Stay in the Game (8/11/19)
It’ll take you maybe 5 minutes to read this blog post. Do it, you won’t regret it. That’s all I’ll say.
All the Options (8/4/19)
This upcoming presidential election is already generating quite the buzz and the Democratic debates have been nothing short of primetime entertainment. Currently, TWENTY Democratic candidates are taking the debate stage. Ever wonder how these candidates get picked and how they progress to future debates? Based on the number of donors for their campaigns…
To qualify for the June and July debates, candidates must have 65k individual donors and to move on to the September and October debates, that number doubles to 130k individual donors. A lot of candidates have turned to social media as a way to attract donors contributing $1 at a time, but experts estimate that it costs up to $70 in online advertising to find one new $1 donor. Which means these candidates need wealthy donors to afford to even buy the contributions from the smaller donors. These rules have fundamentally changed the way candidates connect with their constituents through grassroots campaigns.
The Making of Boris Johnson (7/28/19)
ICYMI, the UK has a new Prime Minister – Boris Johnson. Theresa May decided to step down after failing to deliver on a Brexit deal and under party rules, the next party leader was to be chosen by the members of the Conservative Party (only 160k people versus the 46.8m total registered voters in the UK). Putting aside that disregard for democracy… I spent some time learning a little more about this man that’s apparently going to make Brexit a reality and his story literally reads like a soap opera. Somehow, a man with seemingly no deeply rooted convictions who is seemingly planning on just winging it, has been selected to get the UK through one of the biggest political challenges in its history. Read on for a recipe for disaster…
Boris Johnson is a celebrity politician – he has crazy bright white hair that’s always a mess (tbh looks like Trump), he’s funny, he’s charming, he’s disorganized. He’s not what you would imagine a British Prime Minister to be.
As a politician, he built a following around him to challenge David Cameron (Conservative Prime Minister before Theresa May) and found a way through Brexit. Cameron was against leaving the EU and assumed his party and government felt the same way. Johnson had even written an editorial supporting the decision to remain. But at the last minute, he did a 180 and became the leader of the campaign to leave the EU. This decision seemed to be driven not by his conviction on the matter at hand, but by the political calculation that this could land him in the seat to be the next Prime Minister. Given he didn’t think Brexit would actually get voted through, he was totally surprised when 52% of the population voted to leave the EU and it became evident that Johnson didn’t actually have a plan for any of it. So many of his supporters withdrew their support that Johnson backed out of the race all together. That’s when Theresa May came into the picture but her inability to make progress on Brexit and her unpopularity with the government, which led to her decision to step down, provided another chance for Johnson to step in. I’m still confused as to how he managed to do this despite everything. The EU actually thinks the man is a total clown, so I’m really curious to see what he’s able to accomplish in terms of a Brexit deal, which has an October 31st deadline. Brb grabbing the popcorn to watch this story unfold.
Gates Notes (7/21/19)
I stumbled upon Bill Gates’ blog recently and wow love it. Aside from his incredible achievements at Microsoft, the man is an amazing author, philanthropist, humanitarian, and apparently the most admired man in the world. Shocking zero people, his blog rises to the high standards of the man himself and covers topics from the fight to eradicate polio to climate change to tech. Given I’m always looking for a good read, I loved getting into his summer reading list. I was actually most fascinated by a blog post about the UK Public Health Rapid Support Team. This team that Gates calls “The Avengers of virus hunters,” is a group of scientists that helps local governments stop infectious diseases.
Here’s his reading list for those interested – if you decide to join me in picking up these books over the summer, lmk what you think!
- Upheaval by Jared Diamond – the book uses a series of case studies to demonstrate how countries manage challenges and how societies react during times of crisis.
- Nine Pints by Rose George – apparently filled with super interesting facts that “will leave you with a new appreciation for blood.” This one might be more suited for those of you who, unlike me, are not grossed out by blood.
- A Gentleman in Moscow by Amor Towles – this is a novel about a count that’s sentenced to life under house arrest in a Moscow hotel.
- Presidents of War by Michael Beschloss – includes stories nine major conflicts the US entered in the 1800s and 1900s and highlights important lessons about presidential leadership.
- The Future of Capitalism by Paul Collier – a thought-provoking book with a smart perspective on where capitalism is headed given the current polarization we’re seeing on the topic.
A few months ago, I had referenced a podcast featuring an interview with Adam Robinson that noted economic observations based on indicators from groups of traders. Two observations are worth revisiting given the current focus on interest rates – when bond and equity traders disagree about the economy, bond traders are usually right and early and metal traders are better than bond traders are predicting the direction of interest rates. On the first, the spread between corporate bonds and treasuries actually started increasing at the beginning of this month, signaling a weakening economy. This aligns with the views that would call for the Fed to cut interest rates due to slowing economic indicators. However, equity traders are contradictorily bullish as they’ve sent equities to all time-highs this month. On the second observation, the 10-year treasury yield has increased in the last few weeks after falling for a few months, while the interest rates implied by metal traders has remained relatively stable, following a downward trend over the last three months. My takeaway here is that equity traders are a little too bullish right now and it’s prudent to be weary of the stock market reaching all-time highs while so many indicators are flashing caution signs.
