This week's interesting finds

What Currency Devaluation Looks Like

This chart shows 10-year Treasury yields (blue line) vs the inflation-adjusted annualized return of 10-year Treasuries bought that year and held to maturity (orange bars):

Data Sources: Robert Shiller, Aswath Damodaran

During the 1940’s, the war period of massive fiscal spending, the Fed capped rates below the prevailing inflation rate. Inflation was transient, coming in spikes, and yet rates were capped at 2.5% or below:

Data Sources: Robert Shiller, Aswath Damodaran

As a result, here’s what happened to anyone who bought and held 10-year Treasuries to maturity from the early 1940’s. Those Treasuries were paid back nominally, but a full third of their purchasing power was lost due to inflation of both the money supply and consumer prices.

Data Sources: Robert Shiller, Aswath Damodaran

CalPERS assumed plan return U.S. 10-Year and 30-year Treasury Note Yield

CalPERS’ (California Public Employees' Retirement System) assumed plan returns going back 60 years compared to the U.S. 10-Year Treasury Note Yield. Back in 1960, the 10-Year was at 4%, and the planned return was 4%, so there's basically no risk premium. In 1981, the 10-Year was yielding about 14%, and the planned returns were 8%. So there was a -6% risk premium. You could have basically locked up a lot of your returns for some period of time. And then now the 10-Years is 70 basis points, roughly speaking, and the planned returns are 7%. Which doesn't seem crazy, but let's call it roughly almost a 6% point equity risk premium. So we've gone from -6% to 6% risk premium. Now you're the chief investment officer in one of these big pension funds, and you're like, "How am I going to get there?"

Sounding good or Doing good?

ESG (Environmental, Social and Governance), a measure of the environment and social impact of companies, has become one of the fastest growing movements in business and investing, and this time, the sales pitch is wider and deeper. Companies that improve their social goodness standing will not only become more profitable and valuable over time, we are told, but they will also advance society's best interests, thus resolving one of the fundamental conflicts of private enterprise, while also enriching investors.

Any attempts to measure environment and social goodness face two challenges.

• The first is that much of social impact is qualitative, and developing a numerical value for that impact is difficult to do.

• The second is even trickier, which is that there is little consensus on what social impacts to measure, and the weights to assign to them.

There are multiple services now that measure ESG at companies, but the lack of clarity and consensus results in the companies being ranked very differently by different services shows up in low correlations across the ESG services on ESG scores:

This low correlation often occurs even on high profile companies:

This week's interesting finds

Charts of the week

Leverage equity buying (net calls) at an all-time high

Household savings by year

In 60 years, the Momentum trade has never gotten this carried away (including the top of the market in 2000)

A nice dissection of the components of inflation

Cash generation is strong

The Big Growers’ share of market cap: we’re above 2000 top and are now in line with the Nifty Fifty

Bits and pieces:

• The Shiller cyclically adjusted PE ratio is the highest on record with the two worrying exceptions of 1999 and 1929. (Source: Morningstar)

• Small traders are dominating the options market and 75% of the volume is in contracts that expire in two weeks. (Source: Bianco Research)

• The urge to trade seems to be universal:  A legion of day traders is taking over Korea’s stock market accounting for 88% of the total value of Korean equity trading in the first 8 days of September (Source: Bloomberg)

• Millions of Indians have piled into the country’s stock market helping sustain a strong rebound from the depths of march. Average age of new customers in Zerodha – India’s discount brokerage house: 28. With the impetuosity of youth, the novices are choosing to bypass underperforming mutual funds and do their own stock picking, penny issues preferably. (Source: Financial Times)

Big investors are dying to know what amateur traders are doing

With the sway of stay-at-home traders growing and starting to eclipse other influences on equities, figuring out who is doing what among amateur stock dabblers has become a critical mission for big investors. They’re canvassing Reddit threads and picks at retail brokerages, plugging data into programs and trying to gain an edge.

The Fault, Dear Investor, is Not in Your Investments, But in You

Over the last twenty years, the average equity mutual fund posted a yearly return of 8%. Over the last twenty years, the average investor in an equity mutual fund posted a yearly return of 4%.

The reason is that majority of investors play the short-term game – trading in and out, in and out of equities – an asset class that has been known to build wealth over long periods of time.

The tendency – of short-termism – has become more common over the years. Investors, who are have become so used to chasing short term performance, are acting a lot more with the vastly available information on how funds perform not just year on year, but even on a quarterly and monthly basis.

This doesn’t mean that you must stick with your losing funds forever, as people do with their losing stocks to get their money back. But instead of switching in and out of funds, you must give time to the ones that have been managed well in the past but may just be going through a temporary period of underperformance vis-à-vis the new leaders. This also applies to your losing stocks. Stick with businesses that have been managed well in the past, and even now, even when their stocks are going through a temporary phase of a downturn owing to the overall market weakness.

