What We’re Reading (Week Ending 30 July 2023) - 30 Jul 2023
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 30 July 2023):
1. Why the World Is on the Brink of Great Disorder – Ray Dalio
A few years ago, I saw three big things happening that hadn’t happened in my lifetime but had happened in the 1930-45 period. These were:
- The largest amounts of debt, the fastest rates of debt growth, and the greatest amounts of central bank printing of money and buying debt since 1930-45.
- The biggest gaps in wealth, income, values, and the greatest amounts of populism since the 1930-45 period.
- The greatest international great powers conflict, most importantly between the U.S. and China, since 1930-45
Seeing these three big things that never happened in these magnitudes in my lifetime led me to study the rises and declines of markets, economies, and countries over the last 500 years, as well as the rises and declines of China’s dynasties the last 2,100 years.
That examination showed me that these three big forces—i.e. the debt/money one, the internal conflict one, and the external conflict one—transpired in big cycles that reinforced each other to make up what I call the Big Cycle. These cycles were driven by logical cause-effect relationships Most importantly, this study of the last 500 years of history taught me that:
- The previously described financial conditions repeatedly proved to be leading indicators of big financial crises that led to big shifts in the financial order.
- The previously described levels of political and social gaps repeatedly proved to be leading indicators of great conflicts within countries that led to big changes in domestic orders.
- The previously described great powers’ conflicts repeatedly proved to be leading indicators of international conflicts that led to big changes in the world order.
Said differently, history shows that the painful seismic shifts part of the Big Cycle comes about when there is simultaneously 1) too much debt creation that leads to debt bubbles bursting and economic contractions which cause central banks to print a lot of money and buy debt, 2) big conflicts within countries due to big wealth and values conflicts made worse by the bad economic conditions, and 3) big international conflicts due to rising world powers challenging the existing world powers at a time of economic and internal political crises In doing this study, I also saw two other big forces that had big effects. They are:
- Acts of nature (droughts, floods, pandemics) including climate change.
- Learning leading to inventions of technologies that typically produced evolutionary advances in productivity and living standards —e.g., the First and Second Industrial Revolution, and computing/AI revolution.
I call these the Five Big Forces. I saw how they affect each other and change in logical ways to produce the Big Cycle that produces big changes in the world order. I came to realize that if one understands and follows each of these forces and how they interact, one can understand most everything that’s changing the world order. That’s what I’m trying to do…
…In the U.S., we are now in middle part of what I call the short-term debt cycle and is also known as the business cycle. These short-term debt cycles have lasted 7 years on average, give or take about 3 years. There have been 12 1/2 of them since the new monetary world order started in 1945. So, we are now about half-way though the 13th of the cycles, at the point of the cycle when the central bank has tightened money to fight inflation that is just before the debt and economic contractions which will likely come over next 18 months.
We are also in a late and dangerous part of the long-term debt cycle because the levels of debt assets and debt liabilities have become so high that it is difficult to give lender-creditors a high enough interest rate relative to inflation that is adequate to make them want to hold this debt as an asset without making interest rates so high that it unacceptably hurts the borrower-debtor. Because of unsustainable debt growth, we are likely approaching a major inflection point that will change the financial order. Said differently, it appears to me likely that we are approaching a debt/financial/economic restructuring that will lead to big changes to the financial order…
…In several countries, most importantly the U.S., we have seen a growing percentage of the population that are populist extremists (about 20-25 percent of the right are extreme and about 10-15 percent of the left are) and a shrinking of the percentage of the population that are bipartisan moderates. Though the bipartisan moderates still remain in the majority, they constitute a declining percentage of the population and they are far less willing to fight and win at all costs. In studying history, I saw this growing populism of both sides and increased conflict has repeatedly occurred when large gaps in wealth and values existed at the same time as bad economic conditions. At such times, significant percentages of the population chose populist political leaders who vowed to fight and win for them rather than compromise…
…Looking ahead, the next 18 months will be an increasingly intense big election period which will lead to much greater political conflict which is likely to sharper the divide between the left and the right. Thirty-three Senate seats, the presidency, and control of the House will be fought over by a number of populist candidates and there will likely be poor economic conditions, so the fights will be vicious and there will be a real test of rule-following and compromising, both of which are required to make democracies work…
…The conflicts between the U.S. and China are likely to intensify as domestic political tensions will likely lead to increased aggressiveness toward China. That is because in the U.S. most everyone is anti-China and those running for office will want to out-China-bash each other in an election year. China and the US are already dangerously close to some form of war, whether an all-out economic one or, worse, a military one…
…What can we expect from technology/human inventiveness? Like acts of nature, it is hard to know exactly, though there should be no doubt that generative AI and other technological advances have the potential to cause both massive productivity gains and massive destructions, depending on how they are used. The one thing that we can be sure of is that these changes will be greatly disruptive.
