Value Investing

George Soros, Compounding, and Helen Keller

Alex here with this week’s Macro Musings.

As always, if you come across something cool during the week, shoot me an email at alex@macro-ops.com and I’ll share it with the group.

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Articles I’m reading —

Morgan Housel is a beast of a writer. I’m in awe of the amount of high quality work he’s able to put out week after week after week. In his latest article titled “A Freakishly Strong Base” he manages to tie in the Ice Age, antibiotic usage, smoking rates and WW2, along with how Buffett made so much money; all to explain the power of compounding.

Here’s the link and a quote:

It is so easy to overlook how powerful it can be to take something small and hammer away at it, year after year, without stopping. Because it’s easy to overlook, we miss the key ingredients of what caused big things to get big. How can most of Buffett’s success be attributed to what he did as a teenager? It’s so crazy, so counterintuitive. And since it’s crazy and counterintuitive we overlook the right lessons. So we write 2,000 books on how Buffett sizes up management teams when the biggest and most practical take away from his success is, “Start investing when you’re in third grade.”

Physicist Albert Bartlett put it: “The greatest shortcoming of the human race is our inability to understand the exponential function.”

It’s official, Jerome Powell will replace Janet Yellen as the next Fed Chair. The “Game Masters” (ie, central bankers and government leaders) control the biggest levers on our markets and economies; hence the name. So it pays to know how they operate and the mental models they use to view the world.

Here’s a great tool from the WSJ that aggregates all the speeches from policy makers for the big four central banks (Fed, ECB, BOJ, BOE) and allows you to easily search by speaker or keyword. It’s worth jumping in there and reading up on Powell.

My take: Ideologically, he’s not a big departure from Yellen but is somewhat more amenable to rolling back financial regulations.

Video I’m watching —

Remember the short video I shared a few weeks ago of the Tendai Buddhists monks who partake in a brutal 1000-day pilgrimage called “Kaih?gy?”? Where if they fail — which most do — they have to take their life?

Here’s a full hour long documentary on them. It’s somewhat dated but still good (link here).

This clip was doing the rounds on FinTwit this week. It’s from an old “Adam Smith’s Money World” episode — which was a great Wall St. news program that ran from the mid 80’s to late 90s. You can find a lot of the old episodes on YouTube — where the host Jerry Goodman interviews Soros and Druckenmiller.

Soros gave a freezing cold take when he said he thought the world was in a great depression very similar to the 1930’s. This interview was in 94’. I’m guessing he changed his mind — which he was pretty good at — soon after.

Here’s a section from the video where Soros talks reflexivity:

We all work with preconceived ideas and those ideas don’t necessarily correspond to reality so there is this gap between perception and reality and that’s the gap that I have really explored and exploited. All our views of the world are somehow flawed or distorted and then I concentrate on the importance of this distortion in shaping events.

Book I’m reading —

I just picked up Big Money Thinks Small by Joel Tillinghast. Joel is the long-time manager of the Fidelity Low-Priced Stock Fund and a protégé of Peter Lynch.

I’m only a third of the way through it but I like what I’ve read so far. It’s well written and easy to get through. It reminds me of Ralph Wagner’s A Zebra in Lion’s Country which is another value focused investing book that’s worth a read.

Here’s Joel’s five key principles for avoiding investment mishaps which he discusses at length in the book:

  1. Make decisions rationally: Do not invest emotionally, using gut feel / Do invest patiently and rationally
  2. Invest in what you know: Do not invest in things you don’t understand, using knowledge you don’t have / Do invest in what you know
  3. Work with honest, capable management: Do not invest with crooks or idiots / Do invest with capable, honest managers
  4. Avoid competitive industries and seek stable financial structures: Do not invest in faddish or fast-changing, commoditized businesses with a lot of debt / Do invest in resilient businesses with a niche and strong balance sheet
  5. Compare stock prices with intrinsic value: Do not invest in redhot “story” stocks / Do invest in bargain priced stocks

Pretty common sense advice.

I take rule number three to heart in my own process. Pretty much every time I’ve willingly overlooked management’s past indiscretions to shareholders I’ve ended up with a lot more red on my trading statements. Investing in companies with solid management isn’t everything, but it’s pretty close.

Also, here’s a great section from the book:

Instead, shine a spotlight on the evidence that is silent. Lurking in the background are unexamined assumptions about society and institutions. To fix recency bias, study history — the longer and broader, the better. To envision the future, investors need some idea of the normal baseline. Discover which things change and which endure. Statistics, probability, and the outside view are key. History is especially important because people repeat what works, but in the stock market we don’t get timely feedback on our decisions— and what we do get is mostly noise.

