Gravitas Spark CrowdFunding

Author: Gary McCarthy

  • The Wisdom And Energy Of Crowds

    Mitt Romney defied his own crowd last night when voting to convict GOP cult President Trump of high crimes and misdemeanors in the White House. History will probably be kind to Romney but, as a general observation, large groups tend to make superior decisions in the fields of pop culture, psychology, biology, behavioural economics and other fields. The concept of crowd superiority was popularized by James Surowiecki in his 2004 book, ‘The Wisdom of Crowds’.

    The key idea is that large groups of people are collectively smarter than individual experts. We would agree that’s a rather difficult thought to digest in the midst of Trump and Brexit chaos. Indeed, it is not just the political arena that presents difficulties for this concept given current events in the world of investment and financial markets. Traditional thinking is that the predictive power of crowds will win out over individual expertise but this is tested now and again when things go a bit crazy. Financial history is peppered with periods of crowd “mania” behaviour as tulips, South Sea Islands, technology, crypto-assets and property markets bubble up with investor excitement only to pop painfully after sucking in vast amounts of the crowd and price-following investment capital.  Take Tesla as a very recent example of manic investor excitement.

    The US electric vehicle manufacturer Tesla experienced a parabolic rise in its share price this week which attracted many raised eyebrows from those who did not read our surprises for 2020. True, we didn’t expect this level of madness. Nevertheless, various milestones were truly breathtaking. Here are a few of them:

    •  At one point the value of Tesla with $25 billion worth of annual sales exceeded that of Ford, GM, Chrysler and Daimler (Merc) who actually sell $620 billion worth of cars annually.
    •  One of the daily moves in Tesla’s share price was the equivalent of the entire value of Ford Motor Inc.
    •  The actual value of Tesla shares traded in one day approached $40 billion which is a record for an individual stock.
    •  At the peak valuation of $170 billion on Tuesday the Tesla electric vehicle (EV) franchise was worth more than BP, McDonalds or HSBC and would rank as the second-highest valued stock in Europe.

    We include an oil company deliberately in the final observation above for good reason. Energy is at the centre of the two most extreme market conditions right now. One is a very recent spike in activity (Tesla), the other is a slow-moving multi-year trend (oil stocks). The two examples highlight a key point about the concept of the wisdom of crowds. The information value of a multi-year trend is far more significant than a short term explosion of enthusiasm in the market. One can debate the merits of Tesla’s valuation and the exciting theories as to recent share price surges. Take your pick from climate change, EV revolutions, hidden data centre capabilities and AI but we do need more time to arrive at firm conclusions on the Tesla investment rationale. For the curious, Gavin Sheridan (@gavinsblog) on Twitter is very interesting on the data story. In contrast, the oil market is sending out some serious distress signals.

    First, energy stocks have just had their worst January on record despite World War 3 nearly breaking out in the Persian Gulf. More damning, as a longer trend, the energy sector has been the worst-performing industrial sector for three consecutive years. The arrival of ESG as a primary investment consideration has dramatically reduced investment flows into the sector culminating in the spectacular failure of the Saudi giant, Aramco, to attract any international capital for its 2019 IPO. Furthermore, bankruptcies are picking up significantly in the US oil sector as falling oil prices and declining shale oil well performance squeezes cash flows. And, to cap it all off, the Swiss investment bank, UBS, with lots of Middle-Eastern clients(!) has just published a research paper stating that recently announced global climate/ temperature targets render vast amounts of reserve energy assets almost worthless. UBS estimates the cost of writing off these reserves, or stranded assets, could be in the region of $900 billion. The energy sector is in very big trouble and for lots of reasons which brings us to our final point about crowd wisdom.

    One of the caveats in Surowiecki’s book was that wise crowds should be able to have a diversity of opinions. In the case of energy there is more than one driver of the steady decline in the sector – renewable energy, EV revolution, climate change, etc all have their champions. In the Tesla share price gymnastics this week there was a sense the only driver of investor purchasing or selling was overconfidence on an individual and crowd basis that expertise existed on the direction of the share price. We are tempted to use the expression “price cult” as a description of the crowd. Sadly, history and science would beg to differ with that crowd’s confidence in its ability to predict future price moves.

    Similarly, we would boldly suggest Trump and Brexit cults will in years to come painfully understand the difference between the wisdom of crowds and cult-like intolerance of diverse opinions, history and science.

    “You know, a long time ago being crazy meant something. Nowadays everybody’s crazy” – Charles Manson

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  • The Price Of Certainty

    I attended a meeting last year which was memorable for only one reason. Certainty. The pretext for the meeting was the potential use of innovative data analytics to monitor modeling risks in the field of aircraft leasing. The aircraft leasing industry is rightly considered a genuine Irish success story that has ridden many challenges. So, I was a tiny bit struck by the confidence of the lead analyst in that 2019 meeting declaring his absolute confidence that its sovereign customers were unlikely to ever default and therefore he didn’t need any additional macro analytics on government credit or currencies. His certainty was based on a conviction that the last thing any government would want was a suspension of air travel to and from its national territory. Ehh, hold my Corona….

