Value Investing

Morgan Creek Capital 3Q16 Market Review & Outlook

Morgan Creek Capital market review and outlook for the third quarter ended September 30, 2016.

Morgan Creek Capital

Morgan Creek Capital

Morgan Creek Capital – Letter to Fellow Investors

Save Fairus

In 1985, legendary film director John Hughes sat down for a week and wrote his “love letter to Chicago” – a story of a slacker teen boy (Ferris Bueller) who decides to take a day off school to show his friend (Cameron Frye) some of the good things in life, and the result was the iconic movie Ferris Bueller’s Day Off. In an interview with the AMC Blog, Hughes said, “I really wanted to capture as much of Chicago as I could. Not just in the architecture and landscape, but the spirit.” That spirit is everywhere in the movie from scenes set on Lakeshore Drive on Lake Michigan to the spectacular vistas from the top of the Sears Tower (now called the Willis Tower for the younger generation who don’t know that Sears was once the dominant retailer in the U.S. instead of a stock to be perpetually short). From mimicking the open outcry hand signals in the trading pits of the Chicago Mercantile Exchange (yes, there was a time when people traded commodities with people instead of machines) to the glorious works in the Art Institute. It’s there in shots along the Miracle Mile of Michigan Avenue and in the Friendly Confines of Wrigley Field (home of the World Champion Chicago Cubs). Hughes shot the film in three months in 1985 and released it in June of 1986 to rave reviews of critics and audiences (including yours truly and his soon-tobe wife who were married two weeks later) and the film was a huge commercial success grossing $70 million after costing less than $6 million to produce. Rolling Stone magazine had an article celebrating the decision by the Library of Congress in 2014 to include the film in the National Film Registry as a work that is “culturally, historically, or aesthetically significant” (we agree on all three). 2016 was the 30th anniversary of the movie (and my marriage), and Paramount re-released the movie, which of course merited another viewing. Ferris was just as good as the first twenty-something viewings (which brought it to mind for the opening of this letter). One of the great parts of the movie is the breaking of the fourth wall, where an actor speaks to the camera/audience to reveal something happening in the film or to share their personal thoughts (like using the parentheticals in these letters) and we will explore some of Ferris’s musings below.

The movie opens with some classic shots of the Chicago skyline, the Gold Coast and O’Hare Airport, with some radio talk show hosts talking about what a beautiful day it is in Chicago and then cuts to a darkened room with Ferris Bueller huddled under the covers with his parents standing over him.

Katie Bueller: “Feel his hands, they’re cold and clammy.”

Ferris: “I’m fine, I’ll get up.”

Tom & Katie Bueller: “No!”

Ferris: “I have a test today. I must take it. I want to go to a good college so I can have a fruitful life.”

Katie Bueller: “Honey, you’re not going to school like this.”

As his parents leave the room, Ferris pops out of bed and gives us the first of many glimpses into his evil genius and ingenuity. It is these elements of Ferris’s character (and the setting in Chicago and the Cubs, which we will discuss later) that make this movie the perfect opening for this quarterly letter. Given what we just experienced in the U.S. elections, many of the themes, scenes and events in the movie are symbolic of, related to, or downright just déjà vu-ish of the election. If life imitates art, then here is yet another example. As Ferris throws open the blinds and begins fiddling with his stereo equipment to fake his voice, he breaks the fourth wall by turning toward the camera and saying:

Ferris: “Incredible, one of the worst performances of my career and they never doubted it for a second. The key to faking out the parents are the clammy hands, it’s a good non-specific symptom. I’m a big believer in it. A lot of people will tell you that a good phony fever is a dead lock, but, you get a nervous mother, you could wind up in a doctor’s office. That’s worse than school. You fake a stomach cramp, and when you’re bent over, moaning and wailing, you lick your palms. It’s a little childish and stupid, but then, so is high school.”

