What We’re Reading (Week Ending 10 January 2021) - 10 Jan 2021
Reading helps us learn about the world and it is a really important aspect of investing. The legendary Charlie Munger even goes so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 10 January 2021):
1. One of The Great Bubbles of Financial History – Michael Batnick
Jeremy Grantham is going for it. In his latest piece, Waiting For The Last Dance, he writes:
“I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”
Yikes
Grantham is famous for calling the Japanese, tech, and housing bubbles. So when he speaks on this topic, investors pay attention. You can’t mention his prescient calls without mentioning the ones that didn’t come to fruition. It’s only fair to point out that he has been bearish for much of the recent bull market….
…It’s hard to argue with Grantham when he says, “a higher-priced asset will produce a lower return than a lower-priced asset.” It’s hard, but I’m going to try anyway. I have a massive amount of respect for Grantham, so I hope this does not come off as disrespectful. I’m just trying to provide an alternate view…
…One of the most popular methods that market historians use is the CAPE ratio, which I want to discuss briefly. At just under 34x, it’s the second-highest it’s ever been, behind only the tech bubble in 2000…
…One other thing the long-term does is hide the medium long-term. Including numbers from the 1800s masks the fact that the CAPE ratio has been rising for decades, as I wrote about in 2017, “Should Stocks Be Worth More Now Than They Used to Be?
The average CAPE ratio for the entire data series is 17. But it averaged 25 in the 90s, 26.7 in the 2000s, and 25.5 in the most recent decade. We haven’t once talked about how things like low interest rates, low inflation, Fed intervention, fiscal policy, or market structure affect market behavior, but those are different stories for a different day.
At 34x on the CAPE ratio, it’s impossible to argue stocks are cheap. I won’t do that. But what if we’re looking at the wrong metric?
Ensemble Capital recently tweeted:
“The 9% long term rate of return to US equities has historically come from a 4% FCF yield and 5% growth. In the decade since 2009, there have been regular claims that we were back in a bubble, but the FCF yield suggested valuation was not stretched. This is still true today.”…
…I will go on record that I don’t think this is anywhere near like 1999 or 1929, despite what the CAPE ratio says. Are there pockets of excess? Absolutely, I’m not blind. But a 70% decline in the major averages? Sorry, I don’t see it.
2. Twitter thread on the establishment of Amazon Web Services in its early days – Dan Rose
I was at Amzn in 2000 when the internet bubble popped. Capital markets dried up & we were burning $1B/yr. Our biggest expense was datacenter -> expensive Sun servers. We spent a year ripping out Sun & replacing with HP/Linux, which formed the foundation for AWS. The backstory:…
…Amazon’s CTO was Rick Dalzell – ex-Walmart, hard-charging operator. He pivoted the entire eng org to replace Sun with HP/Linux. Linux kernel was released in ’94, same year Jeff started Amzn. 6 years later we were betting the company on it, a novel and risky approach at the time….
Product development ground to a halt during the transition, we froze all new features for over a year. We had a huge backlog but nothing could ship until we completed the shift to Linux. I remember an all-hands where one of our eng VPs flashed an image of a snake swallowing a rat
This coincided with – and further contributed to – deceleration in revenue growth as we also had to raise prices to slow burn. It was a viscous cycle, and we were running out of time as we ran out of money. Amzn came within a few quarters of going bankrupt around this time.
But once we started the transition to Linux, there was no going back. All hands on deck refactoring our code base, replacing servers, preparing for the cutover. If it worked, infra costs would go down by 80%+. If it failed, the website would fall over and the company would die.
We finally completed the transition, just in time and without a hitch. It was a huge accomplishment for the entire engineering team. The site chugged on with no disruption. Capex was massively reduced overnight. And we suddenly had an infinitely scalable infrastructure.
Then something even more interesting happened. As a retailer we had always faced huge seasonality, with traffic and revenue surging every Nov/Dec. Jeff started to think – we have all this excess server capacity for 46 weeks/year, why not rent it out to other companies?
Around this same time, Jeff was also interested in decoupling internal dependencies so teams could build without being gated by other teams. The architectural changes required to enable this loosely coupled model became the API primitives for AWS.
3. Two Worlds: So Much Prosperity, So Much Skepticism – Morgan Housel
The demand for forecasts grows after a surprise. It’s quite an irony. Surprises make you feel like you’re not in control, which is when it feels best to grab the wheel with both hands, listening to those who tell you what happens next despite being blindsided by what just happened…
…But the most important economic stories don’t require forecasts; they’ve already happened. And they tend to be the most overlooked, because when everyone’s focused on the future it’s easy to ignore what’s sitting right in front of us.
