What We’re Reading (Week Ending 21 March 2021) - 21 Mar 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 21 March 2021):
1. Reverse Wealth Transfer on Steroids – Josh Brown
Do not buy SPACs, digital currencies or non fungible tokens sold to you by millionaires and billionaires with your stimulus check.
This is the exact opposite of what’s intended for young people like yourself receiving stimulus checks from the government. These checks are meant to improve your current situation by giving you a chance to purchase things that you need today or pay your bills or pay down debt. Speculating in digital assets is not part of the intent. Buying an online baseball card is not helping you, even if it goes up in price immediately after your having bought it…
…Trillionaires have the right to create any kind of nonsense they want and offer it up for sale. You have the right to come to your senses and say, “You know what, I don’t actually need that shit, I need a job. I need a nice new suit to go on interviews with. I need to fix my car. I need to upgrade my apartment so I can bring a date home and not be embarrassed about my situation.”…
…Take the $1400 and do one of these things:
Buy a business suit, some nice shirts and a pair of shoes. Laugh all you want, but these will be tools you can use to get into the right rooms and meet the right people. I promise you this is true: When you’re well dressed, people treat you differently. With respect. With honor. They hold doors for you and make eye contact with you. They can tell you hold yourself in high esteem and this subconsciously encourages them to hold you in high esteem as well. You can scoff at this and call it materialistic or bourgeois or anachronistic or whatever other big bad words you learned in college, but what I am telling you is the truth. If you had invented Facebook, you would have invented Facebook. But you didn’t. So the hoodie isn’t going to work. Watch how people deal with you when your shirt is tucked in and your shoes are shined.
Buy a bicycle. Set a routine. Breathe fresh air. See the sun. Feel the breeze. Smell the roses. You can listen to your podcasts while getting some exercise and being a human being. Every hour you spend with your eyes off the screens is an hour better spent. You will know I am right because you will feel it in your soul.
Buy a cookbook and some high quality pots and pans. Maintaining a grown-up kitchen with nice implements and utensils, as well as obtaining the ability to make quality meals for yourself or others will bring you the kind of psychic income that speculating in someone else’s shitty art projects can never replace.
2. Ray Dalio & The Power of Setting Defaults For Optimism – Ben Carlson
Optimism pays when it comes to investing because, most of the time, markets go up. The stock market is up roughly 3 out of every 4 years, on average. Over the long-term, optimism as a strategy is nearly impossible to beat. This is why buy and hold is perhaps the greatest strategy ever invented.
Unfortunately, there are always good reasons to be worried. The future is always uncertain. There is always bad news and we hear about that bad news more than any generation in history in the information age.
And there is something about finance people that makes them worry more about the downside than the upside. It’s like the exact opposite of people in Silicon Valley who are almost unanimously optimistic about the future.
Ray Dalio may be right to worry about the future. But he has a long track record of worrying about the future that hasn’t really panned out that well.
Dalio penned a piece for Institutional Investor about the importance of knowing when you’re wrong and changing your mind. He used his own prediction of a depression in the early-1980s as an example:
The biggest of these mistakes occurred in 1981–’82, when I became convinced that the U.S. economy was about to fall into a depression. My research had led me to believe that, with the Federal Reserve’s tight money policy and lots of debt outstanding, there would be a global wave of debt defaults, and if the Fed tried to handle it by printing money, inflation would accelerate. I was so certain that a depression was coming that I proclaimed it in newspaper columns, on TV, even in testimony to Congress. When Mexico defaulted on its debt in August 1982, I was sure I was right. Boy, was I wrong. What I’d considered improbable was exactly what happened: Fed chairman Paul Volcker’s move to lower interest rates and make money and credit available helped jump-start a bull market in stocks and the U.S. economy’s greatest ever noninflationary growth period.
Of course, there was no depression. Instead, the early-1980s kicked off one of the longest expansions in market and economic history.
That history bled into the 1990s as well. It may not seem like it when you look back at high double-digit returns from 1980-1999 but the nirvana-like economic and market environment in the 1990s was not a foregone conclusion at the outset of the decade.
