Regarding… Vol 3 no 2 – The market for lemons

Dear Fellow Investors and Friends,

Welcome to my investment (and other) musings. For those of you who are new, this letter is where I share my efforts to make sense of the world around me.

I do appreciate you taking the time to read this.

Today is Thursday, January 23rd, also (of course) the 23rd day of the year. There are 342 days left until the end of the year.

Today, five years ago, China locked down the city of Wuhan and its 9 million people in an effort to control the city’s COVID-19 epidemic. Almost instantaneously, governments worldwide followed suit in a case of what can only be called mass hysteria. Mainstream media supported arbitrary and irrational government policies.

Today, those governments have been – or are on their way to being – voted out, and mainstream media has lost all credibility.

As Hannah Arendt said:

“On the other hand, if everyone always lies to you, the consequence is not that you believe the lies, but that no one believes anything at all anymore.”

Trust is the glue that holds society together.

For instance, see what everyone does next time you come to a traffic light. If the light is green, you’ll drive straight on without checking if other traffic has stopped. You trust everyone is obeying the lights. However, taxis are increasingly ignoring traffic rules unimpeded by the traffic police. Handing out parking tickets rather than monitoring serious traffic violations is much easier.

As a result, traffic slows down, and driving becomes more dangerous, resulting in more accidents.

Corruption among South African government officials is so out of control that they are no longer respected as impartial arbiters of the country’s laws and regulations. As the moral authority of government officials and politicians has dissipated, lawlessness among the country’s ordinary citizens has increased.

As a result, the only recourse people and businesses have is the courts. Getting things done takes much more time and is more expensive; those lawyers don’t come cheap.

When trust breaks down, the bad drives out the good.

The “market for lemons” is shorthand for what happens to the quality of goods in a market where information asymmetry is abused and trust breaks down.

From Wikipedia:

“Suppose buyers cannot distinguish between a high-quality car (a “peach”) and a “lemon”. Then they are only willing to pay a fixed price for a car that averages the value of a “peach” and “lemon” together.

But sellers know whether they hold a peach or a lemon. Given the fixed price at which buyers buy, sellers will sell only when they have “lemons”. And they will leave the market when they hold “peaches” (as the value of a good car as per the seller will be higher than what the buyer is willing to pay).

Eventually, as enough sellers of “peaches” leave the market, the average willingness-to-pay of buyers will decrease (since the average quality of cars on the market decreased), leading even more sellers of high-quality cars to leave the market through a positive feedback loop.

Thus, the uninformed buyer’s price creates an adverse selection problem that drives the high-quality cars out of the market.”

Slowly but surely, everything on offer becomes a lemon. This happens in many spheres:

• Have you noticed that almost every phone call you get is spam? You don’t answer a call from an unknown number anymore.
• Just about 100% of SMSs are spam. As a result, no one uses SMS anymore; everyone’s on WhatsApp.
• An email inbox filled with thousands of unsolicited spam messages is no longer a helpful tool; it has become a lemon.
• A growing list of high-profile people in South Africa falsified their qualifications. The problem is not just lying about the qualification, but what else they might be lying about. The market for talent also becomes a market for lemons.
• The ultimate breakdown of trust is when a currency gets debased. Out-of-control money printing results in the market being flooded with currency lemons no one wants. And this has happened to exactly every currency that has ever existed.

When trust breaks down, everything turns into garbage.

What does such a world look like?

The “Dark Forest” is a hypothesis for why we haven’t found any aliens yet, despite searching for decades. First proposed in 1983, it became popular with Liu Cixin’s Three-Body Problem trilogy.

Again, from Wikipedia:

“The dark forest hypothesis is that many alien civilisations exist throughout the universe but are both silent and paranoid.

In this framing, it is presumed that any space-faring civilisation would view any other intelligent life as an inevitable threat and thus destroy any nascent life that makes its presence known. As a result, the electromagnetic spectrum would be relatively silent, without evidence of any intelligent alien life, as in a “dark forest”…filled with “armed hunter(s) stalking through the trees like a ghost”.”

There is an argument to be made that the stock market has become somewhat of a “Dark Forest” with investors carefully keeping to themselves, scared of falling foul of some arcane rule or regulation. Building barriers to protect themselves from marauding “hunters”, self-styled as “shareholder activists” looking for easy pickings should someone let down their guard.

The result is an increased cost of doing business and lower returns to shareholders.

In a low-trust world, increasingly populated by bad actors, being listed makes almost no sense.

In the fullness of time, it could be that the only stocks left on the market will be lemons.

Over the last week, the big news was that Reinet sold its entire holding of British American Tobacco (BAT). To recap, Reinet was started 16 years ago as an investment company for the Rupert family to diversify out of its large shareholding of BAT.

Initially, bits and pieces of BAT were sold, and the proceeds were used to invest in various private equity, Chinese, and hedge funds – none of which achieved much.

