This week's interesting finds

Berkshire Hathaway Annual Shareholders Meeting 2020 
As most of you might know, Berkshire Hathaway had their annual shareholders’ meeting this past weekend, with the highlight being Warren Buffett speaking and answering questions for more than 3 hours on topics ranging from his views of the post-COVID-19 market, economic trends, and his current investment strategy. Here are links to the full video and meeting transcripts.

Personal Saving Rate and U.S. Household
Savings rate hits its highest level in 40 years, as Americans are accumulating cash.

When You Have No Idea, What Happens Next
Do we know more about what’s going to happen in the next 12 months today than we did in January? We now know there’s a pandemic that shut the economy down. We didn’t know that in January.

We’ve learned this year that the assumptions you have about the future can be destroyed overnight. That’s true for the poorest to the most successful, the old dry cleaner to the tech startup. It was true in January, and it’ll be true again in the future. 
If that’s the lesson, the question is: what do you do about it? 

Read more history and fewer forecasts. Think of all the 2020 market forecasts published in December. Accepting that forecasts have little use doesn’t mean you become a blind fatalist. When you pay more attention to history than forecasts you pick up on the patterns that guide how people respond to unforeseen events, which – given how stable behavior is over time – is the next best thing to knowing what will happen next. 

Have more expectations and fewer forecasts. Forecasts rely on knowing when something will occur. Expectations are an acknowledgment of what’s likely to occur without professing insight into when it will happen. Expectations are healthier than forecasts because they provide a vision of the future stripped of all false precision. If you know a recession will occur at some point, you won’t be that surprised whenever it arrives – which is a huge benefit. But if you assume you know exactly when it will occur you’ll be tempted into all kinds of dangerous behavior, leveraged with overconfidence.

COVID-19 internet search trends

Streaming Services Face an Economic Reckoning After Covid-19
The race to attract and retain subscribers — and turn a profit — was challenging enough before the coronavirus shut down entire swathes of our economy. Now, the U.S. is in a recession, and consumers are rethinking how much content they need and what’s a worthwhile household expense. When all a country can do is sit home and gorge on movies and TV, a free trial to stream Netflix or any other services is worth its hours of content in gold. (Look no further than Netflix’s recent spike in subscriptions.) The question is, will users just ditch once those free trials are up?

Because of Netflix, viewers have become accustomed to not having to sit through ads, and they like it. But that approach probably can’t work long-term if consumers want an affordable service with a constant flow of fresh content.

This week's interesting finds

EdgePoint Academy: The big day has arrived
“Am I ready for retirement?” and “How do I get ready?” are questions on the minds of many. Our latest article in the Retirement series discusses four things you need to consider to help answer these questions when planning for retirement with your financial advisor.

Advice for young people from Buffet
The best advice Warren Buffett can offer to young people who want to invest is to learn accounting. Furthermore, he warns investors against obsessing over stock price charts and urges them to focus on buying good businesses instead.

This week in charts
Nasdaq-listed stocks were briefly worth more than the entire developed market ex-USA.

The largest US tech stocks (FANMAG) aggregate market cap trails only the US (ex-FANMAG) and Japan. 

The tech-heavy Nasdaq is now above its outperformance trend versus the S&P 500 (the ISM Composite is a measure of US business activity). 

Investing in "top dog" stocks globally (largest stocks by market cap) returned considerably less than the overall market over the past 50 years.

Cities face 100 million 'new poor' in post-pandemic world
About 100 million people living in cities worldwide will likely fall into poverty due to the coronavirus pandemic. Densely populated cities are poised at the frontline of the contagious outbreak, hard-hit, where people live in poverty with little or no running water, sewage systems, or health care access, said experts at the World Bank. "Our estimate is that there will be possibly upward of a 100 million so-called 'new poor' on account of losses of jobs and income," said Sameh Wahba, global director for the World Bank's urban, disaster risk management, resilience and land global practice. He warned that cities will see a drop of between 15% to 25% in tax revenues next year, making it difficult for authorities to invest in improving slum areas.

