January 2022
Grimacecoins
It's all about (virtual) location location location.
Momentum works both ways.
Inflation non-hedge
With the Fed letting inflation run hot before commencing its well-signaled interest rate hikes later this year, investors continue to imagine alternative inflation hedges. Treasury Inflation Protected Securities (TIPS) are perhaps the most obvious products for insuring against inflation. But this idea is most definitely not new, and investors getting in now may have already missed the opportunity for an effective inflation hedge. At these elevated TIPS prices, the potential for price declines may negate the hedging benefits of TIPS’ interest rate adjustments from increasing CPI readings.
Tech stocks have borne the brunt of the pain as rate increases loom. There’s the attractiveness of other sectors, including banks, that become more profitable with higher interest rates. A disproportionately larger number of tech companies relative to non-tech companies are either unprofitable or minimally profitable, which triggers short-termism among investors in seeking currently profitable opportunities. As economies emerge stronger in a post-COVID world, stocks that investors dumped amidst the COVID shutdown are regaining attractiveness in the reopening trade.
Enter bitcoin. With a fixed maximum supply of bitcoins, 21 million to be precise, the theory is that bitcoins will retain their value in a way that inflated fiat currencies cannot - because their fixed supply will forever remain constant. Therefore, bitcoin may be an effective inflation hedge with price action uncorrelated to investors’ inflation-sensitive holdings.
Well, the Wall Street Journal has some bad news for investors who bought Bitcoin as an inflation hedge:
It is becoming a more common occurrence: When stocks fall, so does bitcoin.
Bitcoin, the world’s largest cryptocurrency by market value, fell below $37,000 Friday to its lowest dollar value since August 2021, according to CoinDesk. The selloff continued into the weekend, with Bitcoin falling to below $35,000 on Saturday before edging back above that level as of Sunday afternoon. Bitcoin has nearly halved its record price from the fall.
…
One measure of how bitcoin has become more entwined with markets: The cryptocurrency is near its highest correlation with the stock market since September 2020, according to Kaiko. That means when the stock market goes down, so does bitcoin.
That’s not how hedges are supposed to work. For investors looking for reasons to own bitcoin, hedging inflation should not be one of those reasons.
Update: Cash for the next 7 years
You may recall this Likelyhoods reference to the article when it was published in January 2021:
Well, this is the first of six annual Likelyhoods updates to KCI Research’s controversial call 1 year ago that It's Time To Go To Cash For The Next 7 Years. Leaving no ambiguity, the author wrote “Most Investors Would Be Better Off Taking A Seven-Year Vacation”.
To be clear, the author sells a newsletter aptly called The Contrarian, and thus is in the business of making contrarian calls to paying clients. Mundane, slightly contrarian calls do not make headlines - and definitely do not drive subscriptions - the way that bold, attention-grabbing contrarian calls do.
Anyway, as evidence for the go-to-cash-for-7-years call, the author cites some GMO forecasts:
Specifically GMO is forecasting U.S. large-cap stocks to return a negative 6.6% annually for the next seven years, for U.S. small-cap stocks to return a negative 7.8% annually for the next seven years, and for U.S. bonds to return a negative 3.3% annually.
Well, one year later, the go-to-cash-for-7-years call is off to a not-so-good start. But I give the author credit - unlike most incorrect forecasts that our short attention spans quickly forget, the author is standing by his bold contrarian call: It's Time To Go To Cash For The Next 7 Years - Update | Seeking Alpha
"With starting valuations still extremely poor, I'm sticking to my outlook that the average investor will be better off simply holding cash over a seven-year time frame, dating to the January 20th, 2021, publication of the original article in this series."
“This article generated a lot of discussion, and was controversial because it argued that simply being in cash would be a better alternative for many traditional investors over the forthcoming seven years, because collectively investors were starting from their worst valuation point in modern market history.”
Let’s regroup and formalize the author’s claim. The author does not detail his prescribed move to cash, a position of which could be built in countless ways. Since the author chose 7 years, let’s assume the author’s cash position is established in a low-risk 7 year Treasury Note (“T-Note”) which as of January 29, 2021 yielded 0.79% annually (1). On the other side, let’s assume the author buys VOO, Vanguard’s low cost S&P 500 Index fund, as a proxy for the broader market exposure that the author wants to avoid for 7 years. Good, now we will track these two positions for the 7 year window from January 31, 2021 through January 31, 2028, testing the author’s claim “The average investor will be better off simply holding cash over a seven-year time frame, dating to January 20th, 2021”:
Source: Likely Capital Management
(1) T-Notes pay a fixed interest rate every 6 months, is exempt from state and local taxation, but is subject to federal taxation. The calculations herein are simplified projections that do not perfectly reflect the outcome of an actual investment in T-Notes and excludes consideration of their tax-advantaged benefits. The information herein is not personalized investment advice nor an investment recommendation on the part of Likely Capital Management, LLC.
Likelyhoods is on-the-beat, we will follow this story and provide annual updates through January 2028. Of course it is possible that cash finishes ahead of the S&P 500 Index, but not Likely.
This is a good opportunity to revisit Resulting, also known as Outcome Bias, which is judging the quality of a decision by the outcome rather than the decision-making process. In uncertain contexts, we need to look beyond the influence of luck in an outcome because getting lucky does not replicate well over time. Here’s Likelyhoods in July:
There are countless obvious examples of what I call “Resulting fails”:
Drunk driving. If you make it home safely, the decision to drive drunk was okay!
Blackjack. If you hit on 20 and get an Ace, you made the right decision!
If you pick up a penny in front of a steamroller and get out of the way in time, you found a good strategy.
Day trading. Well, this one writes itself.