    All financial models try to account for risk but there are occasional “black swans” which can blindside the brightest. That’s why most investors look for some valuation comfort or a margin of risk. We do not mean to pick on aircraft leasing per se but it has certainly triggered a wry recollection while the Coronavirus threatens to shut China’s airspace from the rest of the world. Yep, the world’s second-largest economy is on lock-down and oil consumption is already estimated to have fallen by a quarter.

    Ecowarriors will be thrilled; OPEC and central bankers are extremely anxious. This virus can’t even be considered a “black swan” given previous SARS outbreaks in 2002-2003 so let’s hope aircraft leasing models have factored in significant economic damage at the sovereign level. It’s not necessarily China we are talking about. It will be poorer Asian and Latin American nations dependent on Chinese trade. This is already causing the Brazilian real and other emerging market currencies to hit new lows. Meanwhile, “certainty” is evident elsewhere across a number of financial markets. Here are a few high profile examples:

    • Apple is now worth more than Germany’s entire stock market. It is incredible that the future of Apple (all equities discount the future) outstrips the entire corporate prospects of the leading exporting nation on the planet.
    • Bonds continue to hit new valuation highs as yields go lower. Again, a multi-year perspective would hesitate in declaring inflation effectively dead. Black swans and all that…..
    • US stock markets continue to roar to new valuation highs oblivious to the fact that China is a vastly more significant player in the global economy than it was during SARS time when the S&P 500 dropped 16% in a 5 month period.

     

    Returning to aircraft leasing one can’t help noticing that other trends are less than helpful. Take your pick from climate change, carbon/gas emissions targets, ESG investing criteria and populist (anti-globalism) electoral trends. In some ways the Coronavirus is already a global carbon tax, killing off 3 million barrels of oil demand in a matter of weeks. It’s possible the first significant financial impact of the Coronavirus will be a commodity or oil-producing nation defaulting on debt payments. This will test my aircraft leasing friend’s assumptions.

    It is true that a country would be loath to destroy its credit rating in the aerospace market. However, Greece is the word these days for credit doomsdayers. Remember how Greece was “certain” to take decades to return to the bond market. Take a sip of that Corona and note that Greek 10 year bond yields have traded as low as 1.15% in recent days. That’s a 0.45% cheaper rate of borrowing than the U.S. of A!

    The price of certainty can sometimes be rather embarrassing and painful…

     

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  • Corona Contagion Or Brexit Lesson?

    There used to be an old trading rule of thumb that if British Airways financial performance started to suffer then it was sensible to sell the shares of global investment banks like Goldman Sachs, Morgan Stanley and Credit Suisse. The trader thinking was that a drop in profitable business bookings on BA signaled a downturn in international financial activity. Today’s news that BA is suspending flights to and from China did prompt some similar thoughts. Clearly, the Corona Virus is a medical story first as medical authorities struggle to contain the outbreak. The good news is Australian scientists have made some progress in recreating the virus and ultimately finding a vaccine. The bad news is possibly more financial.

    Despite the best efforts of Donald Trump, Boris Johnson and other stable geniuses to mislead on trade, the global economy is incredibly connected these days. Just-in-time supply chain management allows companies to efficiently manufacture goods and sell to consumers at ever-cheaper prices. As we digest Apple’s astounding quarterly results from last night, we couldn’t help noting that AirPods alone are on course to exceed $20 billion of sales. This product only launched 4 years ago and is on the cusp of matching the annual global revenues of  Starbucks by 2021. Mind-blowing.

    Apple is Exhibit A in incredible manufacturing/supply chain management;  through 2019 Apple was shipping more than 500,000 iPhones and 150,000 AirPods on a DAILY basis. However, it needs air freight to move high-value parts and finished products around the globe. The BA news today will focus minds. Airfreight moves $6 trillion of goods globally each year which is more than a third of global trade by value. In our previous piece “Charting A Dose Of Flu” we flagged that the real worry for financial authorities is a global halt of the cross border movement of people and goods. One can be hopeful that the medical outcome will be managed but the economic damage could be significant for companies in 2020. Here’s a few headlines which caught the eye:

    Financial markets yesterday recovered from Monday’s swoon but it is difficult to see how the Coronavirus will not inflict financial pain on companies and that is before we start to read headlines about supply chain interruptions for manufacturers all over the world. Bosch has already warned about problems brewing in its own operations which employ 400,000 people globally with 60 factories in China alone. They probably know what they are talking about.