Striking Gold (7/7/19)
I recently had dinner with a Caltech scientist whose team’s chain of observatories around the world recorded, for the first time, ripples in space and time (aka gravitational waves) as well as light produced and emitted by the same cosmic event: the collision of two neutron stars (smallest and densest stars known to exist – 1 tsp of neutron star material has a mass of ~1 billion tons). These observations provided the first proof that such collisions lead to the creation of elements heavier than iron – including platinum and gold.
Less than 20 known paintings can be attributed to Leonardo Da Vinci, a quintessential renaissance man – scientist, inventor, painter. The last Da Vinci to be discovered was the Benois Madonna in St. Petersburg in 1914 and as of 2005 only two paintings were unaccounted for – Leda and the Swan and the Salvator Mundi. Originally created in 1500 for Louis XII of France, the Salvator Mundi passed through many hands before being purchased in 2005 for $1,000 at an auction by art speculator Alexander Parish and gallery owner Robert Simon. Given the large proportion of restoration required for this piece, there is much skepticism by experts around the world about not only the value of the painting but also the attribution of the painting. It also begs the question – when does conservation become invention?Adding to the controversy, the painting became part of a melodrama of money – it was eventually purchased by dealer for $83m, immediately sold to a Russian oligarch for $127.5m (which started a litigation battle), and then purchased (allegedly) on behalf of the Saudi crown prince for $450.3m to be given to the Louvre Abu Dhabi. ICYMI this painting was originally purchased 12 years prior to this for only $1,000. Raise your hand if you want to go find Leda and the Swan with me. Unfortunately, the painting never made its debut at the Louvre Abu Dhabi and its current whereabouts are unknown. Let the conspiracy theories run wild.
The Other Kind of Libra (6/23/19)
I’ve talked about Chinese consumer behavior before, including the widespread use of mobile payments, because fintech and the adoption of new technologies within this space is pretty fascinating (think back to the Law of Diffusion of Innovation). It seemed like particularly opportune timing to look into the adoption of electronic payment systems this week given Facebook’s announcement of a cryptocurrency (Libra) and mobile wallet (Calibra) to enable free transactions around the world for users on its platforms. Given Facebook’s recent privacy and antitrust issues, I think widespread adoption of this new technology is an uphill battle. But I came across some really interesting research that found in the presence of externalities, large and temporary economic (or policy) shocks can lead to persistent waves of technology adoption. Given the current level of global uncertainty – Brexit, the future of the Eurozone, slowing global growth, tensions in the Middle East, trade wars, and on and on – the end of this economic growth cycle might just provide Facebook the economic shock necessary to pull this off.
The Art of Gathering (6/16/19)
I heard a quote this week from a group conflict resolution specialist: “Every gathering is an opportunity to create a temporary world.” Interesting. So I dug deeper into The Art of Gatheringand came away with some interesting takeaways for everyday gatherings – meetings, baby showers, dinner parties, etc. – that could probably turn a lot of these gatherings into more meaningful interactions with others. These are the three steps suggested by the author:
- Embrace a specific and disputable purpose – the “why”and not the “what”of the specific gathering. For example, just because you’re planning a baby shower, you can’t just find cute ideas for games off Pinterest – what’s the actual purpose of this for the couple who is about to have a baby? Is it to just have fun? Is it to help them better prepare for parenthood? Find that purpose for this specific gathering and build the event around it.
- Cause good controversy – remove the norm of politeness that could prevent progress. For example, if there is unspoken tension, facilitate the discussion via
- Use of pop-up rules – because of the diversity in most gatherings, unspoken norms are trouble because everyone’s norms are different.
Political Disagreements (6/9/19)
Headlines tend to paint the current political divides at all time highs. I listened to a podcast recently that made me feel like I was back in my high school US History class. My favorite thought from the podcast – similar to how problems are being solved through innovation in the private sector, conflict causes similar innovation in the political system. During this conversation, Harvard historian David Moss framed conflicts as either productive or destructive. An example of a productive conflict would be one between small states and large states that wanted equal and proportionate representation, respectively, in Congress. When the Constitution was finally created, leadership reached a compromise, not by meeting in the middle, but by taking the best of both ideas and creating a House of Representatives and Senate. This structure has proven quite effective for hundreds of years. An example of a destructive conflict, on the other hand, would be that arising after Abe Lincoln’s election when the disagreement on slavery led to the Civil War. Is our current political polarization wide enough to cause a productive or a destructive conflict? I hope despite everything, we can come together, as Ben Franklin wisely chose to put on the national seal, e pluribus unum, “out of many, one.”