Wealthy New Yorkers flee Manhattan for suburbs and beyond
New York’s wealthy are moving their money — and often their families — into surrounding suburbs as they look to escape a crowded lifestyle and reduce their risk of contracting coronavirus. “I can’t remember the last time we were this busy,” said real estate advisor Owen Berkowitz. Eighteen people are waiting to see a home in Greenwich, Connecticut, that is renting for $65,000 a month, another broker said.

This week's interesting finds

EdgePoint: Second-level thinking in periods of market extremes
Portfolio manager Andrew Pastor and analyst Sydney Van Vierzen discuss why using second-level thinking to choose 'non-obvious' survivors is especially important during periods of market extremes. To illustrate, they break down three examples from the EdgePoint Canadian Portfolio.

Charts that caught the eye of the investment team
With everyone crowding into the growth/tech trade the five largest stocks in the S&P 500, Microsoft, Amazon, Apple, Google, and Facebook, now represent more than 20% of the entire index. The last time the top 5 were this concentrated was in 1970!

A tale of two investors
While it can be tempting to sell in the midst of a downturn, investors who hold their investments historically see much greater returns. To see how this plays out, let's rewind to the Global Financial Crisis. Here are two hypothetical investors, Sharon and Barbara, both start out with a $1000 investment at the market peak. After the decline, Sharon reacts emotionally as the market declines. Her $1000 is now worth $432 at the bottom and Sharon sells. She later rebuys once the market rebounds to the previous peak. After 7 years Sharon has $531. Barbara reacts rationally despite the downturn and stays invested.  At the end of 7 years, Barbara has $ 1,232.

This week's dilemma

This week's interesting finds

Thoughts from the investment team 
Is the 40-year bull market in bonds over? Yields have officially hit the lower bound. In Germany for example, yields are flat year-to-date despite experiencing one of the worst economic shocks since WW2. German bond yields should be falling based on the deflation in the system. Here is the 10-year German treasury.

The crowd's stampede into "quality" or safety investments has made them very expensive while value has bounced. This trend is even more pronounced in Europe.

As long-only funds crowd into the “safe” trades, they are avoiding the undervalued stocks that stand to gain. Since the lows, in March most long-only funds have had a hard time beating their benchmark.

History shows that investors who are crowding into today’s crowded “safe” trades may also pay an opportunity cost by avoiding the undervalued stocks that stand to gain the most when the unwinding of “safe” strategies begins.

Large-cap stocks in the lowest quintile of beta are trading at historic high valuations.

Electric Vehicle penetration in China is back to pre-2018 levels
Perhaps it’s a function of the +60% drop in sales.   In a tough economy, people will not pay up for an EV. Car sales in China have recovered, but down 33% in the first week of April vs last year.

Howard Marks Memo: Knowledge of the Future
In this week’s memo, Howard Marks discusses the notion of making informed guesses regarding the future and shares questions about re-opening the U.S. economy. He also reviews the latest Federal Reserve moves to help the economy combat the coronavirus.

This week's interesting finds

We have met the enemy and it is us
The average investor continues to lag the performance of all major asset classes year after year. What causes this? Unfortunately, investors tend to jump in and out of their investments at precisely the wrong times. They pile into funds that have been performing well and redeem at the first sign of underperformance. Buying high and selling low eventually leads to this behavior gap. 

Relative valuations

Who cares what Mr. Market thinks
If you own a restaurant on a beach and the weather forecast shows a hurricane approaching, are you going to rush to sell the restaurant before the hurricane hits? Are you going to lower the selling price because you know the hurricane is going to hit and you are going to lose a few days or possibly weeks of business? Of course not! So why would you do the same with stocks?

The intrinsic value of the restaurant is not going to be impacted by the coming hurricane. Yes, they will lose business, and will probably have to repair some damage.  Of course, there is a possibility that it wipes out the whole beachside town and it takes years to rebuild. But most market exogenous events in the past ten or twenty years weren't of the magnitude to destroy everything (in aggregate) for years.

We have to understand that regardless of what the 'market' is looking at, or what the pundits say on TV, a business is simply worth the present value of all future cash flows.

Here's the illustrative model. Let's say the market has an EPS of $10/year, and the discount rate is 4%. In this table, I just took the earnings for the next 10 years and discounted it back to the present at 4%, and then added a residual value at year 10 based on a 25x P/E ratio (or 4% discount rate), and discounted that back to the present and added them together. Of course, this would give the market a present value of 250.

