Weekend Reading #187

Photo from Unsplash

This is the hundred-and-eighty-seventh weekly edition of our newsletter, Weekend Reading, sent out on Saturday 24th September 2022.

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What we're thinking.

It feels like this section is just a repeat of what we wrote last week and the week before but one thing has changed for sure and that is that the market finally believes the Fed is not messing around anymore. Also we for the first time we can finally see the signs of some panic although we are not quite there yet. If Friday’s close gets abetted by gamma then next week is going to start off with a bang. Something is going to break. What will be first?  

When markets are behaving like this it tends to bring most investors back down to earth as the realisation dawns on them that for all the best bottom up analysis in whatever sector it was over the past decade or so, it largely wasn’t about that. Those that worked it out first though will have weathered this a lot better than those who are looking around in bewilderment. This is a great meme! 

Reference: @mycroftcap Twitter feed 

For the past decade or so, with rates at close to zero, there was no way at all for anyone to save and earn a return. Every cent had to go into the market otherwise “we would see value eroded by inflation” - funny that was the tagline of every financial advisor when inflation was at lows for an entire decade. Either way, there was no alternative. Saving was a fool’s game, if even the fools bothered, as deposit interest rates went all the way down to 0.1%, a sad excuse for a deposit rate (at least it’s better than zero!). As it stands now, however, sticking your cash into 2 year US government treasuries gets you 4.2%, which if you had a mortgage locked in at 2% prior to this year means you get a free mortgage and some extra cash to spend, not to mention the upside from rolling those coupons into probably higher yields over the next year or so. The point is there is no longer “no alternative” - cash in a savings account is now appealing again. So, if everyone knows deep inside that the past decade, especially the past 2 years, was a liquidity fuelled game of hot potato, now that an option to exit the game and go for a much lower risk option for 4.2% p.a. exists, what happens then? 

The counterargument to being bearish is that sentiment is already at lows, so we should countertrade positioning and try to catch the up move. That could well be the case, although we’ve learnt that trying to be too clever often doesn’t work out. But while everyone is trying to sniff out reasons to be bullish, here’s one thing to think about: what are retail and passive money doing? 

One chart making the rounds, used in support of the bullish tilt, is this one showing AAII Net Bulls at -43%, with the index only having made these levels thrice before: twice in Oct 1990, and once in Mar 2009. 

Source: Bloomberg, Morgan Stanley Research

The argument goes that we should therefore expect a bottom soon, and sentiment should be counter-traded because retail is not “clever money”. In reality, retail is the single largest group of asset owners of the US$63tn equity market, owning 37% of total assets. Now consider this: if a persistent sentiment of bearishness within the retail community hangs around for long, with retail equity P&L since the start of 2020 already in the red, AND a 4.2% risk-free yield now on offer in just cash, what happens to retail allocations, including those to passive equity ETFs?

Remember the tracker ETF rule: “If you give me money, I buy; If you ask for your money back, I sell.”

Source: Goldman Sachs Research

What we're doing.

This week, we were in Zurich catching up with friends and colleagues from across our various businesses. Whilst I had been in Switzerland at the beginning of the year for some winter sport, it had been quite some time since either of us had visited for business. The scenery was phenomenal and fortunately the weather held out to enable us to enjoy perhaps one of the last warm few days before the fast-approaching arrival of winter. In addition to Zurich, we also spent one of our days in the seemingly quiet town of Zug, which has become renowned as a hub of great tax efficiency, and often dubbed ‘Crypto Valley’. It’s a great place to do business and being so close to nature means that if time would have allowed, we could have gone for a spot of hiking or a quick swim in the famous Zürichsee... perhaps next time! HS

What we're reading.

Matthew Ball has become somewhat famous as an expert on the Metaverse as his essays on it were well timed with the narrative explosion in 2020/21. So much so that he wrote a book about it, which I have no read as of yet. But before that and alongside all the fun in the metaverse, he is an absolute mind of information on the media space. His latest essay and his first in a while, talks about the future of blockbuster movies and how things are changing more than anyone can even imagine. He digs through the last 20 years and covers Disney et al’s relationship with the biggest market on earth, China. This essay is outstanding in that it goes deep into the reason why Hollywood is struggling in China and indeed in many other countries. And it isn’t because of censorship (though that does play a part). It is because of the changing nature of most non-American’s perception of America. Gone are the days of American heroes being feted all over the world. With production becoming more global people are developing an ability to tell their own stories, one’s which are beautifully produced and filmed with the latest technology and most importantly which have stories that resonate with their own populations. America has lost the narrative battle and that doesn’t bode well for Hollywood and especially for Disney. This is well worth a read.