Exactly how events will unfold is beyond my ability to say, but there is no doubt in my mind that those who assume that things will work in the orderly ways we have gotten used in the last few decades will be shocked and probably hurt by the changes to come.
How well these changes are managed will make all the difference. If our leaders can rise above their tendencies to fight and instead focus on cooperating, we can certainly navigate these tricky times to create a better world for most people. Presumably, this outcome is best for everyone, so we should be strongly against civil disorder and war between nations, keeping it in the back of our mind so we strive for cooperative decision-making.
2. Americanas, The Titanic Fraud – Consuelo Diguez (h/t to Marcelo Lima)
Two days earlier, at 6:30 pm, Rial had released a material fact that exploded in the market like dynamite in a fuel tank – and resigned from the company he had taken over on January 2nd. He had only been in office for nine days. The relevant fact (the name given to the statement that a publicly traded company makes to its investors and the market in general about a matter of paramount importance) informed that Americanas, the giant retailer controlled since 1982 by the three richest and most admired businessmen in the country, Jorge Paulo Lemann, Marcel Telles and Carlos Alberto Sicupira, had “accounting inconsistencies” in its balance sheet – in the order of 20 billion reais.
Aside from the colossal gap, the company accumulated a debt of around 22 billion reais with the banks and owed 6.67 billion reais in debentures. All in all, the debt exceeded 48 billion reais, almost five times Americanas’ equity. In summary: the traditional retailer, founded in 1929, was broke. The hole discovered by Rial when he took over the company would be, by itself, scandalous in any part of the world. But in this case, it concealed something even more serious. The expression “accounting inconsistencies” was actually a euphemism for titanic fraud. The biggest fraud in the history of Brazilian corporations.
To the general astonishment, the scam filed against the retailer had been going on for at least ten years. Worse. The first investigations indicated that everything happened with the knowledge and participation of its then president, Miguel Sarmiento Gutierrez, a man trusted by the controllers, who had left his post on December 31st…
Sergio Rial started the virtual conference with bankers asking for calm. He no longer spoke as president of Americanas, but as a representative of the controlling shareholders Lemann, Telles and Sicupira, who had asked him to help alleviate the crisis. His challenge was to explain how it had been possible for this colossal shortfall of 20 billion reais not to appear on the balance sheet. The operation – as he told it – was intricate and took place through the misuse of a legal instrument, known in the market as drawn risk.
This is a very common transaction between banks and retail companies. It works like this: the retailer buys a product from its supplier, but, in order not to run out of capital, it transfers the debt to a bank. The bank then pays the supplier in cash, but with a small discount. The retailer becomes indebted to the bank, with which, despite the incidence of interest, it manages to extend the payment terms – long terms that it would not be able to obtain from its supplier. When making this transaction, the retailer needs to record the drawn risk operation on its balance sheet as bank debt. After all, the debt he had with the supplier was assumed by the bank.
That’s when the fraud at Americanas began: the managers did not account for such bank debt on the balance sheet. For all intents and purposes, it was as if he didn’t exist. They resorted to this makeup for two reasons. First, because, by hiding the withdrawn risk operations, the retailer was able to present a balance sheet with a profit (false) and not a loss (true). For ten years, the balance sheet shone as if the company was healthy and the company’s shares appreciated year after year, leading more and more investors to buy its shares – which ended up guaranteeing more money in the cash register. The good – fictitious – results helped Americanas capitalize and obtain loans from banks.
The second reason was the greed of managers. As they were remunerated based on the company’s performance, executives pocketed stratospheric bonuses the better the result. Part of these bonuses was paid in shares of the retailer. Therefore, they gained twice: with the bonuses received for the good performance of the company and with the appreciation of their shares, boosted by the numbers made up.
In the last Americanas balance sheet, published in September last year, the total long-term debt with banks, referring to the normal loans that the company took, was 19.3 billion reais. For the market, this was not a worrying figure, given that the company had revenues of 14 billion reais per year, and could therefore meet its commitments without difficulty. However, when the 20 billion that were hidden came to light, in January, Americanas’ real debt with the banks surpassed 40 billion. It was double what had been officially declared. And it was priceless…
…Since the beginning of the scandal, the trio of controllers, until then considered the maximum personification of the efficiency of Brazilian capitalism, started to be derided. In addition to the revolt at the damage caused by Americanas and the clumsy way in which the crisis was announced, the market, which idolized Lemann, Telles and Sicupira, suffered a shock and began to give vent to a powerful disappointment.
