NEWSPAPER READING - September, 2024

As an intro I will post this piece. Grant's Daily Aug 22: "That’s (FED's balance sheet) down $65 billion from this time last month, and 20.4% below the March 2022 peak. 20% in 2 years. That is pace of normalization. Took few month to build and then decades to unwind. 20% in 2 years." Sounds about right - that's the pace of life. If you cut rates, effect will be felt in a few years.

How do I feel in terms of financial security?

In its August consumer survey, Mizuho found that both low- and high-income Americans alike are trying to get as thrifty as possible, which means eating out less and searching for discounts wherever they can.

I thought in previous post that thrift is coming and similar language in quarterly reports will stay for some quarters to come. Our household's annual income went up roughly twice in the last 5 years (from 6 figures). We were doing ok even before Covid, however, I feel uneasy to order a tap beer for 4-5, while 10 years ago it was 2 and 1 in plenty of places 15 years ago here. I mean normal tap beer. In Tenerife, you could still buy a glass below 2 but it's a different beer. My point is that such a rapid bout of inflation left a deep scar on psyche of 98% of consumers. The process of "frog boiling" (gradual adjustment until the effect will wear out) will take time.

In the background, AI will be eating high earning jobs. Those jobs will have the best ROI to replace first. My feeling is that "universal income" is coming and will be paid by taxing M7. I hope that BRK has nothing to do about it, while M7 should see enormous assault on multiples in the next 5 years. In the next few quarters, there should be a few material (in terms of number of layoffs) stories published. They are coming. Thrift may stay for longer. Internet was a clear enhancer for all, while AI is a replacement for human. Technology and robots replace lower skill jobs, while AI will replace middle skill jobs.

NEWSPAPER READING - August, 2024

When Covid hit, first impulse was to spend cash on home. When all opened up, first impulse was to spend on experiential. Good question (for quite some time) - what's next? Looks like (Walmart, Q2) it could be simple life or picky cash spending avoiding big outlays (which was overdone in 2020-2021) and cutting on experiential (2023). Sounds very organic, given all the recessionary (almost 2 years) background. Most of people simply balance the cashflow while Covid induced printed money cash surplus ended. People with cash may simply need a break from everything until life will continue as before the Covid.

Low expectations about the future (contrasting normal current confidence - h/t end of July, Authers) is probably an ongoing hangover from GFC, which was catalyzed/reminded by Covid and, especially, the uncertainty induced by AI, and polarization of US because of growing inequality. It is clear that internet was an obvious tailwind (1995) for all but AI put in jeopardy many higher earning professionals. [I added this after rereading the post: this sounds very bullish because people are not yet complacent, they still remember.]

On sustainability of margins: China Shock, once it started happening, lifted both the profit share of GDP and the Gini coefficient of inequality to the highest levels since the Second World War. Obvious, that current state of event are towards more inflation and smaller margins.

To grease the wheels (and feed the Skinner's pigeons), its probably 1-2 25bps cuts this year and same next year, at best. Hopefully (cheering for muddle through).

Stanley Druckenmiller used to say - cyclical stocks are the best economists he knows. Back in December 2018, he cited the sharp selloff in cyclical stocks such as autos, home builders, banks and retailers as a warning sign that the Fed has tightened interest rate too much. Shortly after, the Fed pivoted, ending the tightening cycle. Now, there are plenty of pockets with their own (relatively) good (home builders, banks) and bad (discretionary retailers) lives. Do nothing is the path of least resistance.

Thought about going long yen a year ago. Thought about it a few month ago. In hindsight, everything is obvious - once it reached 160, it took it a month or so until "blew up".

At this time it seems that majority of experts and forecast agree again, like in December.

Oil is the Jocker at the moment.

NEWSPAPER READING & MACRO PICTURE - Q2/2024

 I will post a string of random things, which caught me in the last month or so. Highlighted the topic which attracted my attention.

Fight of fiscal vs monetary continues. It could also be called as massive market manipulation and people misinformation.

Monetary will cause internal (maturity wall?) or external shock (Japan? China?), which will cause easing. Real asset should be in demand in inflationary panic (ht Hugh Hendry), which should follow because of fiscal vulnerability, as in UK. Such thinking is probably impatient as may sound like a trade for next 6 months. It is rather for next 5, maybe more years. 

I cannot forget the fact that quarterly non-financial profit after tax in US jumped to $2T in Q1/22 (and stayed there) from roughly $1T in Q4/19 (and many quarters before). Hm, maybe this somehow could be related to the $2-3T US annual fiscal deficit? 

