We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general. 

Here are the articles for the week ending 11 February 2024:

1. Sal Mercogliano on What’s Happening in the Suez Canal Right Now – Tracy Alloway, Joe Weisenthal, and Sal Mercogliano

Joe: (02:45)

Let’s just start really big picture with how extraordinary and unusual is the scale of this disruption happening right now?

Sal: (02:55)

You’re looking at about 11% of the world’s trade goes through this vital maritime choke point, the Bab-el-Mandeb. This is the Gate of Tears, this is the very southern end of the Red Sea. This is the connection between Europe and Asia, but it’s much more than that. You’re looking at trade that goes not just between those two areas, but actually kind of like a hub and spoke system kind of radiates out around the planet.

And this attack by the Houthis, which started off very small scale, you saw a helicopter assault onto a ship. The Galaxy Leader back on November 19th has now escalated. And what we’ve seen is not just container ships that have started to divert around, but now liquified natural gas carriers, liquified petroleum gas carriers, tankers, and even bulk vessels are now moving around.

And as you mentioned, this adds 3,500 miles. But the biggest thing is it creates massive delays and disruptions. And for the Houthis, which are a small player, you know, one part in a three-way civil war in Yemen, they have created more disruption of global trade than you — you almost have to go back to the world wars to find something similar to this.

Tracy: (04:06)

So Sal, you mentioned that the Houthis have sort of expanded their repertoire of attacks, I suppose to now include LNG and bulk vessels and things like that. What is their strategy here and how has it evolved over time? Because we have seen an escalation since November, but there were sort of isolated attacks happening [even] before then. So what is changing here?

Sal: (04:30)

Yeah, so initially they were focusing on ships connected to Israel. I mean, the root of this issue is the Houthis’ kind of solidarity with the Palestinians and Hamas in the Gaza Strip. And then again, it goes all the way back to the Israel-Hamas issue.

But we’ve seen the Houthis attack ships prior to this. Go back to 2016, 2017, we saw attacks on UAE vessels. We saw an attack on a Saudi frigate. We even saw an attack on a US Navy destroyer. But this effort recently is focusing on Israeli-owned Israeli flagships.

So we saw ships of ZIM and other Israeli companies immediately divert, but then the Houthis expanded. They started targeting vessels, they said [were] connected to Israel, either through their ownership, so for example, Mediterranean Shipping Company, what [is] the largest container liner in the world. They started targeting their ships because the owner’s wife, of Mediterranean Shipping Compan,y has dual citizenship — Switzerland and Israel.

And then we saw attacks that really had no connection at all to Israel, but they would try to make those attacks. And what these attacks are doing aren’t really so much damaging vessels. We’ve seen ships hit and we had a very dramatic one just the other day with a ship called the Marlin Luanda, which caught fire.

But what they’re doing is raising the cost to sail through this area by escalating war risk insurance. And we saw a very similar thing happen in the Red Sea between Russia and Ukraine. But by escalating war risk insurance, the added insurance you need to sail through an area, you make very expensive ships such as container ships, which have a value of between a quarter to a half a billion dollars, cost-prohibitive to sail through. We saw the war risk, for example, jump from 0.02% the value of the ship up to 1%. And when you start doing the math on value of vessels, the very expensive vessels find it more costing economical to sail around Africa.

Joe: (06:27)

Wait, wait. This is interesting. How is war risk insurance assessed? And when you say, like, 1%, is that per trip? How do those… talk to us a little bit more about these deals and the math there.

Sal: (06:44)

Sure. So shipping insurance is done by a group of companies called clubs. And they get together and literally there’s a committee in London that puts together areas of war risk. They identify the areas that there are confrontations and basically whether or not you need this added insurance, kind of like flood insurance for your house. If you don’t have it and your house is damaged by a flood, your normal insurance wouldn’t cover it.

So they identify the area in and around the Red Sea as a potential war risk, initially down to that 0.02%. But as the Houthis attacked and then increased their level attacks, they have ratcheted up that war risk. We’re seeing right now, for example, up in the Black Sea, that war risk is right around 1.25%. That’s come down from about 3%. And so this committee will assess that. And if you want to sail through these regions and they specify latitude and longitude and the distance, you pay it for that one time voyage.

So let’s assume you have a ship of a hundred million dollars, both the value of the ship and the cargo, then you have to pay a million dollars to go through there. And now, you start weighing that against, well, it’s about a half a million to go through the Suez, but it’s going to cost me over a million dollars in extra fuel to go around. What’s the cost-benefit here for doing it?

And what we saw is on the higher end ships, the container ships, the LNG and LPG carriers, then they were weighing as like ‘Okay, it’s much more economical and safer for me to go around Africa than to take this risk.’…

…Tracy: (19:13)

So we have seen [spot] shipping rates go up recently, but my impression is that a lot of the shipping rates are, you know, the shipping rate is sort of pre-agreed, contractually agreed some time ago. And yet we have seen this increase in costs. You described how the wartime insurance rate goes up, it seems [it does so] fairly quickly. You have captains that are presumably wanting additional compensation for taking on this risk. How quickly and how much could shipping rates actually rise from here?