Unicorn schmunicorn (6/2/19)
A few large unicorns have come to the public market this year and while some IPOs have done well, two of the most widely known (Uber and Lyft) have not been received well by the public equity market. I’ve been asked many times why this happened and my answer (backed by anecdotal evidence) has been that a) there’s too much money chasing these companies in the private market, which drives up valuation and b) early investors are looking for a way to cash out. This week, however, I came across a paper from Stanford that answered this question from a quantitative perspective (you know how much I love that). The punchline is that reported valuations in the private market assume all shares are valued the same as the most recently issued shares, which generally have more protections (IPO return guarantees, vetoes over down-IPOs, seniority over other investors) and therefore a higher value. However, this method over-values previously issued shares by 58%. After valuing each share class individually based on the risk profile, the study found the average unicorn in the sample was overvalued by 50%.
Instagram vs. Reality (5/26/19)
In our lives of planning and living by those plans, we sometimes forget that these plans are abstractions of reality, not reality itself. Think of maps, for example, as presented by mathematician Alfred Korzybski in a paper from 1931 on mathematical semantics. In the technicalities of the paper, Korzybski introduced an idea – the map is not the territory (i.e. the model is not reality) –
A map may have a structure similar or dissimilar to the structure of the territory
Two similar structures have similar ‘logical’ characteristics. Thus, if in a correct map, Dresden is given as between Paris and Warsaw, a similar relation is found in the actual territory.
A map is not the actual territory.
An ideal map would contain the map of the map, the map of the map of the map, etc., endlessly…we may call this characteristic self-reflexiveness.
and identified a map’s limitations –
A map could be incorrect without us knowing it.
The map is, by necessity a reduction of the actual thing, a process in which you lose certain important information.
A map needs interpretation, which can cause major errors (the only way to solve this would be through self-reflexiveness).
Super interesting 15-page paper for those interested in reading through it, but my main takeaways:
- You can’t understand models (or maps) unless you understand their limitations – it’s important to understand the context in which the models and plans we use are useful
- When the map and terrain are different, follow the terrain
Good to Great (5/19/19)
Turnaround stories can make for the best types of investments, but what turns a company from a good company to a great company? Jim Collins did some research around this – he started with 1,435 good companies and looked at their performance over 40 years to find the 11 companies that became great (i.e. generated cumulative returns that exceeded the broader stock market by at least 3 times over 15 years) – and wrote an interesting little piece on the common characteristics of these companies. He starts by shutting down probably the most stereotypical “strategy change” myths –
- The launch event/tag line and proceeding activities.
- Stock options, high salaries, and bonuses grease the wheels of change.
- The fear of being left behind, watching others win, or presiding over monumental failure.
- You can acquire your way to growth and, therefore, greatness.
- The breakthrough can be achieved by using technology to leapfrog the competition.
and the punchline of his study is that each of the great companies has a down-to-earth and pragmatic framework that kept the company, its leadership, and its people on track for the long term. This ties in so well with one of my favorite concepts from Angela Duckworth on grit, but I’ll save that one for another week.
Shoe Dog (5/12/19)
Nike’s success story is probably one of the most common business curriculum case studies, especially when it comes to brand marketing, and the story of the company’s success has always made me admire the entrepreneur of Phil Knight. His memoir, Shoe Dog, is a fantastic read for those interested in being inspired by this company’s incredible ride, but here are the main lessons:
- You’re only going to get a few chances to start something, might as well go for broke when you’re young. Knight had written a paper on Japanese high-end, low-cost running shoes. While in Japan on a trip after graduation, he came across such shoes and decided to just cold-call the CEO of the company that manufactured those shoes and the CEO ended up giving Knight the rights for to sell the shoes in the western United States.
- Find somebody who can be your mentor and partner – somebody who will believe in you and bring valuable skills to the table. Knight’s track coach was this person for him.
- As a leader, don’t tell people how to do things, tell them what you want to achieve and let them figure out how to get there – if you’ve built the right team, they’ll surprise you.
Anthropological Philosophy (5/5/19)
This week I came across a piece on René Girard, a French historian/literary critic/social scientist known for his work in anthropological philosophy. The topic itself sounds super interesting, so obviously loved the read – it’s not too long for those who might want to get into it on their own, but for the rest, below are some of the main parts of Girard’s ideology that basically suggest a stable society is a differentiated one.
Humans don’t want things, they want to be things. Mimetic desire is the core of Girard’s work – he argues the root of what we desire isn’t the objects or experiences we pursue, it’s really more about mimicking “models” that we strive to become. The Don Drapers of the world play to this human nature – they’re not selling you a product, but they’re selling you membership to a particular peer set – whether it’s one that drives Ford pick-up trucks or uses Louis Vuitton handbags.
