Regarding… Vol 2 no 38 – Keep Your Friends Close

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.

Today is Thursday, October 17th, the 291st day of the year. There are 75 days left until the end of the year.

On this day in 1854, British and French troops began the siege of Sevastopol, a pivotal battle in the Crimean War. During this war, Florence Nightingale became famous for revolutionising how soldiers were treated on the battlefield.

Today, Crimea is part of Ukraine. So, if you think what’s happening there is new and unique, you need to think again. Ukraine’s history involves many battles and wars. Our first knee-jerk reactions to historical events outside our usual frame of reference may not always be correct. The Russian-Ukrainian conflict has many layers and a deep historical angle we might not always fully understand.

And as it is with history, so it is with investments.

One point we can all agree on is that markets are volatile and tend to surprise.

But then, many take that as their investment point of departure and then either:

• Work hard to develop an edge in predicting the unpredictable. Of course, this is impossible, but it does increase their sense of control over the uncontrollable. But this feeling of control comes at a price: poor returns.
• Simply react to this unpredictable volatility, buying high and selling low. This does provide short-term comfort, as they feel “in tune” with the market.  But this feeling of comfort comes at a price: poor returns.

Neither approach works, but the A-type personalities in the money management business are convinced that doing something is better than doing nothing, even if that something has been proven – again and again – not to work.

It strikes me that combining what actually works with what we can actually control would provide a better framework for a sensible investment process.

What actually works?

• Time in the market. Equities provide a satisfactory return precisely because they are risky. The return you get is payment for the risk you take. In the short run, the returns will be volatile and deviate from the underlying business fundamentals, often significantly. Equity is the most junior – i.e. risky – layer of the capital stack of a business. Anything that happens to the business – good or bad – gets magnified in the equity layer. But if you hold that risky sliver long enough, your returns will reflect those of the business itself.
• Diversification. Nobel laureate Harry Markowitz famously asserted that diversification is the only free lunch in investing. His insight was simple yet profound: investors can achieve higher returns without increasing risk by diversifying across assets. There are many stats behind this, but believe me, the numbers work – mainly due to a statistical concept called covariance. Here’s the math.

What can we actually control?

• How we react. Being patient is an investment superpower and is well within our control. We can reduce our consumption of “news”, avoid watching the market daily and not care about what others say or do. In so doing, we can increase our patience and prevent reactiveness.
• Endurance – the length of time over which we can invest. If time in the market is important – and it is! – then increasing our lifespan is a massive contributor to better returns. Buffett earned 99% of his wealth after age 60, not by compounding at a higher rate, but by living another 34 years.
• Strategy – choosing a sensible investment strategy that aligns with your psychological makeup. There is more than one way to skin the cat. Whether you are a value investor, growth investor, small-cap, or private equity – it doesn’t matter. Just apply a sensible investment strategy consistently. And you can only do that if it aligns with the way you think. Over a long enough period, your returns will be defined by your strategic choices.

The important thing here is that in managing money, there is no one correct answer to the exclusion of anything else. Each investor has their own strategy and process.

Over the next few weeks, I will share my thought processes for creating the investment framework for the equity portion of the MWI Worldwide Flexible fund (aka the cockroach). This month-long series of articles will culminate in a discussion of exactly what this equity allocation looks like and why.

There is no doubt that we are in a global bull market in equities. Markets are hitting new all-time highs every week. Here is the SP500 index, which is leading the pack:

Even perennial laggard Japan has joined the party:

But what’s going on underneath the hood? I found this chart on X, posted by @MikeZaccardi.

In common currency terms, over the past 15 years, Japanese companies have grown their earnings at a higher rate than US companies in the aggregate (the purple bar). So much for US exceptionalism!

However, Japanese companies have derated, i.e. investors have placed a progressively lower multiple on their earnings over time. Coupled with a weaker currency, this has led to Japan marginally underperforming the USA – but not by much.

It’s also clear that Europe is not competitive in terms of earnings growth over almost any period.

My take: US exceptionalism is taken for granted in today’s markets, but I’m not sure they are that much better than other countries. In the equity portion of the MWI Worldwide Flexible fund (aka the cockroach), I am overweight in Japan, the UK, and emerging markets and underweight in Europe and the USA.

The platinum price has been going sideways now for 10 years:

At the same time, mining costs keep increasing, leading to margin compression for platinum miners, which is not good for their share prices. This is the price of market bellwether Amplats:

Amplats has done well to be unchanged over 10 years.

Approximately 33% of the world’s annual platinum production is used in automotive catalytic converters. Various industrial applications, such as petroleum refining and chemical processing, use a further 30% of platinum.

The rise of electric vehicles (EVs) has cast doubt on the platinum industry’s future.

Recently, the EV industry has faced some pushback. Hybrid vehicles (which use catalytic converters) have gained market share due to their better range. Also, EVs have been quite expensive up to now.

However, the one thing we know about technology is that it improves over time. EVs are getting cheaper – even without government subsidies. The price of second-hand EVs has collapsed, and judging by what the legacy manufacturers are saying, they will produce more affordable vehicles in the not-too-distant future. I have no doubt the range issue will improve over time.

It’s looking increasingly likely that demand for platinum – at least from one of its primary users, the automotive sector, is on a permanent downtrend. The only question is how quickly this happens.

