Lumida Ledger: Mr. Market Needs Prozac
Welcome back to the Lumida Ledger. Here’s a preview of what we cover this week:
Markets: Markets are Skittish, Sector Positioning, Consumer Staples Good Entry Point, Mr. Market Needs Prozac
Macro: Inflation Expectations Takeoff, Yield Curve Control, Making your First Million in CRE
Company Earnings: Must See Earnings Recap Table
Digital Assets: Rotating out of ETHE, Sizing the Bitcoin ETF Market
I spent the early part of the week spending time at Money 2020.
Pictured above: Raj Date (Fenway Summer) & Ryan Gilbert (Launchpad Capital)
My main takeaway is that FinTech investing, like much of venture capital, is incredibly crowded.
I counted no less than 12 Fraud AI startups. There are 6 startups streamlining ‘Subscription Docs as a Service’
The market is not in denial. But, I did sense a great deal of posturing from VCs and Founders.
VCs wrote checks in expensive late-stage rounds, and those checks may well return a zero.
To be clear, there are phenomenal FinTech VCs.
Folks like QED, Social Leverage, Bain, and Oak HC/FT come to mind.
However, other VCs are saying ‘You can’t vintage time. Invest in us because our job is to get you exposure to the asset class and participate in the best startups. Our job is to beat other managers.”
This is a form of ‘cope’.
Simply put, there is no capital imbalance in venture capital.
A mismatch between capital and opportunity is the first way to assess the attractiveness of an asset class.
Returns on capital are highest where capital is scarce.
On vintage timing, it is possible. Yes.
First off, we live in a world where startups are going bust. That’s a trend that is going ‘up and to the right’ as many VCs like to say.
Second, look for seed valuations to decline.
Uber’s seed round was ~$4 MM. Add in inflation and you get something like $6 to $10 MM seed valuations is normal.
Another key point here is - don’t invest in a category simply because you are familiar with it and have network or skill.
This is one of the most common mistakes we see. Investors tend to ‘over own’ what they know.
That might generate ‘relative outperformance’, but if the tide is going out you’re going to get caught up in the current.
New Lumida Legacy Podcast Episode
In episode 3 of the Lumida Legacy podcast, Justin Guilder speaks with Jared Finkelstein, founder of Inspired Wealth Strategies, who specializes in life insurance and estate planning for high net worth individuals.
Here are the Key Topics Explored:
- Innovative Tax Reduction with Life Insurance
- Maximizing Tax Deductions through Defined Benefit Plans
- Tax-Free Investing in Alternative Assets
- Harnessing PPLI for Tax-Deferred Growth
- Aligning Incentives for Maximum Client Benefit
Short Poll To Help us Curate Content
If you can spare a minute, we would appreciate if you can take this short 10 question poll. It helps us get a better sense of our audience and what content is most impactful.
The 10-Year Is Weighing on Equity Markets
Recap: We took a tactical underweight on August 1st.
Markets nosedived since then. Two weeks ago, at the same time Hamas inflicted great suffering on Israel and its own people, we went to neutral.
Our first step was to deploy to semiconductors, which sold off the most and have high earnings expectations and a secular trend.
Today, the 10-year note, which is flirting with 5%, is acting like a pair of concrete boots on the market.
What’s happening is markets are re-pricing PE ratios due to ‘higher for longer’ rates.
Tech stocks are a claim on a long-duration stream of cashflows. Therefore the 10-year is the primary rate used to discount future cashflows.
I wrote a few months ago that I expect higher rates will lead to a gradual re-pricing of the PE multiple. It appears markets are front-loading the re-pricing. (Markets generally do that, they jump from one equilibrium to another).
There’s a lot to like about markets now. Earnings are beating expectations. Some of the most positive seasonality of the year just started. The coming week has some of the best seasonality on record. And the economy is stronger than expected.
However, we are seeing two items that make the immediate path forward more volatile.
Markets Are Skittish
There is heightened risk aversion. Markets often bottom when there is bad news and prices don’t decline. That means bad news is priced in.
We aren’t seeing that yet. Google and Microsoft delivered a double beat, but both stocks declined.
Markets finished the week with stocks down, oil up, and gold up. That’s a sign that markets are experiencing an increase in risk aversion. Investors are going into a turtle shell.
However, we have seen capitulation in sectors such as Utilities, REITs, and even Staples. Those first two are rate-sensitive. That’s why they capitulated first. Those sectors are ‘safer’ because they already washed out.
This chart shows just how oversold the market is.
Energy, a sector we like, has outperformed. But even energy is capitulating.
Communication services are massively oversold.
Utilities and Stapes capitulated - and both are bouncing back.
Technology has been fighting capitulation. They are the last hold-out.
Paradoxically, the failure of Tech stocks to capitulate is preventing markets to get back to a clean rally.
A metaphor here is sometimes you have to go back down the mountain to base camp to make the next ascent up the mountain. Tech stocks haven’t retreated to base camp.
How to Position
Gradually deploying cash into quality names in sectors that have capitulated - such as Consumer Staples - is, in our opinion, the best course of action.
On technology stocks, we believe Apple’s earnings report next Thursday will be decisive.