The nature of human conflict (to succeed, the hero must overcome the obstacle in order to reach a goal, where the primary relationship is between the hero and the goal) realistically is one where the hero’s goal is actually the hero’s model – wanting what the model wants or has – generally in today’s society is in the pursuit of status, which Girard believes to be a zero-sum game in which models and their imitators become rivals. However, distance between the model and imitator is important. If the model is far (God, historical figures, etc.) then the imitator will generally always be able to strive to become like the model and that relationship probably won’t change. The dynamic is much different for when models are close to the imitators (family, coworkers, neighbors, etc.).
Cash & Carry (4/28/19)
If you’ve been with us for long enough, you’ll remember one of my very first posts was about one of my go-to books on investing called One Up on Wall Street by Peter Lynch. One of the main takeaways from the book is to know what kind of investor you are – know how you’re going to react when the market goes down 25% and make sure you can stomach losing that money before you invest it. I came across a really interesting investor letter this week that highlights some characteristics of a dividend growth mindset as well as a value mindset. I love both when thinking about long-term investments, so obviously found the piece to be a great read. If you’re into it, I’d highly recommend reading the whole thing, otherwise below are my main takeaways.
As a dividend growth investor – focusing on positive carry investments (a company that grows at 12% every year) versus future monetization investments (a company that will be monetized at 3.1x the value today in 10 years). Both companies give you a 12% compounded annual return, but the positive carry investment is the superior investment (from the perspective of most rational investors, but especially from the perspective of a dividend growth investor) because:
- Money now is better than money later – the consistent annual returns can be reinvested at higher rates of return
- Consistent performance allows investors to assess progress – does the company’s performance continue to support your thesis on the investment?
- The public market is not a private market and it’s crazy to approach public market equity investments with the mindset of evaluating a private business with a permanent time horizon (this company’s investment horizon is around three years). My pushback on this argument, and I go back to a fundamental learning from “One Up on Wall Street” for this, is that once you buy a stock, sell it once your reason to own the stock changes, not just because of the price reactions in the market. By default, I think of my investments to have a much longer time horizon. But that’s the type of investor I am – I have a thesis for the business itself and I keep the stock until it no longer fits that thesis.
As a value investor – the tendency to overlook opportunity cost. For example – you have $100 today and two options over a year’s time:
- Have $110
- Have $105
A rational investor would choose option 1. But if you add some more color to these options so that your two options now are:
- Have $110 but after you see your investment rise to $150 and then fall to $110
- Have $105 through slow and steady positive returns
While option 1 is still the superior option, from an emotional standpoint most people would think about how they “lost” $40 through option 1 because it’s more visible. If you choose option 2, you don’t see your money disappear at my point during your investment, so you come out of it thinking you’ve made $5 while you’ve actually lost $5 compared to option 1. That $5 is your opportunity cost.
We think of diversity so much in the sense of gender, race, sexual orientation, etc. but this week I came across Scott Page’s work on cognitive diversity. His book closes with this thought – “when we meet people who think differently than we do…we should see opportunity and possibility. We should recognize that a talented ‘I’ and a talented ‘they’ can become an even more talented ‘we.’” YAS!! I have observed this anecdotally, but for the data-driven thinkers like me, Page actually puts together a large body of empirical evidence and lays out two theorems. The “Diversity Trumps Ability Theorem” states a randomly selected collection of problem solvers almost always outperforms a collection of the best individual problem solvers. The “Diversity Prediction Theorem” states the collective error is the average individual error less prediction diversity (read: diversity doesn’t just add marginal value, but matters as much as individual ability).
Social Capital (4/14/19)
The concept of social capital has always been pretty fascinating to me and I came across an interesting piece that looks at social media through the lens of social capital as a “Status as a Service” business. It’s a hefty read, but if you’ve got some time, I’d recommend giving it a try – it’s quite thought-provoking. The entire piece is based around the two principles that people are status-seeking monkeys (I think this is true of the majority but not all people), and people seek out the most efficient path to maximizing social capital. The analysis of the success of social media as it relates to formation of social capital goes something like this –
- Social media must have a strong network effect so as more users come onboard, the network realizes compounding incremental value (this point is fairly obvious).
- ROI is thought of as the number of likes/comments/shares on any post – and social networks have to devote resources to ensure users feel they’re receiving sufficient return on their work by putting the content in front of the appropriate audience (think of how Facebook starts personalizing your feed based on your prior actions/clicks).
- The piece then goes on to analyze social capital through inflation, deflation, rate hikes, devaluation risk, accumulation, storage, and arbitrage.
Up Up & Away (4/7/19)
Remember how Warren Buffet has turned $1 into $5,288 over the last 77 years? The stock market is the best wealth creator but frequently we forget to explain the reasoning behind why markets go up like this. I came across a fairly simple article that lays out the three drivers of growth (in order of magnitude) –
- Dividends – these are paid to shareholders who can then reinvest this capital into companies with higher growth, thereby compounding returns at a higher rate.
- Earnings growth – this is the most straight-forward economic explanation – and it’s driven by inflation, productivity, and demographics.
- Inflation occurs when demand exceeds supply (deflation occurs when the opposite is true, and it’s not great).