Most creditors and managers had worked or dreamed of working in one of the companies controlled by the trio of billionaires. Starting with Banco Garantia, founded by Lemann in 1972, which acquired a mythical aura in the market for having changed the way investment banks operated, although it was hastily sold to Banco de Investimentos Credit Suisse (Brazil) in 1998 , hit by the Asian crisis. Generations of managers tried to emulate the talent of Lemann, Telles and Sicupira for business, who gained worldwide visibility with their most radiant undertaking: the creation of AB InBev, one of the largest beer producers in the world, owner, among other brands, of Brahma and Antarctica, Belgian Stella Artois and North American Budweiser (the latter in partnership with mega investor Warren Buffett).
Among many of those bankers at the meeting with Rial, the feeling of disenchantment was perceptible, as if the “divine trinity of the market” had betrayed them. “If these guys get demoralized, who are our role models for successful entrepreneurs? The old man from Havan?”, asked me a former partner of the trio, who confessed to having spent a sleepless night talking to a friend to try to understand what had happened to produce a fraud of this magnitude. Economist André Lara Resende, who worked at Garantia at the beginning of the institution, before assuming relevant positions in the Fernando Henrique Cardoso government, said he was not satisfied. “They are my friends. I find this all very sad. I don’t believe they have anything to do with this fraud. But of course it’s very bad to have your reputation shaken at this point in your life. Of course it’s a blow to them.” The owner of a large investment fund interviewed by piauí expressed his disappointment as follows: “If, on the eve of the material fact, someone told me that a fraud like that would happen at Americanas, I would see it as a joke. No one would ever assume that such a thing could happen in a company whose owners had a track record of success and credibility.”…
…Almost centuries old, Lojas Americanas was founded by three North Americans who happened to land in the Brazil. They wanted to open a business in Buenos Aires, but when the ship stopped in Rio de Janeiro, they realized the country’s potential and changed their plans. The first store was opened in 1929, in Niterói. In 1940, when it was no longer in the hands of the founders, the company went public. Then, in 1982, in a move on the Stock Exchange, Lemann, Telles and Sicupira, who controlled Banco Garantia, took the helm of the company for 24 million dollars. Sicupira became its president, going against Luiz Cezar Fernandes, a partner in Garantia, for whom the best thing was to sell the retailer straight away, pocketing a good profit. After several fights, Fernandes left Garantia and founded Pactual. “Beto wouldn’t give up Americanas”, Fernandes told piauí, in his apartment facing Guanabara Bay, in Rio de Janeiro. “It’s a business that, if you look at the numbers, has always been mediocre. But he, with his arrogance, did not accept discussing the problem.”…
…Since the beginning, Americanas’ Board of Directors has been under the control of the controllers. Of its 7 members, 4 were nominated by the trio Lemann, Telles and Sicupira. In recent years, among the directors were Eduardo Saggioro Garcia, chairman of the board and trusted man of the controllers, Sicupira himself, who passed the command of the company to Gutierrez in 1991, and Paulo Alberto Lemann, son of Jorge Paulo Lemann. For years, Sicupira’s daughter, Cecília, also occupied a chair there. Although it is a public company, the company does what the board, controlled by the trio, approves. Even because, as a former executive at the retailer told me, who would dare to question the decisions of three aces of Brazilian capitalism?
For some lower-ranking employees, the management model at Americanas, due to the managers’ aggressiveness and lack of empathy, was never the best. Other former executives told me that problems were systematically ignored. “Any proposal we made was rejected. Miguel Gutierrez only worked with his people. And, in fact, everything that happened there was Beto’s orders. There was even a joke in the company among employees. Every time an order came from above, the group would ask: ‘Did Beto authorize it?’” According to these former executives, there was “a culture of fear”.
The idea of “meritocracy” sold by the trio was also questioned. “There was neither merit nor autonomy. It was a hand-kissing culture,” said a former employee who worked at the house for ten years. Another added: “There was no feedback from employees. They liked to promote younger people to managers simply so they wouldn’t pay overtime.” One of these managers, who has already left the company, told me that the meal ticket was 4 reais. But if the company made a profit, even though the salary was low, everyone got a dividend. Only, in return, “you had to subject yourself to an unhealthy workload and a lot of humiliation.” In 2019, the company was sued and ordered to pay 11.3 million reais for moral harassment of employees with disabilities in Barueri stores, in the Metropolitan Region of São Paulo.
