up a good thing. Earnings are growing at a record pace, and economic growth is steady — two things markets like. New legislation could force businesses to change, potentially hurting their growth...

 

Last week the Bank of Canada embarked on what may be the slowest cycle of interest rate increases in more than three decades as it awaits evidence that consumer prices are picking up.

 

Surprisingly the median forecast of 16 economists in a Bloomberg survey suggest that the central bank will raise borrowing costs in October, and then twice in 2018 to bring its benchmark interest rate to 1.5 percent.

 

Governor Stephen Poloz flagged the risk of higher inflation as one reason the central bank hiked for the first time in seven years last week. Yet rapid inflation is among the least of Poloz’s concerns, according to the survey. Asked to rank five risks to monetary policy in order of importance, economists put “inflation overshoots” last.

 

Instead the biggest risk is the opposite one, they said: that inflation remains below target. They flagged a housing correction and U.S. policies that hurt Canada’s economic growth as the second-biggest. Despite these concerns, this Friday Canada’s core consumer prices and retail sales came in higher than expected, signaling that overall inflation may turn around to clear the way for another rate increase this year...

 

Nevertheless, this fear is and should be shared by monetary policy watchers worldwide. As we have mentioned before, global inflation is far from target and in fact appears to be decreasing rather than increasing as expected/modeled…

 

Just this week The Bank of Japan kept monetary policy steady, but pushed back the timing for achieving its 2% inflation target to 2020. "Risks to the economy and price outlook are skewed to the downside," the BOJ said in a statement. Inflation targets have been pushed back six times since the central bank launched its massive stimulus program in 2013. Foreshadowing what comes next for the rest of the developed world or isolated case?
 

Musings
 

Read an interesting piece this week in Harvard Business Review which suggested that business leaders should read more science fiction. Typically the genre is associated with spaceships, aliens and distant worlds, but it offers far more than escapism. By presenting plausible alternatively realities, science fiction encourages us to confront what we think but also how we think and why we think it. Science fiction tales reveal how fragile the status quo is and how malleable the future can be.

 

As Eliot Peper points out, William Gibson famously coined the term “cyberspace” in his 1984 masterpiece Neuromancer. Neal Stephenson’s The Diamond Age inspired Jeff Bezos to create the Kindle; Sergey Brin mines Stephenson’s even more famous Snow Crash for insights into virtual reality and the Star Trek communicator spurred the invention of the cell phone. Just last week researchers in China successfully teleported the first object from earth into orbit...

 

Nevertheless, to understand the real value of science fiction it is best to view it as useful not because it may be predictive, but rather because it reframes our perspective of the world.

 

We can think of “science fiction” as a “mental model” in the sense used by Charlie Munger on the path to building what he terms “worldly wisdom”. Worldly wisdom is an approach to business, investing and life which is based upon using a range of different models from a range of different disciplines to produce something that has more value than the sum of its parts.

 

As Robert Hagstrom wrote in his book on worldly wisdom entitled Investing: The Last Liberal Art: “each discipline entwines with, and in the process strengthens, every other. From each discipline the thoughtful person draws significant mental models, the key ideas that combine and produce a cohesive understanding.”

 

Although it may be a stretch to call science fiction a “discipline” it is useful to consider it a mental model which helps us to question our assumptions.

 

Assumptions which lead us to follow the herd. Assumptions which lead us to make decisions which are merely average and at times assumptions which can cause disaster.

 

As such, “science fiction” can increase the power of a latticework of such mental models which extends far beyond narrow questions. Such a latticework can lead to rich and unique understanding of the full range of market forces- new business opportunities and trends, emerging markets, the flow of money, international shifts, the economy in general and the actions/behaviour of humans in society and markets.

 

Assumptions can be useful as they help us with the cognitive shortcuts we need for navigating an increasingly complex and noisy world.  Nevertheless, they can also be detrimental as they fail to update as the world changes and condition us to be trend followers.

 

Superior decision makers, businesess people and investors train themselves to do the exact opposite. They train themselves to think in a way that is different than others, more complex and more insightful. By definition, most of the crowd can’t share such a way of thinking.

