Dear Fellow Investors and Friends,
Welcome to this edition of my newsletter, where I share my efforts to understand markets and the world around me. I do appreciate you taking the time to read this.
Today is Thursday, March 20th, the 79th day of the year. There are 286 days until the end of the year.
Isaac Newton was born two hundred and ninety-nine years ago today. He famously said, “I can explain the movement of heavenly bodies, but not the madness of people.”
This madness is most evident regarding people’s belief in forecasts.
Forecasting, n. “The attempt to predict the unpredictable by measuring the irrelevant; a task that, in one way or another, employs most people on Wall Street.”
– From The Devil’s Financial Dictionary, by Jason Zweig
When I began in financial markets, stockbrokers employed teams of analysts whose primary job was to predict how the economy would perform, the direction of the gold price, what the Rand would do, and in which direction the price of shares would go next. These individuals were highly respected – and well compensated. They were the authorities on all matters related to the market.
As a junior analyst, I would hang on to every word they said, and they would largely guide my investment actions. It was like a security blanket, having these smart people tell me exactly how why and when the future would unfold.
Except for a tiny detail – it never seemed to work out the way they confidently said it would.
Even worse, as networks harness the wisdom of crowds and computing power increases, the ability of experts to add value through their predictions – starting from a low base – is declining. Experts still hold an advantage in certain domains. These include areas that resemble the game of chess, which is rules-based with a wide range of outcomes, or poker, which is probabilistic with a narrower range of outcomes. However, neither of these scenarios mirrors the stock market. The stock market is probabilistic with a wide range of outcomes, where the crowd and computers always do better than the expert. For more on this, read Think Twice by Michael Mauboussin.
This has ramifications for how we should invest. The market is supposed to set asset prices efficiently so that each asset’s price encompasses all possible probability-weighted future outcomes. As a result, no excess return should be available from owning efficiently priced assets. This is the basis of the belief in indexation.
Excess returns are only available when market efficiency breaks down.
Stock market efficiency breaks down when the diversity of opinion declines – most often due to strong emotions – leading to irrational group behaviour, as seen during stock market bubbles and crashes. During those times, everyone thinks alike, and investment opportunities abound.
With the advent of social media and being connected 24/7, this lack of diversity, which was always present in the extremes, has now migrated towards the middle. Increasingly, independence of thought has broken down, compounded by so-called experts playing to the crowd, gunning for popularity and consensus, not accuracy.
Barry Ritholz is more direct: “All forecasts are marketing.”
The late Bear Stearns CEO, Jimmy Cayne, brazenly asserted that their economist, Wayne Angell, was merely an “entertainer” whose advice should never give rise to liability. “Economists are right only 35 to 40 per cent of the time,” Cayne said. “They don’t have a good record when it comes to predicting the future,” he continued. “I think it is entertainment, but he probably doesn’t think it is.”
In the fund management industry, forecasts are made to raise AuM, not be accurate. You are regarded as a pariah if you stand out from the crowd with an independent view. If you go along with the consensus, but it turns out to be wrong, then it must have been a black swan for which no one can be blamed. Forecasts become a marketing tool, telling people what they want to hear. From an asset-gathering perspective, the businesspeople who run these firms know that their clients cannot handle the truth.
In his inimitable way, Charlie Munger said, “People have always had this craving to know the future. The king used to hire a magician, and he’d look at sheep guts or something for an answer on how to handle the next war. There’s always been a market for people who purport to know the future based on their expertise, and a lot of that is still going on. People have an economic incentive to sell some nostrum. It can be sold over and over and over again … I think it’s disgusting. It’s much better to make a living by being part of a system that delivers value to the people buying the product.”
Decision scientist Baruch Fischoff wrote, “When both forecaster and client exaggerate the quality of the forecast, the client will often win the race to the poorhouse.”
What should we do given the poor prospects of making money from listening to the “experts” forecasts?
- Think independently. Forecasts are there to provide comfort. There are no excess returns available in comfortable places.
- Diversify. Buffett said, “Diversification is protection against ignorance.” Well, face facts – we are all ignorant about the future, especially us “experts.”
- Look for investments in places outside the consensus, which these days is quite a wide spectrum, given the broad consensus and narrow market.
- Read a lot of history. Human nature doesn’t change, and history keeps a good account of it. The best investment ideas come from understanding human nature, not trying to divine the future.
Markets
1. CK Hutchison
Hong Kong-based CK Hutchison was founded in 1897 by John D. Hutchison. The company started as Hutchison International, a trading firm focused on tea, silk, and other commodities. By the early 20th century, it expanded into shipping and real estate, laying the groundwork for its diversified portfolio.