There was also no rational cost control. Just cuts without further analysis. Basic things like hiring stores with cheaper rent were ignored. “They didn’t have that concern. Instead, they preferred to strangle suppliers and employees.” Part of the employees’ remuneration was in company shares. Anyone who wasn’t willing to buy them was frowned upon. In addition, they could not dispose of the shares and, when they left the company, many took a loss, losing part of the investments they had been obliged to make, because they had not completed the period of service necessary to withdraw the money.
A defining moment at Americanas, according to the executives who preferred not to be identified because they are employed at other companies, happened at the end of 2019, when online sales at Mercado Livre and Magazine Luiza surpassed those at Americanas. “We were close to Black Friday and many employees mobilized to make suggestions in order to increase sales. Managers ignored the suggestions.” Sales dropped. “Everyone had been warning that Magazine Luiza was going to overtake us and the managers said no. Finally, Magazine Luiza became almost twice as big as Americanas.”
Another criticism was related to the treatment given to customers. When there were pricing errors or complaints, the managers, instead of trying to solve them, preferred to put the Legal Department to work. “They spent fortunes on lawsuits when they had a solution on the table,” a legal official told me. A former financial coordinator at the retailer, when asked what it was like to work at the trio’s company, confessed: “That was bizarre. The motto I heard several times there, excuse the expression, was ‘an eye for an eye, a tooth for a tooth, dick up the customer’s ass’.”
Financial operations, on the other hand, were very closed, restricted to the president, the group of directors and a “little group of sycophants”. It was unusual behavior in the market, according to one of the former financial managers interviewed by piauí . “Everything there was very centralized. It always has been,” he said. “The board of directors would gather in the room discussing financial operations that we only became aware of through material facts or the balance sheet. The company was not transparent.”…
…Americanas’ disrespectful behavior towards suppliers was one of the biggest annoyances for employees. As the retailer buys a lot, the suppliers depend on it. “Buyers were very tough, they were hard to pay and they hurt many companies with this abusive treatment,” said a former purchasing manager. The practice was always the same: Americanas committed to pay the supplier within 30 days, but unilaterally changed the deadline to 60 days. When the supplier called to complain, the order was not to answer. Afterwards, the term was changed to 90 or 180 days, until the supplier was strangled. Once that was done, they got in touch, advising that they were going to pay, but with a discount and without interest. “The guy was already so desperate to get paid that he would do any business,” said a former employee in the purchasing department…
…It is not from now that Americanas presents problems. Business administrator Oscar Malvessi, from Fundação Getulio Vargas, studies the reasons why Brazilian companies lose value. In a conversation at his office on Avenida Paulista, last March, he was indignant with what had happened to Americanas. “It is impossible to imagine this scandal in a company that has corporate governance, which, in theory, means that it follows national management principles, with a risk committee, compliance, with internal and external audits . ” The fact is, however, that the retailer has already been losing value on the Stock Exchange since July 2021, according to him. “The resounding destruction of the wealth of shareholders, the company and stakeholders did not just happen after the outbreak of accounting fraud”, he explained.
When Lojas Americanas merged with B2W, creating Americanas SA, in 2021, the reaction was not good and the value of the two companies together fell from 77 billion to 55 billion. The trio of managers, at that time, diluted their stake in the company, which was 60%, to 31%, gave up the control premium and started to call themselves “reference shareholder”, a figure that does not exist in the Law of Brazilian Corporations. From then on, the value of Americanas continued to fall, until it reached 11 billion reais and, the day after the material fact, crumbled into 1 billion reais, imposing a monumental loss to investors large and small, including the employees forced to buy company stock.
BTG Pactual, in its lawsuit against Americanas, accuses the trio of having diluted its stake in the company, already predicting the gap that would surface in 2023. Malvessi, from FGV, makes another association. He considers that “the culture of profit at any price, the abusive pressure on suppliers, the form of executive compensation, in addition to creative accounting, quickly turned into autophagy, with the destruction of the company, shareholders and stakeholders”.
The fall of Americanas cannot be compared to any other business failure of the Lemann-Telles-Sicupira trio. But the current view is that the policy of “meritocracy” or executive compensation based on profit at any price, combined with the irrational cost-cutting policy, is at the root of all losses. Starting with Warranty. The bank has always carried out risky operations and its operators have spared no efforts to earn a lot of money, even putting the institution at risk. In the book Sonho Grande, the trio explains that the bank almost went bankrupt, which is why it was sold in a hurry, as the “three would have walked away from the business and let the boat run smoothly”. They blamed the new generation of managers for just wanting to “fatten their personal wealth, without thinking about the institution”. In other words, as in the case of Americanas, the troika of Brazilian capitalism exempted itself from responsibility for the failure of the deal.
