This week's interesting finds

This week’s charts

Wage pressure

In the “hood”

China’s steel mills must improve efficiency if they’re to cut their huge carbon emissions, say analysts  

China’s steel mills can meet their goal of reducing carbon emissions if the industry is willing to accept the high cost of improving the efficiency of production, according to analysts. 

As the largest crude steel producer and consumer, China’s steel accounts for about 15 per cent of the country’s carbon emissions and over 60 per cent of the global steel industry’s emissions. Steel companies in the country are under pressure now Beijing has fully committed to achieving carbon neutrality by 2050. 

The largest steel producer in the world, Shanghai-based China Baowu Steel Group said it will reach carbon emission peak by 2023 and will reduce emissions by 30 per cent before 2035. The steel maker is also investing in innovative technologies to ramp up production. It has formed a five-year partnership with Anglo-Australian miner BHP to invest up to US$35 million in greenhouse gas emissions research, including the deployment of carbon capture and hydrogen injection in the blast furnace.

Innovative technologies have been developed and tested to eliminate the carbon footprint by using hydrogen or by capturing and storing the carbon during production. Still, the high costs have prevented the technologies being used on an industrial scale. Analysts said the situation would change in the future.

Ecosystem for failure  

There has been a lot of cheerleading about do-it-yourself investing. People are opening discount brokerage accounts in record numbers and young investors are flooding into the market. 

I can’t help but think we’re building an ecosystem for failure. The excitement isn’t about investing. It’s about gambling and speculation. About riding a one-way market that’s being fuelled by low interest rates and a complacency to risk. 

To explain what I mean, let’s take a tour of the ecosystem, starting with discount brokers.

These firms are fighting for market share and their promotions are all about trading: low commissions, no commissions, 300 free trades a year and easy-to-trade apps. The visuals in the ads are powerful. A person who oozes success is looking at a screen with colourful charts and lots of numbers. Even I feel like I’m missing out on some really cool stuff, and I do this for a living.

The emergence of ETFs has brought the cost of investing down and made it possible to build well-diversified portfolios with just a few funds. But the industry doesn’t know when to stop.

There are more than 1,000 ETFs to choose from in Canada. There’s a fund for any mood you’re in. The initial emphasis on broad market exposure at a low cost has shifted to sector rotation (hard to get right), market timing (impossible to get right) and, yes, trading.

Option volumes have exploded for the same reason lottery tickets are popular — a small investment can pay off big. But there are no silver bullets in the options market. It’s dominated by professional traders and is highly efficient.

Today, investors have a cheering section rooting them on. Business news, apps and research websites like Motley Fool, and promoters on Reddit are telling you how to find the next Amazon and where the action is. Unfortunately, they’re selling the same edge to millions of others.

Investing is a solitary pursuit, not a social activity or entertainment.

We should not be too sanguine about a shrinking population  

When my mother was born, there were fewer than 3bn people in the world. When I was born, there were almost 5bn, and when I gave birth to my daughter, there were 7.7bn. She may live to see the beginning of a new era: the point at which the number of people on the planet begins to decline. 

The pandemic has caused a baby bust of historic proportions in some countries. In Spain, 20 per cent fewer babies were born in December 2020 than in the same month a year earlier, the lowest number since 1941, when such records began. Births fell 22 per cent in Italy and 13 per cent in France.

Almost half the global population now lives in a country or area where the lifetime fertility rate (the average number of babies per woman) sits below the “replacement rate” of 2.1 — the number that would keep the population stable. Even in sub-Saharan Africa, where the population is still growing fast, the fertility rate has declined from 6.8 in the 1970s to about 4.6.

Many will see this as good news for the planet. Rapid population growth has helped to put the environment under extreme stress. And in developing countries, declining fertility rates are usually connected to women gaining more education and opportunities.

That said, we shouldn’t celebrate declining fertility rates regardless of the cause. In some countries, people are having fewer babies than they say they want. In South Korea, where the fertility rate is now below 1, the working hours are too long, housing and education are too expensive and mothers too unsupported. Erin Hye-Won Kim, assistant professor at the University of Seoul, says the same system that powered the economy’s rapid development has put society under stress: “Working long and working late became virtuous.”