    The above information is just that. It is not a call to panic. Markets encounter external shocks all the time. On the contrary, a little deflation of markets is healthy and allows investors to avail of cheaper opportunities. Perhaps, the more significant lesson is for the anti-globalist delusionists occupying political leadership positions. Disruption to global trade or trade agreements can be incredibly painful. So, take that as our 50 pence worth for Boris and the Big Ben clappers. Sadly, the commemorative tea towels for January 31st won’t be sufficient to clear up the Brexit mess.

  • An All Cash Strategy Is A Very Big Bet

    Winter League tennis is hardly in the glamour league of January sporting events but it still can deliver learning lessons. As my doubles partner whispered to me at the weekend that his back was crocked, we had a rueful giggle recalling the Mike Tyson quote that “Everyone has a plan until they get punched in the mouth”. Indeed, investors might be feeling the same this week as markets take fright at the potential economic impact of a Chinese Coronavirus. The excellent financial commentator, Bill Blain, at The Morning Porridge calls the unexpected punches “no-see-ums”. Of course, regular readers will be less surprised at developments given our words of caution last week in “Charting A Dose of Flu”.

    We’d rather move on and tackle another area of concern. It is striking to us that total Irish household deposits (cash) in the banking system now exceeds €110 billion. That number increased by circa €7 billion alone through 2019 despite every asset class on the planet posting significant gains thanks to the global central banks’ QE methadone clinic. Of course, it is wise to have a healthy skepticism when the crowd gets giddy. Keeping some cash on hand is always prudent. But €110 billion? Over the years when I have been in wealth advisory mode I have often heard individuals claim an agnostic attitude to financial markets and a preference for cash safety by avoiding “any bets”. Sadly, that is a dangerously inaccurate perception of one’s own safety strategy. The truth is holding too much cash is an extremely strong “bet” in its own right. We can think of two “punches” which could throw that safety plan into disarray.

    Firstly, in a low inflation world, holding cash is less punitive because the purchasing power of savers is largely unaffected. One might quibble with that “low inflation” view when you look at health, housing education and insurance costs but let’s just focus on traditional inflation reports. It is true to say at this moment inflation is very subdued in developed markets but inflation is one of those things that can suddenly appear without much advance notice. Hence, our curiosity was tweaked to see an FT report on consumer price inflation in emerging markets hitting a six-year high in recent weeks. Here’s the chart of a significant inflation spike:

    This spike is driven mainly by food inflation which we warned of earlier in 2019 as African Swine Fever decimated the Chinese hog population. However, Coronaviruses and climate change are examples of other potential disruptions to the food supply for a rapidly growing Asian middle class.

    Perhaps inflation spikes will be just a temporary thing, but the meeting of a low-interest rate world and a digital world is also worth thinking about as a second threat to cash savers. Bluntly, banks are losing money by holding deposits for private depositors. Corporates are already being charged for the safe custody of cash in Europe as negative interest rates wreak havoc with traditional deposit/lending banking models. Furthermore, the use of physical cash in payment transactions is more costly than digital equivalents.

    Be prepared for cash payments to incur additional charges and look no further than Sweden for a glimpse of the future. Barely 1% of the value of all payments in Sweden are made using coins or notes. In fact, Sweden is forecast to become an entirely cashless society by 2030. It seems inevitable that banks and governments will encourage/incentivize the use of cash deposits through taxes and fees. Suddenly that “cash safety plan” feels like a very big bet that things are just going to carry on as before. While it is difficult to forecast the future it is safe to say the future and the value of cash are less certain.  As we always say, a strategy allocated to just one asset class, even cash, is a very risky one.

    A balanced investment strategy across residences, property, pensions, cash, alternative assets, wine, fine art and even funding exciting start-ups has its merits. For those interested in looking for cash alternatives it might be worth looking at our recent piece “Good Portfolio Habits Pay Off” to prompt some thought! So, ship those Boris Brexit souvenir 50p’s in. They could be both financial and comedy collectors’ memorabilia items over time. Embrace change. It is happening and we must remember another boxing legend’s words…

    “A man who views the world the same at 50 as he did at 20 has wasted 30 years of his life”  – Muhammad Ali

  • Charting A Dose Of Flu For The Markets

    The old adage that financial markets climb a wall of worry is very well known. However, human beings are particularly poor at identifying in advance exactly which specific worry or risk might spook the markets. Furthermore, the army of 2020 hindsight ‘gurus’ providing post-factum analysis has never been shy of rationalising a market swoon despite this same analysis providing zero commercial value. Risk is a fact of life in capital markets and market fluctuations come and go.

    Indeed, my former colleagues still tease me about a previous analytical role of mine in the early Noughties by mimicking my high pitched squealing about the potential impact of Bird Flu. Not surprisingly I have been on the receiving end of a few playful calls already about the Coronavirus outbreak in Wuhan. Unperturbed by this ribbing, I am going to go out on a limb here and state that markets are at an interesting inflection point where heightened levels of market exuberance are coinciding with the limited risk muscle memory of previous mystery virus outbreaks in China. Here’s a quick reminder of the impact of the SARS outbreak in 2002-2003 and a number of current exuberant data points plus charts.