After tax and interest profit margins vs. net profit margins. Tax went down, interest also (until 2022). Fiscal problem and higher for longer will be strong headwind to markets even if multiples are sustained. More like a reminder. However, S&P is probably really different now - less leverage, better businesses, which could justify elevated margins. No doubt they benefited from low interest and reduced profit taxes but they will be harmed much less by the reverse (and could be enormously benefiting from 5% interest on cash). Profit tax is the one to watch. In some places it was increased to fund the defense spendings.

John Hussman: There’s no question that innovation should be rewarded enough to preserve incentives. But my impression is that corporate profits and extreme wealth, particularly among mega-cap companies, have become a sort of “capture” or “rent” that reflects network effects, social dynamics, and general technological efficiencies that were no part of that entrepreneur’s invention, and might be better characterized as public goods. End of quote. Another reason to watch the profit taxes. It is easy to imagine e.g. 10% public goods tax and sounds attractively in some circles.

AI: The reduction in the cost of knowledge production will transform information economics.

Bloomberg Economics did a more thorough analysis of data going back to 1969. Economists Eliza Winger and Anna Wong found that aggregate spending showed few signs of slowdown before prior recessions. “Rather, spending slows moderately only when a recession is already underway,” they wrote. And it’s precisely a slowdown in goods — durable goods — which appeared to have some signaling value ahead of downturns. Services was found to be often “insensitive to recessions.”

John Authers: In other words, the bet is on that AI has raised the profit share, or the proportion of revenues that companies can keep as profit, a number that tends to mean-revert, and has underwritten a continuing secular rise in earnings growth. That’s a big assumption. End of quote. Katsenelson had a timely reminder about price of cars in 2022 and situation now. There will always be those who want to grow at the cost of profit (which will come later, after the land grab).

Howard Marks, April 30: What does matter in this department is whether rates will stick in the range of 3.0% to 3.5% for the next 5-10 years, as I think, or return to the 0-2% range that prevailed most of the time from 2009 to 2021. If it’s the former, it should follow that equity returns will be lower than they were in that halcyon period; leveraged investment strategies will be less advantaged; and returns from credit will be markedly better than they were. That’s about all I can say, but it’s a lot. End of quote.

NEWSPAPER READING & MACRO PICTURE - Q1/2024

WEB claims that thinking about macro is waste of time. However, he spends a few hours per day reading newspapers (vaguely remember that it could be even 3-4 hours daily). Somehow I cannot force myself to pay for content when there are plenty of free quality content and I would simply have no mental processing capacity to read more if I buy additional daily readings. I spend roughly 2 hours per day on "newspapers" and X. It took me more than 20 years to figure out what is useful to read and definitely it is different for every person. Those few hours is probably 70% macro, 30% business news. A few days after reading I do not remember almost anything what I read but still hope that something is sticking to the wall. You really need only one or two good insights per year.

Times are unclear and hopefully not nuclear. So far so good. The storm is coming - since 2009. In 2020 seemed like it's here. Still, bank strategists are very afraid of 2000 and 2008.

For those with ADD, fiscal policy so far is winning: 

[QT + Interest Rates] < [Budget Deficits + FED's talks]

Longer version: 

QT (-$1.4T from peak, $7.5B remain) + Interest rates (net interest for non financials in Q4/24 hit Q2/99 level and going down) < $2T budget deficit (NOW, in $23T economy) + Fed's talk (vague promise to cut acts as "Powel's Put"). Mr. Market is saying that if troubles start surfacing, QT/interest induced constrains are easily removable. Major central banks are shrinking balance sheet at roughly annual 8-10% pace. With success.

Last few weeks have brought a number of very good posts on bi-polar facts, which well explains no need for rate hikes. Last week the FED/ECB "promised" something in June. My take is that June will become September. Cuts were promised and priced in, therefore, there should be - at least 1, though it's 50/50. It's the election year.. In 2007, circumstances were different but the first cut was in September, after 9 no action meetings, 15 months after maxing out. In 2023, the last increase was in June.

Essence is always in risk vs. reward and position sizing. My take is that probably now we have a similar probability of sustained 20% jump and 30% fall in S&P (even 50% would be understandable in the latter case but so far nobody came up with a bull thesis and bear is simply not working). The US health for the next 6 months seems perfectly intact. 