A stressed generation is not something to welcome, and it is not unique to South Korea, though it is particularly acute there. When the Financial Times surveyed young people around the world earlier this year, many spoke of a deep sense of insecurity that spanned unstable work and housing to the fear they would never be able to retire. Some said they didn’t feel secure enough to have children.

The risk is that, as countries begin to age and shrink, these dynamics enter a vicious circle, especially if young people see policy shaped increasingly around the needs of the more populous older generations.

We can’t control the number of babies women have, nor should we want to. But in many ways, having a child is an act of faith in the future. If some people are not having the babies they say they want, it is a warning sign we should heed, not something to shrug off because there are too many humans on the planet anyway.

This week's interesting finds

Immigration and Canadian housing market

Americans taking personal loans to invest in the stock market

Thinking about macro 

Macro forecasting is another area where – as with investing in general – it is easy to be as right as the consensus, but very hard to be more right. Consensus forecasts provide no advantage; it is only from being more right than others – from having a knowledge advantage – that investors can expect to earn above average returns. 

Nonetheless, since macro developments are so influential, many people think it is downright irresponsible to ignore them when investing. Yet: 

•Most macro forecasts are likely to turn out to be either unhelpful consensus expectations or non-consensus forecasts that are rarely right

•There are few investors who successfully base their decisions on macro forecasts. The rest invest from the bottom up, one investment at a time. They buy when they think they have found bargains and sell things they consider overpriced – mostly without reference to the macro-outlook.

•It may be hard to admit that you do not know what the macro future holds, but in areas entailing great uncertainty, agnosticism is probably wiser than self-delusion.

How Trader Joe’s $2 wine became a best-seller

In the spring of 2002, the label made its retail debut at the shockingly low price of $1.99 per bottle. Early on, in an internet chat room, a Trader Joe’s employee dubbed it “Two Buck Chuck” — a moniker that caught the eyes of budget-conscious shoppers. 

In the wake of the dot-com bubble, there was a demand for cheap wine. But nobody could’ve anticipated the brand’s success. 

For a $2 bottle, it performed astonishingly well in competitions: The Chardonnay won a double-gold at the 2007 California State Fair, and Wines & Vines magazine rated it higher than a $67 bottle in a blind tasting.

Two Buck Chuck, declared one New York Times critic, had “revolutionized wine drinking” forever. \

How to make money on a $2 bottle on wine 

Industry experts estimate a bottle costs ~$1.50 to produce, accounting for processing, packaging, labor, and shipping. The wine itself only makes up ~30-40% of this cost. Though the Charles Shaw label claims to be “Cellared and Bottled in Napa,” most of the grapes in the wine are grown in the Central Valley — an area with dramatically cheaper land and operation costs. 

Costs in the supply chain have also been minimized:

•oak chips are used to ferment wine rather than barrels 

•real corks substituted for composites

•lighter glass bottles are used, allowing them to ship more cases per truck and save on shipping

His role in changing the wine industry has earned him near-universal disdain among “true wine people” — mainly vintners who claim he’s “cheapened” the good Napa name. 

But this doesn’t seem to bother him much. 

“You tell me why someone’s bottle is worth $80 and mine’s worth $2,” he told a reporter in 2009. “Do you get 40 times the pleasure from it?”

Wisdom from decades of investing 

A podcast with Carl Kawaja, who has served as a portfolio manager at Capital Group for decades.

[00:16:37] - Discussing his investment style through the lens of simplicity

[00:24:35] - A time where he worked to try and create a simplified equation but couldn’t

[00:36:03] - Thoughts on whether buying well or holding well is more difficult 

[00:40:40] - Capital Group’s history and his river-rafting analogy in regard to the company 

[01:13:08] - Advice for new investors who want to step into the field and set themselves up for success

History does not repeat itself, but it rhymes

This week's interesting finds

This week’s charts 

In the market for a car? 

Market corrections by decade 

Social media 

Canada’s fiscal reality

It’s imperative that Canadians distinguish between convenient political rhetoric and reality when it comes to the country’s finances. The Trudeau government continues to promulgate three assertions that must be clarified. 

