This week's interesting finds

This week’s charts

There have never been more job openings in the US before

Who has the real pricing power?

Investors willing to take on higher risk debt while losing money relative to inflation  

Investors in European junk bonds have begun accepting interest payments that are lower than eurozone inflation levels for the first time ever. Analysts said investors’ willingness to extend credit to the riskiest borrowers while losing money in real terms reflected the scarcity of other opportunities to earn returns in debt markets. 

Some investors may be inspired to buy junk bonds because they believe some issuers’ fortunes could improve to the point they would obtain investment-grade ratings.

Credit rating agencies have been upgrading bonds from junk status at an unusual rate with €7bn of European high-yield issues having been pushed up to investment grade in the past 12 months. This stands in contrast to the average €7bn worth of bonds that had been downgraded in each of the past five years, on average.

Equities and inflation  

This chart shows the correlation between the 12-month real equity return and the 12-month change in the inflation rate, for quintiles formed by the starting inflation rate. Only in the lowest quintile (starting inflation rate less than 1.0%) is the correlation positive at 0.4. In all other cases, there is a negative relationship between the real equity return and inflation changes, and more so for higher starting levels of inflation. The trend suggests that equities actually benefit from rising inflation if the starting level is low, but are hurt by rising inflation if it is above median (increased risk of inflation escalating).

The Case for a longer-term oil and gas bull market  

Back in mid-2020, folks were pronouncing the energy sector dead. Now, oil and gas companies in the US shale industry, and more broadly among publicly-traded independent oil companies, are on track to make record free cash flows in 2021: 

Historically for two centuries now, whenever humanity finds a better energy source, we add it onto the previous energy sources, rather than replace them. The previous energy sources remain flat or even continue to grow in absolute terms, while the new one grows faster and becomes more important:

This week's interesting finds

Field crops

Statistics Canada released its annual crop production forecasts. The numbers were expected to be down sharply because of a lack of rain, higher than normal temperatures and low soil moisture levels to begin. This was not a big surprise for the market, however year over year declines were large, nonetheless.

Rent increase

Car inventory at multi-decade low

Crackdown on ESG labels

U.S. regulators have long said they’re dubious about the green and socially conscious labels that Wall Street applies to $35 trillion in so-called sustainable assets. For several months, SEC examiners have been demanding that money managers explain the standards they use for classifying funds as ESG-focused. The review is the SEC’s second into possible ESG mislabeling since last year - showing the issue is a priority for the agency and a reason for the industry to worry about a rash of enforcement actions.

Few businesses are booming in high finance like sustainable investing, as governments, pension plans and corporations all seek to lower their carbon footprints and be better public citizens. Amid the rush for dollars, more and more ESG insiders have started sounding alarms that a lot of the marketing is hype, a term known in the industry as greenwashing.  

The fund industry has said one problem is that no one really agrees on what qualifies as sustainable investing. Since March, European money managers have had to disclose the actual ESG features of products being touted. In the U.S., no such mandate exists - prompting confusion among financial firms and investors alike.

Still, any murkiness over rules and requirements isn’t insulating firms from criticism.

InfluenceMap, a London-based nonprofit, said last week that more than half of climate-themed investment vehicles aren’t living up to the goals of the Paris Agreement.

Why Fund Returns Are Lower Than You Might Think

Morningstar’s annual "Mind the Gap" study of dollar-weighted returns (also known as investor returns) finds investors earned about 7.7% per year on the average dollar they invested in mutual funds and exchange-traded funds over the 10 years ended Dec. 31, 2020.

This was about 1.7% less than the total returns their funds generated over that span.

This shortfall, or "gap," stems from inopportunely timed purchases and sales of fund shares, which cost investors nearly one sixth the return they would have earned if they had simply bought and held.

Good news: The most popular material on Earth is great for storing CO2

Concrete is the most used material of the modern era. More than 10 billion tons of concrete are produced each year. Luckily, scientists are showing that it’s our most promising place to stick all of that CO2, too.