Under the leadership of Li Ka-Shing (who acquired a controlling stake in 1979), CK Hutchison transformed into a global conglomerate operating in a diverse group of industries:
- Ports and Logistics
- Telecommunications
- Retail
- Energy
Its share code is 1 HK, which denotes its pre-eminence amongst the Hong Kong conglomerates. Historically, these conglomerates used their political connections to gain access to deals.
But over the years, Hong Kong has lost influence globally and has fallen out with the Chinese political leadership, and this is reflected in 1 HK’s share price:
This decline was accentuated recently when politically connected BlackRock and its Global Infrastructure Partners unit agreed to take control of two major ports at the Pacific and Atlantic entrances of the Panama Canal. The seller? CK Hutchison. The port deal immediately made political waves, even as the seller denied politics were at play.
The Blackrock consortium will acquire 90% of Panama Ports Co., which operates the ports on either side of the Panama Canal, and 80% of the Hutchison Ports group, which adds 43 additional ports in 23 countries to the agreement. Apparently, President Trump believes that “foreign” owned ports pose a security risk, so he called in Larry Fink’s Blackrock. Hutchison stated that the deal totals £22.8 billion, including £19 billion in cash proceeds.
But now China is pushing back, hoping to scupper the transaction. I’m sure this deal will have more twists and turns before finalising.
My take: Investing in politically connected entities is risky. Political connections work both ways. And politics is rapidly moving away from the ideals of “globalisation.” Over time, 1 HK might be a forced seller of more “Western” assets.
2. Rheinmetall
Yes, I had never heard of this company until historically pacifist Europe recently decided to go full gunboat. In the wake of the USA backing off from supporting Ukraine, Germany announced plans to abandon its so-called debt brake in service of beefed-up defence and infrastructure outlays.
Rheinmetall says it “provides mobility and security technologies worldwide”. That’s the politically correct way of saying it makes all kinds of bombs and weapons. No wonder its share price is on a roll after the German government’s announcement:
Recently, Nvidia told investors, “I make computer chips that are changing the world, so I’ll do a 10X in 4 years.” Rheinmetall just said, “Hold my beer, I make bombs” and went up by 20 times over the same period.
A word of caution, though. The energy and raw materials shortage in Europe might place a ceiling on Rheinmetall’s ability to produce additional armament. If Germany is hell-bent on running the economy hot, a better bet might be Deutsche Bank.
My take: With Rheinmetall on a forward P/E of 50 and Deutsche Bank on less than 8, I know which one the odds favour – especially in light of the collapse of those other European one-hit wonders, Moderna (Covid vaccines) and Novo Nordisk (weight loss drugs). Or maybe it’s different this time?
3. Bond yields in developed markets
Speaking of Europe, bond yields have been hitting new highs – which means declining prices in the upside-down world of bonds. This is happening not only in Europe but also in the UK and Japan.
Here are 10-year yields in France, which S&P has just put on negative watch:
Germany:
The UK:
Japan:
It’s safe to say the generational bull market in bond yields – at least in developed markets – is over.
My take: Rising bond yields will trigger an acceleration of financial repression and its twin, capital nationalism. The time has come to be aware not only of the returns on your capital but also of the return of your capital – especially if you are invested in developed markets. I wrote about the financial repression in August last year, Vol 2 no 32 Certificates of Confiscation.
4. Discovery
Most firms’ shareholders are too impatient to wait for organic growth to pay dividends. They pressure management to grow by acquisition, overtly or covertly, through poorly devised incentive schemes.
Most acquisitions fail, but fortunately for the executives who carried them out, this only becomes apparent once they have cashed in on their generous option schemes and left the building. Shareholders are always left holding the bag, wondering what went wrong.
So it’s a breath of fresh air when a company successfully grows almost entirely organically.
Enter Discovery, hitting a new high, to a round of applause:
It has grown to a market value of R134bn by leveraging the cashflows from its medical scheme business into life insurance, asset management vitality programs and, just recently, banking. Analysts say Discovery is on track to double the size of its business in the next five years following a decade of significant investment in the company’s latest offerings, particularly the launch of Discovery Bank, into which it has injected R14.5bn.
Despite being known for its medical scheme business, its life and investment business has grown to a significantly larger size – all organically:
My take: It’s easy to criticise acquisitive strategies. However, when management produces the growth they have achieved at Discovery almost 100% organically, they should be congratulated. I don’t own Discovery, and I’m beginning to wonder why.