In a piece from the New York Magazine in 1992, Dalio was quoted saying bonds were a better bet than stocks over the course of the 1990s:
Over the long term, both Dalio and Jones agree, as a result of these circumstances bonds in the nineties will almost certainly outperform stocks. In the fifties, says Dalio, wary investors were still looking in the rearview mirror at the Depression of the thirties, when stocks took the shellacking of all time. Thus, bonds remained the preferred investment when the environment of accelerating growth and inflation actually favored stocks. As a result, those who took what appeared to be a risk and bought stocks in the fifties wound up making fortunes, while those who bought bonds wound up eventually losing their shirts.
Now, says Dalio, the situation is precisely reversed. Investors in the nineties remain traumatized over the carnage that inflation and sky-high interest rates wreaked in the bond market in the seventies, so they’re investing in stocks instead. Unfortunately, says Dalio, the current economic climate of low inflation and historically slow growth means that bonds will actually prove to be the better long-term performers.
To be fair, bonds did perform well in the 1990s. The 10 year treasury returned nearly 67% in total from 1992-1999 or 6.6% per year. That’s pretty good for bonds. But the S&P 500 was up more than 316% or nearly 20% per year from 1992-1999.
Dalio was wrong again.
Then in 2015, Dalio began warning we could see a repeat of the 1937 downturn. This nasty recession and 50% market crash is highly underrated by historical standards because it was sandwiched between the Great Depression and WWII. Dalio made a similar prediction for a 1937 situation in 2017.
Alas, there was no double-dip recession following the Great Financial Crisis. The stock market and the economy were doing just fine until the pandemic hit and now are back on trend.
Now, I’m not pointing out Dalio’s mistakes here to rub it in his face. We all get stuff wrong when it comes to the markets. This stuff is hard…
…Whatever the case may be, it appears Dalio doesn’t allow his macro predictions to influence Bridgewater’s investment strategy. Or if he does, it certainly doesn’t show up in their long-term track record.
I’m a huge advocate for default settings as an investor.
You should default your savings rate. Default increases to that savings rate over time. Default your investment choices. Default your bill payments. Automating good decisions ahead of time is one of the most important steps you can take to meaningfully improve your finances.
And when it comes to investing, the most important default by far is optimism.
Yes, there are always going to be risks but pessimism does not pay as a strategy over the long-run.
If you’re not optimistic about the future, what’s the point of investing in the first place?
3. Too Much, Too Soon, Too Fast – Morgan Housel
Let me tell you about Robert Wadlow. He was enormous, the largest human ever known.
A pituitary gland abnormality bombarded Wadlow’s body with growth hormone, leading to staggering size. He was six feet tall at age seven, seven feet tall by age 11, and when he died at age 22 stood an inch shy of nine feet tall, weighed 500 pounds, and wore size 37 shoes. His hand was a foot wide.
He was what fictional stories would portray as a superhuman athlete, capable of running faster, jumping higher, lifting more weight and crushing more bad guys than any normal person. Like a real-life Paul Bunyan.
But that was not Wadlow’s life at all.
He required steel leg braces to stand and a cane to walk. His walk wasn’t much more than a limp, requiring tremendous effort. What few videos of Wadlow exist show a man whose movements are strained and awkward. He was rarely seen standing on his own, and is usually leaning on a wall for support. So much pressure was put on his legs that near the end of his life he had little feeling below his knees. Had Wadlow lived longer and kept growing, casual walking would have caused leg bones to break. What actually killed him was nearly as grim: Wadlow had high blood pressure in his legs due to his heart’s strain to pump throughout his enormous body, which caused an ulcer, which led to a deadly infection.
You can’t triple the size of a human and expect triple the performance – the mechanics don’t work like that. Huge animals tend to have short, squatty legs (rhinos) or extremely long legs relative to their torso (giraffes). Wadlow grew too large given the structure of the human body. There are limits to scaling.
Writing before Wadlow’s time, biologist J.B.S. Haldane once showed how many things this scaling issue applies to.
A flea can jump two feet in the air, an athletic human about five. But if a flea were as large as a man, it would not be able to jump thousands of feet – it doesn’t scale like that. Air resistance would be far greater for the giant flea, and the amount of energy needed to jump a given height is proportional to weight. If a flea were 1,000 times its normal size, its hop might increase from two feet to perhaps six, Haldane assumed.