An initial investment was made in the Pension Insurance Corporation Group Limited around 10 years ago. Over time, Reinet has upped its shareholding to 49,5%. The increased shareholding and the good performance of the underlying business caused PGIC to grow to around half of Reinet’s NAV.

The bad news is that Reinet has been a poor performer. Despite the “advantage” of owning foreign currency-denominated assets, its NAV per share growth has only matched the JSE/FTSE All-Share Total Return Index growth. As a result of the discount to NAV per share widening over time, the share price has underperformed the JSE.

Reinet has not only underperformed the JSE but also the stock it was created to diversify out of: BAT. It’s not a great outcome for the Rupert family.

They did have the consolation prize of extracting substantial fees along the way, just like any other self-respecting fund manager.

So now Reinet has a cash pile of £ 1.2 bn. What to do? Given their long-term investment results, they probably shouldn’t make any new investments – at least, that is what the discount to NAV suggests. If there is enough liquidity, their best action would be to buy back shares. Alternatively, they could pay a special dividend. Or, do a combination of those two things.

My take: These actions would enhance the value to its shareholders, which include the MWI value fund. Let’s see how Mr Rupert treats his minorities. Given his track record, I bet he will do the right thing.

I’ve noticed over the last while that drinks businesses are struggling. Here’s Remy Cointreau, down 75%:

Brown-Forman, down over 50%:

Pernod Ricard, also down 50%:

The brewers, Heineken, ABInBev, and Molson Coors, are also all struggling with share prices that are not significantly higher than they were ten years ago. It has been a lost decade for them, following a hectic acquisition spree that ended – you guessed it – around 10 years ago with the ABInBev-SAB coup de grace.

It used to be that these companies were super stable compounders. What’s going on?

Enter “Zebra-striping”, a term I had never heard of until I read my friend Aaron Edelstein’s latest newsletter, appropriately called “Zebra striping”, subtitled “A Look into Alcohol’s Secular Decline.”

In the letter, Aaron explains it as a new trend amongst the younger crowd:

“Inspired by its monochromatic namesake, this practice of alternating between alcoholic and non-alcoholic drinks is becoming popular among a generation increasingly mindful of their health and well-being.”

Here is the money chart:

“In 2023, the volume of spirits sold in the U.S. declined for the first time in nearly three decades…” WSJ 1/13/25

Apparently, the younger generation also substitutes cannabis for alcohol from time to time. I don’t know about that, but I have been going through a dry January and have never felt better. Sleep quality is through the roof, and I am much more energised.

If you are interested in cannabis as an investment possibility, you could do worse than subscribe to Aaron’s Substack called Mindset Value.

My take: I couldn’t agree more with Aaron from the point of view of my sample of one. Maybe this is really one of those “this time it’s different” times. For the record, no alcohol-related shares made it into my “ten stocks forever” portfolio, as I did not want exposure to businesses that might be detrimental to one’s health. I’ll continue to watch this from the sidelines.

5 years ago, we were entering what will be remembered as one of the biggest cons of the modern era – the Covid lockdowns, with all the associated grift and governmental maladministration. Of course, the private sector wasn’t far behind in bringing products to market that desperately isolated people would buy. From untried, untested and ineffective vaccines (Moderna) to wonky indoor training devices (Peloton) to the ability to virtually connect with your fellow “inmates” with primitive video software (Zoom) – these products caught the inmate’s attention in a big way.

Their stocks went through a boom, with runaway share prices. But now they are coming to earth, having failed to develop a decent product from a promising beginning.

Moderna:

Peloton:

Zoom:

A trifecta of terrible totalitarian tragedies!

My take: Avoid fads. Like IPOs, they seldom turn out well for the investor. You never know who the real long-term winner will be. Who would have picked Netflix, Microsoft Teams etc. a few years ago? That sort of thing belongs in the too-hard pile. So look around you today. Do you really know who the ultimate winners in the weight loss drugs stakes or the AI revolution will be?

During the week, the MWI Worldwide Flexible Fund (aka the cockroach) hit a new all-time high:

The fund price trajectory since the change in the process in August 2020 has been relatively smooth. The fund is compounding steadily – above inflation, in US$ terms – and, importantly, it is doing so with low volatility. In the worldwide flexible sector, its above-average returns over the past three years, low volatility and downside risk make the Cockroach one of only two funds with a Sharpe ratio above one. It also has the second-highest Sortino ratio in the sector. There are 97 (!) funds in the Worldwide Flexible sector.

A positive Sharpe ratio above 1 indicates that an investment has generated returns that exceed the risk-free rate, adjusted for the level of risk taken. The Sortino ratio does a similar thing but only considers downside risk.

My take: Allow me to indulge in some promotion here. Above-average returns with sector-leading risk levels, regardless of market conditions – that’s the job the cockroach set out to do almost five years ago, and it’s the job it’s doing.

