Over the last 12 months a lot has happened in the markets and in everyone’s life. The following are some of the things I think I have changed my view on or become more sure of. Writing them down helps me when I look back 12 months from now so I can build on them or break them and start again.
1. Quantitative Tightening in the US is noise. US banks do not lend out their Fed reserves. Follow and read Mark Dow primer on liquidity. Be wary of the shills that spin the narrative about the end of the world with QT.
Think about the following quote from the article mentioned above:
From 1981 to 2006 total credit assets held by US financial institutions grew by $32.3 trillion (744%). How much do you think bank reserves at the Federal Reserve grew by over that same period? They fell by $6.5 billion.
I have learnt to be wary of people using QT as reason for a market collapse. QE caused the market to go up so therefore QT will cause the market to go down. This seems to me to be narrative building and a tool for blaming everyone else for their own mistakes.
What seems to matter more is the level of the Balance Sheet to maintain operations, and this no one really knows yet probably including the Fed.
Liquidity does matter but it is more linked to the markets risk appetite. In a way this is driven by expectations of the Fed so maybe it does matter so I am keeping an open mind on this.
2. Don’t blame Algorithms and Quants for market turmoil. For me this debate again is noise. Supposedly markets were slapped due to the quants and the algo’s back in the last quarter of 2018. However maybe the quants and algos drove the market up recently? Nah it was the Fed and Powell put. Again goal post shifting.
Maybe the real story was that the market was pricing in a recession and earnings growth slowing in 2019 and now is revisiting this view. But that would not be as interesting as blaming a machine or Skynet or AQR.
3. When we are not sure what is happening or we are confused then authority still is King. People will take to twitter or their medium of choice and explain why things have happened and x, y z will happen next. So many hedgehogs and not enough foxes.
The hedgehogs will get all the attention as they will use slogans and compelling charts to show why something happened. The links will be tenuous at best. When what happens next does not pan out, the goal posts will move.
Foxes just go about quietly doing their thing and say I am not sure.
Cialdini has written extensively on this authority bias and social proof. When faced with uncertainty we will look to authority to give us clues as to what our actions should be. We will look to management, we will look to the person who seems to have the most credibility to guide us to our decisions. We look to “experts” for guidance.
But maybe some of the experts are just Brick Tamland from AnchorMan, loud noises with no substance.
4. A lot of investors are still lazy and rely on P/E multiple as their go to heuristic. Comparing P/E multiples to other companies in an industry or what the company has traded historically ignores the future dynamics of growth for the company and any re-investment options.
I suspect that as the internet has rebuilt the way we do business then maybe it will also rebuild they way we value companies. As an investor I have to be throwing away old rules of thumbs however embedded they may be. I think I have been slow to adapt to this but I feel I am catching up.
5. Battle grounds and which tribe you belong to define how you think. If anyone has been watching the latest Modern Monetary Theory (MMT) debate/argument will see how passionate people become if an idea may jeopardise a tightly held belief. I have no skin in this dog fight but as a tweet from Joe Weisenthal shows isn’t this an opportunity to keep an open mind?
Again lots of hedgehogs on show but Joe is showing what it means to think like a fox.
6. Buybacks are not bad and evil. So over this one. Replace anyone using the word buyback with dividends. Also think about Shareholder yield (buyback + dividend). From my understanding as a factor when combined with quality this has outperformed a buy and hold strategy.
Is the reverse argument that a share issue or dilution is good? I much prefer a buyback any day over a share dilution.
7 . Everyone is still looking for the next big short. Investors who survived 2000 and 2008 are leaving in fear of another 50% drawdown. Maybe much the same way people who lived in the 1930’s mistrusted banks for the rest of their lives and put their money in a tin under their bed.
Or people who lived through the 70’s feared inflation throughout their life and are still obsessed with gold.
8. Pessimism is so draining and time consuming. The market goes down a lot and you are right, and then what? Odds are you will never buy back in. Be an optimist as the tide will always work with you.
All this leaves me to something that I am more sure of now than I have ever been in investing. What matters is whether I have over-estimated or under-estimated the earning power of the companies I own or do work on. Simple.
What I am still working on and not sure of is the evolution of subscription business models and whether Life Time value, which is in a lot of share prices, will be captured.
Can sales and marketing be switched off or reduced and still maintain the life time value of clients? Or is the S&M just another hidden COGS?
Is the R&D spend a fixed cost that can never come down as the product or service needs constant reinvestment to keep the client and keep the competition at bay?
The expectation build in share prices for a lot of these businesses is that the steady state Operating Margin will rise to enable the company to turn on the cash flows once the opportunities to acquire and reinvest in new clients become marginal. Those companies that do not and are trading on high multiple of revs will find their equity value get destroyed.
What I suspect is that not all will make it and the majority will find the competition will over time dwindle this accumulated Life time value to a point where equity will be disappointed. The key is to find those that really can turn the high revenue growth into strong free cash flow and capture embedded life time value and more. That is not so simple.