I want to tell you two of the biggest economic stories that aren’t getting enough attention.
One is that household finances might be in the best shape they’ve ever been in. Ever. That might sound crazy, and it’s easy to overlook because of the second story: Covid has dumped kerosene on wealth inequality in ways we’ve yet to fully grasp…
…Your spending is someone else’s income.
When you don’t spend, someone else gets laid off, which means they don’t spend, and someone else gets laid off, on and on.
Same thing works in the other direction. That’s why booms and busts have momentum.
And it’s why last March was such a red-alert moment for the global economy. Once spending stops due to lockdowns – and “stop” is hardly an exaggeration here – incomes collapse, and a nasty cycle takes hold.
Stimulus checks blunted the worst. Big portions of the economy figuring out how to operate with everyone working from home helped too.
But a lot of the spending still stopped. Vacations that would have been taken never happened. Weddings that would have taken place were postponed. Trips to the mall were replaced with aimlessly scrolling Twitter.
When income is replaced with stimulus checks but spending doesn’t rebound, savings surges.
Which is what happened in 2020, in an epic way.
The personal savings rate averaged 7% in the quarter-century before 2020. Then Covid hit, and overnight it went to 34%. It’s since dropped to about 14%, which would have been a 50-year high before Covid.
The result is that the amount of cash households have in the bank has absolutely exploded. I don’t even know if that word does justice. American households have $1 trillion more in checking accounts today than they did a year ago. For perspective, they held $800 billion in checking accounts a year ago. So it’s more than doubled. In one year. Benjamin Roth observed that “no one had any money” during the Great Depression. We now have so much I’ve run out of adjectives.
You begin to wonder what happens to that money once there’s widespread vaccination and the vacations, weddings, and mall trips that have been delayed are suddenly unshackled.
The best comparison might be the late 1940s and 1950s.
Then, as now, bank accounts were stuffed full as war-time spending brought record-low unemployment. And then, as now, a lot of that money couldn’t be spent because of war-time rationing.
After the war ended and life got on, the amount of pent-up demand for household goods mixed with the prosperity of war-time employment and savings was simply extraordinary. It’s what created the 1950s economic boom.
Fewer than two million homes were built from 1940 to 1945. Then seven million were built from 1945 to 1950. Commercial car production was virtually nonexistent from 1942 to 1945 as assembly lines were converted to build tanks and planes. Then 21 million cars were sold from 1945 to 1950.
4. Tweet on how nobody can foresee the future – Bill Mann
[Title of memo] Thoughts for the 2001 Quadrennial Defense Review
If you had been a security policy-maker in the world’s greatest power in 1900, you would have been a Brit, looking warily at your age-old enemy, Frane.
By 1910, you would be allied with France and your enemy would be Germany.
By 1920, World War I would have been fought and won, and you’d be engaged in a naval arms race with your erstwhile allies, the U.S. and Japan.
By 1930, naval arms limitation treaties were in effect, the Great Depression was underway, and the defense planning standard said “no war for ten years.”
Nine years later World War II had begun…
… By 1970, the peak of our involvement in Vietnam had come and gone, we were beginning detente with the Soviets, and we were anointing the Shah as our protege in the Gulf region.
By 1980, the Soviets were in Afghanistan, Iran was in the throes of revolution, there was talk of our “hollow forces” and a “window of vulnerability,” and the U.S. was the greatest creditor nation the world had ever seen…
… Ten years later [in 2000], Warsaw was the capital of a NATO nation, asymmetric threats transcended geography, and the parallel revolutions of information, biotechnology, robotics, nanotechnology, and high density energy sources foreshadowed changes almost beyond forecasting.
All of which is to say that I’m not sure what 2020 will look like, but I’m sure that it will be very little like we expect, so we should plan accordingly.
5. Deep Risk in the United States of America – Ben Carlson
One of my favorite descriptions of risk in the financial markets comes from William Bernstein in his book, Deep Risk: How History Informs Portfolio Design:
Risk, then, comes in two flavors: “shallow risk,” a loss of real capital that recovers relatively quickly, say within several years; and “deep risk,” a permanent loss of real capital. Put into different words, shallow risk, if handled properly, deprives you only of sleep for a while; deep risk deprives you of sustenance.