Given the stunning surprise victory of Donald Trump over Hillary Clinton, this passage takes on a myriad of new meanings insofar as there are many who would argue that Trump was “faking it” throughout the entire campaign (some even mused that he was really a Democratic operative running simply to destroy the Republican party) and there are plenty of people who thought he was “childish and stupid,” but in the end, the people that mattered (the voters) never doubted it for a minute and he won. There is a thesis (which I hope is correct), that Trump was indeed performing all throughout the campaign, following something called the Southern Strategy , where a candidate attempts to win over white voters by playing on common phobias and creating a coalition to secure enough Electoral College wins to counteract the northeast and west coast bias toward the Democratic side. The danger of this strategy is that given demographics (white people becoming a smaller proportion of the overall population), you have to win near unanimity of this cohort in order to win the election, which means the rhetoric has to be pretty extreme (and extreme it was). It is also important not to forget that this is not just a Republican strategy (although primarily) and that Bill Clinton won the White House using some of the same tactics. The rest of the thesis goes to something that I have been talking about for many years, that there are no longer the traditional two parties. There are simply those IN power and those who are OUT of power, and those who are OUT do or say whatever it takes to get IN, and those who are IN do or say whatever it takes to stay IN. Trump’s performance in this regard was actually spectacular, as he achieved moving from OUT to IN not once, but twice, both against the Republican Party in the primary and then against the Democrats in the general election. With the ultimate prize being so important (top of the power food chain) the performance had to be perfect (there is another funny irony that with Ferris the symptom was clammy hands given all the jokes about Trump’s hands). The thing about elections is that no matter how many great ideas you have, or how great a person some think you are (lots of people thought Mitt Romney was really smart and had great ideas), if you don’t actually get elected it doesn’t matter because you can’t implement anything if you lose.

Ferris: “How can I possibly be expected to handle school on a day like this? This is my ninth sick day this semester. It’s pretty tough coming up with new illnesses. If I go for ten, I’m probably going to have to barf up a lung, so I better make this one count.”

The final part of the thesis is that now that the goal of winning the White House has been achieved it is time to “make this one count” and it is no longer necessary to be the extreme personality that was needed to win, but it is time to be presidential. Many of the great presidents from Kennedy to Reagan to Clinton used this same strategy of running way out on the extreme and then governing from the middle. Perhaps it is just wishful thinking (but we don’t think so) that Trump was this strategic and that he was simply channeling his inner Ferris, but this path to power is not without precedent. In order to have the epic day in Chicago that Ferris is contemplating, he needs some supporting cast. In other words, he needs someone with transportation since he was not endowed with a car. A president with no political experience has the same problem; he will need to find a supporting cast with the “cars” that can navigate Washington and help him get to where he needs to go (and where he has promised a whole bunch of others he will take them). Ferris reaches out to his friend Cameron who does indeed have a car, but who is not excited about getting out of bed (as he is home from school and actually sick) to participate in Ferris’s adventure.

Ferris: “I’m so disappointed in Cameron! Twenty bucks says he’s in his car right now debating on whether or not to go out.”

Cameron: [in his car] “He’ll keep calling me. He’ll keep calling me until I come over. He’ll make me feel guilty. This is ridiculous, ok I’ll go. I’ll go. I’ll go. I’ll go. I’ll go. Sh%#!”

Next we cut to Ferris in the shower (with wet hair neatly styled into a Mohawk) – again breaking the fourth wall – giving us some thoughts on the fact that he really did have a history test, but why it doesn’t matter if he misses it. Again the comparisons to the election are striking. One of the central tenets of the Trump agenda was rebelling against the far left and the socialist tendencies that many ascribe to the Democrats today. In fact, part of the trouble for Hillary was that Bernie Sanders (a self-proclaimed democratic socialist) pulled apart the base of the party by appealing to those who do believe (like the Europeans Ferris was studying) in socialist philosophy. As believers in strong form capitalism, this was disconcerting to us, and we would make the point that there actually was risk in the U.S. becoming “European” (or worse yet – Japanese) if we didn’t make some significant policy changes to combat the Killer Ds of demographics, debt and deflation.

Ferris: “I do have a test today, that wasn’t bull****. It’s on European socialism. I mean, really, what’s the point? I’m not European. I don’t plan on being European. So who gives a crap if they’re socialists? They could be fascist anarchists and it still doesn’t change the fact that I don’t own a car.”

