Manifesto

All views expressed are ours and not those of any other organization. This blog is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. You should be very skeptical of anything you read on the internet…especially from an anonymous source.


Who we are

We are an anonymous team of retail investors that believe we should think before we invest our hard earned money. We are passionate about how technology is reshaping our economy and creating new investing opportunities. Learning helps us grow. Writing helps us learn. We write for ourselves, but enjoy building new relationships and sharing new ideas more than just about anything so you are more than welcome to join our conversation.

For those unfamiliar to investing, “thinking” is a radical idea. Most everyone, from Jack Bogle to Warren Buffett, seem to agree. The conventional wisdom is that it is exceedingly difficult for the average person to consistently beat the market. Without inside information, expert knowledge in an neich market, or a team of quants and computers, it just isn’t worth the trouble. This is a compelling argument as evidenced by the consistent flows from actively managed to indexed mutual funds and ETFs. Most people, it seems, like having an excuse to ignore their retirement portfolio and spend more time living…who can blame them!

 

We also happen to like buying cheap, another radical idea. The largest funds in the world track the S&P 500, an index of large US companies weighted by how much they are worth (market capitalization). So when the price of Apple goes up more than other companies these funds buy more. This seems backwards to us. We like to buy low and sell high.

Our world has exhibited several trends that cannot continue much longer. Global debt as a percent of GDP is higher than at any point in recorded history. This has only been possible because interest rates have been falling for three decades and now sit near zero across most of the industralized world. Low interest rates are also the justification for record high stock prices that are now higher than before the 1929 crash that proceeded the Great Depression.

Stock and Bond Price Fundamentals – 2016/09/25

Why interest rates fell – 2016/08/27

Global wealth has been rising while global economic growth has been slowing since WWII. This imbalance of wealth relative to positive yielding assets is at the heart of why interest rates and dividend yields are are so low. These trends seem unlikely to continue because at the heart of our global economy are many people who have been left behind, and the people (which seem increasingly frustrated by their elected officials and stagnant wages) have the power to redistribute this wealth. New technologies are displacing jobs faster than folks can be retrained and re-enter the work force. The burdons of this trend on our social safety nets have been hidden by rosy forecasts from pension funds, governments, and quantitative easing (printing money). There is no realistic scenario that allows for these trends to reverse themselves without a major shock, but no need to worry just yet!

Why Growth Fell

How high will interest rates rise?

The Fourth Turning – 2016/11/12

Economies experience shocks all the time. What matters is whether households and businesses have the capacity to obsorb those shocks. This is why credit lies at the heart of the modern economy and why business cycles are more predictable than a coin toss. Today, debt levels are near record highs, but the cost of this debt as a percent of income (debt service) is at historic lows. Households and businesses are only just now starting to forget the pain of the global financial crisis. As memories of the housing bubble and soverign debt crisis fade, we will collectivly begin to spend again. In time, reasonable purchases will be replaced by unreasonable. The prudent will be replaced by the impractical. In time, even the models that banks and hedge funds use to price financial assets will no longer include much if any data from these historical stress events. That is when we will be vulnurable. That is when the constant shocks that we experience even today willsnowball into the financial crises of tomorrow. This is why we think its important to Think before we invest.

How the Economic Machine Works – 2016/09/18

The Heisenberg Uncertainty Principle asserts a paradox of physics: The act of measuring the whereabouts and momentum of subatomic particles distorts the very qualities you seek to measure. So what happens when everyone accepts as gospel that the best thing to do with their retirement savings is to invest in X without thinking? Is it necessarily the case that no matter what you substitute for X the result is that X becomes overpriced?

What is a bubble – 2016/11/19

There can be no simple rule for investing. Any such rule, when followed by enough of the world’s capital, will necessarily lead to excessivly high prices in the assets identified by the rule. This is why, unlike every other discipline (except perhaps physics), what we learn from the past may not be a useful guide to success in the future. Optimal investing can never be automated. The game will always change with the bahavior of the players; weighted by how much money they have to spend. The only constant is change.

What we do

We provide an alterantive to the conventional wisdom for those who believe in critical thinking and seek to be lifetime learners. We provide  intuitive explanation of the most helpful investing concepts, strategies, and models. We keep up with the leading minds, reading financial statements of greatest companies, study the best books, and listen to podcasts from the most brilliant people. We use these insights to identify new investment ideas like our cryptocurrency trade before this years 1000%+ run up.  We also collaborate with other anonymous retail investors to challenge and shape our ideas. We discuss what we learn and share with the world from our website and on Twitter @intuitecon.  This never gets old to us. If you have similar interests feel free to email us at intuitecon@gmail.com.

The Crytocurrency Trade – Bitcoin and Ether

Markets are efficient, so why care?

There is no doubt that many of you are still skeptical of the usefullness of thinking about your investments. No investing blog is complete without addressing this elephant in the room. Here is our view and the story of why we got started.