When they lost Garantia, the three had already made their most successful move: the purchase of Brahma, in 1989. In this case, it fell to Telles to assume command of the company. Again, it increased profits by cutting staff – 2,500 were laid off, out of a total of 20,000 –, reducing salaries and skinning suppliers, which they paid only 120 days after purchase. If you didn’t, you were out of business. With few breweries on the market, everyone swallowed the impositions. Brahma, however, became a success story, mainly with the standardization of products. In 1999, despite the screams of competitors, the trio bought Antarctica and formed Ambev. The operation was criticized by consumer protection associations, politicians and analysts, for whom the Administrative Council for Economic Defense (Cade), the body that watches over competition, should not have approved an operation that created a monopoly in the Brazilian beer market.
In 2004, Ambev merged with the Belgian Interbrew, forming InBev and becoming a leader in the world market. In the end, the trio took over the entire management of the business. The Belgian employees, according to the testimony of the trio in the book Sonho Grande, were shocked by the aggressive and greedy practices of the Brazilians. The strategy was repeated: fixed salary reduction and remuneration increase via bonus. Anyone who didn’t agree, get out. But the most spectacular step of the three Brazilian businessmen was taken in 2008. In association with the mega investor Warren Buffett, they bought the North American Anheuser-Busch (AB), maker of Budweiser. Thus, they created AB InBev.
Americans were shocked to lose such a traditional brand to a foreign group. Even then President Barack Obama was against the deal. The Brazilian executives taken to the company were encouraged to reduce expenses and integrate AB into InBev within five years. According to the book Sonho Grande , the 39 top executives of the new company’s management were offered around 1 billion dollars in stock options (the right to buy the company’s shares after the business took off), if they hit the target. And they knocked. One of the executives, Carlos Brito, the mastermind behind AB’s merger with Interbrew, received 500 million reais in bonuses.
The operation was a success, with shares appreciating by 270%, and application of the old formula: cutting costs to the limit, laying off employees – in the first few weeks alone, 1,400 people were laid off in 2008 –, squeezed suppliers, bonuses spectacular. In one year, executives cut $1 billion in costs and sold $9 billion in assets. While Brazilians celebrated, Americans complained. In 2013, they even accused the new managers of changing the flavor of the beer to save money, an accusation that was never proven…
…The most embarrassing story occurred in América Latina Logística (ALL). The company was acquired in 1997, at the beginning of the privatization of the railroads and when the trio’s big dream was to buy infrastructure and logistics companies in partnership with state pension funds and the BNDES. Business at the time was done through GP, the investment fund of the three, which was later sold and replaced by 3G Capital.
After purchasing ALL, they chose Alexandre Behring, a 30-year-old executive who knew nothing about railroads, to run the company. He adopted the same cutting recipe. In 2004, Behring switched to 3G and ALL had other presidents, among them Bernardo Hees and Eduardo Pelleissone, but the way of dealing with middle-level employees continued to create a toxic environment. In order to achieve the cost-cutting targets with a consequent increase in profit, as told by a company executive, the controllers did not invest in the company. In 2008, Cosan, a sugar producer and today one of the largest fuel distributors and ethanol producers in the country, owned by businessman Rubens Ometto, signed a contract with ALL for the company to transport sugar from its farms in the interior of São Paulo to the Port of Santos. For the business to work, Ometto invested 1.2 billion in ALL for the duplication of the railway track and investment in new trains and wagons. The problems did not take long to appear. Cosan’s administrators began to complain that their products were being delivered late and that the new locomotives were being used to transport soy because it was a more profitable commodity. ALL transported Cosan’s sugar on trains from the 1960s. The delay in delivering the product generated fines that ALL never paid.
As ALL did not invest in the preservation of the tracks, accidents were not uncommon. In 2010, an accident with a train in the city of Brotas in São Paulo spilled 100,000 liters of fuel around the track. The most serious, however, happened in 2013, when a locomotive transporting corn derailed, killing eight people in São José do Rio Preto, also in São Paulo. It was a wake-up call that cost-cutting was bumping into the safety issue.
Working conditions were deplorable. Drivers who needed to sleep in the wagons had to settle on the floor. As the old locomotives did not have bathrooms for employees, unlike the new ones, ALL’s managers decided to close the toilets on the new ones because the drivers only wanted to work on those that guaranteed a minimum of comfort. “The guys thought that running the railroad was the same as brewing beer,” an executive who worked at Cosan told me. “They didn’t invest in anything. They breached contracts. Not even the cargo transport regulatory agency wanted to talk to them anymore and suggested that we give up the partnership.”