- Productivity gains occur when we are able to either produce more with the same amount of input (think industrial revolution) or create something totally new (think the internet). Inflation and productivity are closely interconnected, as inflation occurs and costs increase, it forces innovation for the sake of efficiency.
- Demographics – labor is the most expensive part of production and makes up 60% of the value of output. Growing populations lead to growing labor forces that earn wages that get put back into the economy in the form of the consumption of goods and services.
- Valuation multiples – this is the least straight-forward component of growth – it’s effectively the price per share investors are willing to pay for a dollar of earnings per share. And it’s driven by how an investor currently values the company’s future growth (assuming the company will still be around in the future).
The punchline – we can count on components of this market growth (i.e. productivity gains and demographics that largely contribute to earnings growth) with a decent amount of certainty and they should continue to push markets higher for the foreseeable future.
What’s an Inverted Yield Curve? (3/31/19)
A yield curve shows interest rates for different durations – it’s generally cheaper to borrow money for shorter term than to borrow money for longer term so a normal yield curve is upward sloping. In a situation where the opposite is true, the yield curve slopes downward and is referred to as an “inverted” yield curve. This yield curve inversion, especially between the 3-month and 10-year Treasury yields, has preceded the last seven US recessions and is the most reliable indicator of a potential recession according to the San Francisco Fed. Fun fact, the yield curve inverted a week ago – it remained inverted all week, closing out Friday essentially flat.
Data shows that if the yield curve remains inverted for at least ten straight days, a recession generally follows in about a year, so all eyes are on the 3-month and 10-year Treasury yields. It’s difficult to predict when the stock market peaks in relation to the yield curve inversion and the actual recession, as this hasn’t followed any standard pattern in the past. While the yield curve flattened out by the end of the week, there are still many other technical warning signs – breadth and momentum recently slowing and the very crowded long (read: stocks seem to be overbought) tech position continuing. Additionally, other general economic indicators, like manufacturing and GDP, have shown weakness. Meanwhile, the labor market is still strong, and lower interest rates generally encourage borrowing, which then boosts consumption. Then, take into consideration what the Fed might do in response to an extended yield curve inversion – to normalize the yield curve (lower the short-term interest rates below the long-term interest rates), they would have to start cutting interest rates, which could lead to a whole different set of considerations regarding the state of the economy. At the end of the day, this recent yield curve inversion isn’t a clear indicator on the impending state of the economy yet but it’s something to watch closely and its sure to drive sentiment in the market.
The Dropout (3/24/19)
A few years ago, Elizabeth Holmes was arguably viewed as a role model for entrepreneurs, especially female entrepreneurs. She was recognized as the youngest female self-made billionaire. She was glorified as the “next Steve Jobs” and a “revolutionary” who was going to change medicine as we know it through the company she started when she dropped out of Stanford at the age of 19, Theranos. This company intended to create machines that could run hundreds of blood tests using just a single drop of blood. As high as she soared, she fell – further and faster – once she was exposed as a fraud by The Wall Street Journal in 2015. I had known of her demise but didn’t realize the extent of the deceit until I listened to a podcast serializing the story.
The criminal proceedings against Elizabeth Holmes aren’t complete, so we’ll see whether she is found guilty. The biggest catch here is that prosecutors have to prove not only did Elizabeth commit fraud, but she intended to commit fraud. At the end of this six-episode podcast, it’s interesting to think about whether she was just a bad person or so delusional in her vision that she didn’t realize what she was doing. It honestly might be a little bit of both, I’d love to hear your thoughts. Below are some tidbits I found particularly interesting:
- When asked as a young girl what she wanted to be when she grew up, her answer was “a billionaire.”
- She vehemently dismissed any criticism. As a student at Stanford, as a CEO, if anyone questioned her ideas or methods, they were gone. The turnover at all levels in Theranos was unbelievable.
- Her obsession with Steve Jobs seems really unhealthy (speaking obviously with no subject matter expertise). She started dressing like him. She started speaking in a deeper voice that wasn’t her natural voice. She poached talent from Apple. As soon as these people started working at Theranos and realized the company was built on lies, they were gone – most resigned of their own volition. See point above on rate of turnover at Theranos. It’s good to know most people still have a moral compass that largely points north.
- What got me the most in this entire podcast – stories from patients who were misdiagnosed by Theranos, Theranos employees who were emotionally abused to the point of suicide, and the lack of responsibility from Elizabeth Holmes toward the entire situation.
“Starving the Watchdog” (3/16/19)
Who has a subscription to a local newspaper? *crickets* I don’t think I’ve ever had a subscription to a local newspaper. I believe my neighbors have a subscription just for the coupons featured in the Sunday paper. Today, news (or fake news) just gets delivered to our fingertips, and millions of Americans have decided they don’t need to pay for a subscription to the local newspaper anymore. If nobody is reading the paper, businesses aren’t going to pay for advertisements in the paper. Without advertisements in the paper, local newspaper revenues plummet and the business has to downsize by cutting staff or shut down all together. I didn’t really think about this much, but came across a podcast that was really informative about the broader effects of the decline of local journalism as Americans move away from print media.