The fund is designed for those who want to protect and grow their wealth in real US$ terms without worrying about market volatility. It is best-suited to foundations, endowments, pension funds, and family trusts – anyone with assets required to cover long-term liabilities and not beholden to the groupthink of “Actuarial consultants” or “Discretionary Fund Managers”. And if you don’t know what those are, good for you!

Importantly, it’s not my brilliance in forecasting markets that generates the returns (far from it!) – it’s the structure of the fund. No forecasts or brilliant “insights” are required. Call me if you’re interested. And for those just starting their investment journey, it’s also available as a tax-free investment. If you are interested in taking advantage of this sensible tax incentive, here is a form you need to fill in before the end of February. All the disclaimers about doing your own research and speaking to advisors apply here.

This is the best thing I’ve read since…well, since I was 11 and took my dad’s Wilbur Smith novel off the top shelf in his library. It gave me the same feeling of guilty pleasure – where Smith lifted the veil on the steamy sex lives of his heroes and heroines, Asness lifts the veil on the muddled thinking and destructive herd behaviour that permeates the institutional investment environment.

The difference is that I believed what Smith wrote to be accurate, not having experienced it myself at that tender age. But I have spent a significant part of my early career – too long, I might add – in the institutional investment space. And every word Asness writes is, in fact, accurate.

In the piece, which you can read here, Mr Asness fast-forwards to the year 2035 and looks back at the investment decisions made by an imaginary investment committee. Anyone who has ever sat in a performance review of an institutional portfolio will instantly recognise the thinking going on here.

And even if you are not an investment professional, you will recognise the folly of groupthink, which this piece so accurately skewers.

My take: “There is truth in jest” is an old saying suggesting that humour often reveals deeper truths. This piece does that in spades. Reading it should be required for anyone with even a passing interest in investments.

Luminate is a preeminent entertainment data and insights company. Every year, they compile a review of the music industry, containing insights as to what’s popular, who’s making inroads, who’s losing market share, and what the superfans are doing. They also provide some year-end charts.

If you’re interested in music and the business of music, it’s a must-read. And even if you’re not, parts of it are still quite enjoyable.

Here are some interesting facts:

• Streaming volume grew by 17% globally.
• Contrary to popular belief, almost half of streamed music was from the 2020s. Not the eighties.
• 1 in 4 streams are R&B/Hip-hop (popular taste has never been good taste!)
• Pop edged out rock as the fastest-growing genre in 2024 (hello Swifties!)
• Speaking of Ms Swift – she was the nr 1 streamed artist. Nr 2 was Billie Eilish with a third of Ms Swift’s streams. Out of the top 10, I knew 5 names. OK Boomer.
• Women drive 63% of pop audio streaming.

Here are the top ten global songs for 2024 and their number of streams:

How many of them do you recognise? My score is 4 – OK, Boomer, again.

Here are the most popular albums and songs for the year:

Again, I haven’t heard many of these, and I listen to a lot of music. The one common factor is that it doesn’t matter which top ten you look at – Taylor Swift will be at the top. Do you know any of her songs? I don’t. I guess if you’re not on TikTok, you’re not in tune with popular culture. Because TikTok is where these songs become popular.

My take: It used to be that everyone knew the most popular songs and could probably sing along to them. This isn’t the case anymore. The music industry has fragmented, which is good for fans like me because streaming has made accessing interesting music so much easier. But it is probably not great for the artists, as there is so much more competition for a stream – not even counting the frauds!

I hate forecasts and forecasting, but this is an interesting list if you remember that it is simply food for thought, not investment advice. It’s by a Substack called Digital Native and focuses mainly on the tech scene. Which increasingly permeates the world we all live in, after all.

Here is prediction no 1 to 13

Here is no 14 to 25

Some highlights:

Self-driving cars – It’s happening.
Space and defence – getting hotter.
Consumer AI hardware – not a chance.
Gaming goes mainstream – overdue.
Financialisation of everything – inevitable. But sad.

Killer quote: “I would rather stare at a language I don’t understand than ever use a social media that Mark Zuckerberg owns.”

My take: If nothing else, these predictions will be directionally correct but not 100% accurate. But it’s fun to contemplate the implications.

In line with my ambition to read 15 books this year, I’ve finished my first one – a re-read of Grey Area by Will Self. Grey Area is a collection of short stories that delve into the human condition and reflect on how individuals navigate a chaotic world. Self uses his characters – of which many recur – and plots to critique contemporary society, touching on issues like consumerism, mental health, and modern relationships. Always with surreal and absurd elements in the mix.

As a bonus, his command of the English language is superb – almost every page contains a word I had to look up – but once I grasped it, it turned out to have been the perfect word to use.

Call me a fan of Self’s writing.

This is probably one of his more accessible works – a gateway drug, so to speak.

That’s all for this week. Remember – it always pays to be careful out there; you just never know what’s coming around the corner.

Piet Viljoen
RECM