“Investing is simple, but not easy,” says Charlie Munger. Knowing that following the herd or chasing market leaders is a way to hell is the ‘simple’ part. Avoiding it is the ‘not easy’ part.

Trying to time the market or finding winning stocks or fund managers and then siding with them till you find the next batch of winning stocks or fund managers is a waste of time that often backfires.

To do well over the long run, your best bet is to keep things simple. Stick with stocks, funds, and managers who are intrinsically good, even when they are going through temporary bad phases, do not deviate from your investment process, minimize your costs, and keep a long-term perspective.

This week's interesting finds

Amazon’s weight in S&P 500 Index is now bigger than the entire energy and materials sector combined.

S&P 500 Index EPS vs. U.S. Corporate Profits

This chart puts into perspective the wide divergence between S&P 500 Index EPS and U.S. corporate profits.

RHS – right hand side of the chat

NIPA – National Income and Product Accounts

Reed Hasting on Work from Home

WSJ: What elements of the Netflix culture are tougher to maintain now that so many employees are working from home?

Mr. Hastings: Debating ideas is harder now.

WSJ: Have you seen benefits from people working at home?

Mr. Hastings: No. I don’t see any positives. Not being able to get together in person, particularly internationally, is a pure negative. I’ve been super impressed at people’s sacrifices.

WSJ: It’s been anticipated that many companies will shift to a work-from-home approach for many employees even after the Covid-19 crisis. What do you think?

Mr. Hastings: If I had to guess, the five-day workweek will become four days in the office while one day is virtual from home. I’d bet that’s where a lot of companies end up.

WSJ: Do you have a date in mind for when your workforce returns to the office?

Mr. Hastings: Twelve hours after a vaccine is approved.

WSJ: I like that.

Mr. Hastings: It’s probably six months after a vaccine. Once we can get a majority of people vaccinated, then it’s probably back in the office.

Mental Models: The Best Way to Make Intelligent Decisions

This guide explores everything you need to know about mental models. By the time you’re done, you’ll think better, make fewer mistakes, and get better results.

In a famous speech in the 1990s, Charlie Munger summed up the approach to practical wisdom through understanding mental models by saying: “Well, the first rule is that you can’t really know anything if you just remember isolated facts and try and bang ’em back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form. You’ve got to have models in your head. And you’ve got to array your experience both vicarious and direct on this latticework of models. You may have noticed students who just try to remember and pound back what is remembered. Well, they fail in school and in life. You’ve got to hang experience on a latticework of models in your head.”

SoftBank’s Big Options Bet Tests Investor Faith in Masayoshi Son

Just when investors thought Masayoshi Son was reining in risk at SoftBank Group Corp., the Japanese billionaire’s foray into highly leveraged derivatives is giving them fresh reason to worry. SoftBank shares tumbled 7.2% on Monday in Tokyo, erasing about $9 billion of market value. The drop came after the conglomerate made massive bets on high-flying technology stocks using equity derivatives. What has alarmed shareholders is that Son appears to be using options to amplify his exposure to a corner of the market where valuations have soared and mercurial individual investors are playing an ever-greater role.

This week's interesting finds

No Income or Protection

The inimitable charm of government bonds over the last 30 years or so has been their wonderful tendency to give capital gains when the world starts to fall apart. The fly in the ointment is that those capital gains came from an expectation that the Federal Reserve would reduce interest rates to combat any economic weakness Today that is probably no longer true. And while you can argue as to whether I’m merely speculating about a hypothetical future problem, let’s look at what happened to the 10-year bonds in each of the G-10 markets during the Covid-19 crisis this winter.

Those markets where short rates were meaningfully above zero saw significant gains in their 10-year bond, even if none were quite as impressive as we saw in the U.S. Those markets where the short rate was already around zero or lower, though, told a very different story. The average bond return in those markets was -1.3% and none of them had a positive return in the period. So much for hedging the losses in the rest of the portfolio!

And today, the group of countries where short rates are already around zero or lower consists of every member of the G-10, the U.S. included. As a result, it seems to me unlikely that any government bond in the G-10 would provide meaningful positive returns if the global economy should encounter further problems associated with the Covid-19 outbreak or for any other reason in the near future. If short rates and bond yields rise meaningfully between now and that future downturn, that might no longer be the case. But if you are counting on such a rise occurring before the next downturn, you are also counting on bonds delivering a negative return in the interim.

Long Bonds Are Bringing Trouble

Nothing new here, but it looks like a bad month for investment-grade in August has some managers and their clients taking notice.