• First, that the government lowered personal income taxes for the middle-class. It simultaneously eliminated a number of tax credits such as children’s fitness, public transit and income-splitting for couples with young children. A 2017 analysis of these tax changes, which included both the tax rate reduction and the elimination of the tax credits, found that 81 per cent of middle-income families paid on average $840 more in income taxes. And a follow-up study found that 61 per cent of low-income families faced higher personal income taxes due to these tax changes. 

• Second, the Trudeau government continues to use Canada’s comparative government debt position as a rationale for more debt-financed spending. Using net debt, however, turns out to favour Canada in a way that fundamentally misrepresents our indebtedness because it includes the assets of the Canada and Quebec Pension Plans to adjust total debt when calculating net debt. Those assets are required to finance the promised benefits to current and future retirees. Therefore, it’s misleading to offset government debt with these pension assets. This is one of the main reasons why Canada’s total debt ranking is so different from its ranking on net debt. When we compare total government indebtedness as a share of the economy among 29 industrialized countries, Canada falls to 25th with only Japan, Italy, Portugal and the United States having higher levels of indebtedness. 

• The third and final clarification relates to rates of economic growth. The government continues to reiterate its commitment to improving the economy, the inference being that their policies—namely higher taxes, higher debt-financed spending and more regulation of the economy—have led to stronger economic growth. But if we compare the four years prior to the 2020 COVID recession (2016-2019) to similar periods in the past, the Trudeau government experiences the lowest annual average rates of economic growth (2.1 per cent) dating back to Brian Mulroney.

The private equity backlash against ESG

Call it Newton’s law of corporate ownership. As listed companies come under increasing investor pressure to act on everything from executive pay to carbon emissions, a reaction against those constraints seems to be fueling a spate of buyouts by private equity firms. 

The first half of 2021 was a boom period for the sector with $500bn-plus of deals, the highest level since records began four decades ago. 

Done well, private equity has a crucial role to play in modernizing economies, helping companies to restructure efficiently away from the short-termist glare of public markets. Buyout firms rightly pounce on listed companies that they deem undervalued or bloated. In so doing, they keep capitalism efficient and act as a positive reactionary force.

But is private equity also reactionary in the conservative backlash sense of the word — facilitating a rebellion against some of the progressive constraints of public company existence, particularly the growing demands of complying with standards on environmental, social and governance issues? The evidence is mounting. 

More freedom on governance has long been seen as a plus for private companies. As listed company governance has become stricter, so the advantage of private company status has increased. Heads at private equity owned companies relish diminished bureaucracy and the ability to earn more money without critical scrutiny from public company shareholders. Fortress’s agreed £9.5bn buyout of Morrisons this month came with a strong hint that management “incentives structures” would be boosted, only weeks after the listed UK supermarket suffered a shareholder revolt over pay.

The fact remains, though, that ESG is a fringe topic in the private equity industry. That in turn risks undermining the whole drive to embed ESG in global business. First, the steady switch towards private ownership and away from public markets neutralises progress made in public company ESG standards. Second, private equity is under little pressure to change. Buyout firms claim that their “limited partner” end investors, such as right-thinking pension funds and endowments, are demanding more focus on ESG. However, those LPs have little genuine influence, given the wall of return-hungry money clamouring for access to the best private equity funds.

Can the nuclear industry power Canada’s future?  

Governments encourage electrification of cars, buildings and nearly everything else. Those efforts could double, even triple, electricity demand in the coming decades. But renewable forms of generation – hydro, wind, solar and biomass – have become preferred tools for decarbonizing electricity grids. And utilities can buy inexpensive wind turbines and solar panels today.

Seeking to catch up, dozens of nuclear vendors sprung up just in the past few years, promoting a dizzying assortment of next-generation models that have collectively been dubbed “small modular reactors” (SMRs)

Though the characteristics of individual designs vary widely, in brief, these compact new reactors promise to retain the main selling points of nuclear power generation – namely, low carbon emissions and predictable electricity output, rather than the intermittent power generated by wind and solar. The makers also hope to ditch the nuclear industry’s considerable baggage, which includes a long history of cost overruns and construction delays.

Senior government officials regard SMRs as indispensable tools for meeting Canada’s greenhouse gas emissions targets, by replacing coal-fired plants and by electrifying mining and oil and gas facilities. U.S. President Joe Biden and U.K. Prime Minister Boris Johnson have also indicated they will also support SMR development, as have some prominent investors, notably Bill Gates.