CO2 enters the atmosphere whenever we burn fossil fuels, like gas and coal. Once it’s made, it sticks around because CO2 has a stable structure that requires energy to change. Depending on exactly what you want to turn CO2 into, that can take more or less energy.

When CO2 is incorporated into concrete, it’s literally piped into the mix. The natural tumbling motion of churning concrete is all the energy that’s needed to transform the CO2 into a calcium carbonate. All of this tough calcium carbonate means the concrete needs less cement in its mix, which is another environmental savings, since cement is the worst polluting component of concrete.

This week's interesting finds

This week’s charts

Shopping online? 

Cash Hoarders   

EV effect on oil consumption  

As of July, 64% of the cars sold in Norway are electric. It hits the IEA’s target for ‘Net Zero’ scenario set for 2030. However, the country’s oil consumption is surprisingly unchanged. Here are some of the reasons: 

• Cars account for about 20-25% of global oil consumption Which dilutes impact that EVs have on total oil demand 

• While the new EV car sales are high the total number of EV cars on the road is under 10%. It takes significant time to turn over the fleet. 

• Oil usage for non-passenger car purposes has increased in a last decade due to increased number of vans and trucks. 

• LPG/ethane consumption which mostly used for petrochemical plants or for space heating and cooking increased by 31%.   

Rules, Truths, Beliefs 

• The line between bold and reckless is thin and often only visible with hindsight, so be careful who you admire and what you admire them for. 

• Few things are more persuasive than the opinion you desperately want or need to be true. 

• Average returns sustained for an above-average period of time leads to extraordinary returns. 

• Price drives narrative and narrative drives price, so crazy things can last a long time. 

• Investors as a group don’t learn from booms and busts because when people say they’ve learned their lesson they underestimate how much of their previous mistakes were caused by emotions that will return when faced with similar circumstances. 

• It’s easy to ignore the power of tail events because it’s painful to accept that most of what happens isn’t that important. 

• “Be more patient” in investing is the “sleep 8 hours” of health. It sounds too simple to take seriously but will probably make a bigger difference than anything else you do.   

Canadians are paying off nonmortgage debt  

• Overall non-mortgage debt fell by a record $20.6 billion from the start of the pandemic to January 2021, including a $16.6-billion drop in credit card debt 

• Mortgage debt, however, rose by a record $99.6 billion over the same period. 

• The largest reductions in debt loads were among those with the lowest credit ratings 

• The change came as household consumption spending dropped significantly, down 14.7 per cent in the second quarter last year compared with a year earlier 

• The debt repayments have also come about as government support programs helped prop up incomes and, in some cases, paid more than what people had been earning before 

• People with the lowest credit scores also generally face higher interest rates. Any extra dollar that they have, it’s a huge saving to be deleveraging and paying down that credit card.

Fukushima water 10 years later 

Tokyo Electric Power Company Holdings Inc. plans to construct an approximately 1 kilometer-long undersea tunnel to release treated radioactive water from the crippled Fukushima Daiichi nuclear power plant out to sea. 

The level of the radioactive substance tritium that remains in the treated water will be diluted to below regulatory standards 

The decision to release it offshore into the Pacific is aimed at preventing reputational damage to local marine products amid an outcry from fishermen. 

The Japanese government said the same day it will buy marine products as an emergency step to support fishermen if the planned discharge of treated water from the Fukushima plant into the sea hurts their sales.

This week's interesting finds

This week’s charts

Hard market conditions continue with the U.S. Property & Casualty rate growth trending at high single-digit range for 12 consecutive months 

Shortest corrections

Since we broke through the 2007 pre-GFC highs in the summer of 2013 we are now looking at more than 320 new highs in this bull market. Which means in the past 7 years US stock market has reached a new high once out of every 7 days or so.

The difference between this cycle and the last is that corrections did not last very long, while crashes in early 2000s were measured in years instead of months.

How the US tech giants could fall  

American tech companies lead the world’s top 10 by market value and many commentators and investors see no reason to question their continued dominance. The conventional narrative is that these giants are growing bigger, faster and more durably than their predecessors

Only we have seen much of this before.