 

Thus, the judgements, ideas and assumptions of the crowd can’t hold the keys to success. Instead to free your mind from its false constraints and assumptions and connect with the intellectual explorer within, consider some science fiction this summer and your investment returns may just improve...

 

I recommend The Dispossessed by Ursula K. Le Guin and for a list of the top 25 works click here.

 

Let the mind bending begin...


Thought of the Week

 

"The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.” - Warren Buffett



Articles and Ideas of Interest
 

  • Americans agree on the best way to invest their money - but they’re wrong. A new survey by Bankrate.com through Princeton Survey Research Associates International asked more than 1,000 Americans what they consider the best way to invest money they won't need for 10 or more years. The most popular answer, chosen by 28 percent of respondents, is to use it to buy real estate. Zero-risk cash investments, such as high-yield savings accounts, came in second with 23 percent of respondents, while the stock market took third place, with 17 percent of respondents. Yikes….does this support the thesis that US stocks find themselves in a bubble? (full article in CNBC here).
  • Just because something is popular doesn't mean it's wise. Bankrate cites a study from London Business School and Credit Suisse, which found that after adjusting for inflation, housing offered returns around 1.3 percent per year from 1900 to 2011, while stocks performed more than four times better. If you believe the story that everyone else believes you will get what everyone else always got. Only a skeptic can separate the things that sound good and are from the things that sound good and aren’t...The ultimately most profitable investment actions are by definition contrarian: you’re buying what everyone else is selling (and thus the price is low) or you’re selling when everyone else is buying (and the price is high). These actions are lonely and uncomfortable because most people don’t believe them or do them...Next time you look at your “investments” consider how comfortable you are…

 

 

  • Focus on the future. Keep your eyes on the prize
  • What we should be saying: Live (or work) in the moment   

 

  • Stress is inevitable - keep pushing yourself
  • What we should say: Learn to chill out

 

  • Stay Busy
  • What we should say: Have fun doing nothing

 

  • Play to your strengths
  • What we should say: Make mistakes and learn to fail

 

  • Know your weaknesses, and don’t be soft
  • What we should say: Treat yourself well

 

  • It’s a dog eat dog world
  • What we should say: show compassion to others

 

  • Why Canada is able to do things better. Interesting perspective in the Atlantic suggesting that most Canadians understand that when it comes to government, you pay for what you get. Since the election of Donald Trump, there’s been no shortage of theories as to why America’s social contract no longer seems to work—why the United States feels so divided and dysfunctional. Hyper-partisanship, racist tendencies, secular politics of race and nationalism? The author suggests something more mundane: “The United States is falling apart because—unlike Canada and other wealthy countries—the American public sector simply doesn’t have the funds required to keep the nation stitched together. A country where impoverished citizens rely on crowdfunding to finance medical operations isn’t a country that can protect the health of its citizens. A country that can’t ensure the daily operation of Penn Station isn’t a country that can prevent transportation gridlock. A country that contracts out the operations of prisons to the lowest private bidder isn’t a country that can rehabilitate its criminals.”

 

  • Earth’s sixth mass extinction event is underway. Researchers talk of “biological annihilation” as this new study reveals billions of populations of animals have been lost in recent decades. There hasn’t been much talk of the effects of climate change of late but this piece does a great job of highlighting new research which analysed both common and rare species and found billions of regional or local populations have been lost. The researches blame human overpopulation and overconsumption for the crisis and warn that it threatens the survival of human civilisation, with just a short window of time in which to act.                    

 

  • There are two kinds of popularity and we are choosing the wrong one. Which kind of popularity you pursue matters, says Mitch Prinstein, a professor and director of clinical psychology at the University of North Carolina. He recently published Popular: The Power of Likability In A Status-Obsessed World. Prinstein delves into reams of research about what popularity is, and what effects it has on us. He shows that people who seek to be likable tend to end up healthier, in better relationships, with more fulfilling work, and even live longer. Status-seekers, on the other hand, often end up anxious, depressed, and with addiction problems. In the age of Instagram, it’s no surprise that most of us are gravitating to the wrong kind...Getting lost in the pursuit of status will likely come with sacrificing of the only relationships that matter..No wonder we are living in the golden age of “bailing”. David Brooks for the NYT suggests that “There was a time, not long ago, when a social commitment was not regarded as a disposable Post-it note, when people took it as a matter of course that reliability is a core element of treating people well, that how you spend your time is how you spend your life, and that if you don’t flake on people who matter you have a chance to build deeper and better friendships and live in a better and more respectful way. Of course, all that went away with the smartphone.”

