Regarding… Vol 2 no 34 – Analysing Stories

Dear Fellow Investors and Friends,

Welcome to this week’s edition of my investment musings, where I try to make sense of the world around me and share stuff that I find interesting.

I do appreciate you taking the time to read this.

Today is Thursday, September 5th, the 249th day of the year. There are 117 days left until the end of the year. That is not a lot of days.

On this day in 1793, the French government devised a plan to make “terror the order of the day.” This plan, known as the September 5th Decree, was intended to subdue widespread civil unrest. This marked the start of the “Reign of Terror” during the French Revolution. Around 300,000 people identified as counter-revolutionaries (defined as nobility, priests and “hoarders” ) were arrested, and 17,000 of them were tried and executed. Another 23,000 were killed without trial or died in prison.

High inflation was the principal cause of the civil unrest. As all governments have done since time immemorial, price controls were imposed to combat this inflation, leading to food shortages and, eventually, mass unrest.

The name of the committee that came up with the brilliant plan of identifying and executing the scapegoats? The Committee of Public Safety.

Yet more proof that history doesn’t repeat, but rhymes.

The stories of history inform us about the present and give clues about our future. Instead of worrying about predicting the future, we should spend more time studying the past.

Successful businesspeople have a superpower – they can tell stories.

Coen Jonker, one of the founders of the successful start-up bank TymeBank, said:

”So, the one leadership skill that I think is a superpower is the ability to persuade people. For me, persuasion is the ability to tell a story about something that does not yet exist with such clarity that we can mobilise people and resources to serve that vision. That storytelling, I think, is at the heart of leadership. Particularly if we think about leadership as being transformative. Then, if we become good at storytelling, we are willing to take the responsibility of working until that story becomes true.”

Successful investors have a superpower – they can cut out the noise.

Jack Bogle said: “Don’t pay a lot of attention to the volatility in the marketplace; all these noises and jumping up and down along the way are just emotions that confuse you.” Warren Buffett agreed with him, saying, “Beware the investment activity that produces applause; the great moves are usually greeted by yawns.”

Investors and businesspeople are intertwined in a symbiotic relationship. One needs the other. Investors provide businesspeople with the capital they need to grow their businesses. Businesspeople provide returns on that capital by optimally managing their companies to create shareholder value.

However, a Venn diagram containing the skills and attributes of a businessperson in one circle and those of an investor in the other circle would have a surprisingly narrow intersection.

Morgan Housel came up with a formula for a company’s share price (and regular readers would know I do love a formula):

Share price = today’s cash flow multiplied by a story about tomorrow.

Business leaders have the skills to change the world from what it is to what they want it to be and are paid to execute this change. They are telling the story about tomorrow.

Some of the skills they bring to the table are:

• Getting people that work for them to buy into a positive vision. They are good communicators.
• Having a positive, can-do attitude. They are good motivators.
• Creating more favourable terms of trade for their business with suppliers and customers.  They are good negotiators.
• Understanding the industry dynamics and role players within which they operate. They are good relationship builders.

They have what can be called “soft power”, characterised by positive thinking and persuasiveness.

Investment professionals are paid to see the world as it is. They have the skills to evaluate share prices relative to business fundamentals and analyse today’s cash flows.

Some of the skills they bring to the table are:

• They understand the downside of any investment proposition. They are good risk managers.
• They can quantify business and industry fundamentals in a spreadsheet. They are good analysts.
• They understand how management actions translate into changing cash flows.
• They are good at valuations.

They have quantitative skills characterised by analytical thinking.

Good investors think about what can go wrong and how to control for that. Good businesspeople think about what they can do to make things go right.

Of course, these skills are not mutually exclusive. In each group, there are people with both sets of skills. The Venn diagram does have an intersection.

However, the intersection is much smaller than each group thinks.

That is why so many smart businesspeople get taken in by investment scams – they love nothing better than an exciting, positive story – the type of story con artists are so good at telling. Naturally, businesspeople ignore analyst naysayers who say something is too risky or doesn’t make sense.

That is also why non-fund managers mostly manage fund management companies. If your outlook is too focused on the downside, you will struggle to move your business forward.

Businesspeople need fund managers, and fund managers need businesspeople. Each has something valuable – and different – to offer.