Unfortunately for Ferris, he was born a few decades before Uber (and Lyft), which have greatly eased the transportation headaches of car-challenged teens. The great thing is that because of investments in disruptive innovation, for many, there is no need to own a car today. The sharing economy is just one example of the type of creative disruption that is emanating from Silicon Valley. The refrain of the Trump campaign was Make America Great Again (#MAGA) and while we might argue that America is already great, we would argue vehemently that the innovation and wealth creation coming out of the Bay Area are what make America truly awesome and policy needs to be focused on making it easier (read: less regulation) and keeping it profitable (read: no change to taxation of carried interest).

Allow me one quick rant on the attack on carried interest. The idea that when an investor puts capital at risk (meaning it could go to zero and there would be no profits to tax) that the return on that investment is somehow the same as fixed income interest (which is protected by contract) is ludicrous. The concept of carried interest came from the ancient shipping practice that captains were awarded 20% of the goods they “carried” should the voyage be successful. There was huge risk in taking wooden ships across the ocean and when capital is put at risk, the gains on that investment are in no way, shape or form income. Profits earned from venture capital investments must be taxed at capital gains rates, period. Now I can go further and explain why having a capital gains tax rate of zero would lead to much higher overall tax revenues (encourages investment & innovation which leads to more jobs which leads to more income which leads to more taxes), but we will leave that for another time.

After complaining about not having a car, Ferris sings into the hand-held showerhead a verse from Wayne Newton’s ‘Danke Schoen’ as he completes his shower.

Ferris: “I recall Central Park in fall, how you tore your dress, what a mess, I confess…”

Suffice it to say that there have been many great leaders who have made what many of us would consider mistakes in the fidelity department. We don’t have enough psychology training to know if it is a chicken or egg issue (does the character trait lead those men to pursue power, or does the position, once attained, create temptations that can’t be resisted?) so we won’t explore the issue too deeply, other than to say that choices people make in their personal life should not necessarily disqualify them from serving in public office and we probably should spend more time talking about more substantive issues. Ferris emerges from the shower with his head wrapped in a towel and continues the conversation about the Europeans and offers some commentary about fascist anarchists.

Ferris: “Not that I condone fascism, or any -ism for that matter. -Isms in my opinion are not good. A person should not believe in an -ism, he should believe in himself. I quote John Lennon, ‘I don’t believe in Beatles, I just believe in me.’ Good point there. After all, he was the walrus. I could be the walrus. I’d still have to bum rides off people.”

Again, the parallels to the campaign and the Trump himself in this passage are uncanny. On many occasions over the past couple of years, Mr. Trump has made comments that were so outrageous that they struck many people as being reminiscent of the 1930s and 1940s European leaders where the word fascism would not be out of context. Ferris’s point that he doesn’t condone any -ism is probably a pretty good philosophy to live by as avoiding fascism, anarchism, communism, socialism, Marxism, authoritarianism, racism, cynicism, etc. is a better way to approach life (we would also argue that avoiding populism, nationalism, isolationism and protectionism is a better was to run a government). We disagree with the extreme comparisons that some have made, just as we were skeptical eight years ago when similar assertions were made that President Obama was really a Muslim who was secretly attempting to move the country toward socialism. On this point, the evidence is fairly strong against the Obama as a socialist assertion since after recovering from the global financial crisis, GDP has recovered, the stock market stands near all-time highs, employment has surged and the number of workers in the government has actually fallen. Clearly there were some things said on the campaign trail that we fundamentally disagree with, but the hope is that they were all part of the performance to achieve the end goal. There is one significant potential downside to the use of the Southern Strategy in that by having a leadership figure model such extreme behavior, some of the followers feel emboldened to act in ways toward minorities that are simply unacceptable. There have been some isolated reports of violence against immigrants and persons of color in days following the election and we can hope that these reflect a fringe element (that unfortunately exists whoever is in office) and that once in office President Trump will act more presidential and not condone this type of behavior (we maintain he should directly speak against it). In his victory speech he did say the things we need to hear in this regard, saying, “Now it is time for America to bind the wounds of division, I say it is time for us to come together as one united people. It is time. I pledge to every citizen of our land that I will be president for all of Americans.” It is easy to read words off a teleprompter, but much harder to live up to those words and actually become an inclusive leader. Obviously, if he were to move to center (which he will need to do to be truly successful) he will lose the support of the most extreme fringes of the populace (but he already won the prize), but that is a small price to pay for doing the right thing for America.

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