Data going back to 1970 shows companies that finished a decade in the top 10 saw median earnings gains of around 330 per cent over the course of that decade, and their stocks beat the market by more than 230 per cent. The top 10 of the 2010s were not that different from the norm: earnings were up 350 per cent and their stocks outperformed the market by 330 per cent.

Since 1970, companies that finished a decade in the global top 10 have had a less than one in five chances of finishing the next decade there.

Capture more value  

Switzerland-based Vestergaard introduced its LifeStraw technology, which removes 99.99999% of bacteria and 99.9% of protozoan cysts from contaminated water. The product is a favorite of aid organizations: Over the past decade, LifeStraws have been distributed after almost every disaster.

But not every place with bad drinking water is a relief zone; 780 million people in the world lack access to clean water in their daily lives. So Vestergaard saw a much larger potential market than its NGO customer base—and proved that it could innovate in another way. The challenge was LifeStraw’s cost, which is beyond the means of most households in developing countries. The company found a clever means for families to fund their purchases: with carbon offset credits. Thanks to the worldwide carbon emissions trade, any documented C02 savings can now be monetized—and using LifeStraws means not having to burn petrol or wood to boil dirty water. Vestergaard’s Carbon For Water initiative has enabled hundreds of thousands of Kenyan families to pay for its product, growing its business substantially.

Both these kinds of innovation—one in value creation, the other in value capture—are important. But most companies focus only on the first.

To benefit from both kinds of innovation, companies need to think about value capture more imaginatively and as a matter of course.

This framework shows 15 ways firms can capture new value, clustered under five focal points of change. 

A Framework for Value-Capture Innovation

The rise of warehousing  

The demand for warehouse space is pushing industrial real estate into new terrain, and Canada may have limited warehouse space by the end of the year, thanks to the surge in e-commerce sparked by the pandemic. 

Statistics Canada reported retail e-commerce sales were up 110.7 % year-over-year to $3.5 billion in January 2021. 

Online splurging by Canadians is estimated to reach $92.7 billion by 2025 and net-new warehouse requirements from e-commerce-related pressure are expected to exceed 40 million square feet over the next five years.

This growth is more significant than all the available leasable space in Canada’s three largest industrial markets combined.   

Bets against Cathie Wood’s ARK Innovation ETF  

Ms. Wood’s ARK Innovation ETF raced higher in 2020 and at the start of 2021, boosted by big bets on companies like electric car maker Tesla Inc., Roku Inc. and Square Inc.

But as shares of technology and other fast-growing companies lost some of their luster over the following months, so, too, did Ms. Wood’s innovation fund. It is down 6.9% this year, while the S&P 500 has risen 18%

Several hedge funds took out fresh positions in the second quarter betting against Ms. Wood’s actively managed ARK Innovation exchange-traded fund, according to the most recent 13F filings.

Mr. Burry’s Scion Asset Management held bearish put options worth nearly $31 million against 235,500 shares of the ARK Innovation ETF. Laurion Capital Management held roughly $171 million worth of put options against 1.3 million shares of the ARK Innovation ETF. GoldenTree Asset Management, Moore Capital Management and Cormorant Asset Management also held sizable bearish positions on Ms. Wood’s fund.

This week's interesting finds

This week’s charts 

China

Source: Bank of America

Correlation of yields and styles

*5Yr rolling correlation; monthly change in US 10-yr yields vs outperformance to S&P 500 (TR) ANALYST TEAMSource: Scotiabank GBM Portfolio Strategy, Bloomberg.

Producer Price Data (PPI) as a measure of inflation 

Unlike the CPI report, producer price data surprised to the upside. The Producer Price Index (PPI) is a measure of inflation based on input costs to producers.

Is Inflation Here to Stay?

The August 1979 BusinessWeek issued a magazine with cover line “The Death of Equities — How Inflation is Destroying the Stock Market” in which it outlined how inflation would depress equity returns for a generation of investors. 

In retrospect, this was probably the worse market call ever made.