Let's say that the economy is wiped out for a whole year, and the S&P companies make no money for a whole year. 

First Year Earnings $0.00 Instead of $10.00

The intrinsic value of the market would go down less than 4%. With zero earnings for 4 years, the intrinsic value would go down by about 15%.

Zero Earnings for First Four Years

So, with the market where it is right now, it is like the market is discounting no earnings for more than four years!

The above tables clearly show that there is a negative impact on intrinsic value by even temporary business interruptions. But the magnitude is not nearly as much as the market usually moves.

We all had the same thoughts every time something happens. We all see some permanent negative change that explains a lower stock market. For example, after 9/11, the thought was that the world would never be the same, and that increased security measures will permanently reduce global growth potential and profitability.

Again, the market makes the news, and the market creates the explanations, not the other way around. We all try to model the facts to explain what is going on in the market to maintain the two illusions that 1. the market is always right, and 2. that we know what's going on. We wrap the market volatility tightly into these rational-sounding wrappers, pleased at having figured it out, secure in the knowledge that we know what's going on.

Stay home

Much needed humor 

This week's interesting finds

2020 Q1 EdgePoint commentary

In this quarter’s equity and fixed-income commentaries, we address the gravity of the responsibility you have entrusted us with. We know that you have a similar responsibility to your own clients. For the first time, we have also recorded a podcast of the commentaries.

Equity commentary: We understand the gravity of our responsibility to you – 1st quarter, 2020

Fixed-income commentary: Glass half full – 1st quarter, 2020

Which way now?
In the last six weeks the markets have seen the best of times and the worst of times:

• From February 19 to March 23, the U.S. stock market saw the quickest meltdown in history, for a loss of 33.9% on the S&P 500. Then its 17.5% gain from Tuesday through Thursday of last week made for the best three-day stretch since the 1930s.
• Of the 21 trading days between February 27 and March 27, a total of 18 days saw moves in the S&P 500 of more than 2%: eleven down and seven up. They included the biggest daily percentage gain since 1933 and the second-biggest percentage loss since 1940 (exceeded only by Black Monday in 1987).
• From March 9 through March 20, issuing a new investment-grade bond seemed inconceivable. Then, as our trader Justin Quaglia points out, last week’s news of the government’s rescue package enabled 49 companies to issue $107 billion of IG bonds. That made it the biggest week for issuance on record; In fact, there was more issuance last week than in nine of the 12 months in 2019.
• Finally, on March 26, Justin wrote, “It’s hard to believe I used the words ‘panic’ and ‘FOMO’ within two weeks of each other.”

Looking at the above, it’s important to note the degree to which people (and thus markets) seem to think long-term phenomena can change in the short run. 

A chart that may prove useful:

On average the market bottoms 5 months before the recessions ends, and rallies 26% before the recession is officially over.

The Craziest Month in Stock Market History

But enough of the numbers and charts.  The thing that made March 2020 especially insane for most investors was the constant news coverage and speed at which everything was happening.

The entire month was an onslaught of information, fear, and uncertainty.  And to top it all off, we spent most of this month physically separated from each other, sitting within the same 4 walls every day.

So no matter how crazy this month was for you, the most important thing to remember is that…it ended. 

Market volatility may not go away anytime soon, but the important thing to remember is that investing isn’t about a single decision, but a collection of decisions over a lifetime. The biggest important thing is to make sure that you live to invest another day.  A lot of the very basic stupid mistakes are the most important things to avoid.

Family's lockdown adaptation of Les Misérables song goes viral
A family from Kent who shared a video of their living room performance of a lockdown-themed adaptation of a Les Misérables song has become a sensation online. Ben and Danielle Marsh and their four children changed the lyrics of One Day More to reflect common complaints during the COVID-19 lockdown. They say the video, which has gone viral, was intended to give friends and family a laugh during this stressful time.

How to stay creative and keep your family sane during the lockdown
British art and textiles teacher Andria Zafirakou won the 2018 Global Teacher Prize and has two teenage daughters. Here she gives some practical tips – from giving your children time to transition to homeschooling, to creative ideas – for navigating staying at home together. Parents can encourage creativity. Here are just a couple from the list. 