Sal: (19:46)

So, you know what we saw during the height of the supply chain crisis, you see all those charts, that was the spot [rate], right? That’s the rate you pay if you don’t have a long-term commitment in place. Most shipping, most containers, for example, are on long-term charters. And so those, you know, about 70% of the cargo that’s moved is on long-term.

But ironically, the route between Europe and Asia was up for renegotiation as of January 1st. So right when this was taking place, we saw that happen. But even if you have a long-term shipping route agreement, there are charges that can be imposed on top of that surcharges for extra fuel for port stays.

And so a lot of companies that were shipping goods all of a sudden started getting notices like ‘Well, my container’s going to be a thousand dollars more than I thought it was going to be.’ Well, that’s because the company sat there and said ‘Well, I had to stop in South Africa and buy really expensive fuel. Plus we’re not going to the port initially, we were going to drop your container off in, so we’ve got to drop it off in a sub port and it’s got to be moved over there.’

And so we saw the prices begin to escalate because the shipping companies tend to pass that cost on. And what you’re seeing now is even the long-term rates are seeing readjustments because of that. Plus the shipping companies have to readjust their schedules. You know, if you had a container ship that was going through the Suez and stopping in the Med, that’s not happening now. And now you’re seeing ships stop at other terminals dumping their containers and reshuffling them. So the ports at the entrance to the Med, Tangier and Angier and Algeciras, are getting a lot of business because you have to reshuffle containers.

And so now the, the freight rates are changing. If you look at the freight rate charts right now, they kind of peaked and they’ve kind of dipped down and now they’re starting to stabilize at this point. But we’re also seeing impacts in other ways.

So for example, the US freight rates get negotiated by May 1st, but we’re seeing freight rates increase to the United States. Why? Because a couple of factors, if you are shipping containers from Asia to Europe, I mean to Asia, to North America, for example, well you may be shipping it, you know, I don’t want to go to LA and Long Beach anymore because of the issues with LA and Long Beach that happened a couple of years ago. So I’m going to put my containers on these new Neopanamax ships.

They go through the big lane of the Panama Canal that opened in 2016. But, [it’s not] like we don’t have enough choke point issues. Panama Canal’s at low water levels. We’ve seen a two thirds reduction in the number of ships going through there. So now you’ve got this fully loaded Panama, Neopanamax ship, it arrives on the Pacific side of the Panama Canal and they can’t get through because it draws too much water.

Now I’ve got to take 3,000 boxes off rail them across Panama and meet them on the other side. That’s a cost I didn’t plan on. That ship comes to the United States offloads. But instead of going back the way it came, because it doesn’t want to take a passage through the Panama Canal, it’s now going to head back to Asia through the Mediterranean and the Suez Canal. But wait a minute, the Houthis are there. Now I’ve got to head around Africa. And so what you’re seeing is a lot of surcharges and extra charges and most importantly, delays in the movement of goods that were not planned on…

…Tracy: (37:33)

How long until the slowdown, and I guess the additional complexity that you’ve been talking about, how long until that makes its way to US supply chains? Because so far, you know, most people are talking about this as a Europe or Asia specific problem, but as you point out, it just takes some time to reverberate.

Sal: (37:53)

Well, I mean, you’re seeing that right now in Europe. You’ve had a very kind of high visibility [companies], some manufacturers, Tesla and a few others, had to shut down production because they’re waiting to get parts to them. And you’re seeing the impact of that also in the fact that ‘Well, we’ll just throw them on airplanes and send them over.’ Well, 30%-33% of the world’s aviation fuel goes through the Suez Canal and now it’s being diverted. And so now even aviation has issues associated with it.

It tends to be weeks. And we’re going to see it as right after the beginning of February, because what has happened here is a lot of empty containers — which is the most unsexy topic you can talk about is empty containers — empty containers have not been re-positioned back to Asia in time to be reloaded and put on ships to leave Asia before the Chinese New Year, before the second week in February.

Which means that goods that should have been sailing across this week and next week aren’t going to be there. Which means now you’re going to see them about a month later. So we’re going to see some delays. And again, we’re not going to see shortages, we’re not going to have the great toilet paper run that we had during 2020. But what you will see is a little bit of a spike in inflation in terms of transportation costs. A lot of disruptions.

One of the things that we did learn from 2020 and a lot of freight forwarders and smart people who went with companies that do this professionally did, was diversify how their goods come in. So there was a lot of companies who saw what was happening with the Houthis and sat there and said ‘Hang on, let me get my goods on a container ship and I’ll go into LA and Long Beach right now, because even though I hate it, I’ll go in there because I know they’re going to arrive. And I can get them in there and I’ll pay that rail because rail is looking for cargo right now.’

So a lot of people began to make movements, but some didn’t. And the ones who didn’t see this coming ahead of time, they’re the ones who are going to see it. We’re already seeing backlogs of ships, for example, start to pile up off of Savannah and some of the East Coast ports.