5% risk free is a very good deal at the moment. 10%+ listed 1x leveraged senior/junior portfolios also look attractive (OCSL and similar). I also like dry powder they have for any dislocations. Leverage now simply pays for the high management fees.

I cannot do much because 2/3 of money are tied in private investments but 1/2 of the remaining 1/3 is yielding safely (almost) 7-8% weighted. It's good that I do not have to solve another 1/3 problem.

WHAT WOULD I DO IF I WAS THE FED?

This year is a reminder that Mr. Market is the Almighty. Greed. Fear. Luck. Misfortune. What is simply accident and was is a real skill? Remember Hugh Hendry and his intellectual torture. Pleasure to read but useless otherwise. At least, so far.

In such a market no stock goes down without a proper reason. I am very curious to know what Michael Burry is doing these days. Is he also a part of a survivor's bias? Such thoughts are haunting me after a few investing setbacks. I think that mainly all heroes of Free Capital are simple survivors as for each one there are hundreds or thousands of those who did not make it. On the other hand, what do I know... there are guys from Graham-and-Doddsville. I did not see any pattern in Free Capital except that almost all of them had ten baggers, which set them free, meaning those were significant positions. For every big position, which worked 10 times there are thousand times more big positions, which has not worked.

Emotions aside, what would I do if I was the FED? I would love to know what is the tolerance of the market without risking too much to create an irreversible downward trends. It is easier said than done but something must be tried. Theoretically, the Fed can backstop at any market level. Practically, it is difficult to say.

But back to the question, what would I do?

a) I would pretend that everything is fine as long as possible; (e.g. perform stress test and find out that only 30b is needed to fix it all);
b) I would not let the new reality to set in ("muddle through" is good enough but "going down" - especially risking to reach the point of no return - is not affordable);
c) I would "slightly" manage statistics in case market overreacts downwards and fine tune later - similar to how GDP numbers are being "perfected" for a number of years.

The bad reality is that muddle through is not possible for too long (think 10 years) and this is the tragedy, which will cause another can kicking moment and potentially (4% probability) a full blow up of the system later. However, I think that money are on irreversible trend of losing value and the slowness of the process will cause the system to be in manageable equilibrium to infinity. I would place 4% probability to "nuclear" scenario and 96% to slow decay of money. It is nice to imagine, read and think about this "nuclear" case but it is not very probable. External shock could be a driver and it is the biggest unknown risk but this is normal (think about Buffett's fear of nuclear attack, Ebola expands exponentially, and similar).

Well, I think QE 4 and 5 is on the way but what is the level of S&P for that - this is the question? 1900? 1700? 1500? 1500 looks reasonable for me but could be too risky and too late, therefore, 1800 is probably a nice average to bear in mind. Well, I will note to myself that 2014 will be marked by indexes going nowhere, simply because all expected another 10-20% up year. Big move year will be saved for later.

THE BIGGEST LEGITIMATE INSIDER OF THE WORLD

I have been quiet for a while and traffic to the blog is just from search bots. As a coincidence, we are investing into a startup producing web robots. I (kind of) just want to write to myself that I have no intention to close this blog.

The first half of 2014 was not kind to portfolio and it is mainly my mistake in position concentration of option-like trades (they were not investments), which should be a fraction of portfolio and I confused feeling and past luck in similar situations to skill and knowledge. I let positions rise and did not liquidate in time, so since options expired worthless, portfolio is down double digits. Think of RSH, UNTK…

All these portfolio hits and my general busyness and lack of time made me rethink my current investments tactics. I have to admit that head is quite messy. Market is high and tempting to remove hedges. At least shorting small caps was a somewhat right insight. Well, I keep reminding myself that there is a price for cherry consensus and if everything would look right, there would be no upside left.

Thinking about general market perceptions is a fruitless thing, too. Who in his right mind can measure it? Do people are bearish too much or enough or not enough for the market to keep on climbing the wall of worry? Low interest rates just do not look right to me. Muddle through and new normal were very precise descriptions and predictions at their origination. At least, about the general background (I do not need even to search for evidence, it keeps coming like on a live news feed: Link).

So, who is this insider?

I am getting Daily Reckoning updates daily and sometimes read them, especially Chris Mayer and Bill Bonner. Chris is really good in giving tips to new interesting companies (whom we all tend to collect) and books, while Bill is a master of word and common sense. However, this time I read about insiders from a different author (Link).