Look around and this concept is everywhere, in every direction…
…“For every type of animal there is a most convenient size, and a change in size inevitably carries with it a change of form,” Haldane wrote.
A most convenient size.
A proper state where things work well, but break when you try to scale them into a different size or speed.
Which, of course, also applies to business and investing.
4. Apple, CAID, and China: rock, meet hard place – Eric Seufert
Early this week, it was revealed that the China Advertising Association (CAA), a state-backed advertising trade group in China, has rolled out its China Advertising ID (CAID) to a consortium of large Chinese advertisers for use as an alternative to the IDFA, which is set to be deprecated imminently in iOS 14.5.
The CAID is effectively a crowd-sourced persistent ID derived from device fingerprints: the CAA has created something of a data co-op, where members — which pay a participation fee — pool IP-indexed fingerprints to allow for devices to be identified as they engage with apps. The general idea is that if enough parameters are captured for a given device in a fingerprint, and the device is fingerprinted in enough apps in a short amount of time, the device can be identified even when its IP address changes because the other parameters (like memory utilization) stay relatively constant.
Building this type of probabilistic identity mechanism is fairly straightforward, but in order for it to be viable, participation and coordination are required from publishers that have large and overlapping user bases. This is the reason I was skeptical of such a solution being broadly adopted, as I articulated in this Twitter thread from a few months ago: in order for a fingerprinting solution based on IP addresses to provide utility, frequent touchpoints with users must be maintained to capture fingerprint snapshots that change subtlely enough for an identity to be probabilistically valid. It seemed unlikely that Western companies would be willing to cooperate to the degree necessary to deliver that. But the ability to coordinate nearly unimaginable, mass-scale projects, of the flavor seen during COVID, is the Chinese government’s distinctive advantage. Whereas a data co-op comprised of large US-based app publishers and ad networks is nearly unimaginable, apparently, ByteDance, Tencent, and Baidu are all participating in the CAID program that is organized by the state-sponsored CAA.
The development and adoption of the CAID puts Apple in a difficult position. Rock, meet hard place: China is Apple’s second-largest market after the US, and the specter of a WeChat ban on the iPhone during the Trump administration was estimated to potentially reduce Apple’s iPhone sales revenue by up to 30%. Apple already applies a separate standard with its App Store guidelines for certain Chinese developers, allowing eg. Tencent to run what is essentially an app store inside of WeChat. Would Apple simply extend this notion of a separate Chinese principle to privacy and allow CAID to be used for persistent identity by Chinese companies while subjecting companies domiciled elsewhere (read: Facebook) to the restrictions of ATT, which explicitly prohibits fingerprinting?
5. Twitter thread on the laws that govern the banking business – Maxfield on Banks
The longer you study a subject, the closer you get to the core laws that govern it. Here are 10 laws that govern banking, deduced from a decade of studying the industry… [thread]
1. Success in banking is foremost about winning a war of attrition. More than 17,300 banks have failed since the birth of the modern American banking industry in the Civil War. That’s over three times the number of banks in business today…
…3. The darlings in one era are often pariahs in the next. In 1978, Continental Illinois Bank & Trust was selected by Dun’s Review as one of America’s five best-managed companies. Six years later, it was seized by the FDIC due to mismanagement.
4. The crux of banking is watching what others are doing and then not doing it yourself. Warren Buffett calls this the institutional imperative: “the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so.”
5. Credit quality is a myth until it’s a reality. Washington Mutual’s nonperforming assets as a % of all assets:
1998: 0.73% 1999: 0.55% 2000: 0.53% 2001: 0.93% 2002: 0.97% 2003: 0.70% 2004: 0.58% 2005: 0.57% 2006: 0.80% 2007: 2.17% 2Q08: 6.62% 4Q08: Failed…
…8. All roads lead to skin in the game. One reason M&T Bank has been so successful, its CEO Rene Jones once explained, “is that we could get 60% of our shareholders seated around the coffee table in my predecessor’s office.”