    First, let’s remind ourselves of the SARS effect on markets in 2003. From November 2002 when the first SARS case was identified in Southern China to March 2003 the S&P 500 index of the largest US stocks fell by 16%. I recall a senior trader at a large Swiss Bank telling me about very anxious risk management meetings and the less-well-known critical significance of the potential global halt of cross border movement of people and goods. Let’s just say the economic worst-case scenarios were not pretty. Ok, that’s the scary reminder bit. What about the exuberance we referenced earlier? Take your pick from the following data points and charts.

    Markets are rising on a daily basis but in terms of volatility, things have been “quiet”,  i.e. the number of individual big day moves has been non-existent for a long period now. Stocks rarely go this long without a big move. The chart below illustrates where the current period ranks in the league tables of complacency.

    Individual stocks showing parabolic moves can also be a “tell” of exuberance so we are quite intrigued by Tesla’s recent moves. Its market capitalisation (value) now exceeds that of the entire US auto sector (GM, Ford etc). This prospect was written up in this column previously as a potential 2020 uber-surprise; little did we think it would happen within the first three weeks of the year. It’s possible there is a single stock story there but a quick look at the 5 largest stocks in the US also raises a few eyebrows. The concentration of capital in the US market’s 5 largest companies is at a twenty-year high per this Bloomberg chart below.

    It’s not just the mega-cap end of the market. The overall market is cruising to record valuation levels as a multiple of future earnings (P/E) for this business cycle. The chart below shows a pronounced spike in recent months courtesy of the excellent Daily Shot blog/newsletter.

    It is fair to say that if the newsflow on the Coronavirus outbreak continues to escalate the chances of investors sitting on 30-40% gains over the past 12 months taking some money off the table is pretty high. On a more positive note, corrections are healthy and the overall picture of the global economy and financial conditions is pretty robust. There is still a wall of central bank monetary support, historically low costs of capital and signs of a pick up in the global manufacturing sector.  Temporary shocks also present cheaper opportunities to revisit great stories missed in the big moves over the past year.  So, it might be time to be greedy when others fearful as Warren would say.

    In the meantime, I will brace myself for ridicule and a round of Coronas on me in a few weeks at a local hostelry with former colleagues. As the great traders know, it’s best to stay humble and liquid….

     

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  • Good Portfolio Habits Pay Off

    Nobody ever told me the Great South Wall was that long! As the muscles screamed and the expletives flowed on my not-so-little run yesterday there was a fleeting moment when I almost quit. I wouldn’t have been alone on January 19th.  Research conducted by Strava based on 800 million user-logged activities predicts this date as the day most people are likely to give up on their New Year’s resolutions. In fact, approximately 80% of resolutions are abandoned by the second week of February. Thankfully, the sun was shining and the brain cajoled me into accepting that this run was just one of a series of good habits to deliver a very productive 2020. Of course, the outcome is not a certainty but good habits vastly increase my chances. The same goes for investment goals.

    Investment can be made to sound very complex. The professionals love complexity as it’s a perfect environment to sell expensive products and services to the least sophisticated clients.  Whoodathunk there are more investment funds (75,000  at last count) to choose from than individual stocks globally? Yes, financial markets are complex but simple good financial habits can greatly increase investors’ chances of meeting their goals over time. We have previously written about the advantages of a portfolio approach versus the “lucky dip” dreamer derby so a portfolio of multiple investments is a sensible start.  But what’s your goal?

    The answer to this is entirely dependent on your age and your tolerance/capacity to suffer loss (even permanently). We shall assume for the purposes of this article the time horizon is 10 years and that the capital in this portfolio can incur some losses along the way and won’t be needed to fund living expenses over the period. No doubt readers are aware financial markets have had a good run over the past decade. It is entirely sensible to take the view that we must rein in our expectations for the next decade. Wall Street giant, Morgan Stanley, has already tried to manage expectations with its strategists suggesting a standard mix of bonds and equities in a portfolio would earn just 4.1% each year over the next ten years. Low-interest rates, low growth and commensurate low inflation are the familiar returns killers.  Here’s the chart to anchor our goal expectations:

    Now, let’s shift our attention away from the expensive large listed companies and all those bonds yielding zero or even less. In a previous thought piece, we wondered if smaller companies have some performance catch up to do on their much bigger listed peers. Holding that thought, we reckoned it might be helpful to illustrate the relative possibilities of assembling a portfolio of crowdfunding start-up opportunities over a four year period. So, here’s a suggested approach with plenty of good habits:

    1. Invest €100 in an equity crowdfunding campaign every month for 48 months (4 years). This good monthly habit avoids trying to “time” your entry into markets which will fluctuate over a long period.
    2. The portfolio goal is to own 48 equity opportunities in equal amounts of €100 by the end of year 4. This good habit of multiple holdings diversifies the portfolio across industries and geographies.
    3. A portfolio with multiple holdings also allows an investor to collect financial data across those companies and monitor various key metrics like sales, growth, cash flow/burn, margins, debt etc. Like all resolutions/habits – they are only sustainable if measured. This habit of measuring will ensure discipline and selection of opportunities which are consistent with the metrics/averages being observed. More on that again.