The pattern we see is that, underneath the hood, the ‘breadth’ - meaning the number of stocks in a downtrend or decline - is significant.
Back to Apple: back in June, we talked about Apple and criticized the PE of 30 with sub-10% growth:
“The PE ratio for Apple is 32 with a 6% earnings growth expectation. Meanwhile, Taiwan Semiconductor has a PE ratio of 15 and over twice the earnings growth rate expectation of ~10% over the next 5 years”
Apple was a $3 Tn company and a major weight in the S&P and Nasdaq indices.
Take a look at this ugly chart of Apple:
Apple needs to get back into an uptrend after its earnings report.
Generally, it is a good idea to buy when stocks are oversold.
Notice how Apple stock has broken its trend lines.
It is oversold, and volume is increasing, but there is still no capitulation. That combined with 10-year dancing near 5% are the concerns holding us back.
This chart is a good illustration of what we mean:
Statistically, there is a good chance that markets are bottoming.
However, the failure of technology to capitulate and the 10-year breaking above 5% could expose stocks to the risk of a decline. That’s not a forecast, that’s a risk consideration.
Normally, when markets bottom there is decisive evidence.
Now, you can never know in advance if there will be a capitulation. However, the fact that other sectors are capitulating in turn combined with the 10-year note suggests a capitulation in tech may be in order.
We can measure capitulation with a volume climax, a spike in put option premiums, a spike in the Vix and so forth. And if we see that, we’ll let you know.
To the extent losses take place from here, we do expect that asset prices would recover. So, now is not the time to sell and lock-in losses. (Now is the time to do tax-loss harvesting.)
Further, if there is a significant loss from here, you should orient yourself to the idea of going ‘overweight’ after such a capitulation.
The more prices fall, the more attractive securities are. People forget that and grow fearful when they should become more greedy.
How to Position
Focusing on quality names in sectors that have already capitulated: Staples, REITs, and Utilities.
We like Consumer Staples. Staples have been expensive for over a year. These tend to ‘Warren Buffett type businesses with steady earnings regardless of climate. Think food and beverage.
A company like Albertson’s Companies (ACI) that operates food & drug stores around the United States is a good example of a stape. Albertson’s operates under different brands you might recognize such as Safeway and Shaw’s. (Note this is not investment advice, we’re showing how we think about the current market.)
Focus on securities that have reasonable valuations and relative strength and have not broken below their moving averages.
Technology is challenging. It is one of the most crowded consensus trades this year. Tech earnings look solid, and are beating expectations.
We do like certain names like Google which is on sale from a 3-year investment perspective.
Semiconductors. Looking back 10 years from now, we would expect to see a couple semiconductor stocks on the list of the most valuable companies. China is front-loading spending on semiconductor firms to get ahead of export controls
So we believe adding to that sector is a good idea.
Take a look at our prior newsletter to see names in the semiconductor space we like.
Also, take a look at our Company Earnings analysis below to see who’s doing well.
Adding long exposure in these select categories we believe is a good mixed strategy to navigate the cross-currents of rising rates and bullish seasonality and above average earnings.
Let’s hope we get a nice flush capitulation so we can shift to a more decisive posture.
Consumer Staples Sell Off is an Over-Reaction
We have been talking about Ozempic on social media. And Novo Nordisk, its manufacturer, is in our model portfolio.
This headline asserts that food & beverage stocks are tanking due to the rise of Ozempic.
That’s silly - and it’s a sign of jittery and fearful markets. We can take advantage of that.
Ozempic usage is about 100,000 people or so. It costs $10K+/year. It’s not going to destabilize people’s desire for Chicken Wings & Doritos on Sunday Night Football.
Mr. Market Needs Prozac
Another example is Meta’s earnings.
Meta beat earnings handily. The stock was up after-hours during the analyst call. But then the CFO indicated future earnings could be lower due to the Israel vs. Hamas war.
Israel’s GDP is 1/6th of the GDP of India. Yes, there are a lot of great tech startups in Israel… if they’re marketing the United States, however, their programmatic campaign spending on ads is not going to change.
Here is a quote about Mr. Market that resonates right now:
"Mr. Market can be an old fool (or maybe a young fool) who, from time to time, becomes hysterical. Sometimes, in his madness, he sees ghosts. At others, he imagines the good fairy touching him with her long golden fingers." Barton Biggs
Consumer Staples Represent a Good Entry Point
Here’s a technical ‘buy setup’. This is a good way to validate the hypothesis that Mr. Market is sloppy.
The study below shows the percentage of stocks in the Consumer Staples index (XLP) below the 50-day moving average. It’s at 3%. That’s a market of capitulation.
Here’s the historical performance when this condition was obtained for Consumer Staples in the past.
On average, you were rewarded for buying these assets.
Should Consumer Staples fail to rally with this condition, that would be evidence for further downside ahead.
Markets should bounce here, and when they don’t then there’s more risk ahead. This is a learning that just comes with experience.
So, our view here is nuanced.
We do believe markets are finding a bottom. We need to see the 10-year stay under 5% and stabilize first.
