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The Twins at Work

The Days Ahead: Second round of Q4 GDP. Italy heads to the polls.

Bonds are grappling with higher expected growth (even though we had some disappointing existing home sales, retail sales and Industrial Production) and the reawakening of the twin deficits story. For those of you of a certain age, this was a big deal in the 80s and 90s. It’s basically a fear that growth will suck in imports and the, ahem, reformed tax regime won't bring in as much revenue as they hoped because, you know, “tax revenues are going down”.

How bad are those deficits?

Well we already have one of the highest federal deficits at a time of low unemployment. We expect them to go up when recessions take hold but this time they've stayed high despite the halving of the unemployment rate. We also now have a much weaker dollar and the fear is that the two lower lines (the deficit and trade balance as % of GDP) will grow as the dollar weakens (the black line going up). It’s a messy chart and we’d warn about interpreting it too literally but it’s in the background and we expect it to come up in future Fed meetings.

Meanwhile the bond market rallied and moved further away from the key 3% on the 10-Year Treasury. We're very comfortable with this move and don't expect any major pick up in rates. Meanwhile: 

1.     Long-term investments returns:  We're pretty comfortable with long term investing. We don't market time, we keep turnover low, avoid the fads and keep to your asset allocation targets. So it’s nice when we see Credit Suisse’s Global Investments Returns Yearbook, which measures returns from 1900 to 2017. Here are some highlights:

  • The U.S. equity market was one of the best in the world, returning 6.5% in real terms. South Africa and Australia were better probably because of their commodity bent.

  • Equities were a way better asset class than anything else. Better than housing (0.3%), collectibles (2.9%) and bonds (2.0%) and, of course, cash (0.8%). Gold and other precious metals failed to keep up with cash.

  • Emerging Markets lagged the U.S. here:

  • But the Russian and Chinese revolutions er…redistributed those assets and the Second World War hit most of SE Asia hard. Since 1950, the annualized returns for Emerging Markets were around 12% vs 9% for the U.S.
  • The U.S. is dominant. At its 1990 peak, Japan accounted for almost 45% of the world index, compared with 30% for the USA. It fell to just 8%. The US regained its dominance and today comprises 51% of total world capitalization. Here: 

Where does that leave us? We appreciate that no one has a time horizon of 117 years and that some periods have been very painful to investors. If you invested in the market peak of 2000, it took 13 years to make any money. Japanese investors from 1989 are sitting on a 40% loss. But we would say:

  • Equity returns may be lower in coming years, mainly because of low interest rate
  • The case for equities is that, over the long term, stockholders have enjoyed a large risk premium over cash. On average it has been 7.5%
  • Even with a lower equity premium of around 3½%, equities are still expected to double relative to cash over a 20-year period.

2.     A funny thing happened on Thursday, which is sort of a modern parable on corporate governance. SNAP, the disappearing photo app, fell some 17% on the news that one of the Jenner/Kardashians didn't like the new look. Here’s the chart:

Ms. Jenner has 24m Twitter followers and 325,000 of them hearted the comments. That was enough to wipe $2bn off the value of the firm. At the same time, the founder sold stock under SEC Rule 10b5-1, which basically says an insider can sell stock on a pre-determined schedule and avoid running into material non-public information rules…which most of us know as insider trading. How much did he sell? Some $620m making him the highest paid CEO of a public company by a very large margin. It was around 3% of the company’s worth and Snap lost $3.4bn last year. Tim Cook earns around $12m or 0.00001% of the company’s value. And they make a great deal of money.

Now, I’m the first to admit I’m not Snapchat’s target market either for their app or stock. And we made fun of Snap last year.  But a number of things come to mind:

1.     A company like Snap trades on very thin air. It’s one of those winner-takes-all and network effect businesses. You probably only have time in your life for one disappearing app so the company either makes it big or is copied and left in the dust. And if one unhappy client can send your stock plummeting, it seems to me like it’s a very risky business. It’s should not be like the Department of Defense calling United Technologies and saying, “Hey, we don't like your Black Hawks any more.  Or is it just me... ugh this is so sad."

2.     The governance at Snap reached a new low. The Class A shares have no vote, the Class B have one vote and the Class C have 10 votes. Guess who owns the Class C? There are plenty of other companies who issue dual share classes (Berkshire for one) but this seems one step too far for the index providers who ganged up on Snap and said “you can't be in our index”, which turns out is a problem because index funds own some 15% of the S&P 500.

3.     On a higher level, it complicates the IPO market. There are plenty of Unicorns playing in Silicon Valley’s magic forest but they seem content to stay private. And who can blame them? The public markets are going to ask awkward questions like “do you make money?” We need a healthy IPO market for stocks. There have only been around 100 in the last six months and many of those are small or relaunches or spin-offs.

Bottom Line: Earnings are winding down. It’s been as strong quarter with growth at 15% compared to estimates of 11%. Emerging Markets remain very well supported.

Please check out our 119 Years of the Dow chart  

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Credit Suisse yearbook on investments returns

Berkshire Hathaway annual report out this week

 --Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.