    Good habits now in place, will the portfolio deliver? There are no guarantees in finance but here are a few suggestions as to outcomes and the understanding that the professionals think 4% per annum might be the best on offer over the next 10 years. We are suggesting a €4,800 investment of capital. We will assume that all target investments (48) benefit from a 40% tax refund under the EIIS investment scheme.  After refunds of €1,920, investors’ are risking €2,880 in real terms. So that’s the capital at risk. We need to look at where the returns come from.

    Readers will recall our previous references to the famous Arizona University research showing just 4% of all the listed stocks in US history have delivered the entire returns of the S&P 500 since 1926. In theory, and the sample size is small, it is possible as few as 2 holdings in a 48 constituent portfolio will account for the majority of returns. Now, remember Morgan Stanley is telling us a 4 year period might deliver a return on our capital of just over 16%.  Here’s a table to suggest potential outcomes. We are going to assume the rest of the portfolio loses the equivalent of the tax refund(40%) ie 46 of the companies which received €4,600 in capital will lose €1,920 between them. Admittedly, this is probably too harsh an outcome but it will help illustrate what is required by just a few successes to beat a 16% portfolio return forecast on Wall Street. The following table lists a few scenarios and the impact of two companies achieving significant valuation growth:

    Please note in the “2 Winners”  column we are using €200 (€100 in each company) as the initial invested capital. Therefore a gain of €500 in the Match Wall Street scenario requires both companies to increase their value by just 1.5x. This is not a significant hurdle in the world of smaller companies and start-ups. The Run Wall Street scenario might sound fanciful equating to a 20x gain (or 2,000%) on the initial capital invested in the two companies. However, this is very possible in the world of private equity and startups. Yes, there is the risk of losing all your capital when betting on single winners but portfolio diversification is a very good strategy in a high-risk asset class.

    Returns are inextricably linked with risk. That’s a fact and don’t ever buy any product which claims no risk involved. In the worked example above your total capital at risk was €2,880. For perspective, that equates to €15 per week of spend where the loss of capital is permanent – think almond cappuccinos, cars/taxis and mobile data usage on a weekly basis. Maybe take a walk with a bottle of H2O? What productivity goals wouldn’t prosper by ditching the screens, exercising and hydration…..

    Finally, in the spirit of fresher thinking, it is worth noting the most unlikely companies can be the big winners so keep an open mind and spread the risk when building an investment portfolio. As an illustration and a little quiz, what’s the best performing listed stock in the US over the last 20 years? The clues would be that it features in a previous article and it delivers energy, but not the carbon-based kind!  A real Monster which has delivered 87,000% returns over two decades. Wowzers!  Good habits can really energize……

  • Banking Facing The Digital Music

    As I flicked through the quarterly results of JP Morgan and Citigroup this week I was reminded that in some ways the whole future of the financial system lies in my brother’s hands. He currently works for another monster bank and there’s a part of me which hopes he will leave banking for all our sakes. Perhaps I’m over-egging this career wish but the previous four banks for which my grim reaper-relative worked all went bust. The world can’t afford a sudden megabank failure. The good news, for now, is that things in the near term big banking world are pretty strong.

    Despite some gloomy predictions for the future of banking, JP Morgan just posted the most profitable year in the history of US banking. This makes it increasingly likely the record total $111 billion profits made by the big 6 US banks in 2018 will be beaten in the next few weeks as 2019 joins the reporting history books. Regular readers are certainly familiar with the challenges to traditional banks posed by technology transitions and even Big Tech competition.  However, it is still possible banks will not disappear but rather change their interface with customers.

    We recently wrote in our article “Are You Ready For Change?” that finance would probably become “a feature” of most products and services but would no longer be accessed as a standalone access point:

    “If we recall the pre-Amazon era, consumer spend and logistics were separate activities. Now, delivery is a feature of consumer spend from Christmas trees to sushi. In the world of finance, it is quite likely payments and financial services will be embedded features of other services rather than standalone banking. Prepare for “location” banking to die.”

    This prompted some thought as to whether there were any analogous experiences in another industry. Well, it has become mainstream thinking these days that banking is facing a technological music with which it might struggle for relevancy. So, let’s look at the music industry. As recently as 2014 the death knell of the industry was sounded with global recorded music revenues collapsing by 25% from $19.6 billion to $14.3 billion since 2006.