Local newspapers provide the stories cited by so many other aggregators, like news channels or even the more popular online news sources. In John Oliver’s words, “it’s pretty obvious, without newspapers around to cite, TV news would just be Wolf Blitzer endlessly batting a ball of yarn around.” LOL. On top of that, local newspapers act like local police departments by standing up to corruption in local government and business (have you seen Spotlight!? If not, highly recommend.). In fact, new research shows that there’s a price to be paid by taxpayers when these local watchdogs shutter down. Following a newspaper closure, municipal borrowing costs increase by .05-.11%, which roughly translates to $650k for every issuance. The rise in corruption causes municipalities to become riskier in the eyes of lenders, which raises their cost of borrowing money, which falls on the shoulders of the taxpayers that have stopped subscribing to local newspapers.
The Laffer Curve (3/9/19)
It seems almost impossible to tune into the news these days and not pick up on taxes in some way – whether it’s about raising taxes on the wealthy or about the impact of tax reform on tax returns (or lack thereof). And at this point in the political cycle, this is bound to be a politicized topic of conversation. At the end of the day, taxes are meant to generate revenue to fund the government, so the question becomes – at what point is the tax system most efficient at raising revenues while stimulating economic growth? Here, I find Art Laffer’s views interesting. He first explained the concept of his famous Laffer Curve on the back of a napkin in the early 1970s and it’s meant to demonstrate the relationship between tax rates and the amount of tax revenue collected by the government.
The Laffer Curve shows that as taxes increase from 0%, tax revenue generated for the government also increases. However, increasing taxes beyond a certain threshold diminishes the incentive to work or produce more, at which point continuing to increase taxes actually reduces output, and therefore, the amount of tax revenue. And when you tax a person or a company at 100%, they’re going to just stop working and producing, which means they are now generating no income on which to actually pay taxes, so the government’s tax revenues are also 0. Hence, tax revenues as a function of the tax rate follow a curve – they start at 0, increase until you reach that threshold tax rate, and then decrease back to 0. Yes, this concept is potentially too simplistic, but it provides a basic framework when thinking about the effectiveness of tax policies.
From the Oracle of Omaha (3/2/19)
A few years ago, I read The Essays of Warren Buffett, a book that compiles excerpts from Warren Buffett’s annual letter to Berkshire Hathaway’s shareholders. Since then, I’ve made it a habit to read the annual letters – they’re never too long and always prove to be witty and informative in true Warren Buffett style. This year’s letter was published earlier this week and these are my favorite points:
- “Abraham Lincoln once posed the question: ‘If you call a dog’s tail a leg, how many legs does it have?’ and then answered his own query: ‘Four, because calling a tail a leg doesn’t make it one.’ Abe would have felt lonely on Wall Street.” First of all, I laughed out loud. Second of all, I couldn’t agree more – this is in the part of the letter titled “Focus on the Forest – Forget the Trees” and the example Warren uses here is fitting – companies not considering stock-based compensation as an expense – “What else could it be? A gift from shareholders?” So many companies and Wall Street analysts try to cloud the view of the forest by manipulating the minutia of the trees – always step back and look at the big picture when analyzing investments. When you invest in a company, you’re investing in its management team and a management team that calls a tail a leg is usually not one to trust in.
- Viewing the US government as a shareholder at an ownership percentage based on the tax rate. YAAASS!!! Of course when you say it, it makes total sense, but I hadn’t ever really thought of it in this way specifically! If lawmakers would view themselves as 21% owners (based on the new corporate tax rate) in companies, and educate themselves on how capital markets actually work, there would be no talk about eliminating or limiting share buybacks. That’s a whole another topic (read: rant) for another week.
- “The American Tailwind” – This country, in a truly bipartisan way (under the leadership of 7 Democratic and 7 Republican Presidents), has seen the stock market turn $1 into $5,288 over the last 77 years since Warren Buffett made his first investment. Warren Buffett attributes a lot of his success on this country that started with a “small band of ambitious people…aimed at turning their dream into reality. Today, the Federal Reserve estimates our household wealth at $108 trillion, an amount almost impossible to comprehend.” Cue USA chant. I can’t wait to be part of the next 77 years of American growth.
“Capitalism, at its core, is fairly straightforward: create shareholder value by providing customers with access to something scarce.” But software and the internet have decimated so many barriers to scarcity in industry after industry (retail, content, etc.) that we’re entering a new world of abundance – where the friction involved in consumption decisions starts to disappear. This week I came across Alex Danco’s thoughts on industry structures and competitive behavior and how they’re changing as we shift from a world of scarcity to a world of abundance.
If you’re willing to spend some time on it, I’d highly recommend reading the essays in their entirety but here are his punchlines:
- Friction (scarcity) allows for return on capital while the lack of friction (abundance) allows for compounding growth – great businesses harness both.