There is record short interest in Treasury bonds. And Japan is buying bonds as the marginal buyer. As well as plenty of Americans who bought TLT and participated in auctions as bonds continued to sell off.
So there are marginal buyers contrary to popular press, and we believe rates markets are going through the final throes of capitulation.
Rates will top out likely at the same exact time as markets bottom. This is what happened in October of last year, and it happened in 1982, and plenty of other times.
Markets are sneaky like that. Bonds are most attractive just when stocks are attractive. (It’s rational: higher discount rates mean lower stock prices.)
Despite the Fed’s reassuring tone, inflation expectations see inflation preparing for takeoff.
This chart shows markets ‘5 year forward breakeven’ inflation rates. Markets are pricing in ‘higher for longer’ inflation.
This will make the job of the Fed harder. It’s difficult to cut rates until the observables show inflation hit 2%.
On the positive side, we saw continued declines in inflation.
Yield Curve Control
Fidelity makes the case that the Fed may need to engage in Japanese style Yield Curve Control.
If so, that would be strongly bullish for real estate, stocks, Bitcoin, bonds, REITs, TIPS and real assets more generally.
It would also be bearish for the USD. The US has hard choices ahead. So what to do?
Design a portfolio and build a retirement plan with these scenarios in mind. You want to ‘stress test’ the portfolio against a range of shocks and test for resilience against a range of outcomes.
Shocks include: inflation spike, rates spike, unemployment spike, business cycle acceleration or recession.
Example: This is one reason we are overweight Energy and love distressed commercial real estate.
Under a range of scenarios we believe these sectors have attractive risk-adjusted returns.
Not only is the sector cheap on a valuation basis with good tailwinds, but commodities help the portfolio ride out and benefit from inflation.
Our view is the Fed will go to great lengths and coordinate with the US Treasury to avoid resuming QE.
The ‘break the emergency glass’ exception is a failed Treasury auction or a blow out in Treasury yields.
The Fed has performed emergency interventions when financial markets stop working.
We should hope Congress gets its act together on Debt/GDP (eg, entitlement spending) so it does not come to that.
Zoomers: How to Make Your First Million in Commercial Real Estate
If I was a Zoomer and wanted to make my first million as quickly as possible. Here’s what I would do:
Strategy: Buy non-performing CRE notes from small community banks. Approach: Find 1 great note, one deal at a time.
Bid low - 40 to 45 cents on the dollar. Focus on quality assets that don’t need capex but are dislocated and not fully leased. When you own the note, foreclose on the asset. Team: Find a partner with experience in real estate and do this in a tertiary market with good background trends.
Make sure you live in and know the market cold - block by block. Partner with someone who knows what they are doing and has local relationships and can help raise the money. Network to find that (maybe the rotary club or cold email bank board members).
CRE brokers will know quite a few people. After you acquire the asset, set up your office there.
CRE is a slow moving target and you have time to develop the team, skills, and capital. The barrier to entry is technical and knowhow but can be surmounted. This may be the fastest way to become a millionaire in the next few years over a 4 to 6 year timeframe.
Exit: When rates drop, do a cash out refinance which is non-taxable.
The asset’s cash flow will paydown and self-liquidate the debt.
The most legendary version of this story is the startup Treehouse Group, formed by Dallas Tanner and Brad Greiwe. Treehouse received an equity infusion from Blackstone. That business became Invitation Homes and is now the largest publicly traded owner of single family rentals.
Brad Greiwe is now a co-founder of venture capital firm Fifth Wall.
Buying distressed real estate was the smart move after the 2008 crisis. That’s also the best move today from a risk-adjusted return perspective.
We believe that the after-tax returns of distressed CRE will exceed equity returns. Our base case is a 3 to 4X MOIC tax efficiently.
Weak guidance is quickly becoming a theme this earnings season.
Companies not positive heading into 2024.
This week, we shared earnings recaps for 41 companies on our Lumida Wealth Twitter. We selected companies not necessarily because they are worth owning - but because they give insight into the US consumer, the strength of the economy, and trends.
We have summarized the earnings by sector below. 75% of the companies we summarized beat earnings. You can check out the full table here.
Notice the power of Consumer Staples like Hershey’s and Colgate. The category continues to grow revenues - and that’s why you should look for opportunities in Staples now while they are on sale.
You can check out the full table here.
Alex Thorne and the Galaxy Digital research team put out an interesting analysis sizing the market for a Bitcoin ETF.
Bitcoin is up 100% this year. It’s a heated rally, and the most non-consensus idea, and also the best performing asset class this year.
In the coming weeks, we will be rotating out of ETHE. The discount is starting to close on what has undoubtedly been one of our best calls this year (along with ‘higher for longer’ and Energy and JPM and UBS for those keeping score at home 🙂)
Alex believes that when Bitcoin ETFs are approved, these vehicles could see a minimum of $14.4bn of inflows in year 1, ramping to $38.6bn inflows in year 3.
Work with us: we are are looking for a client associate to help us with sales and client service support. Send referrals here.
Meme of the Week
Quote of the Week
“The four most expensive words in the English language are ‘this time it’s different.’” - Sir John Templeton
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