This week's interesting finds

Q2 EdgePoint commentaries

This quarter, Sydney Van Vierzen looks at why we believe that the key to ESG investing is making the world a better place, not just how a company is rated.

 

Derek Skomorowski discusses how we're positioning our Portfolios to deliver pleasing long-term returns regardless of the potential negative effects that central bank measures may have on fixed income markets. 

This week in charts 

Income earned in a savings account is at the lowest level, while income needed to beat inflation is at the highest level since 1994. 

Retail inflows into four direct brokerages account for approximately 20% of all US equity market volume since the start of the pandemic. Inflows were mainly driven from younger age groups, associated with a lower income category. 

The valuation spread between S&P 500 Index companies is wider than its historical average   

Inflation 

There are four main trends underlying the June inflation report. 

First are the items where prices fell sharply at the start of the pandemic and that are now returning to their pre-pandemic levels. 

Second are items where prices have temporarily risen above their pre-pandemic levels due to supply constraints and could come down. 

Third are items where prices are likely settling at a permanently higher level. 

And fourth are items where price increases have slowed rather than accelerated as a result of the pandemic, at least for now.

The loser’s game

To win at amateur tennis, you only need to avoid mistakes. And the way to avoid mistakes is to be prudent, keep the ball in play, and let the other guy defeat himself in doing so. The other guy will try to beat you but an activist strategy will not work. His effort to win more points only increases his error rate. And it works ever brilliantly when he doesn’t realize that he himself is playing a Loser’s Game.

It’s not just tennis. Any game can be assessed through the mental model of the Winner’s and Loser’s Game. What’s important is whether you can assess which one you are dealing with and adjust your winning strategy accordingly. 

Winner’s Games are ones in which the outcome of the game is entirely dependent on the player’s ability. Great examples of Winner’s Games are chess, sprinting, and weightlifting. 

Loser’s Games are entirely different from Winner’s Games. Loser’s Games are ones in which the players struggle to compete against the game itself. In such games you make more progress getting ahead by avoiding mistakes rather than making brilliant decisions. 

The loser’s game of investing

It’s gradually becoming a well-known fact that the majority of professional money managers—the ones who have devoted their entire career and day to picking stocks—are not beating the market. 

The investing game continues to suck in bright and articulate individuals laden with overconfidence who erroneously try to play the Winner’s Game rather than the Loser’s Game. They manage money for outsized gains, expose their clients to too much risk, and rake up too many transaction fees in the process. 

Why? Because these people all compete against themselves and they all try to do it faster than the other.

The very essence of how a Winner’s Game turns into a Loser’s Game is when the players all flock to the same place based on the wild successes of the early players. So, the investing game wasn’t always a Loser’s Game. It was transformed from a Winner’s Game into a Loser’s Game.

Luckily, there are a few principles that allow one to play the Loser’s Game of investing successfully for those who dare to do so.

Principle #1: Make sure you are playing your own game. In other words, know your circle of competence and know it really well.

Principle #2: Keep it simple. Simplicity, concentration, and economy of time and effort have been the distinguishing features of the great players’ methods, while others lost their way to glory by wandering in a maze of details. 

Principle #3: Concentrate on your defenses. Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the Loser’s Game. 

Principle #4: Don’t take it personally. In the investing business, working harder isn’t at all correlated to getting a better outcome. And we are all, as a group, captives of the normal distribution of the bell curve. The way to give yourself the biggest chance of being on the right side of the curve is by fishing in the less-crowded pond.

This week's interesting finds

 CAUSATIONAL OR COINCIDENCE? 

Bond yields peaked at the same time as demographic ratio (number of 20 to 34-year olds divided by number of 55+ year olds). Both measures have been in secular decline since early 80s.

THE MADNESS OF FIRST HALF OF THE 2021

The capital inflows into equity in first half of 2021 are larger than all the inflows in first halves of the years for the last 20 years combined. 

The gain for global stocks in first half of 2021 is 7th largest gain in the past 100 years.

The annualized return for commodities in first half of 2021 is the largest in almost last 50 years and the 5th largest in the past 100 years.