- Technology changes where the friction is located – as scarce resources become abstracted and turn abundant, scarcity appears elsewhere.
- Scarcity motivates us to act for the long term by solving hard problems but when it’s unclear what is scare, short-term thinking takes over, which makes us greedy when we should be fearful and fearful when we should be greedy.
Closing the Loop (2/16/19)
An interesting concept called a “circular economic model” came across my reads this week. I found many different definitions of this concept, but essentially it’s an industrial system that’s regenerative by design – it is intended to eliminate waste as products are designed to be reused and the energy consumed throughout the industrial process is renewable by nature. For example, Rothys makes shoes from recycled water bottles and offers customers free shipping to return used shoes that can be recycled into yoga mats, soles, or even new shoes. A recent survey from ING indicated that 16% of US companies are already adopting circular economies while another 62% of US companies are moving toward a circular economy as part of their future business strategy.
Rewind and Rewrite (2/9/19)
Ever think about something that happened in your life and then think of a thousand different things you could have said or done differently to generate a different outcome? I learned this week that this kind of thinking actually has a technical name – it’s called a counterfactual and is triggered by four elements of the specific memory –
- It is clearly a bad outcome
- It is out of the ordinary
- You can see how you or somebody else had a central role in the outcome
- You can draw a direct cause and effect relationship between what you or somebody else did (#3) and the clearly bad outcome (#1).
Counterfactuals are useful because they can help us see what we can do differently next time and help us feel like we can have more control over future outcomes – they can affect behavioral changes. An interesting podcast I heard this week analyzed why the lack of these triggers might explain apathetic behavior toward climate change.
Results of climate change (think receding glaciers or slowly rising water temperatures) are not seen by many as “end of the world” issues, so they don’t think of them as clearly bad outcomes, and for a lot of people, they aren’t anything out of the ordinary. Additionally, it can be difficult to pinpoint how any one action by an individual directly impacts climate change given it happens at a pace that’s not easily observable. Therefore, it’s difficult to directly observe a cause and effect relationship. The outcome – it doesn’t result in behavioral changes. If you’re passionate about climate change, here’s some food for thought – how can you create these triggers to actually influence others’ behaviors?
The Learning Curve (2/2/19)
You may or may not have gathered how fascinated I am by technological innovation, which, by definition, is brand new territory and therefore difficult to truly evaluate from a financial perspective. Investors determine the attractiveness of an investment based on its underlying value – how do you even think about assigning value to something that hasn’t existed before or is expected to see massive technological disruption? Enter Wright’s Law.
First published in 1936 in the Journal of Aeronautical Sciences, Wright’s Law tries to explain the rate of technological progress and basically tells us that we learn by doing (shocker, I know – fool me once…) and predicts that every percentage increase in the cumulative production results in a fixed percentage improvement in the production efficiency, or the unit cost. A study by MIT and the Santa Fe Institute actually found Wright’s Law to be the best model to forecast technological progress (out of a few that are out there) in various different industries from aircraft production to beer manufacturing. So apparently, to predict how the cost of a product is going to change through technological innovation (which is very useful in creating cash flow forecasts and valuing investments), I just have to figure out the historical rate at which technology has allowed things to get cheaper in that industry (for example, computers) and apply that same rate going forward. Magic.
Life Tips (1/26/19)
This week goes out to one of my favorite books – it resonates with me in ways few others ever have – The Tipping Point by Malcolm Gladwell. In the broadest sense, the book is about the ability of small changes to make huge differences. It explores social epidemics – when ideas, products, messages, or other behaviors in general – become popular suddenly and unexpectedly, and almost seem to happen overnight. The moment at which a social epidemic goes from being invisible to inevitable is called the “tipping point” (based on the diffusion of innovation, remember this concept from a few weeks ago?) and this book explores how these social epidemics happen and whether it’s actually possible to start and control them.
The book explores social epidemics via three concepts – the people who cause them, the actual content of the epidemics, and the environment in which they occur:
- Law of the Few: A small number of people have a disproportionate amount of power. Social epidemics reach a tipping point when Mavens (those who love to accumulate knowledge and therefore discover the trend) tell Connectors (those with massive networks with the ability and propensity to spread information they feel important), who end up telling the Salesmen (those who can persuade people to change their behaviors).
- Stickiness: Unless the idea or product or behavior is “sticky” – memorable enough to make people take action. The example – Sesame Street. The amount of research that went into making the show is fascinating.
- Context: human behavior is largely driven by the physical environment in which we live. This seems super intuitive, but the book uses poignant examples like the broken windows theory and Dunbar’s number to explain human behavioral changes in the face of changing contexts in a really impactful way.
I can’t tell you the number of times I’ve read this book, but every time I walk away wanting to be part of bringing a social epidemic to its tipping point. It’s an easy read and 110% worth every minute of the four hours (at most) it would take to get through it. Highly recommend. We can geek out about it after you’re done.