That drunk driver may get lucky in getting home safely, but also should not expect that safe outcome to replicate for future drunk driving trips. Hitting on 20 will not replicate well over many hands, but ceteris paribus will seem like the right decision once for every 13 hits.
KCI’s call that cash will finish ahead of the broader stock market over the next 7 years may turn out to be correct due to randomness, by rare but lucky timing, or because of a solid analytical and decision-making process. The Likely way is to filter these situations through the lens of reliability, thereby separating quality decision-making processes from lucky outcomes.
Although not nearly as widely publicized, forgive me for thinking that KCI’s call smells of Ted Seides’ wager with Warren Buffett. Seides lost the wager and some money, sure, but took full advantage of both the charitable publicity and close proximity to Warren Buffett by monetizing his fame through two books and a Capital Allocators podcast, both are worthy and quality content. Contrarians play the expected value game whereby a few correct calls pay off larger than the smaller losses of frequent incorrect calls, so it may not be entirely bad for KCI’s business to make wrong calls like this.
My favorite question, chess edition
If you got to meet the President, what question would you ask?
I would hope to ask a question that:
The President has not been asked 37,000 times before
Breaks through their public facade and negates canned political responses
Leads the President to appreciate my question
Teaches me something meaningful about the Presidency
My question would be:
What can your experience as President teach us about investing?
The question “What can X teach us about Y?” accomplishes many objectives. It leads us to think about shared experiences. It helps us learn from seemingly unrelated contexts. It prompts the respondent to relate their own context to ours. It sometimes even produces unexpected insights.
I have featured this question in Likelyhoods many times before, it is that good:
What can beating the dealer teach us about beating the market?
What can NFL and NHL statistics teach us about the Stock Market?
And now, if you followed every game of the World Chess Championship, as my kids and I did, you can imagine my joy in reading Gary Michuris, Managing Partner of Silver Ring Value Partners, as he asked What can the World Chess Championship teach us about investing?:
After just 11 games, rather than the full 14, the World Chess Championship ended today. Magnus Carlsen won, with a score of 7.5 vs. 3.5. Commentators called this the most stunning collapse in modern chess championship history. There was shock and frustration across the chess world. What started out as a promising and exciting match among near-equals degenerated into a one-sided contest with few chess games worthy of real analysis or study.
So what happened? And how is all of this relevant to investing?
In the end it didn’t come down to theoretical chess knowledge or potential. The deciding factor was the same as what determines success in investing – temperament. Nepo played well in the beginning, before he encountered adversity. Game six, which was an epic battle of which he should be proud despite his ultimate loss, was the straw the [sic] broke the camel’s back.
Faced with adversity, and with the pressure of needing to force a win in order to tie the match, Nepo fell apart mentally. No, his theoretical knowledge of chess didn’t evaporate. He still had the same exact training as he had prior to game six. So what changed?
What changed was his temperament caused him to tilt. Tilt is a state of mind where one deviates from their best rational process in their decision making. Playing on tilt, Nepo performed far below his theoretical potential. He was no longer playing his A-game. He was playing his C-game, and the results reflected that.
Many investors are familiar with the affliction that Nepo faced. Decked out in fancy clothes and armed with slick PowerPoint decks, they are able to confidently talk about their investing process when everything is going their way. But what happens to them after a setback? What happens when for a period of time the market doesn’t provide validation for their investing process?
Many fall apart, and start to deviate from their process in major ways. Frustrated, and trying “to get back in the game,” they act in a way that their calm, rational selves would not act based on their knowledge of investing and their experience.
…
So what matters is their temperament. Their ability to maintain an even keel and to make decision [sic] near their theoretical maximum potential. This is perhaps the most underestimated advantage an investor can have – the temperament to stay rational when others aren’t able to do so.
How can you tell if an investor has the right temperament? Examine the quality of their process during and after a period of adversity. Anyone can talk a good game. It takes the right temperament to play one when things haven’t been going your way.
Checkmate.
ONE MORE THING…
Grimacecoins. Really. This is a market that I do not understand and Likely will never enter my circle of competence. "According to cryptocurrency news outlet CoinDesk, Wednesday's tweet spurred the creation of nearly 10 "grimacecoins" on one network alone, with one token reaching a market capitalization of nearly $2 million in the matter of hours." Elon Musk Offered to Eat a Happy Meal on TV. McDonald's Gave the Perfect Response
It's all about (virtual) location location location. Moving next door to Snoop Dogg will set you back just $450k. Investors are paying millions for virtual land in the metaverse
Momentum works both ways. To investors who jumped on the momentum bandwagon on the way up, momentum works both ways. Sell-off in Cathie Wood's ARK Innovation fund reached 48% at low point Thursday and Cathie Wood's ARKK closes at an 18-month low as all its holdings end negatively
The information and opinions contained in this newsletter are for background and informational/educational purposes only. The information herein is not personalized investment advice nor an investment recommendation on the part of Likely Capital Management, LLC (“Likely Capital”). No portion of the commentary included herein is to be construed as an offer or a solicitation to effect any transaction in securities. No representation, warranty, or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained herein, and no liability is accepted as to the accuracy or completeness of any such information or opinions.
Past performance is not indicative of future performance. There can be no assurance that any investment described herein will replicate its past performance or achieve its current objectives.
Copyright in this newsletter is owned by Likely Capital unless otherwise indicated. The unauthorized use of any material herein may violate numerous statutes, regulations and laws, including, but not limited to, copyright or trademark laws.
Any third-party web sites (“Linked Sites”) or services linked to by this newsletter are not under our control, and therefore we take no responsibility for the Linked Site’s content. The inclusion of any Linked Site does not imply endorsement by Likely Capital of the Linked Site. Use of any such Linked Site is at the user’s own risk.