Markets are mostly efficient most of the time. Some efficient market hypothesis (EMH) enthusiasts use this as an excuse not to think critically about their investments. We believe this conclusion is incorrect and that is why we became active investors. Basically, it comes down to the fact that the same asset can have different values to different investors.

The value of a stock or bond is a function of expected future cash flows. If markets are efficient then all market participants have the same belief about these future cash flows. However, differences in time horizon (discount rate), value of liquidity, and definition of risk can have major implications for the present value of these cash flows.

High discount rates are the norm because most of the world’s money is managed by corporations, hedge funds, banks, and other institutions. These institutions are constantly under pressure to perform every quarter. This causes assets to be valued with a high discount on cash flows far into the future. Conversely, a premium is given to cash flows expected in the near term. This reality actually forms the basis for value investing. Private companies, sovereign wealth funds and patient investors have the freedom to underperform in the short term by making smart long term investments. Hedge funds and corporate executives risk losing their jobs when they take their eye off near term performance. This is why the only hope for some failing public companies is to go private. Only by removing executives from short term pressures can they make the best long term investment decisions.

High liquidity premiums are the norm for the same reason. According to the EMH, more liquid investments should pay a higher return. This is because higher liquidity allows deep pocketed investors to easily enter and exit positions. Liquidity is often defined as the bid/ask spread. Small investors generally don’t notice this difference in liquidity because it is sometimes less than a cent for the most liquid ETFs compared to a few cents for less liquid ones. A few cents are a big deal for institutional investors like Vanguard because they have to constantly cross the spread (buy and sell positions). However, longer term investors that buy and hold the most liquid investments are paying for that liquidity (in theory) even though they generally are not using it.

Risk is generally assumed to equal volatility because that’s the definition that makes sense for highly leveraged corporates (which includes banks) and hedge funds. According to the EMH, investment risks are “priced in” to assets. However, little attention is given to how risk is defined. In practice, “risk” according to large institutional investor looking to justify their salary each quarter means something very different than to an individual with a 10 year time horizon. Because of their size, institutional investors get a much bigger say in how “risk” is defined because their dollars have a larger influence on asset prices.

The Sharpe Ratio (below) is perhaps the most important ratio used to measure the performance of a money manager. This ratio is supposed to measure risk-adjusted return by dividing excess return by volatility (i.e. standard deviation). The importance of risk adjusted returns became obvious after the Dot-Com bubble burst as many hedge funds that had simply been making leveraged bets on the stock market went bust. Obviously, a money manager should not get credit for doubling returns by simply doubling their leverage. Thus, attempting to “risk adjust” returns is a step in the right direction.

Sharpe ratio = (Mean portfolio return − Risk-free rate)/Standard deviation of portfolio return

For banks, corporations, hedge funds, and other short term oriented investors this definition of risk makes a lot of practical sense. Those with highly leveraged positions (ex. Banks) could get wiped out by sudden moves in markets so managing volatility through the use of VAR models is practical. Corporations may have short term liabilities that they need to cover and so suffering a short term loss could potentially threaten bankruptcy. Hedge funds are pressured to achieve high returns each quarter or else their clients start to leave (as they have in droves this year). However, for regular folks (like us) with a long time horizon, risk does not equal volatility. In the words of Warren Buffett, the true measure of risk is the probability of a permanent loss of capital.

In short, a patient investor (which we try to be) should be better off investing in assets for reasonable prices that have the following characteristics:

1) Strong companies expected to thrive long into the future. Efficient markets will already give these companies higher valuations because of the certainty of near term cash flows. However, the dominance of market participants using high discount rates on the future means these companies provide even more value to long term investors. This is one reason Warren Buffett owns Heinz, Coca-Cola, John Deere, and other iconic companies that are likely to still exist many decades from now.

2) Small companies and other thinly traded assets that have strong intrinsic value. The lack of liquidity in these assets make them more costly to transact for big movers of capital. This is because big movers will have a big impact on the price of thinly traded assets. When they buy the price gets higher; when they sell the price gets lower. Bid/ask spreads are also generally wider for thinly traded assets. Wide bid/ask spreads add up to higher transaction costs for Vanguard, Bridgewater, and other big movers of capital, because they buy and sell on a regular basis. However, regular folks investing for the long term only need to transact twice; once when they buy, and again when they sell. Moreover, regular folks (including us) generally don’t invest enough to move prices so they don’t need to worry about bidding up prices when they buy and bidding down prices when they sell. So why should regular folks pay the premium for highly liquid assets?

3) Volatile assets that have strong intrinsic value. Volatile assets trade at a discount because most big movers of capital use volatility to measure risk. However, regular folks are better off using Warren Buffett’s definition of risk: the potential for permanent loss of capital. Some great companies experience volatile prices because of the nature of their business or some recent shock. So long as these factors do not threaten the long term viability of the business, most folks should just ignore it. Near term price volatility matters when you are trying to sell, but not if you plan to hold it for many years.