Just don’t conflate the respective skill sets.

If I had to choose two stocks encapsulating the idiocies associated with the COVID panic, it would be these two.

Peloton sold indoor bikes with an iPad attached. Since you weren’t allowed outside because of all the viruses that would attack you, buying an indoor bike was logical. Until you were allowed back outside – when it became a fancy clothes horse.

Products like Zwift and Rouvy, which are orders of magnitude better than Peloton, were also developed. When an indoor – interactive! – bicycle becomes a clotheshorse, this is what happens to the share price:

Remember Zoom meetings? No, neither do I.

When COVID hit, we had to shelter indoors against those marauding viruses, and everyone was on Zoom, holding meetings, socialising, or just chatting. Then two things happened – we were allowed out, and Microsoft developed Teams.

Today, Zoom’s revenue line is barely growing, and their return on capital is low single digits.

It’s hard to compete with the distribution reach of Microsoft, and this is what happens to your share price if you try:

My take: Avoid fad stocks. Human beings have short attention spans and move to the “next big thing” before you can say yo-yo. Don’t become the bag holder when – not if but when – the next fad hits.

Here’s another COVID winner. During the period when we fearfully isolated ourselves so we wouldn’t catch the flu, we could at least watch movies. Netflix had all the content we needed and more.

It became so popular that pretty much every media company that could – and even some that couldn’t, like MultiChoice – offered video on demand. You would think that competition and a return to the real world of actually going outside and experiencing life would have been a death knell to a company that delivered products to compliant couch surfers.

But Netflix’s share price recently hit an all-time high:

Like Peloton/Zoom, Netflix cratered in 2002. But it recovered while the others didn’t.

Why?

Netflix delivered a product that was far superior to that of its competition. It massively invested in content (shows/movies) and created an intuitive and easy-to-use user interface. Even Disney+, with its rich library, can’t touch Netflix.

Also, anthimeria.

In February this year, I wrote about Netflix and the concept of anthimeria in “Leaving for London.”

My take: If you want to invest in a fad, ensure it has a superior product. Then, it might just have staying power. I don’t own the stock but respect what the company has done.

With economic weakness in the major economies of China and the USA, cyclical stocks are taking a beating. Typically, financials would be the ones taken to the woodshed first, as they are the worst of all worlds in a downturn – leveraged cyclicality.

So, why is the share price of Goldman Sachs, the lead steer of global financial stocks, hitting new highs?

Following its annual review process, Goldman Sachs announced a cut of between 1,300 and 1,800 workers (or 3% – 4% of its workforce). Being a tough school, it usually aims to cull 2% – 7% of its workforce annually. The fact that they are at the lower end of the range this year shows that management is not expecting anything disastrous on the horizon.

Financials are flying in the US and back here in South Africa, with FirstRand, Standard Bank, and Capitec recently hitting new all-time highs. Financials in Brazil, Mexico, the UK, Europe and Japan have all performed similarly.

Usually, when the cycle turns down, it happens just after banks have gone on a lending spree, making progressively worse loans as the cycle matures. When the downturn comes, the extent of the bad lending decisions is revealed, and the shares tank.

There’s an old saying in banking: “Feed the ducks when they quack.” But in this case, the ducks never quacked. Loan growth has been subdued. I wrote about South African banks in “Caveat Emptor” in July. Poor loan growth has been a global phenomenon.

My take: At the risk of saying the most dangerous words in finance, i.e. “this time it’s different”, financials could be a haven in a storm this time – if a storm comes. If no storm arrives, they might even do well. Could financials be one of those asymmetrical bets we are always looking for?  The MWI Value fund leans in that direction.

I read his book “The Gulag Archipelago” a while back. It left a lasting impression on me – not only because of the harrowing conditions this so-called enemy of the state was forced to live in, but also because of how dehumanising a socialist command and control system becomes. The book creates a powerful indictment of the Soviet regime’s use of terror against its people.

Just like the French Revolution, what starts as a socialist nirvana ends up in oppressive terror.

In 1978, Solzhenitsyn gave a commencement speech at Harvard, which became one of the most controversial speeches of the 20th century.

Solzhenitsyn can be long-winded, so I will save you from having to read the entire speech. Here is a thread on X which highlights 10 takeaways from the speech.