6. 2020 in Review – Howard Marks
Finally, much of the worry about whether we’re in a bubble relates to valuations. For the S&P 500, for example, the current ratio of price to projected 2021 earnings is roughly 22 (depending on which earnings estimates you use). This seems expensive compared to the historic average in the range of 15-16. But knee-jerk judgments based on the relationship between current valuations and historic averages are too simplistic to be dispositive. Before making a judgment about today’s valuation of the S&P 500, one must consider (a) the context in terms of interest rates, (b) the shift in its composition in favor of rapidly growing technology companies, with their higher valuations, (c) the valuations of the index’s individual components, including those tech companies, and (d) the outlook for the economy. With these factors in mind, I don’t think most of today’s asset valuations are crazy. Of course, a big correction in speculative stocks could have a negative impact on today’s bullish investor psychology.
In particular, as to item (a) above, we can look at the relationship between today’s 4.5% earnings yield* on the S&P 500 and the yield on the 10-year Treasury note of 1.4%. The implied “equity risk premium” of 310 basis points is very much in line with the average of 300 bp over the last 20 years. Valuations can also be viewed relative to short-term interest rates. The current p/e ratio on the S&P 500 of 22 is slightly below the reading of 24 in March 2000 (the height of the tech bubble), and the fed funds rate is around zero today versus 6.5% back then. Thus, in 2000, the earning yield on the S&P 500 was 4.2%, or 230 basis points below the fed funds rate, while today it’s 450 bp above. In other words, the S&P 500 is much cheaper today relative to short-term rates than it was 21 years ago.
The story is similar in the credit market. For example, the yield spread on high yield bonds versus Treasurys is below the historic range, although probably still more than adequate to offset likely credit losses. Thus, as with most other assets today, the price of high yield bonds is high in the absolute, fair-ish in relative terms, and highly reliant on interest rates staying low.
So where does that leave us? In many ways, we’re back to the investment environment we faced in the years immediately prior to 2020: an uncertain world, offering the lowest prospective returns we’ve ever seen, with asset prices that are at least full to high, and with people engaging in pro-risk behavior in search of better returns. This suggests we should return to Oaktree’s pre-Covid-19 mantra: move forward, but with caution. But a year or two ago, we were in an economic recovery that was a decade old – the longest in history. Instead, it now appears we’re at the beginning of an economic up-cycle that’s likely to run for years.
Over the course of my career, there have been a handful of times when I felt the logic for calling a top (or bottom) was compelling and the probability of success was high. This isn’t one of them. There’s increasing mention of a possible bubble based on concerns about valuations, federal government spending, inflation and interest rates, but I see too many positives for the answer to be black-or-white.
7. Twitter thread on lessons learned from working for Sheryl Sandberg, currently Facebook’s COO – Dan Rose
I learned about leadership & scaling from Sheryl Sandberg. My direct manager for 10+ yrs, we spent countless hours together in weekly 1x1s (she attended religiously), meetings, offsites, dinners, travel, etc. Here are some of the most important lessons I took away from Sheryl:
In one of our early M-team offsites, everyone shared their mission in life. Sheryl described her passion for scaling organizations. She was single-mindedly focused on this purpose and loved everything about scaling. It’s a huge strength to know what you were put on earth to do.
Sheryl implemented critical systems to help us scale – eg 360 perf reviews, calibrations, promotions, refresh grants, PIPs. She brought structure to our management team and board meetings, hired senior people across the company, and streamlined communications up and down the org.
Sheryl told Mark the things he didn’t want to hear. As companies grow, people don’t want to give the CEO bad news. Mark knew Sheryl would never worry about losing her job or falling out of favor. And over time Sheryl taught me and others how to be truth-tellers for her and Mark.
Sheryl refused to participate in late night meetings. She had the confidence to admit she went to bed at 10pm and told Mark she’d be happy to meet when she woke up at 5am if he still hadn’t gone to bed yet. Her vulnerability was inspiring and signaled strength not weakness…
…Sheryl & I disagreed early on about a decision. I thought Mark would agree with me so I went around her to make my case. She sat me down and explained that if we were going to work together she needed to be able to trust me. She invited escalation but insisted on transparency.
We faced a tough situation with a partner and one of their board members asked Sheryl to meet. She invited me to join but I demurred, I knew this would be a contentious mtg. She told me about one of her colleagues in DC who testified when nobody else wanted to – “step up, own it”
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. Of all the companies mentioned, we currently have a vested interest in Apple, Facebook, and Tencent. Holdings are subject to change at any time.