 

  • Machines taking over hedge funds despite lack of evidence they outperform humans. Data science is a big part of the comeback story as Credit Suisse’s mid-year survey says 81% of investors likely to put money in hedge funds during the second half of 2017. About 60% of those investors are planning to increase allocations to quantitatively focused strategies over the next 5 years. To be sure, just because a hedge fund has a quantitative strategy does not guarantee returns. A recent Barclays report showed that while investors perceive quant strategies outperform those that are less technology-driven, there's no research that would indicate that is actually the case. In the first half of the year, so-called systematic diversified strategies, or those that have investment processes managed almost entirely by computers and have very little human influence over portfolio management, underperformed other strategies, according to new data by Hedge Fund Research Inc. The HFRI Macro: Systematic Diversified Index declined 2.8 percent during the first half of 2017, while the broader industry gained 3.7 percent. While the headcount, assets and interest appear to be growing, it doesn't appear that the returns are following suit. Interestingly, human brains are able to do useful things that machine brains currently cannot: forget. What does it mean to be human in a world filled with robots anyway? Quartz inquires.

 

  • Lots of talk about bubbles these past few weeks. Justified? Recently for Fox News Greg Ip wrote that: “If you drew up a list of preconditions for recession, it would include the following: a labor market at full strength, frothy asset prices, tightening central banks, and a pervasive sense of calm. In other words, it would look a lot like the present.” In another recent piece Scott Galloway convincingly paints a picture of the “full-monty bubble” we are nearing. As evidence, he mentions some hard metrics but focuses on a few interesting soft ones:
     

    -Mediocrity + two years tech experience = six figures

    -Bidding wars for commercial real estate

    -Gross idolatry of youth

    -You can’t get a table at average restaurants

    -There’s an Uber for private jets

    -Jay Z and Jared Leto are considered thoughtful startup investors

    -The food at your company is … good

    -A lot of articles explaining why “this time is different” (here, here, and here)

    -You’re introduced to remarkably uninteresting tech people at Cannes, who people think are “fascinating”

    -Tech CEOs are on the cover of fashion magazines and marrying supermodels

    -Founders of tech firms believe it’s their responsibility to put a man on Mars and cure death because … you know, they’re awesome

    -Billionaires with undergraduate and graduate degrees pay kids to drop out of college#negligent

    -Currencies mined by machines are … currency (I have a better understanding of the chemical underpinnings of a Leonid Meteor Shower than Bitcoin or Ethereum #huh)

    -There are CEOs of two firms at once

     

    This list I must say is convincing but it should be remembered that calling a market top is incredibly difficult as the only thing we can predict is the inevitability of market cycles. Why? Primarily because the future is unknown. Thus, as the calls of a market top multiply (which at present they are) the best response is simple: try to figure out what is going on around you, and try and use that to guide your actions. Is the pendulum oscillating at its peak ready to swing back to the opposite extreme? Or is it just passing its midpoint? Or as Barry Ritholtz teases, you can join the crowded landscape of pundits predicting the next crash by following his guide: 1) pick a bogeyman 2) cite household authority figures 3) always be confident 4) pay attention to non-financial events 5) pick a favoured asset class 6) charts, plenty of charts 7) claim vindication early and often 8) don’t forget the esoteric technical indicators 9) ignore contradictory data 10) don’t manage money...

 

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

Can Stories Destroy An Economy?

Good Morning,
 

U.S. equities rallied on Friday, with financials rising around 2 percent, following a stronger-than-expected employment report.

 

The Dow Jones industrial average jumped around 180 points — posting its best trading day of the year — signalling that the Trump rally may still be intact. 