The money quote: “Socialism of any type and shade leads to a total destruction of the human spirit and to a levelling of mankind into death.”

This is not a hypothetical construct from a pseudo-intellectual but from a man with lived first-hand experience.

If you have the stomach for the whole speech, here it is. It really is an interesting read.

Sir Ferguson is a world-renowned historian. In January, I wrote a (very) short review of his book The Square and the Tower in my “Review of 2023”.

Niall has been one of the most thoughtful and intellectually honest voices in the cultural battle that has engulfed America’s most storied institutions – including academia.

A few months ago, he wrote a column titled “We’re All Soviets Now”. In it, he draws parallels between the Soviet Union of the ’70s and ’80s and the USA today.

He describes the Soviet Union as a country where resources were misallocated and squandered, resulting in dilapidated infrastructure, shortages, and grinding poverty. Although the USA – or at least everything outside of the bottom decile of wealth – is not like that, Ferguson describes a country travelling on a road with a destination that resembles Soviet Russia.

Here in South Africa, we are much further down that road. We need to turn around.

Cliff Asness is one of the founders of AQR Capital Management. This fund management business uses quantitative methods to build client portfolios – commonly called a quant shop in the trade.

The thing about quants is that they are generally super smart people. Cliff Asness (@cliffordasness on X) stands at the head of the class. It is one of the funniest things to see him destroy someone’s argument on X if it lacks even a little bit of logic.

He is brilliant – not because of how he sets out his stall in casual logical arguments on social media – but, much more importantly, because he clearly explains complicated matters in well-written and researched papers.

This week, he published the draft of a new paper called “The Less Efficient Market Hypothesis”, a play on the famous hypothesis developed mainly by Eugene Fama that asserts that financial markets are “informationally efficient.” This means that asset prices fully reflect all available information, making it impossible for investors to consistently achieve returns that exceed average market returns without taking on additional risk.

The gist of Asness’ article is that he views markets as having become less informationally efficient over the past 30 years, creating opportunities for excess return. However, he acknowledges that these opportunities come with higher risks attached.

The piece is a good summary of what the market knows – or should know – about investing, given all the research and real-life experience we have had over the past 50 years.

You can read this fascinating article here.  And you don’t have to be an initiate in the cultish world of financial gobbledygook to understand his writing. I would describe it as 24 pages of pleasurable financial reading – something you can’t say about most of the genre.

This piece is also hilarious in parts  – something else you can’t say about the genre.

An example:

“Finally, let us talk specifically about the on-line trading of one’s own account. I do not know if many of you readers have played video poker in Las Vegas (or anywhere). I have, and it is addicting. It is addicting despite the fact that you lose over any reasonable length period (i.e., sit more than an hour or two and 9/10 times you are walking away poorer). Now, imagine video poker where the odds were in your favour. That is, all the little bells and buttons and buzzers were still there, providing instant feedback and fun, but instead of losing, you got richer. If Vegas was like this, you would have to pry people out of their seats with the jaws of life. People would bring bedpans so they did not have to give up their seats. This form of video poker would laugh at crack cocaine as the ultimate addiction. In my view, this is precisely what online trading has become over the last several years.”

I’ve mentioned Shane before. He runs a website called Farnam Street, named after the street in which Warren Buffett lives. Farnam Street is dedicated to helping its readers better understand how the world works, make smarter decisions, and live more fulfilling lives.

In this podcast, he interviews Mathew Dicks (@MatthewDicks on X), who he describes as the world’s best storyteller.  Mathew teaches you how to talk so everyone will listen. This is your masterclass if you ever want to learn how to tell a story.

That’s about it for this week – except after the excitement of last Saturday’s match against the All Blacks, I can’t wait for this Saturday. The Bokke now seem to be able to do what New Zealand used to do to us – win from a seemingly hopeless position, again and again.

Saturday, we want to see more of this and much more of this.

Go Bokke!

Importantly, besides being the world champions in Rugby and UFC, South Africa has a new world champion in mountain biking. On Sunday, Alan Hatherly won the world title with a magnificent performance. Chapeau, Alan!

At the moment, South Africa can’t stop winning. It’s a good feeling, so let’s enjoy it!

But always remember to be careful out there.

Piet Viljoen
RECM