'Buy the Umbrella' - Issue #47
Hi there!
Here is your latest dose of ‘Buy the Umbrella’, a short list of interesting things we’ve been reading and thinking about during the week.
If you missed our prior issue, you can find it here.
Quote
“Happiness is simply the absence of desire... Happiness is not about the achievement of pleasure (which is joy or satisfaction), but about the lack of desire. It arrives when you have no urge to feel differently. Happiness is the state you enter when you no longer want to change your state.”
— James Clear (Author of ‘Atomic Habits’)
Tweet
Glenn Kelman, CEO of residential real estate brokerage Redfin, shared interesting insights on the U.S. housing market, which may surprise some given the backdrop of higher interest rates and ongoing recession fears. The market appears to have begun recovering from the weakness his firm had witnessed since March 2022.
What appears different about this downturn (so far) is that inventory did not rise meaningfully and is still at half the levels it was back in 2016. Kelman highlights that “less than 2% of homeowners are underwater on a mortgage, compared to 30+% in 2008” although, that could just be a function of where we are in the cycle.
The big question is whether this will be a short-lived improvement or if we will see more sustained correction in house prices. Of course, time will tell.
Chart
Over the last few weeks, technology stocks have roared back to life after a particularly painful 12 months+, especially for companies that are unprofitable. Some investors are now asking whether this means the equity bear market is over and if they should buy this particular group of stocks.
Let’s take a brief trip down memory lane by looking at Juniper Networks, a prior technology darling during the dotcom bubble. Less than 3 months into 2000, the stock peaked at around $145, along with the Nasdaq Composite Index. The stock having more than halved in value by May, subsequently rallied over 250% to a new all-time high of $245 by October, having smashed analyst earnings expectations. Over this period, the Nasdaq did not recover to its prior high.
During the following 12 months, Juniper Networks proceeded to lose 96% of its value. Incredibly, 22+ years later, the stock has yet to regain those prior highs.
The lessons seem obvious:
Buying companies with extremely elevated valuations is rarely worth the risks.
Anything can happen.
Investor Report
FundSmith’s annual letter written by the founder and CEO Terry Smith is typically a great read and the 2022 letter does not disappoint.
Smith covers a wide range of topics, including the end of quantitative easing, Japan’s bubble in the 1980s and the implications of some fundamental headwinds for the technology sector.
Our favourite section is the part that discusses how a number of listed companies are treating stock-based compensation in non-GAAP (General Accepted Accounting Principals) profit figures. Here is a snippet that will hopefully encourage you to read the rest of the piece:
“Among the 75 companies in the Technology Select Sector Index mentioned above, 45 of them remove share-based compensation from non-GAAP versions of their earnings per share, operating income, or both — in plain English they remove the amount of the debit for share-based compensation which boosts their profits. That is about $26bn of expenses that have been adjusted out in reporting the 2021 profits in the non-GAAP results of these 45 companies. This amounts to about an average of $600m of share-based compensation for each company which is excluded or added back in reaching their non-GAAP earnings. You will find it as no surprise that all of the companies in the index whose share-based compensation represents greater than 5% of revenue remove share-based compensation from non-GAAP measures.”
Articles
Charlie Munger: Why America should ban crypto
A concise piece published on the WSJ, Munger makes it clear why crypto needs to be banned as soon as possible: ”Such wretched excess has gone on because there is a gap in regulation. A cryptocurrency is not a currency, not a commodity, and not a security. Instead, it’s a gambling contract with a nearly 100% edge for the house.”
Crypto-focused Silvergate bank loaded up on $4.3 billion in Home Loan bank advances
As depositors yanked their money out of Silvergate following the collapse of cryptocurrency exchange FTX, the California bank oddly shored up its capital by tapping a quasi-government agency, the Federal Home Loan Bank of San Francisco. The bank now holds $4.6 billion in cash on its balance sheet, according to metrics the bank recently released.
Auto loan performance deteriorated further in December
Subprime severe delinquency rate in particular rose to the highest level in the data series which goes back to 2006, according to Autodealer.
Meanwhile, the value of used cars declined the most in the history of the Manheim Used Vehicle Value Index - this shouldn’t be too surprising given the temporary covid-induced supply chain bottlenecks that significantly boosted demand for used cars.
People’s Bank of China (PBOC), banking regulator urge banks to step up support to real economy
The PBOC and the China Banking and Insurance Regulatory Commission (CBIRC) pushed banks to step up financial support to the real economy and front-load loan issuance, according to a statement released by the central bank.
Microsoft announces multi-billion dollar investment in ChatGPT stake
OpenAI launched ChatGPT to the public free of charge in November 2022, with the program quickly surging in popularity as many users were surprised by how well the bot modeled human speech. Microsoft has now announced that it has boosted its stake in the company having previously invested $1 billion in OpenAI back in 2019.
This week, Microsoft integrated ChatGPT into its Teams videoconferencing software, enabling it to automate tasks such as note taking, recommending tasks, and personalizing meeting highlights for individuals. The tool can also translate meetings into different languages in real time, with captions for participants who don't know the language being spoken.
Earnings commentary insights
Chevron: 2023 production is expected to be flat to up 3% at $80 Brent
CEO on oil supply: “We expect production to grow, led by the Permian and other shale and tight assets.”
On European gas supply: “The successful build of inventories for this year and the reduction of industrial demand have both resulted in an outlook that is less dire for the European economies, than it may have looked like several months ago.”
On dividends: “We haven't cut the dividend since the great depression. […] we've increased the payout 36 years in a row now.”
Schlumberger: Despite concerns for potential economic slowdown in certain regions, oil and gas demand growth remains resilient
CEO: “Markets will remain tightly supplied with modest production increases offset by the end of SPR release and well productivity declines in certain regions, most notably in North America”
Freeport-McMoRan: Demand remains strikingly strong, supply question marks remain
President on copper demand: “Physical market continues to be healthy…. we are selling everything we can produce. If we could produce more, our customers would want it.”
CEO on copper supply: “40% of the world's copper comes from Chile and Peru. And with what went on in their most recent presidential elections, the uncertainties that came out from that and things continue to change in Peru, the government has been in turmoil. […] And then, Chile had the situation where there was a negative vote on the proposed constitutional amendment, which changed the targets there. And you can see what's happening to greenfield projects being delayed in the United States...”
Until next time...
Thank you for reading this week’s issue.
Do you have any questions or thoughts? Please feel free to reach out.
Have a wonderful week.
Why ‘Buy the Umbrella’?
Individuals, many of whom also run businesses and governments, tend to not think of the downside when the present is stable, and the future is looking positive (usually when we feel most in control).
Just because it is currently sunny, does not mean it will never rain. If we are not prepared, once it does begin to rain, we will end up running around looking for an umbrella in the middle of a storm when they are typically in short supply. We therefore need to ‘buy the umbrella’ before it rains.
Simultaneously, we cannot allow our awareness of risk to make us fearful, pessimistic, or paranoid, as this too works against us over the long-term.
Having the right mindset in advance is critical. The challenge is getting the right balance between being optimistic about the future and being able to not only withstand future crises, but in fact grow stronger due to the opportunities they tend to present.
It is not enough just to be conservative. One needs to be willing to put cash to work when others feel least comfortable doing it. To do that with confidence, we need to have a foundational understanding of history, business, markets and human psychology.
Our mission at BTU is to learn as much about the world as possible, and in doing so, to try to find investment opportunities with favourable risk/reward characteristics. These should, over the long term, help build sustainable wealth.