In 2014, ALL’s fine with Cosan reached 500 million reais. As ALL was on the verge of going bankrupt, the producer only had two options: either terminate the contract and demand payment of the fine, which was unlikely to be paid, or stay with the business…
…The attacks against Lemann, Telles and Sicupira began to cool down after the three agreed to put up 10 billion reais to cover the gap in Americanas, which is being negotiated with creditor banks. The market has a version that Lemann even had a separate conversation with the presidents of the banks, to explain himself – among them, André Esteves. But for minority shareholders and suppliers, there will be no refreshment. Luis Stuhlberger, manager of one of the largest investment funds in Latin America, Verde, in a letter to his clients, resorted to harsh words when speaking about Americanas. “We were victims of fraud,” he said.
3. My 12 Biggest Key Investing Takeaways from “Antifragile” by Nassim Taleb – Eugene Ng
Asymmetry is where there is more upside than downside, where the positive payoff is significantly larger if you are right (you “earn big time”) than the negative payoff if you are wrong (you “lose small”).
Antifragility arises from asymmetry of more upside than downside, where one tends not to be permanently wiped out, and tends to gain from (1) volatility, (2) randomness, (3) errors, (4) uncertainty, (5) stressors, and (6) time.
Fragility is where there is more downside than upside, where one tends to be eventually permanently wiped out, and tends to lose from (1) volatility, (2) randomness, (3) errors, (4) uncertainty, (5) stressors, and (6) time.
Seek to be timeless, not timely. Focus on the long-term, not the short-term. Time will position the antifragile well, and the fragile poorly…
…Antifragility is anything that has more upside than downside from random events (or certain shocks).
Fragility is the reverse, anything that has more downside than upside.
What is fragile will eventually break over time, so being able to tell what is fragile helps. Positive black swans are more unpredictable than negative black swans. Focus more on removing all negative black swans, and then position for positive black swans, and the eventual process will take care of the outcome…
…It is a dual strategy of playing it safe in some areas (robust to negative black swans), and taking a lot of smaller risks in others (open to positive black swans), hence achieving antifragility.
Because of its construction, it reduces downside risk, and eliminates the risk of ruin…
…Statistics assume normal distributions, but most are not. Power laws drive venture capital returns, and so does public equities investing.
Most investments don’t do well, a small number tend to do very well, and their gains often eventually overwhelm all the losses from the losers combined many folds over.
Identify and focus on what matters that tend to do well, and ignore the rest that don’t…
…In addition, true optionality does not require intelligence, all it requires is to not be stupid and having the wisdom to avoid and not do unintelligent things to hurt yourself. The pros win first by not losing (then winning), we aim to do so as well. We want to play the game for as long as we can without being wiped out.
Via Negativa lists what is not, and proceeds by process of elimination. E.g. Michelangelo on the carving of the statue of David, the masterpiece of all masterpieces. His answer was: “It’s simple. I just remove everything that is not David.”
Negative knowledge (what is wrong, what does not work) is more robust to error than positive knowledge (what is right, what works). So knowledge grows by subtraction much more than by addition…
…Assign little/zero value to what anyone says or writes, if they have no skin in the game, as being wrong costs nothing to them.
Even more so, be wary of theories or anyone who speaks only for fees, with no skin in the game, or worse still, using their circle of influence to pump their own holdings, and benefit themselves. The first is bad, the second is the worst. In addition, be wary of others, who trade fragility of others for their own antifragility.
Skin in the game matters. Mistakes are costly, not free, and being right brings real rewards. Soul in the game brings it to a whole new higher level, committing to a belief, and having something to lose, if wrong.
4. The best book I’ve read this year – Chris Mayer
If you don’t know much about Rubin (I didn’t), he is a producer who worked on many great records by a long list of artists, from Adele to Johnny Cash (see his Wikipedia page). Perhaps he’s most famous for popularizing hip hop.
Anyway, he published a book this year titled The Creative Act: A Way of Being…
…Rubin defines creativity broadly. It is simply bringing something into existence that didn’t exist before. That could be a conversation, a meal, a new route to get somewhere, an email, lots of things. It doesn’t have to be recorded, stretched on canvas, encased in glass or sold. With this broad view, Rubin sets the stage for wide applicability of what he has to say…
…“Because there’s an endless amount of data available to us and we have limited bandwidth,” Rubin writes, “we might consider carefully curating the quality of what we allow in.”
I think this is such an important and overlooked step for most (nearly all?) investors who simply allow too much garbage to grab their attention. They read too much macro, too much economic analysis, too many forecasts, too much news and think too much about politics.