I Can Transform Ya (1/19/19)
Something that I absolutely love following in the market is disruptive innovation – products or services that will transform how we live and work. It provides a look into what the future holds, which helps me understand what companies out there will be long-term winners and losers of these transformations. Some of the most interesting disruptive innovation is happening in artificial intelligence, especially deep learning, which has the ability to transform every industry. Think of deep learning as a form of artificial intelligence inspired by a human brain – using deep learning, machines don’t need a programmer to tell them what to do, they use data to train themselves.
We’re already using products and services that are powered by deep learning – Facebook and Netflix leverage this to select custom content for users, the Apple Watch leverages this to predict arterial fibrillation, Tesla’s Model 3 autopilot uses this to drive on highways, Google Translate uses this to translate more than 100 billion words per day. Deep learning reaches into every industry and according to Ark Invest, could create 3x the value of the internet aka add $30 trillion to the global equity markets. This growth is powered by an unfathomable amount of data – and processing that much data creates a huge demand for computing hardware like AI chips and semiconductors. Stay tuned for some stock picks in this space, but this week I looked at AI-enabled cyber security platform provider Palo Alto Networks.
A Chess Master’s Views on Finance (1/12/19)
Thanks to one of our readers, Ryan DuBiel, for this week’s interesting find – a podcast featuring Adam Robinson – author, educator, hedge fund advisor, co-founder of The Princeton Review, a rated chess master with an undergrad degree from Wharton and a law degree from Oxford. TLDR, this dude’s really smart and I found two points he made to be really interesting:
First, in the world of finance, we talk about trends all the time. But how do we actually define that term? Adam defines it as the spread of ideas. He also references the diffusion of innovation as the method in which ideas spread (aka how trends appear) even within the stock market. I can discuss the diffusion of innovation for days, I’ll save that topic for another week.
Second, there are five groups of traders who express their views of the future in the way they trade – equity, currency, bond, metal, and energy traders – and below are Adam’s most interesting observations –
When bond traders and equity traders disagree about the economy, bond traders are usually right and early.
Bond traders’ views on the economy are expressed by the yield spread between corporate bonds and 10-year treasuries. Corporate bonds should have a higher yield than US treasuries – the smaller the spread, the stronger the economy. In the stock market, the higher the stock prices, the stronger the economy. So when you see a divergence in the views of the economy expressed by bonds and stocks, Adam says that 99% of the time, the views expressed by bonds are correct and early. My two cents – a bond investor’s method for analyzing a company is much more of a science than that of a stock investor’s just given the different risk/reward characteristics of bonds and stocks. Therefore, by default (pun intended), the bond investor’s method for analyzing a company should yield fewer errors that are introduced by various different biases in a stock investor’s method.
Metal traders are better than bond traders at predicting the direction of interest rates.
Metal traders view the economy in terms of how much copper is being sold – higher the copper sales, stronger the economy. Their effective interest rate is the price of copper divided by the price of gold. When we see this effective interest rate moving in the opposite direction of actual interest rates measured by 10-year treasuries, the interest rate directionality predicted by the metal traders’ effective interest rate has not been incorrect in this century. In August, the effective interest rate as shown by metal traders was at a one-year low, indicating interest rates should move down, while 10-year treasuries were indicating interest rates were at five-year highs above 3%. Since then, interest rates on 10-year treasuries have come down to about 2.7% and metal traders’ effective interest rates have maintained their perfect batting average.
The Essentials (1/5/19)
One of my absolute favorite books on investing is One Up on Wall Street by Peter Lynch. Peter Lynch managed the Magellan Fund at Fidelity Investments between 1977 and 1990. He averaged a 29.2% annual return (which is jaw-dropping awesome btw), more than doubling the S&P 500 market index consistently, and was largely regarded as the best mutual fund manager in the world.
For those of you who are really interested, I’d highly recommend reading the book in its entirety – it’s about 280 pages and filled with great lessons for the average investor and plenty of LOL moments. I read this book at least once a year and learn something new every time. Here are some of the biggest takeaways:
- Invest with a long-term view. These lessons are probably my favorite.
- Once you buy the stock, sell it once your reason to own the stock changes, not just because of price reactions in the market. Be patient and let the reason you bought the stock actually play out.
- Buy when everyone is selling (aka when the stock price drops) – take advantage of your stock being on sale! But at the same time, don’t buy a company just because it seems cheap, you should believe in the company and not just blindly follow the numbers.
“If you can’t convince yourself ‘When I’m down 25 percent, I’m a buyer’ and banish forever the fatal thought ‘When I’m down 25 percent, I’m a seller,’ then you’ll never make a decent profit in stocks.”
- Study and notice companies that you come across in your daily life – it’s the best way to identify good stocks, and usually before that information makes it to Wall Street.
- Know what kind of investor you are before you invest in stocks. Know how you’re going to react when the market goes down 25%. And don’t invest with money that you can’t stomach losing.