For these reasons, the value of an investment will be different for different types of investors. This alone is reason enough for even the most enthusiastic EMH advocates to think critically about their investments. If you think that these reasons produce trivial differences in value … think again!

Example

Once you recognize that assets have different values to different investors the world of potential investments becomes clearer. The question shifts from “which investment is underpriced” to “which investment is better for me”. We use the impact of quantitative easing on long duration bonds as an example.

Since 2014 many of the world’s interest rates have at one time or another fallen below zero. Not once, in the 5,000 year history of borrowing, has this ever happened. The fact that a Danish couple actually managed to get paid to take out a mortgage made me question some fundamental beliefs I (and many others) held about interest rates. My curiosity turned into a full scale literature review of the world’s leading minds for an explanation. This led to one of my first articles titled, “Why Interest Rates Fell“. If you like this article you will probably enjoy my other articles which follow a similar approach. In this article I discuss all the leading theories on why interest rates have been falling for decades, but only one that provided a credible explanation for negative rates…quantitative easing (QE).

Central banks have printed off more than $11 Trillion (at the time of this writing) since the Financial Crisis. Every time they start a new program they announce to the world that they plan to buy billions in bonds for a pre-specified period of time. This provides a huge incentive to front run the central bank as their incessant buying bids up bond prices. As front runners and central banks bought bonds their prices went up and their yields went down. In this way QE has consistently inflated bond prices above their intrinsic value. There is nothing “inefficient” about this, but a long term investor is nothing short of foolish to buy a negatively yielding bond with the intent to hold to maturity. Its a strategy that is guaranteed to loose.

 

 

 

 

 

 

 

Note: You can see the impact of QE on bond (and to a lesser extent equity) prices in the chart above.

The impact of QE on bond prices is a perfect example of a situation where an asset has more than one value. In this case, bonds actively being bought by a central bank through QE program have at least two values:

  1. The value to speculators looking to front run the central bank and
  2. The value to long term investors (like me) looking for a safe dividend.

Two values are not compatible with the efficient market hypothesis (EMH). Proponents of EMH argue that all prices are “efficient”, meaning that they reflect all material information. However, if you are front running QE by buying bonds at a negative rate the only relevant information to you is whether the QE program continues. You just need to be sure to get out before the central bank announces a “taper” (i.e. winding down of the QE program). Again, there is nothing “inefficient” about this…but it does lead to many strange phenomenon. For example, bond prices kept rising through the summer of 2016 despite higher default rates. Default rates are obviously very material, but only if you are a long term investor.

Recognizing that bonds, particularly those with long maturities and small coupons, have inflated values has been helpful to us. We know the coupon is artificially low because of QE. We also know that we will not be fast enough to sell when the central bank announces a tapering of their QE program because there are dozens of hedge funds and bankers playing that game for a living. Therefore, the rational thing for us to do is avoid the most sensitive bonds (long maturity with small coupon…typically sovereign bonds fit this picture) entirely until the program ends and interest rates (i.e. yields) move back to normal.

For more on why efficient markets are no excuse to think critically about your investments see our article, “Actively Managing Efficient Markets“.

This is not to say that we always agree that markets are efficient. In other articles we often bring up examples of “inefficiencies” in markets. The reality is that no market is perfectly efficient. However, in order to take advantage of those inefficiencies one needs to spend a great deal of time an effort. Market efficiency is, therefore, less a “state” and more a matter of “degree”. To the extent that smart people devote time and effort into generating alpha from market inefficiencies … markets will become more efficient. In light of this fact we don’t see much use in the way the EMH debate is framed. It’s not a black and white issue.

Most importantly, market efficiency is not an excuse for not thinking critically about their investments. Even if markets are perfectly efficient the price of assets are going to reflect the weighted average assumption used by market participants to determine the discount rate, liquidity premium, and definition for risk. By “weighted average” we mean weighted by the amount of money managed. This means large corporates and hedge funds get a much larger say in determining what price assets receive in the market because they are more dollars to vote with. To the extent that your situation reflects the mean market participant you can afford to think less about whether the market price is consistent with each asset’s value to you. However, to the extent that your situation differs from the mean (and I’m guessing most readers are not corporate executives and hedge funds here) than an asset’s price is likely to be substantially from its value to you…and that’s reason enough to think before you invest.

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Feel free to share your own thoughts on investing and finance. There is no better compliment you can give me than your thoughtful criticism. You can reach us at intuitecon@gmail.com, or follow us on Twitter @intuitecon

Thank you for your interest.

 

Disclaimer: These are our personal views. This article is not, and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. Our hope is that these observations will merely help you to more critically examine your own beliefs about finance and stimulate dialogue.