Think about what else you might allow in if these things didn’t get so much space. Think like a nutritionist, except now you’re thinking about your brain and what raw material you are going to feed it. Higher quality inputs lead to higher quality outputs. Look for more original research, do more of your own, talk to people closer to the action (i.e., running companies), favor the concrete over the abstract (I’m reminded of Peter Lynch, who said “The GNP six months out is just malarkey. How is the sneaker industry doing?”) and favor annual reports over economic reports…
…Rubin suggests “submerging yourself in the canon of great works.” (What makes the canon of “great” works he leaves rather undefined). Read classic books instead of the news, for example. Watch iconic films. Listen to the most influential music. Or in our case, study great companies.
Rubin says even if you do this for one year, at the end of that year, you’ll have “a more honed sensitivity for recognizing greatness.” Let curiosity be your guide, “stoked by a hunger to… learn, to be fascinated and surprised on a continual basis.” …
…Another theme Rubin hits that I have banged on about in my own work is the idea of being careful with labels. We tend to want to slap labels on everything. But labels can be toxic to clear thinking. They are limiting. As Rubin says:
“Any label you assume before sitting down to create, even one as foundational as sculptor, rapper, author, or entrepreneur, could be doing more harm than good. Strip away the labels. Now how do you see the world?”
This is a big one for investors, who are often so eager to paint the world with labels: “small cap” “large cap” “growth stock” “value stock” and so on. Not only that, but they tend to paint themselves with labels. “We’re value investors,” says one letter. Why the readiness to adopt such a label? What does that even mean? To start with such a label is to limit and twist how you see the world. Rubin says somewhere, where labeling begins, thinking ends.
And think about this, which I loved and wanted to stick in here somewhere:
“Nature transcends our tendencies to label and classify, to reduce and limit. The natural world is unfathomably more rich, interwoven, and complicated than we are taught, and so much more mysterious and beautiful.”
You can say similar things about markets generally. They are way more complicated and interwoven than our labeling suggests.
Labels can be potentially dangerous, but so are narratives. And investors love narratives. (“Inflation is coming down.” “We’re on the brink of recession.” “We’re in a bull market.”) We also have explanations for everything – usually after the fact. But Rubin advises keeping the narratives in check:
“Generally our explanations are guesses. These vague hypotheticals become fixed in our mind as fact. We are interpretation machines, and this process of labeling and detaching is efficient but not accurate. We are the unreliable narrators of our own experience.”...
…I love, too, what Rubin has to say about patience, something almost all investors could use more of. For Rubin patience “begins with acceptance of natural rhythms.” For us investors, that means accepting that bear markets happen, that stocks go down and can go down or nowhere for long stretches of time, that compounding takes time and that many things are out of our control:
“Demanding to control a work of art would be just as foolish as demanding that an oak tree grow according to your will.”
Same with your portfolio. You can’t control it. You plant things and you give them time to grow. You weed when you need to, but you don’t pull up the whole garden because you fear there is a drought coming…
…Here is Rubin on helping create that distance:
“When we obsessively focus on these events, they appear catastrophic. But they’re just a small aspect of a larger life, and the further you zoom back, the smaller each experience becomes. Zoom in and obsess. Zoom out and observe. We get to choose.”
I think of all the times certain sharp stock moves (up or down) seemed so momentous at the time. And yet, when you zoom out and look at a longer-term chart, those events barely register.
5. Goodbye to the Prophets of Doom – Yascha Mounk
For much of the country’s history, most Americans assumed that the future would bring them or their descendants greater affluence. Despite periodic economic crises, the overall story seemed to be one of progress for every stratum of the population. Those expectations were largely borne out: The standard of living enjoyed by working-class Americans for much of the mid-20th century, for example, was far superior to that enjoyed by affluent Americans a generation or two earlier.
But after the 2008 financial crisis, those assumptions were upended by a period of intense economic suffering coupled with a newfound interest among economists in the topic of inequality. Predictions of economic decline took over the conversation. America, a country long known for its inveterate optimism, came to dread the future—in which it now appeared that most people would have less and less.
Three arguments provided the intellectual foundation for the Great Disappointment. The first, influentially advanced by the MIT economist David Autor, was that the wages of most Americans were stagnating for the first time in living memory. Although the income of average Americans had roughly doubled once every generation for most of the previous century, wage growth for much of the population began to flatline in the 1980s. By 2010, it looked as though poorer Americans faced a future in which they could no longer expect any real improvement in their standard of living.
The second argument had to do with globalization’s impact on the worldwide distribution of income. In a graph that came to be known as the “elephant curve,” the Serbian American economist Branko Milanović argued that the world’s poorest people were experiencing only minor income growth; that the middle percentiles were benefiting mightily from globalization; that those in the upper-middle segment—which included many industrial workers and people in the service industry in rich countries, including America—had seen their incomes stagnate; and that the very richest were making out like bandits. Globalization, it seemed, was a mixed blessing, and a distinctly concerning one for the bottom half of wage earners in industrialized economies such as the United States.