CD Projekt Red is a company we’ve written quite a bit about, especially since the catastrophic launch of what was one of the most anticipated game in history, Cyberpunk 2077. But since that botched launch in late 2020, they have been hard at work with patch after patch to improve the playability and slowly it has started to register with players. After the success CD Projekt had with The Witcher 3, the company did a deal with Netflix to provide the IP upon which the hit Netflix series was based. Now they’ve done it again with Cyberpunk 2077. Netflix premiered a new anime series called Cyberpunk Edgrerunner, which has been a success. And just like the airing of the Netflix edition of The Witcher, the renewed interest in the franchise has led to rising numbers of people playing Cyberpunk 2077. Cyberpunk has moved back to the top sellers on Steam and registered 86,130 concurrent players on the platform this week. In fact, each day this week they have had nearly a million players! The stock price doesn’t seem to care though. If this endures it will go down as one of the most incredible comeback stories in the history of gaming (and beyond). In a world where there does seem to be a bit of a dearth of new hit games, maybe the timing is just right for them too. Well done to the CD Projekt team.

The UK’s new prime minister, Liz Truss, has hit the headlines already after being overshadowed by the death of the Queen at the start of her time in charge. With the pound collapsing and Gilts falling precipitously after her newly appointed chancellor, Kwasi Kwarteng’s mini budget announcement today, one could be forgiven for writing her off already. But according to this article by Zoe Strimpel from Common Sense, that would most likely be short sighted. The article is a good one because it is pretty balanced for once making no qualms about the new prime minister’s personality challenges while also making it clear that she is someone who gets the job done through sheer hard work. Let's hope the hard work she does shows some results. It’s been a while since a UK prime minister has delivered. DC

As if what is unfolding in markets isn’t hectic enough, there’s also the question of what is to come. One of the psychological consequences of persistently low interest rates is the loss of the concept of time value of money, and perhaps even the entire notion of time. We’ve become used to thinking of prices as one-off purchases: the price of an iPhone, a car or even a holiday going up are annoying, but they are one-off hits to the budget. But when the price of money over time aka the interest rate goes up, the hit to the budget is continuous, the equivalent of being bludgeoned over time as opposed to getting a slap on the wrist. Add to that the “optimisation” that many have done over the years, especially with the financialisation of almost every decision to be made, pushing spending and leverage to their limits to “make money work harder”, and the risk that households start finding themselves living too close to the edge of solvency becomes exponentially bigger. The reversal of more than a decade of behaviour and decision making, which we touched on before, risks leading to sudden changes in economic activity which exemplify the idea of “gradually, then suddenly”. This article on Epsilon Theory aptly titled “Monetary policy is non-linear" articulates this idea succinctly, in Ben Hunt’s characteristic style. EL

What we're listening to.

For something a little different, I listened to this fantastic episode on Dan Snow’s History Hit, about Suleyman the Magnificent. The man is considered by many to be the greatest Ottoman sultan of them all given that he was the longest serving sultan and controlled the most territory of any over his time in charge. He also is well known for being more European than Ottoman and for bringing a meritocracy when appointing key positions. Both his Grand Vizier, Ibrahim Pasha, (a converted Christian) and Grand Admiral Barbarossa are legendary in their own right. Suleyman was also known to be kind to minorities as he believed it his responsibility to look after all his people. This is a great little pod, which features Dan Snow interviewing historian, Christopher De Bellaigue at the recent Chalke Valley History Festival about Suleyman, the subject of his new book. The two also briefly chat about how history in taught in the UK and how the curriculum could benefit from some more world history (like the Ottoman Empire) rather than just learning all about the Tudors each time. If you are a history lover, it's worth a listen. DC

The news last week of Adobe’s acquisition of Figma for a stunning $20bn does give a lot to think about. We’ve come across Figma in the work we do on Nachas Networks, with Figma being a household staple amongst the developer and designer communities. In fact, it’s so easy to use compared to most of Adobe’s specialised products that even we manage to occasionally get things done on it, despite having close to zero design skills. Built in the cloud and native to the collaborative world, Figma was founded by Dylan Field, who – as it turns out – was a Thiel scholar. This Invest like the Best podcast from 2020 was essential re-listening to understand how Figma became the leader in collaborative cloud design software.

Nonetheless, the question of whether the price tag paid by Adobe is justified lingers in the market, not to mention the record-setting generosity of the retention package for CEO Dylan Field. This discussion in last week’s All-in podcast is food for thought – not only on the matter of Adobe essentially paying to take out an existential threat for a price tag much bigger than the actual headline number, but also the more profound topic of how monolithic software companies of the past are to evolve and thrive in a rapidly changing marketplace for collaborative, cloud-based solutions. Indeed, even tech companies that used to be the vanguard of disruption (Adobe included) find themselves eventually on the receiving end of that same disruption, coming in a different form. EL