 

The U.S. economy added 227,000 jobs in January, while the unemployment rate ticked higher to 4.8 percent, the Bureau of Labor Statistics said Friday. Economists polled by Reuters expected payrolls to grow by 175,000 with the unemployment rate holding steady.

 

Another factor improving investor sentiment was the move on Friday by Trump to sign executive orders aimed at watering down financial regulations in the U.S. This move lifted the Financial Select Sector SPDR Fund (XLF) by 2 percent.


 

Our Take

 

Remember when people used to talk about the Federal Reserve? No longer. What we are looking at is a structural shift in the market from a Fed-driven market to a policy driven market. 


Musings
 

Do humans for the most part act rationally, or are they for the most part driven by emotion? To what extent can our decisions and judgements be tainted by emotion? Can stories and rumours throw an entire economy off course? 

 

I read a fascinating piece this week by Mark Buchanan a physicist and science writer which took up a theme I alluded to in a previous letter that rhetoric can become reality. Sentiment can cause outcomes. 

 

In his piece, Buchanan fleshes out this concept by demonstrating how narratives can spread economic uncertainty, discouraging consumer spending and business investment. 

 

In a recent speech Yale University Economist Robert Shiller made arguments about the Great Depression and the 2008 financial crisis. 

 

In the 2000s people passed around stories about getting rich flipping homes and this contributed to a belief that home prices would always rise. The real estate industry as well as the financial industry played into this but the key is that most appeared to buy into this narrative. Dissenting voices were few and far between. (Sound like the familiar narrative you hear in Toronto with home prices jumping 22%?)

 

Schiller has written extensively on these topics yet his new work has coined the term “narrative economics” - the idea that stories more more like infectious agents, with some being much more contagious than others, and that an epidemiological approach might help to better understand their movement. This is becoming more of a reality as we are able to perform more complete analyses of news feeds and social media. 

 

If moods, feelings and emotions drive decision making to what extent to they drive markets and economies? 

 

As Buchanan states: 

 

“It is perhaps appropriate that the power of stories is gaining greater recognition during the age of Donald Trump, who rose to the presidency thanks in large part to an utter disregard for objective reality. As Shiller acknowledges, Trump is a “master of narrative." Let's hope this one doesn’t prove to be disastrous.” 

 

Pay attention to the prevailing mood. Take the temperature of the stories and narratives that dominate the hearts and minds of those that surround you. You may find that causality can be turned on its head…



Thought of the Week


 

"Words are but symbols for the relations of things to one another and to us; nowhere do they touch upon the absolute truth.” -Friedrich Nietzsche




Stories and Ideas of Interest

 

  • Since the election, your personal filter bubble has been a big topic of conversation. To solve this bias problem, Wired magazine suggests using tech to re-engineer your media diet. You can try an app called Discors or the Chrome browser extension EscapeYourBubble to help you better understand and accept others. Barry Ritholtz suggests that these are good places to start but that they miss the mark as bias is but one cognitive error we make. He offers a few additional steps here

     

  • The multinational company is in trouble. Mr Trump is unusual in his aggressively protectionist tone. But in many ways he is behind the times. Multinational companies, the agents behind global integration, were already in retreat well before the populist revolts of 2016. Their financial performance has slipped so that they are no longer outstripping local firms. Many seem to have exhausted their ability to cut costs and taxes and to out-think their local competitors. Mr Trump’s broadsides are aimed at companies that are surprisingly vulnerable and, in many cases, are already heading home. The impact on global commerce will be profound.

     

  • Inside the mind of a Snapchat streaker. Bloomberg dives into the life of an avid user demonstrating that the photo sharing app is dangerously addicting by design. This is a depressing account but a must for those who are not users. Timing is right given that this week Snapchat filed for an IPO stating in its filing that: "We have incurred operating losses in the past, expect to incur operating losses in the future, and may never achieve or maintain profitability.” Will the app’s addictiveness be enough to convince investors to overlook the company’s net loss: $514.64 million in 2016, wider than $372.89 million in 2015? 