The final, and most sweeping, argument was about the nature and causes of inequality. Even as much of the population was just holding its own in prosperity, the wealth and income of the richest Americans were rising rapidly. In his 2013 surprise best seller, Capital in the Twenty-First Century, the French economist Thomas Piketty proposed that this trend was likely to continue. Arguing that the returns on capital had long outstripped those of labor, Piketty seemed to suggest that only a calamitous event such as a major war—or a radical political transformation, which did not appear to be on the horizon—could help tame the trend toward ever-greater inequality…
…The U.S. economy, Autor wrote in a highly influential paper in 2010, is bifurcating. Even as demand for high-skilled workers rose, demand for “middle-wage, middle-skill white-collar and blue-collar jobs” was contracting. America’s economy, which had once provided plenty of middle-class jobs, was splitting into a highly affluent professional stratum and a large remainder that was becoming more immiserated. The overall outcome, according to Autor, was “falling real earnings for noncollege workers” and “a sharp rise in the inequality of wages.”
Autor’s past work on the falling wages of a major segment of the American workforce makes it all the more notable that he now sounds far more optimistic. Because companies were desperately searching for workers at the tail-end of the pandemic, Autor argues in a working paper published earlier this year, low-wage workers found themselves in a much better bargaining position. There has been a remarkable reversal in economic fortunes.
“Disproportionate wage growth at the bottom of the distribution reduced the college wage premium and reversed the rise in aggregate wage inequality since 1980 by approximately one quarter,” Autor writes. The big winners of recent economic trends are precisely those groups that had been left out in preceding decades: “The rise in wages was particularly strong among workers under 40 years of age and without a college degree.”
Even after accounting for inflation, Autor shows, the bottom quarter of American workers has seen a significant boost in income for the first time in years. The scholar who previously wrote about the “polarization” in the U.S. workforce now concludes that the American economy is experiencing an “unexpected compression.” In other words, the wealth gap is narrowing with surprising speed….
…A few years ago, Milanović set out to update the original elephant curve, which was based on data from 1988 to 2008. The result came as a shock—a positive one. Once Milanović included data for another decade, to 2018, the curve changed shape. Instead of the characteristic “rise, fall, rise again” that had given the curve its viral name, its steadily falling gradient now seemed to paint a straightforward and much more optimistic picture. Over the four decades he now surveyed, the incomes of the poorest people in the world rose very fast, those of people toward the middle of the distribution fairly fast, and those of the richest rather sluggishly. Global economic conditions were improving for nearly everyone, and, contrary to conventional wisdom, it was the most needy, not the most affluent, who were reaping the greatest rewards.
In a recent article for Foreign Affairs, Milanović goes even further. “We’re frequently told,” he writes, that “we live in an age of inequality.” But when you look at the most recent global data, that turns out to be false: In fact, “the world is growing more equal than it has been for over 100 years.”…
…But even Piketty’s pessimistic diagnosis, made a decade ago, has come to look much less dire.
In part, this is because Piketty’s work has come in for criticism from other economists. According to one influential line of argument, Piketty mistook why returns on capital were higher than returns to labor in many industrialized countries in the decades after World War II. Absent concerted pressure to prevent this, Piketty had argued, the nature of capitalism would always favor billionaires and giant corporations over ordinary workers. But according to Matthew Rognlie, an economist at Northwestern University, Piketty’s explanation for why inequality increased during that period was based on a misinterpretation of the data.
The outsize returns on capital during the latter half of the 20th century, Rognlie argues, were mainly due to the huge growth in house prices in metropolitan centers such as Paris and New York. If returns on capital were larger than returns to labor over this period, the reason was not a general economic trend but specific political factors, such as restrictive building codes. In addition, the main beneficiaries were not the billionaires and big corporations on which Piketty focused; rather, they were the kinds of upper-middle-class professionals who own the bulk of housing stock in major cities.
Economists continue to debate whether such criticisms hit the mark. But even as Piketty defended his work, he himself started to strike a more optimistic note about the long-term structure of the economy. In his 2022 book, A Brief History of Equality, he talks about the rise of inequality as an anomaly. “At least since the end of the eighteenth century there has been a historical movement towards equality,” he writes. “The world of the 2020s, no matter how unjust it may seem, is more egalitarian than that of 1950 or that of 1900, which were themselves in many respects more egalitarian than those of 1850 or 1780.”
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