The funny aspects of business magazine cover stories is that in the short term they are perceived to be correct. It was not until August 1982, three years after the publication of the BusinessWeek article that investors suddenly recognized the financial landscape had dramatically changed. The stock market exploded off the bottom on August 17th and never looked back.

Two years have passed since BusinessWeek/Bloomberg’s 2019 “Is Inflation Dead?” piece and we believe we are rapidly approaching inflation’s inflection point.

Multiple fundamental trends now confirm this view: 

o  In 2019, money supply was only growing at 4% per year; today it is growing at 27% per year — the fastest rate in history. In 2019, the Federal Reserve’s balance sheet stood at $4.3 trillion compared with $7.3 trillion today. In 2019, US government debt totaled $20 trillion. Two short years later, it stands at $28 trillion — up 40%. 

o  Over the last year, the US government has borrowed and spent $2.4 trillion to replace $800 billion of lost economic activity resulting in a US savings glut of nearly $1.5 trillion. Not content with the massive surge in government spending, the Biden administration is proposing an additional $3 tr in stimulus spending. 

o  With the economy now starting to recover, the press is filled with stories of shortages that have developed in countless markets from lumber to semiconductors to restaurant workers to ketchup packets.   

Mixed reviews  

• From farm to bottler to supermarket cooler, a liter of Coca-Cola creates 346 grams of carbon dioxide emissions, the company’s data show. That’s less than half the tree-to-toilet 771-gram carbon footprint of a mega roll of Charmin Ultra Soft toilet paper, as measured by the Natural Resources Defense Council, an environmental group. 

• Math like this is fast becoming obligatory. Investors are increasing pressure on businesses to disclose the emissions of greenhouse gases related to their products and services. Regulators are starting to ask about that, too. Within the next couple of years, every public company in the U.S. might well be required to report climate information. 

• Investors are eager to buys stocks that rank high on ESG factors. A Wall Street Journal analysis of ESG grades issued for nearly 1,500 companies by three rating firms found that nearly two-thirds—942 companies—got different grades from different raters. 

• Nearly a third of the companies were deemed ESG leaders by one or more rating firms, but labeled ESG laggards by one or another rater. Credit ratings, by contrast, are broadly consistent.   

Wealth inequality

• Americans may be richer than they think and less unequal than they’ve been led to believe. 

• There are strong reasons to include pension and Social Security guarantees in wealth calculations. Most workers forfeit 12.4% of their income annually in payroll taxes in return for Social Security payouts starting in their 60s, but that wealth is ignored in standard inequality measures. 

• In the 40 to 59 age group that is the paper’s focus, the top 5% of households control 63.5% of “market wealth”—liquid assets, housing, and accounts like 401(k)s. But include future pension and Social Security income, and the top 5% share is a more modest 45.4%, the authors find.   

Simple Explanations For Complex Topics  

One of the biggest residential real estate brands in the world, Zillow, is getting hammered in the midst of one of the biggest housing booms we’ve ever seen? What gives? 

• Some claim this was the market’s acting as a forward-looking indicator showing the housing market is going to crash. This one doesn’t pass the smell test. Other housing-related stocks are crushing it this year.

• Another theory was that this is a housing boom in price only. This makes sense considering how low inventory levels are. On the other hand, part of the reason for this is houses are flying off the shelves. Existing home sales are higher than they’ve been in a long time. 

• If it’s not the industry and it’s not a company that’s falling out of favor the next logical guess would be valuation. This is an argument that seems to hold water. The price to sales ratio was well over 13x in the February blow-off top, twice the average over the past 5 years. 

There are a number of stocks with similar return profiles. Stocks that are still up a lot from the lows of the Corona crash, despite being down a lot from their highs. 

Sometimes there is a good reason stocks get cut in half. Sometimes there is a good reason stocks rise 500% in a matter of months. 

We would all like for there to be a simple explanation for complex topics like the movements of stocks in the short run. But most of the time these price moves are random, an amalgamation of emotions, differing opinions, expectations and momentum.

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