     

  • People wouldn’t care if three quarters of brands disappeared: Survey showed. Havas Group's "Meaningful Brands" report shows that people wouldn't care if 74 percent of brands they use vanished. They also say that 60 percent of the content produced by companies is poor, irrelevant or failing to deliver. This is a clear sign that over communication is diluting brand value and thus making it more difficult for brands to grow. The fight for consumer attention has perhaps never been more difficult. 

    What is a meaningful brand? Delport defined a meaningful brand as one which functionally works, offers value for money and makes someone's life easier, as well as considering the impact it has on a community. 

 

All the best for a productive week,

Could Trump Be Powerful Enough?

Good Morning,
 

U.S. equities closed higher in volatile session on Friday after Donald Trump took a protectionist tone in his first speech as president.

 

"We must protect our borders from the ravages of other countries making our products, stealing our companies, and destroying our jobs," Trump said after being sworn in. "Protection will lead to great prosperity and strength. I will fight for you with every breath in my body and I will never ever let you down.”

 

Our Take

 

It was a very populist speech. But what were you expecting? No Trump isn’t normal but that’s sort of the point as he spoke to the Heartland appealing directly to those who voted for him. It was vintage Trump and quite frankly it was what many in the United States needed to hear. Perhaps if businesses and consumers truly believe that Trump will “make America great again” the rhetoric will become reality as wallets open and corporate war chests are put to work. 

 

Sentiment is powerful and often precedes outcome. The way you carry yourself will often determine how you are treated. The things you say in the long run can have a way of creating the future.


The great leader respects himself and inspires the same sentiment in others. By acting regally, by tempting others to become confident in their powers, in their country and in themselves they make themselves and their subjects seem destined to wear a crown. 

 

Could Trump be powerful enough to catalyze rhetoric into reality?



Thought of the Week

 

"Be royal in your own fashion: act like a king to be treated like one.” - Robert Greene



Stories and Ideas of Interest

 

  • U.S. investor optimism is highest since crisis as Trump era dawns. It's been a month since the post-election rally in U.S. stocks stalled, but to hear high net worth investors tell it, there's only blue sky ahead as Donald Trump takes office….

     

  • That awkward moment when the world’s richest people have the same amount of money as half the world. Eight billionaires from around the globe are as rich as the 3.6 billion people who make up the poorest half of the world's population.   
         
     

  • Lifelong learning is becoming an economic imperative. Interesting piece from the Economist suggesting that technological change demands stronger and more continuous connections between education and employment. The faint outlines of such a system are now emerging. We are moving towards in which schools are places that you may return to several times over a lifetime in order to train for several different careers. 

     

  • Trump’s nationalization via Twitter. Here’s a question: When is a company considered privately owned? There’s ownership, and there’s control. If a company’s shareholders and executives don’t have control over the day-to-day operations of their organization -- if the government calls them up and tells them what to do -- is it really private?

     

  • AI pioneer wants to build the Renaissance machine of the future. Juergen Schmidhuber taught a computer to park a car. He’s also showing that same machine how to trade stocks and detect flaws in steel production. Unrelated as these tasks may appear, Schmidhuber thinks a seemingly random training regimen is key to creating artificial intelligence that can solve any problem.

 

  • Can Snapchat’s culture of secrecy survive an IPO? Last September, Snapchat employees read a report about a leaked commercial touting a new product—a pair of glasses for shooting videos. They felt emboldened to ask their bosses: Are these Spectacles glasses really from us? It seemed plausible. Paparazzi had photographed Chief Executive Officer Evan Spiegel wearing similar frames months earlier. Interesting piece chronicling the rise of a company in which employees are last to know. 

 

  • Mathematical model reveals the patterns of how innovations arise. The MIT technology review suggests that the work could lead to a new approach to the study of what is possible, and how it follows from what already exists. 

 

  • Move over coders- physicists will soon rule Silicon Valley. Interesting piece from Wired suggesting that structurally and technologically, the things that just about every internet company needs to do are more and more suited to the skill set of a physicist. Stay interdisciplinary. 

 

All the best for a productive week,


Logos LP