PEAK FISCAL STIMULUS AND GAP BETWEEN LABOUR AND BALISTIC SPENDING

Large retail sales despite jobs still not being fully recovered could be explained by fiscal stimulus

As a result, US inflation was up 8.4% annualized in past 3 month, which is 9th fastest since WW2.

Patient investing is hard 

Patient investing is the ability to endure long periods of underperformance — adhering to your well-thought-out plan in the form of an investment policy statement — in hopes of achieving your investment objective. 

When it comes to judging the performance of investment strategies involving risk assets, far too many investors believe that three years is a long time, five years a very long time and 10 years an eternity. This is true even of most institutional investors — a State Street survey of senior executives with asset allocation responsibilities at 400 large institutional investors found that just 20% of respondents said they would tolerate underperformance of two years, and just 1% for three years.

Vanguard’s Chris Tidmore and Andrew Hon examined the amount of patience required of investors by quantifying the wide range of frequencies, durations and magnitudes of underperformance that both equity factor tilts and outperforming traditional active managers experience. Here are some of the findings: 

• About 70% of outperforming funds underperformed their style benchmarks between 40%and 60%of all one-year periods. 

• Almost 100%of outperforming funds had experienced a drawdown relative to their style and median peer benchmarks over one-, three- and five-year periods. 

• 8 out of 10 outperforming funds had at least one five-year period when they were in the bottom quartile relative to their peers.

This week's interesting finds

Private Equity gears up or the siege of Japan Inc.

Unlike in the U.S., private equity doesn’t have a big presence in Japan. According to consulting firm Bain, 8% of Japan’s mergers and acquisitions involve private equity, compared with 15% in the U.S. And M&A activities, relative to the size of the economy, are much lower in Japan than in the U.S. or Europe.

But private-equity funds are gearing up to look for opportunities in the country now. Total assets under management in Japan-focused private equity amounted to $35 billion as of September last year, more than double the sum at the end of 2015.

Signs of real progress on corporate-governance reform are clearly one factor driving the increasing interest. Shareholder activism has been rising, demonstrated most dramatically at Toshiba. That in turn has driven companies to reassess their business portfolios: Cross-shareholdings have long been common in Japan, but are beginning to be sold off more regularly. Goldman Sachs says Japanese companies made a record 472 restructuring announcements in 2020, a 56% rise from the previous year. 

Buffett & Munger: A wealth of wisdom interview

Born and raised in Omaha, Nebraska, both worked at Buffett’s grandfather’s grocery store, but their paths didn’t cross until Buffett was 29 years old and Munger was 35.

They met thanks to a well-known doctor couple in town Eddie and Dorothy Davis, who told Buffett she trusted him to manage money because the investor reminded him of someone named Charlie Munger. 

“Well, I don’t know who Charlie Munger is, but I like him,” Buffett responded.

They made it a goal to eventually connect Buffett and Munger, Buffett said. It happened over dinner two years later, in 1959, when Munger, then a lawyer in Los Angeles, was back in Omaha after his father, Alfred, died. 

“About five minutes into it, Charlie was sort of rolling on the floor laughing at his own jokes, which is exactly the same thing I did,” Buffett, 90, said. “I thought, ‘I’m not going to find another guy like this.’ And we just hit it off.” 

“We made a lot of money. But what we really wanted was independence. And we have had the ability since pretty much a little after we met, financially, we could associate with people who we wanted to associate with. And if we had, if we associated with jerks, that was our problem. But we didn’t have to. We’ve had that luxury now for, you know, 60 years or close to it. And, and that beats 25-room houses and, you know, six cars or that stuff is, what really is great is if you can do what you want to do in life and associate with the people you want to associate with in life. 

Inflation on the menu

Transitory or not, this hurts

The power of deferred consumption 

A ProPublica reporter wrote an article about the largest Roth IRAs in America. Think of a Roth IRA as a TFSA meets RRSP. There was a time-period in the U.S. where you could port your IRA (akin to RRSP) into a Roth IRA (akin to TFSA) by paying the one-time capital gains at the time of transfer. The benefit of course is that all compounding in the Roth IRA thereafter would be tax exempt as well as go forward withdrawals. 

The largest Roth IRA in America is believed to be Peter Theil's at over US$5 billion. This is not that interesting as he basically put his PayPal founder shares in his Roth IRA and this anecdote should be less about the largest Roth IRA and more about starting a multi-billion-dollar company. Theil did not respond to the reporter's request for comment. 