A few weeks after Trump was inaugurated in early 2017, I wrote a piece called Deep Risk Under President Trump. This was my conclusion:
Let’s hope shallow risk — run-of-the-mill market volatility — is the only thing we have to worry about over the next four years. But with Trump threatening countries, companies, regulations and industries, it’s worth understanding what could happen if we do experience deep risk within our financial markets.
It turns out it wasn’t the markets where deep risk resided. Markets have done just fine throughout this entire ordeal. Investors have learned to live with geopolitical risk. Markets don’t care about politics.
The real deep risk came to fruition in our democracy and the trust and faith in our government institutions.
While the stock market continues to hit new highs, our political sphere is in the midst of a great depression.
The first time I became truly terrified of this deep risk came from a Vanity Fair article by Michael Lewis in the fall of 2017.
This piece would lead to Lewis’s book, The Fifth Risk: Undoing Democracy, which detailed the neglect and mismanagement of government agencies and services by the new administration in 2017. Lewis details four risks of this neglect in the book, leaving the fifth risk open-ended.
That fifth risk is the risk that’s hard to imagine.
No one could have imagined we would experience a global pandemic in 2020.
No one could have imagined the United States would have one of the worst responses to that pandemic.
No one could have imagined the president himself would contract that disease.
No one could have imagined we would have a contested presidential election.
And no one could have imagined that same president would incite mob violence on our own Capitol Building because he refuses to admit he lost fair and square.
6. No, you did not miss a bull run – Chin Hui Leong
Here’s the thing. I have never timed my stock buys perfectly over the last 15 years of investing. And that’s not the worst thing in the world. Let me share two examples that stand out.
In February 2007, I invested in shares of a Mexican food chain, Chipotle Mexican Grill. With the benefit of hindsight, my timing was pretty bad.
In October 2007, less than 10 months after I bought the shares, the S&P 500 almost hit 1,600 points before proceeding to fall to below 700 points over the next one and half years. That’s a fall of well over 50 per cent. But my timing didn’t matter over the long run.
Today, 13 years later, those shares are up over 2,300 per cent, a satisfying return by any account. In short, it didn’t matter that I bought too early. And that’s not the only instance.
Here’s a different example.
In June 2010, I bought shares of Apple, more than a year after the stock market had bottomed out in March 2009. By then, the stock market was already up by 60 per cent from its low.
Again, the timing of my entry was off by a wide margin. But that didn’t matter in the end. Today, over a decade later, the shares have risen by over 1,200 per cent from the day I bought my first shares.
7. Twitter thread on 40 lessons on investing and life – Eugene Ng
Reflecting on 2020 with 40 Lessons on Investing and Life. Below are my reflections for 2020 in my investing journey, I hope by sharing, it might help you in many ways as it did for me as well. Here goes…
(1) You can do it.
I used to be get horrible grades in English. To write a book, self-publishing it & being an Amazon Best Seller in 5 countries (US, Canada, Australia, Germany & UK) is no mean feat. Anyone can do anything, as long as you set your mind & heart to do it…
…(3) Your Vision.
Make your portfolio reflect your best vision for your future. This drives what I do at Vision Capital through Vision Investing to invest in companies that are shaping and changing the world for the better. The companies you own, ultimately reflect who you are….
…(6) Staying in the game.
The only reason we can be in the game for the long term, because our portfolio is not concentrated & we don’t use leverage or options. It might be great 80–95% of the time, but when it bites, it will take you out of the game, that’s not what we want…
…(10) Creating Value. For Others.
The sole purpose of the book was never for fame, recognition or the money. It was to help the world invest better in the the best companies, creating a flywheel of change, capital, investors, companies, culture & a new way of investing…
…(12) Network.
Dare to ask, dare to engage, dare to try. For there is little downside, & a lot of upside if you find a new meaningful interaction. Luck & serendipity is when preparation meets opportunity. Dare to say yes sometimes. If it works out, great, if not, move on….
(13) Concentration vs Diversification.
Less than 1% of companies & a small handful of companies will drive the majority of market returns, that’s why I don’t hold a concentrated portfolio. Also because they are so many great companies & opportunities. Choose what works for you…
…(25) Gratitude.
Be grateful. Practice gratitude every day. Give thanks for the smallest things in life, the sun, the clear skies, the clean air, the greenery, the birds chirping, your loved ones, your kids, anything. There is beauty in everything.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. We currently have a vested interest in the shares of Amazon, Apple, and Chipotle Mexican Grill. Holdings are subject to change at any time.