In The Media
1. The Dystopian Media Environment
I want to refer to two pieces I read recently, describing the dystopian environment that the media environment on the Internet is pushing us towards.
The first is a Substack by Adam Singer, who writes under the title “Hot Takes”. The column was “The dystopian spectacle of streamers”, which you can read here. In the column, he criticises modern media for prioritising spectacle over substance, specifically referring to a gamer who taught himself to play a complicated song on “Guitar Hero” – at twice normal speed.
Hard to do – it took him 9 months and 50 00 attempts! But what’s the point? Singer says, “Everywhere, we see spectacle over substance. Mindless novelty, for its own sake. It’s why Hollywood keeps churning out sequels, why nostalgia is endlessly milked, why people remain mentally stuck in the places they stopped growing years ago.”
But it’s not only the wasted time on the absurd activity he bemoans but also the audience’s reaction. Why celebrate such a monumental waste of talent and time?
The true creatives, spending hours and days producing something that will stand the test of time and make our lives better, are being marginalised. That’s what soundbite as entertainment chosen by an algorithm and a prize for every effort, regardless of how meaningless the outcome, is taking away from us.
The second piece is by Ted Gioia, who writes a Substack called “The Honest Broker” It’s called “If William Shakespeare came to Hollywood”, and you can read it here.
In it, he decries the state of the entertainment industry, which he believes has abandoned creativity. Now, it’s all about IP and “owning the content”. Gioia believes that if Shakespeare were alive today, he would go “indie” or alternative media, as it is called today.
I agree. I have given up reading anything from mainstream media. I avoid the algorithm on Spotify like the plague. I prefer learning about new music by talking to real people and random sampling. And yes, I listen to a lot of new music because that is where creativity still surprises you now and then. There’s nothing better than listening to a new piece of music and getting that thrill of thinking you’ve discovered something special.
In terms of news, I subscribe to BizNews, one of the few media outlets that allows you to hear both sides of the story and make up your own mind. I also subscribe to Currency, a new South African digital business journal that has attracted some of the best financial journalists around. Undercurrents, a daily email by Roman Cabanac, gives a very nice summary of what’s really going on around us. For South African company news, Ghost Mail is my go-to source. Finally, a carefully curated timeline on X is invaluable for connecting with worldwide events. In real-time, as they happen, uncontaminated by editorial ideology.
That’s it. Nothing else required.
2. Book review: “Read Write Own, Building the Next Era of the Internet” by Chris Dixon
Dixon is a 25-year software industry veteran and is currently a general partner at VC firm Andreessen Horowitz. He founded and led a16z crypto, a division of the firm dedicated to investing in crypto and blockchain technologies.
In the book, Dixon explores the evolution of the internet through three distinct eras – ”read,” “read-write,” and the emerging “read-write-own” phase. This latest phase, often associated with web3 and blockchain technology, emphasises decentralisation and user ownership. He advocates for a shift towards decentralised networks, moving away from the centralised, walled gardens created by major platform companies.
He states that the business model of these large corporations always boils down to an “attract-extract” cycle. Initially, the “service” is offered for free, and as the network adds nodes, it increases in value. When it reaches a tipping point, it begins to raise its take rates, often to exorbitant levels. It becomes difficult to extricate oneself from the network, as one does not own their data.
Blockchains are a new type of computer, with computers being an abstraction defined by what they do rather than by their appearance. This blockchain-based computing system, or “computer,” has many advantages.
- It is open source
- permissionless
- decentralised
- everything on-chain is public and traceable
- it conveys ownership
According to Dixon, blockchain is a way to reinvent the internet in a more democratic, transparent way.
The book strikes a balance between entry-level definitions and nuanced discussions, making it accessible for non-technical readers while remaining engaging for those familiar with the subject. Although I didn’t come away with massive new insights, I thoroughly enjoyed the read. If you’re taking your first few steps into the world of blockchain and crypto, this book is a must-read.
This is also my fourth book of the year, so I remain on track for my goal of reading at least 16 books this year, hopefully more.
That’s it for this week, except for the small matter of an inter-family race on Sunday. The young ones – Ben’s girlfriend Courtney in the swim, Nic on the bike and his girlfriend Daneel on the run – will take on the old man in the Cape Town Triathlon on Sunday. They seem to be confident of taking home the win.
Let’s see how it goes.
Amanda decided she couldn’t take the stress and decamped to England to visit with Zac and her parents. So the race will be no-holds-barred!
I think Team Junior needs to be careful out there. You’re on your own now.
Of course, we should all be careful out there all the time.
Piet Viljoen
RECM