The more interesting story is the reporter also picked up on Ted Weschler's Roth IRA which exceeded US$240 million at end of 2018. His Roth IRA is likely far larger today given overall strength in the U.S. market since then and the ripe opportunities COVID presented for Weschler's investment style (traditional deep value). Interestingly, unlike Theil, Weschler felt the need to provide more context to his Roth IRA performance. His statement can be found here and is well worth the ~2 minute read.  

The takeaway is what everyone should know - that savvy security analysis, luck and patience does wonders! 

Correlation: Large cap stocks & bonds

Source: Empirical Research Partners

This week's interesting finds

When Americans Took to the Streets Over Inflation

 Today, after decades of nearly invisible inflation in the U.S., many Americans have little idea what it looks like. Nearly half of the U.S. population was born after 1981, the last year of double-digit consumer price increases. But America’s long inflation holiday shows signs of ending. Consumer prices are now rising again: The Labor Department’s consumer price index rose 5% in May from a year earlier, the biggest increase in more than a decade. History provides some useful lessons.

The nagging inflation of the late 1960s and 1970s didn’t happen overnight. It took root over years, building through a cascade of policy missteps and misfortunes until it became embedded in the psychology of nearly every American. It would take two deep recessions and new ways of thinking about economics to tame the inflation of that period.

 

Real cost of lighting in United Kingdom over 700 years 

Growing Capital Discipline in the E&P space

If we want to fight the climate crisis, we must embrace nuclear power  

On 30 April, the Indian Point nuclear power plant 30 miles north of New York City was shut down. For decades the facility provided the overwhelming majority of the city’s carbon-free electricity as well as good union jobs for almost a thousand people. Federal regulators had deemed the plant perfectly safe.

New York’s governor, Andrew Cuomo, a key figure behind the move, said that the shuttering of Indian Point brought us “a big step closer to achieving our aggressive clean energy goals”. It’s hard to reconcile that optimism with the data that’s recently come out. The first full month without the plant has seen a 46% increase in the average carbon intensity of statewide electric generation compared to when Indian Point was fully operational. New York replaced clean energy from Indian Point with fossil fuel sources like natural gas 

It’s a nightmare we should have seen coming. In Germany, nuclear power formed around a third of the country’s power generation in 2000, when a Green party-spearheaded campaign managed to secure the gradual closure of plants, citing health and safety concerns. Last year, that share fell to 11%, with all remaining stations scheduled to close by next year. A recent paper found that the last two decades of phased nuclear closures led to an increase in CO2 emissions of 36.3 megatons a year - with the increased air pollution potentially killing 1,100 people annually.

Pembina and TC Energy Partner to Create World-Scale Carbon Transportation and Sequestration Solution: The Alberta Carbon Grid 

Key Benefits of the Alberta Carbon Grid 

• World-Scale Carbon Capacity: The open-access system is being designed with the ability to scale up to more than 60,000 tonnes per day of capacity, or 20,000,000 tonnes per annum, representing approximately 10 percent of Alberta's industrial emissions. 

• Environment, Cost and Time Benefits: Utilizing existing assets dramatically accelerates timing, greatly reduces cumulative environmental and community impacts, and is significantly less capital intensive than building a new pipeline. Pembina and TC Energy are targeting the first phase to be operational as early as 2025, with the fully scaled solution complete as early as 2027, subject to regulatory and environmental approvals. 

• Economic Development: The construction and operation of the ACG, along with other investments in CCUS technology and infrastructure, will create an entirely new business platform for each company and create new high-value jobs and support economic growth across Alberta.

• Safe & Reliable Operations: World-leading experts have been engaged to evaluate technical and operating conditions of using existing pipeline systems to transport CO2. The companies have the skills and experience to safely operate these kinds of systems as the characteristics of CO2 are very similar to other products which are safely transported today, such as specification ethane. The completed feasibility study demonstrates that ACG is achievable while maintaining high standards of safety and reliability. The companies have been working with regulators to advance the Project. 

• Customer-Focused Solution: With multiple inlets and outlets, customers will have flexibility to decide delivered CO2 end-uses including industrial processes and sequestration.