    The revenues from physical music alone in 2006 were worth $16.4 billion. The doomsdayers were correct. Physical music revenues have fallen a further 75% but there was no such thing as “streaming” back in 2006. Now, music streaming revenues account for more than 50% of global music revenues. Here’s the comeback graphic:

    Graphic showing the global recorded music industry revenues 2001-2018 (US) Spark Crowdfunding blog

    So let’s hold that “streaming” thought for the banking industry. It is entirely possible there will be new channels for banks to deliver core services. We should be watching activity in the “plumbing” of financial services for clues to the future. Interestingly, this week we witnessed a very big fintech deal with Visa Inc agreeing to purchase fintech start-up Plaid for…. $5.3 billion.

    For perspective, Plaid raised $250m in a Series C funding round barely more than a year ago at a $2.65 billion valuation. Plaid is a “plumbing” or “streaming” play as it allows consumers to connect their bank accounts to various 3rd party services from wealth manager robo-advisors to insurance. The technology which allows this connectivity is Application Programming Interfaces, or APIs. The following graphic shows how APIs work:

    How Open APIs work Spark Crowdfunding blog

    Clearly, Visa Inc sees the value of owning the plumbing which is connecting the latest fintech to traditional bank accounts. Note this deal does not preview a world where bank accounts disappear. Perhaps current thinking is too negative on the future of banking?  Music could be the inspiration, and ironically music featured in our last banking crisis. It was a rather unfortunate quote from a Citigroup CEO in 2007 who insisted “as long as the music (liquidity) is playing, you’ve got to get up and dance”. Well, the music stopped too quickly for Chuck Prince and many other failed banks.

    Technology is the current gloomy soundtrack for banking but “streaming” and APIs provide potential recovery and a future. Now, all we have to do to ensure planetary financial survival is persuade my brother to take up the guitar full time…..

  • Warren Buffett Not Feeling The Love

    It is amazing how a new series of Love Island can prompt such profound existential questions. Were Conor’s teeth stolen from the Fleabag make-up department? Will apprentice Lord, Ollie Williams, confess to predatory trophy hunting of wild animals before the Gale twins entertain his drooling advances? Profound questions indeed but these still couldn’t better contestant Callum Jones’ query as to whether the twins were both 20 years old. Yep, the twins bit was the clue Callum. While we pine for the return of the Teletubbies for intellectual stimulation let’s move on to another more serious question bothering us last night.

    The world’s most famous investor, Warren Buffett, is currently sitting on $128 billion of cash and we are wondering why he isn’t listening to President Trump. The White House is telling us the US economy is in the best shape of its life. Thankfully this observation stands up to data scrutiny better than the medical opinion of the doctors looking after the Orange Toddler. Consumer confidence is high as the US enjoys full employment, record Wall Street highs, low-interest rates, tax tailwinds and energy independence. What’s not to like about that?

    Well, Warren has been doing this investing thing for a very long time and he doesn’t need the instant gratification or performance required of more youthful investment houses. However, we were struck by the fact that Buffett’s last big deal was in 2016. Back then during a ‘socialist’ Obama administration, he splashed out $32 billion on industrial player, Precision Castparts. It must irk Trump that the Sage of Omaha has failed to endorse his presidency with a big deal. An unusual experience as this may be for regular readers, we are reluctant to pin Trump with the blame on this occasion.

    In this particular instance it would seem that very large companies are pretty expensive at the moment. And Buffett needs to do big deals to really move the performance dial. In his most recent annual letter to shareholders the Berkshire Hathaway chairman admitted that “prices are sky high for businesses possessing decent long-term prospects”. A few other things also probably bother Warren.

    Over the years he has been very fond of monitoring the relationship between the total value of the US equities markets and the US economy (GDP). The current measure of that relationship indicates a market valued at 157% of the GDP of the US, according to Wilshere index data. That is high by historical standards and compares to a 137% figure just before the credit crisis in 2007. Buffett is typically uneasy when the market goes over the 100% mark. So, that certainly must be weighing on his mind.

    He will also be noting that the global equivalent stock market value of $88 trillion (record high) amounts to 100% of global GDP. Furthermore, Buffett understands the role of credit/debt. Ultra-low global interest rates are rocket fuel in the short-term but excessive leverage can come back to bite investors very badly. Current IMF estimates of global debt are closer to $260 trillion. A debt pile almost three times the size of equity funding the global economy can certainly be described as ‘leverage’.