My take: I don’t know the answer to that question. However, the sector is not yet showing signs of a bottom. Such signs would include severe and broad-based financial difficulty, significant mine closures, and a complete lack of interest from the market. This would be the exact opposite of the very public flip-flopping on the sector that a large local institution has been subjecting investors to. They have done this to focus market attention on their alleged investment acumen. Ignored sectors are usually not used for marketing purposes.

Which segues very neatly to the man of the moment, Elon Musk. Love him or hate him (and his politics); the man is a genius. I reviewed his biography in Vol 2 No 23, “Financial Irrationality”; it was not a positive review.

This week, his company, Space-X, achieved a milestone: it caught a “super-heavy” booster returning to Earth after launching a rocket. Here is a video of the achievement. The event’s significance is that it is one more step in substantially lowering the cost of launching rockets, with the eventual aim of enabling (affordable) human settlement on Mars.

In this week’s Stratechery column, Ben Thompson illuminates Musk’s strategy with SpaceX, Tesla, and the elusive “self-driving” taxis, which he also launched a few days ago. It’s well worth reading the piece, especially for his insights on Musk’s self-driving strategy for Tesla.

The market didn’t think much of the taxi launch, as it was light on detail. As a result, the Tesla share price took a bit of a knock:

The money quote from Thompson’s piece:

“If you start with the dream, then understand the cost structure necessary to achieve that dream, you force yourself down the only path possible, forgoing easier solutions that don’t scale for fantastical ones that do.”

My take: I have been an inveterate Musk sceptic, but I am changing my mind. There might be something to Tesla, after all.

Since its original publication in 1949, Benjamin Graham’s revered classic, The Intelligent Investor, has taught and inspired millions worldwide and remains the most respected guide to investing. Best of all, it’s an easy read. I remember going through the book, chapter for chapter, with my son Nic during lockdown. It was a fun way to connect remotely and learn together.

This book should be the first port of call for anyone aspiring to be an investor.

The 75th-anniversary edition will be released next week. Previous editions have been annotated and edited by financial luminaries. This one features commentaries on each chapter by one of today’s best financial journalists, Jason Zweig.

Here is an example of his commentary on chapter 8:

My take: Just this little paragraph makes the book worth getting! Here is a thread on X in which Zweig highlights some key editorial comments.

This is a new book by the economist David McWilliams. I haven’t read it yet, but here is a podcast in which he discusses the book with Russell Napier. It’s a pleasure to listen to, and I look forward to getting the book.

The money quote from the interview: “Despite being a fully paid-up member of the economist tribe for many years, I’ve concluded that most economists don’t really understand money.”

McWilliams’ basic assertion is that money is a coping mechanism that allowed humans to evolve from hunter-gatherers. Once you arm people with a technology that will enable them to improve themselves, it liberates them. As a result, society has evolved from vertically orientated to horizontally networked, glued together by that technology called money. Liberty makes systems less (or even anti-) fragile. Money creates liberty.

McWilliam is famous not only for his economic writing. By the way, you can follow him on X, @davidmcw. He is also one of the founders of the Kilkenomics Comedy and Economic Festival, which is held annually in Kilkenny, Ireland.

My take: I love the juxtaposition of economics and comedy! If you are in Ireland in early November, this year’s festival takes place from 7 to 10 November. I won’t be there this year; but it’s on my list of events to attend in future.

Speaking of economists, this year’s Nobel Prize laureates for the economic sciences – Daron Acemoglu, Simon Johnson, and James Robinson – won the prize for their work demonstrating the importance of societal institutions for a country’s prosperity.

Societies with a poor rule of law and institutions that exploit the population do not generate growth or change for the better.

Their theories help explain this situation:

You can read a summary of their work here.

My take: Most poor countries blame some kind of exploitation for their failure to grow their people’s wealth. This year’s Nobel prize winners’ work suggests otherwise: to understand their inability to close the economic gap, poor countries should look in the mirror and spend more time thinking about how their governance structures are set up.

Speaking of institutions that don’t work for the people, one of them is Cape Town’s public transport system.

Yes, they have implemented a bus system, but taxis still present a mortal danger to their clients and other road users.

Yes, there is a rudimentary bike lane system in place, but it has turned into a parking lot for Uber drivers and, in some areas, homeless encampments. This makes cycling a more, not less, dangerous way to commute.

Yes, the railway system is the national government’s responsibility. As such, it has suffered greatly from a lack of investment. I know the Cape Town City Council is negotiating to take over the management of the system. But this has dragged on for a long time, providing no relief for Cape Town’s stressed-out commuter class.

This graphic illustrates the situation:

My take: the fact that Cape Town is the 9th worst city in the world for traffic congestion is ridiculous. And I see no signs of anything being done to alleviate the situation.

No – there is no playlist this week. But Ted Gioia did write an interesting piece on predictions for the future of music. See if you agree with him.

The Spotify share price seems to think otherwise, for now at least:

My take: I am not a religious person. But live music has sometimes played a similar role in my life, and many friends have had the same experience. So, Ted might possibly be onto something here.

I started writing this letter in the bush near Hoedspruit while on a five-day getaway with some of my best friends – friends I have known for over 40 years. I can’t remember the last time I laughed so much.

One of these friends has what could turn out to be a terminal case of prostate cancer. As he lives in Australia, spending some time with him was precious.

It would not be an exaggeration to say that the past five days were a joy.

Here is a picture of our group:

I was once more reminded that none of us are getting younger. This further reminded me not to take friends for granted and to stay as close to them as possible – even if we are geographically challenged, so to speak. It is so worth it.

But even if you have friends on your side, it still pays to be careful out there.

Piet Viljoen
RECM