“U.S. companies are locking in low yields now for as long as they can, and the result is pain for investors. So far this year companies ranging from snack food maker Mondelez International to airplane manufacturer Boeing to communications giant AT&T have sold more than $290 billion of bonds maturing in 30 or more years, more than twice the longer-term securities sold over the same period last year, according to data compiled by Bloomberg. The average tenor of new issues this year is 12.9 years, up by more than a year from 2019, according to JPMorgan Chase strategists

Investors are buying longer-term notes to get higher yields in a near-zero-interest-rate world. But they’re also taking on more interest-rate risk in the process. Investment-grade notes posted a loss of 1.4% in August, the worst monthly returns since March and only the third negative month in the last two years, driven in large part by rising Treasury yields hitting longer-term securities.”

“Money managers who focus carefully on credit risk might have to pay more attention to the risk of longer-term yields rising, said Matt Brill, head of U.S. investment-grade credit at Invesco.”

Longer-term notes may offer yields that look high relative to the alternative, but they are still low on an absolute basis. The notes Mondelez sold this week that mature in 2050 paid a coupon of 2.625%, compared with 1.5% for the 10-year notes.

“For our total return clients on the insurance side, it’s hard to invest in these low, all-in yields, so more client dollars are going to different asset classes,” said Travis King, co-head of investment grade credit at Voya Investment Management in Atlanta.

By Max Reyes

Source: Bloomberg LP.

Party like its 1999

Here is an article from 1999 where a record number of U.S companies attempted to capitalize on market euphoria by splitting their shares. During the dot-com craze, investors responded very positively to stock splits, bidding share prices up even further, and stoking the eye-popping run-ups in the U.S. stock market. Qualcomm for example announced a 2-for-1 split in May 1999 and then a 4-for-1 split in November 1999. By December 25th the stock was up 1500% for the year.

Today, Tesla’s stock split investor reaction is somewhat ‘1999ish’. Tesla shares ran up 13% in a single day on just the announced stock split earlier in August.

Stock splits add zero liquidity or additional tangible value to investors but nonetheless broadcast a bullish message that resonates powerfully with investors. They often open the gates to more buyers by lowering the price of a company’s share. This makes them more attractive to more investors because more people are more likely to buy more.

Signs investors are paying far too much attention to short-term noise

In Malcolm Gladwell’s latest book, Talking to Strangers, he writes about the concept of alcohol myopia. It’s a theory that alcohol causes drinkers to focus on their immediate environment. As Wikipedia puts it, intoxicated individuals act rashly, choose overly simple solutions to complex problems and act without considering the consequences.

What does this have to do with investing? Well, right now it feels like we’re experiencing market myopia. Investors are focused on today, leaving the future for later. I’m not so much referring to the strength of the stock market, but rather all the stuff that’s going on around it.

Here are some signs that investors are getting intoxicated:

Extrapolating current demand

Companies that did well during the lockdown are generally expected to keep growing and profiting in the post-pandemic world, including home improvement stocks such as Home Depot Inc., Lowe’s Cos. Inc. and Best Buy Co. Inc., athleisure stocks like Lululemon Athletica Inc. and Nike Inc., and, of course, technology stocks.

Worrying about profits later

One of the features of this market cycle has been the emergence of what I call the “non-profit” sector: companies that are growing rapidly, but don’t have a clear path to profitability. Some of today’s tech giants weren’t overly profitable in their early days either (for example, Facebook Inc. and Alphabet Inc.), but the next generation (Netflix Inc., Uber Technologies Inc., Zoom Video Communications Inc., Slack Technologies Inc. and Wayfair Inc.) appear to be different. They are mature companies and are losing money in a favourable business environment.

Chasing yield

The bonds of cyclical and highly indebted companies got hammered during the March meltdown as holders worried about getting their money back. Since then, however, most of the lost ground has been made up, even though the economic outlook is no more certain. Investors are moving up the risk scale to feed their insatiable appetite for yield, because high-quality corporate and government bonds are yielding next to nothing. Investors are getting a little more yield with a lot more risk.

Stock splits and price targets

In recent weeks, Tesla Inc. and Apple Inc. were sharply up on news that they were splitting their stocks. The splits made the shares more accessible to smaller investors but didn’t create one dollar of additional value.

Crowded trades and fat pitches

We can’t be sure how or when the hysteria will end. We just know it will. The most enduring inefficiency in the stock market is time frame. There will always be rewards for looking beyond the near-term noise to the opportunities and risks further out. The myopic market has put the spotlight on a select number of popular trades, which leaves plenty of other areas to explore. There are fat pitches out there, to use Warren Buffett’s analogy, they just haven’t gone viral yet.