The downside of history is the narrative fallacy. In The Black Swan (2010), Nassim taleb wrote:

The narrative fallacy addresses our limited ability to look at sequences of facts without weaving an explanation into them, or, equivalently, forcing a logical ling, an arrow of relationship, upon them. Explanations bind facts together. They make them all the more easily remembered; they help them make more sense. Where this propensity can go wrong is when it increases our impression of understanding.

I’ve been on a value investing reading binge lately. If you have any good and more obscure — I’ve read most of the popular ones — value oriented investing books, please shoot them my way. I’m always on the lookout for a good read.

Also, for you Sci-Fi fans, I’m reading Cixin Liu’s The Three-Body Problem — I’m about halfway through it. It’s good. Kind of reminds me of Asimov’s Foundation series but a tad darker. So if you’re an Asimov fan then I suggest you check it out.

And for more of my book recommendations, check out our comprehensive reading list for global macro traders and investors.

Chart(s) I’m looking at —

This is an interesting chart from Nautilus showing how an uptick in realized volatility doesn’t necessarily correlate to a selloff in the SPX. Quite the opposite; uptrending realized volatility from historically low levels (like where we are now) have in the past been accompanied by large advances in the market.

From the way other sentiment and liquidity gauges are looking, I’m thinking we may be entering the beginnings of a frenzied blow off top that will play out over the next year or so. But we’ll see…

And on that note, I’ll be watching this chart of the Barclays High-Yield Bond ETF (JNK). It just closed below its 200-day moving average for the first time since August and the tape is looking heavy. JNK is a useful chart for  gauging the market’s risk-appetite. A continued selloff here would likely portend a retrace in the broader market.

Trade I’m looking at —

During earnings season I read through maybe 10-20 hedge fund investors letters. I have a stable, of mostly small-cap value funds, that I like to read. It’s a good source of idea generation. If any of the companies fall under a broader macro thematic I’m tracking, I’ll dig in and see if I agree with the author.

I recently wrote about how I’m keeping a close eye on the shipping industry. There’s signs that it might be done putting in a bottom. The Baltic Dry Index is hitting multi-year highs, international fuel regs are set to pinch supply, and the order book as a percentage of fleet capacity is at an all-time record low.

It’s reasonable to expect that we’ll soon enter a supply constrained environment if demand stays where it is.

In light of this, I came across an interesting write-up by hedge fund Cable Car Capital on Pangea Logistics (PANL) which is a specialty shipping company. Here’s a section from the writeup and you can read the entire letter here.

Through a consolidated joint venture, Pangaea owns or operates a majority of the world’s supply of ice-class 1A drybulk tonnage, enabling the company to earn a premium for operating routes that are inaccessible to ordinary vessels. In winter months, ice-class vessels trade profitably in the Baltics and Canada. In the summer, they are the only drybulk ships that can traverse the Northern Sea Route (NSR). The NSR is a route from Europe to Asia through the Arctic that can save nearly two weeks of travel time. When fuel costs are higher and/or day rates are sufficiently elevated, ice-class vessels can justify charging a substantial premium for this savings. The commodity price environment has made the NSR uneconomic since 2015. For now, the ice-class vessels are profitably employed in summer contract business in the region, and PANL has a call option on a potentially lucrative trade route in the future.

At current vessel prices, I estimate PANL nevertheless has a liquidation value approximately equal to its current share price. That assigns no value whatsoever for the long-term contracts or the chartering business. A net asset value approach is imperfect, as it ignores going concern value for activity that is not part of the owned fleet. As discussed before, PANL is unique in the industry in that two-thirds of its fleet is chartered in on a short-term basis. Ignoring this source of earnings is the rough equivalent of valuing a retailer that does not own its real estate at zero! However, it is a good method to assess downside protection.

We have no position and I’ve only done cursory digging into the company. But I haven’t found any major red flags yet. I’ve still got some work to do but there’s a lot of potential asymmetry in this stock if everything checks out.

Quote I’m pondering —

Life is either a daring adventure or nothing. ~ Helen Keller

Not trading related but it’s one of my favorite quotes nonetheless. I have it carved into wood and hanging near the entrance to my cabin. Is that cheesy? Maybe, but I don’t care.

The quote is from Keller’s Let Us Have Faith. Here’s the full paragraph:

Security is mostly a superstition. It does not exist in nature, nor do the children of men as a whole experience it. God Himself is not secure, having given man dominion over His works! Avoiding danger is no safer in the long run than outright exposure. The fearful are caught as often as the bold. Faith alone defends. Life is either a daring adventure or nothing. To keep our faces toward change and behave like free spirits in the presence of fate is strength undefeatable.

We’re only here for a short time. We get to choose the games we play and how we play them. We might as well actively make our choices then instead of passively accepting what comes our way. Take some risks and live a little… because, why not?

Qui audet adipiscitur.

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Have a great weekend.

Your Macro Operator,

Alex