I carry this insider idea in my head from early spring when Ukrainian situation was in its emotional Maidan stage. Such events cause stock fluctuations and Russian political decision makers do not have to report to SEC. It is trivial to make a billion dollars with a simple press release. It is redistribution of wealth in Russia when rich will get richer. But only for those who are close to the man.

It is September now and the idea does not seam so convincing anymore. The man has proven to be unpredictable and it is unclear what are his real motives, if any. Gazprom is a huge arbitrage story where a company with such proven reserves would cost probably 100x more if situated in a stable democratic country. Everything has a price. You can see my thought flow and here is the chart. The thing has started to brew between January and March.

2013 END NOTES

2013 was fast as probably each year when you get older and especially when you have small kids.

It was a mixed bag for me - stock picking was almost 1.5x better than market but excessive hedge position, obviously, materially lowered the returns. I cannot complain – mid teens with low downside risk is quite good (longs were covered with 1.5x index shorts for most of the year). I would settle for 10% pa with limited risk given the elevated valuations because of high margins and multiples.

As I wrote before, this year I have spent little time on my portfolio. Probably, it was in the spirit of Charlie Munger (documented by Value Investing World): “We use a lot of experience and do it [investment returns] in our heads. We don’t like complexity and we distrust other systems and think it many times leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something that is false. We’re so afraid of that process so we don’t do it.” Devil is in the details and footnotes but more and more I notice that the first hour of reading gives 80% of thesis. The most important is if I can build a constructive opposite thesis – if I feel that something was overdone with price movement, I act. When I see that insiders are on my side, position gets bigger.

Almost all returns came from 2 boring cellular telcos. No moat, no profit (almost no). Value investors were skeptical. However, in such cases, holding period is not forever and IRRs are quite good. I hope (a very important word) that UNTK and EZPW will be similar.

Macro is another topic hated by value investors. It is an interesting time when long-term interest rates are going up together with homebuilders. Mr. Market is saying that higher interest rates will not affect the recovering housing market.  The money printing was reduced by ~10% and its annualized run rate now totals ~6% of US GDP, while interest rates went up 40-80%. That was a price discovery of roughly 7 months, which will continue.

TNX is 10Y yield, TYX is 30Y yield and XHB - homebuilders.

Many many investors think like me; therefore, it is not that contrarian and quite painful at the same time while it should be painful when alone. They think and act with hedging their portfolios and keep on fighting the last war. Understandably, perma-bears continue to capitulate. Hugh Hendry did that in kind of a funny way. He thinks it will get much much worse but it will get better before that, which is worth a try to gamble. Those who were unhedged are definitely winning, so far. WEB is among them but he is in his own long-term game (he is not exiting the market before crash like the most intend to do). Correct me if I am wrong but the last three horsemen standing are John Hussman, Gary Shilling and Hoisington. Still await for G. Shilling's 2014 outlook, which should come in the first weeks of January. It should be an interesting read because he ended his 2013 mid year views: “So here’s my “risk-off” quartet: short stocks and commodities, long the dollar and Treasuries.” So far, so bad…

I will speculate that surprisingly the world cannot withstand a higher long term interest rates and a complete stop to QE would not anyhow influence rates (I am talking about longer term as in a short term market would correct and people would fly to safety).

This year I started to practice a basket of “option” stocks (stocks, which are priced like options, usually close to $1). I will see if my stock picking instincts are worth a dime as so far the score is 0:2 (thanks to PNCL and GAXC; long DM and ABM.L). However, mathematically, I am sure I should continue. I will decide after 10 or so attempts and positions should be closer to 0.5% (now larger) for now. On the positive note, such things absorb natural inclination towards activity and gamble - modern man needs variety and to have at least some fun. Discipline is boring and painful.

After writing this, I got a little better regarding my short XHB position (hurting in the last few weeks). It is painful but feels like a right thing to do given another interest rates run up attempt, which I believe (a very important word) to be another fake. I should at least reduce it at $28, though. I am afraid for pent up demand and normal household formation, does not matter how slow it is. Something similar to what is going on with autos.

I am intrigued about NLY. LOJN is coming back to a trade-able range.

A few reminders:

> Next crash will come from something not known or too obvious.

> General trend of the market is up - roughly 3/4 of the time. White men will do everything to preserve status quo and inflation is the key element of this. 

> The world has not deleveraged, yet (it is beautiful but takes very long or another 3-6 years, remember EU bank leverage ratios…).

It is getting too long, so Happy New Year!