    Before we spook the horses it is important to point out that Buffett, due to Berkshire’s size, is nowadays forced to do very large deals. There is a school of thought that excessive valuations are concentrated in the very large market capitalization stocks. As an illustration, just 5 stocks (Apple, Microsoft, Facebook, Google and Amazon) accounted for a quarter of the S&P 500’s 26% gain in 2019! On top of those elevated valuations Buffett would also have to pay a premium to execute a buy-out. Now consider the estimated $2.5 trillion of private equity money sitting on the sidelines competing with Buffett to do deals. Low-interest rates and great tax deals are fueling great exuberance at private equity houses. However, it is worth considering one of Buffett’s more famous pieces of advice, “ Be fearful when others are greedy, and greedy when others are fearful”.  Just recently Buffett was outbid by private equity house, Apollo,  in a relatively small $6 billion deal for Tech Data Corp (TDC).

    Perhaps readers should take encouragement from Buffett’s attempts to take smaller ‘bites’ like TDC. In fact, it is interesting that the US index which tracks smaller companies, the Russell 2000, is at exactly the same levels as it was trading at two years ago. There appears to be more worry and fear in the smaller companies’ world. Now hold that thought and think about Buffett’s patience and requirement for ‘value’ as a margin for error. How heartwarming it would be, as Love Island envelops our consciences and sanity, that smaller companies could begin to feel ‘the love’ of investors in 2020.

     

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  • Pick A Winner Or A Portfolio?

    I met a very glum Italian fund manager at a Dublin bus stop the other day. A former client, he’s usually a cheerful chap and my initial fear was that after 18 years living in Ireland the excruciating “1-minute due” display at urban bus stops had finally broken him. I was wrong. Something else was broken.

    Irrespective of our professional relationship, both of us over the years would have shared a passion for financial markets and the events that shape them. On this particular morning, my fund manager friend was less talkative and declared he was past caring about the specific drivers of markets as it just didn’t matter anymore. For a brief moment, I thought he had lost his job but he quickly reassured me he was still working in the equities market. He then explained that the reason for the dip in his professional enthusiasm was a sense that markets were “broken”.

    After further discussion, it was clear that central banks’ ultra low-interest rates and consequent turbocharging of prices across all asset classes were not his only professional frustration. Yes, as an “active” fund manager this combination of almost free money and frothy asset inflation made it difficult for his firm to beat or even match the performance of overall market replicating index funds and exchange-traded funds (ETFs). But there was also a whiff of resignation that the higher fees charged by an “active” manager who picks individual stock winners could no longer be justified. Bluntly, the active fund manager business model was in danger of breaking too.

    Not so in the world of super cheap index funds and ETFs. These funds don’t pick winners or actively trade. They just mimic at very low cost the exact constituents of major indices like the S&P 500, Nasdaq, Dax and FTSE 100. The past decade has only seen one negative performance year for global equities and passive fund costs to investors continue to go lower, in some cases to almost zero. No surprise then to see that index funds and ETFs have quadrupled in size since 2010 to just over $10 trillion according to Robin Wigglesworth at the FT.

    The investor flight to cheap index portfolios is killing the traditional active manager who charges his/her clients an annual management fee based on their expertise in researching and selecting winning stocks. The ugly truth is that such “expertise” fails to reveal itself consistently and only a very few active managers produce long-run market-beating performance. Time is possibly the active manager’s greatest weapon – think Warren Buffett. However, long-run historic data would suggest there really are only a few meaningful winning bets.

    We have previously referenced a famous 2017 research paper from Arizona State University’s Hendrik Bessembinder. The findings are stunning. The best-performing 4% of all listed companies account for the entire gains of the US market since 1926. As practitioners in the world of start-up investments, this has given us pause for thought as to the best investment strategy for investors on equity crowdfunding platforms like Spark CrowdFunding.  The good news for crowdfunding investors is that a critical component of performance/success in the larger public markets is low costs.

    The no-fee model for investors on crowdfunding platforms is a great start. It gets even better if one takes into account a further 40% discount on your initial capital stake when the investee start-up company carries an EIIS badge.  So far so good. The next suggestion leverages the experience of active and passive managers over the years and the historical truths in Bessembinder’s research. It is incredibly difficult to pick winners, particularly at an early stage in a company’s journey. The information gaps are huge. However, by employing a portfolio/index type strategy an investor can not only build his own low cost (free) exposure to an entire asset class of start-up private equity but can also avail of a steady stream of opportunities on crowdfunding platforms over 3-4 years.

    A simple monthly budget of even €100 to be invested in a company every month for 4 years would give a patient investor exposure to almost 50 companies with exciting prospects. Some companies might not survive but those that thrive can deliver very nice returns for the overall portfolio. Don’t forget you have a 40% tax cushion to start with so your approximate €5,000 budget over 4 years is really only €3,000. Then remember that 4% figure from Arizona.  My fund manager friend is beginning to realise his time would have been better spent building portfolios for specific asset classes (like private equity) rather than trying to find the very few “winners” in the broader market indices.