• Asking questions: Creativity is all about questioning: How can I? Why should it? What would happen if? How can I make this, or how can I change this? It’s about making sure that children are always being asked those questions.
• Keeping everything: Do not chuck anything away. Keep a bag with all the egg boxes and toilet rolls in a corner, because that’s going to be a mine of incredible craft-making materials.
• Giving them time: The beauty is that the parents are in control of the time, for once. So you can give your child two hours to get on with a wonderful creative task, and they wouldn’t have that in school.
• Thinking outside the paintbox: Creativity is not just about arts and crafts, it’s also about the kitchen. What kind of lunch can they make for you while you’re working?

This week's interesting finds

EdgePoint Bond Desk
By the end of today (March 23, 2020), the high yield bond market will be down over 20% YTD… the high yield bond market is in a bear market!

Spreads (the premium earned over government bonds) are now above 10% for the entire market.

Weekly Update: Howard Marks

• Yields and yield spreads have increased significantly (which is another way of saying there's been a lot of damage done). The price declines have been substantial, but the increase in yield for each point of price decline tends to put on the brakes. A yield of 9%, 10% or 12% is impressive in a world of 1% Treasuries and thus tends to slow the fall. Declines to date of 15-20% for the bond and loan indices have brought substantial losses to holders, but also vastly improved opportunities for new investment.

• "The bottom" is the day before the recovery begins. Thus it's absolutely impossible to know when the bottom has been reached ever. 

• "Even though there's no way to say the bottom is at hand, the conditions that make bargains available certainly are materializing."

Warren Buffett: Focusing on businesses, not the stock market.
Everyone wants to know what happens next. When will it end? Was that the bottom? The only good answer is: “I don’t know.” But that’s not what you’ll hear. Instead, everyone also has an opinion. Many will go out of their way to express it. The trouble starts when people listen and act on it.

Warren Buffett dealt with this situation in 1966 after a few of his close partners felt obligated to tell him what would happen next. He responded this way.

If we start deciding, based on guesses or emotions, whether we will or won’t participate in a business where we should have some long run edge, we’re in trouble. We will not sell our interests in businesses when they are attractively priced just because some astrologer thinks the quotations may go lower even though such forecasts are obviously going to be right some of the time. Similarly, we will not buy fully priced securities because “experts” think prices are going higher. Who would think of buying or selling a private business because of someone’s guess on the stock market?

We don’t buy and sell stocks based upon what other people think the stock market is going to do (I never have an opinion) but rather upon what we think the company is going to do. The course of the stock market will determine, to a great degree, when we will be right, but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen, not when it should happen.

Why We Panic: Long Toilet Paper / Short Equities
Panic is an overwhelming feeling of fear that can dominate our decision making.  It typically begins with a significant and sudden change in circumstances.  The outbreak of coronavirus has provided numerous examples of decisions that are seemingly fuelled by stress and uncertainty; from the bizarre stockpiling of toilet paper to the dramatic daily moves in equity and credit markets.  From a financial market perspective, the discussion around the recent explosion in volatility often centres on changes to market structure, liquidity and leverage.  But panic buying and selling is primarily a behavioural phenomenon – what are its main causes?

Scarcity: Panic purchases are often the result of a current or future scarcity of a good or service.  The case of toilet paper hoarding is an issue-driven by self-perpetuating scarcity.

Other people: Panic buying and selling are always about how we react to the behaviour of others (and how they react to us).

Removing worry: As panic is a result of fear and anxiety, the actions that come as a consequence are typically carried out in an effort to relieve it.  Our decision making becomes centred on a single goal – removing the worry. What is the easy way for investors to mitigate the fear and uncertainty around the financial and economic impact of coronavirus?  To sell risky assets and hold cash.

Contracting time horizons: One of the most important features of behaviour under stress for investors is how our time horizons contract. 

Emotional decision making: Our attitude towards a given risk is heavily influenced by its emotional salience.  How we perceive both the likelihood and magnitude of a threat can be dominated by its prominence and how it makes us feel.