    Crowdfunding investors can benefit from the 2020 hindsight of battered active fund managers over the coming years with a sensible portfolio strategy. We will be writing much more on this in the coming weeks as we get a sense of our monthly pipeline of campaign opportunities. Unlike Dublin Bus, we will avoid the “1-minute” hype and do our best to provide a steady flow of campaigns through 2020.

     

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  • Are You Ready For Change?

    Any year featuring a new business, a new home, a 50th birthday and a divorce probably qualifies as a year of change. However, as I ran by the Poolbeg towers in the early days of 2020 my initial anxiety as to the pace of change in my life last year receded with the calming effect of a healthy dose of fresh air, endorphins and perspective. Maybe it’s an age thing, rather than my running speed, but it feels like the pace of change in the world is also picking up rapidly. In fact, on more considered reflection as I skirted Dublin Bay, my gut feeling was bolstered by the hard evidence of recent events.

    Let’s start with location. Location, location, location is the perennial property mantra. Indeed, investment in Irish commercial property in 2019 set a new record of €7.2 billion in sales value. That reflects a healthy business environment and, given 74% of the investment came from overseas investors, an external vote of confidence in Ireland’s future. However, striking as those sales statistics may be, the most stunning location figure for me in 2019 was the discovery of the largest live music venue in history. It wasn’t even on planet Earth.  The online gaming platform, Fortnite, hosted a 10 minute Marshmello performance which was witnessed by 10.7 million gamers at the same time. Now think about  Mass Open Online Courses (MOOC) in the world of education and one begins to realise the most valuable locations in the next decade are more likely digital than physical.

    Of course, many people spend the vast majority of their waking hours in the office place. The five day 40 hour week is undergoing serious review as productivity growth has ground to a halt in many developed economies. This puzzles many economists in a digital world but ignores the behavioural aspects of human endeavour. Four day weeks are increasingly common and “hot desks”  have become a major feature of office life but is it helping productivity? The evidence from Microsoft is thought-provoking. Having briefly regained its crown (pre-Aramco IPO) as the most valuable company in the world the business community is keen to learn from the Seattle brains trust. So, when Microsoft tested a 4 day work week in Japan the business world was jolted by a whopping productivity jump of 40% during the summer trial period.

    Companies may not have a choice in changing the conditions of employment. Japan now sells more adult diapers than infant diapers as demographic change bites. Japan now supports an over-65 demographic which accounts for 26% of the population! A shrinking labour force supporting a growing retirement population is not sustainable unless productivity grows sharply. China and Europe face similar problems this decade so expect major change to employment practices.

    Fortunately, AI (Artificial intelligence) is going mainstream. The value creation associated with AI in the next decade is estimated to be in the region of $15 trillion by the likes of McKinsey and Accenture. The numbers might not materialise but there is no doubt the workers of this decade will need to embrace the reality of working with technology, automation and even robot supervisors. The option for businesses to wait and see, do nothing or just hope is a death strategy.

    Financial services and banks are a good example of businesses that must change, quickly. Recent announcements from Apple, Facebook, Google and a plethora of Chinese players is confirming a major move by Big Tech into payments and financial services. If we recall the pre-Amazon era, consumer spend and logistics were separate activities. Now, delivery is a feature of consumer spend from Christmas trees to sushi. In the world of finance it is quite likely payments and financial services will be embedded features of other services rather than standalone banking. Prepare for “location” banking to die.

    Clearly, as human beings, our DNA has strong survival instincts despite our collective best efforts to kill our planet over the last industrial revolution. It would seem climate change will be an accepted part of our lives over the next decade. The last decade was the hottest on record with July last year documented as the hottest month in human history. The catastrophic fires in Australia are a further reminder that climate science denial is not a survival strategy.

    It would be wrong to conclude this piece with a negative change and it is wholly appropriate that the most prominent climate neanderthals are leaders elected on election platforms railing falsely against the woes of the world and warning how everything is taking a turn for the worst. The facts do not support fanning those fears. A recent fascinating article by Pulitzer Prize winner, Nicholas Kristof, in the New York Times posited the view that 2019 was actually the greatest ever year to be alive:

    “If you’re depressed by the state of the world, let me toss out an idea: In the long arc of human history, 2019 has been the best year ever … since modern humans emerged about 200,000 years ago, 2019 was probably the year in which children were least likely to die, adults were least likely to be illiterate and people were least likely to suffer excruciating and disfiguring diseases.”

    Furthermore, some of the statistics of recent years are truly remarkable. Every day in the past few years 325,000 got their first access to electricity and an amazing 650,000 people went online for the first time, every single day! Child mortality before the age of 15 has dropped from 27% in 1950 to less than 4% today and extreme poverty globally has halved since 1990.

    So it’s all change. A lot of it good. There will be challenges ahead but without sounding like Mel Gibson in Braveheart if, as a business or a human being, one runs away from change you might live. At least for a while. To really survive, the time to prepare for change is now and accept there will be failure along the way. That’s life.

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