2. The risks to global finance from private equity’s insurance binge – The Economist

Adecade or so ago private equity was a niche corner of finance; today it is a vast enterprise in its own right. Having grabbed business and prestige from banks, private-equity firms manage $12trn of assets globally, are worth more than $500bn on America’s stockmarket and have their pick of Wall Street’s top talent…

… Core private-equity activity is now just one part of the industry’s terrain, which includes infrastructure, property and loans made directly to companies, all under the broad label of “private assets”. Here the empire-building continues. Most recently, as we report this week, the industry is swallowing up life insurers.

All of the three kings of private equity—Apollo, Blackstone and kkr—have bought insurers or taken minority stakes in them in exchange for managing their assets. Smaller firms are following suit. The insurers are not portfolio investments, destined to be sold for a profit. Instead they are prized for their vast balance-sheets, which are a new source of funding…

…Firms like Apollo can instead knowledgeably move their portfolios into the higher-yielding private investments in which they specialise…

…Yet the strategy brings risks—and not just to the firms. Pension promises matter to society. Implicitly or explicitly, the taxpayer backstops insurance to some degree, and regulators enforce minimum capital requirements so that insurers can withstand losses. Yet judging the safety-buffers of a firm stuffed with illiquid private assets is hard, because its losses are not apparent from movements in financial markets. And in a crisis insurance policyholders may sometimes flee as they seek to get out some of their money even if that entails a financial penalty. Last year an Italian insurer suffered just such a bank-run-like meltdown…

…As private assets become more important, that must change. Regulators should co-operate internationally to ensure that the safety-buffers are adequate. High standards of transparency and capital need to be enforced by suitably heavyweight bodies. The goal should not be to crush a new business model, but to make it safer.

3. Mark Zuckerberg’s new goal is creating artificial general intelligence – Alex Heath and Mark Zuckerberg

No one working on AI, including Zuckerberg, seems to have a clear definition for AGI or an idea of when it will arrive.

“I don’t have a one-sentence, pithy definition,” he tells me. “You can quibble about if general intelligence is akin to human level intelligence, or is it like human-plus, or is it some far-future super intelligence. But to me, the important part is actually the breadth of it, which is that intelligence has all these different capabilities where you have to be able to reason and have intuition.”

He sees its eventual arrival as being a gradual process, rather than a single moment. “I’m not actually that sure that some specific threshold will feel that profound.”

As Zuckerberg explains it, Meta’s new, broader focus on AGI was influenced by the release of Llama 2, its latest large language model, last year. The company didn’t think that the ability for it to generate code made sense for how people would use a LLM in Meta’s apps. But it’s still an important skill to develop for building smarter AI, so Meta built it anyway.

“One hypothesis was that coding isn’t that important because it’s not like a lot of people are going to ask coding questions in WhatsApp,” he says. “It turns out that coding is actually really important structurally for having the LLMs be able to understand the rigor and hierarchical structure of knowledge, and just generally have more of an intuitive sense of logic.”…

…The question of who gets to eventually control AGI is a hotly debated one, as the near implosion of OpenAI recently showed the world.

Zuckerberg wields total power at Meta thanks to his voting control over the company’s stock. That puts him in a uniquely powerful position that could be dangerously amplified if AGI is ever achieved. His answer is the playbook that Meta has followed so far for Llama, which can — at least for most use cases — be considered open source.

“I tend to think that one of the bigger challenges here will be that if you build something that’s really valuable, then it ends up getting very concentrated,” Zuckerberg says. “Whereas, if you make it more open, then that addresses a large class of issues that might come about from unequal access to opportunity and value. So that’s a big part of the whole open-source vision.”

Without naming names, he contrasts Meta’s approach to that of OpenAI’s, which began with the intention of open sourcing its models but has becoming increasingly less transparent. “There were all these companies that used to be open, used to publish all their work, and used to talk about how they were going to open source all their work. I think you see the dynamic of people just realizing, ‘Hey, this is going to be a really valuable thing, let’s not share it.’”

While Sam Altman and others espouse the safety benefits of a more closed approach to AI development, Zuckerberg sees a shrewd business play. Meanwhile, the models that have been deployed so far have yet to cause catastrophic damage, he argues.

“The biggest companies that started off with the biggest leads are also, in a lot of cases, the ones calling the most for saying you need to put in place all these guardrails on how everyone else builds AI,” he tells me. “I’m sure some of them are legitimately concerned about safety, but it’s a hell of a thing how much it lines up with the strategy.”

Zuckerberg has his own motivations, of course. The end result of his open vision for AI is still a concentration of power, just in a different shape. Meta already has more users than almost any company on Earth and a wildly profitable social media business. AI features can arguably make his platforms even stickier and more useful. And if Meta can effectively standardize the development of AI by releasing its models openly, its influence over the ecosystem will only grow.

There’s another wrinkle: If AGI is ever achieved at Meta, the call to open source it or not is ultimately Zuckerberg’s. He’s not ready to commit either way.

“For as long as it makes sense and is the safe and responsible thing to do, then I think we will generally want to lean towards open source,” he says. “Obviously, you don’t want to be locked into doing something because you said you would.”

4. Famed Short-Seller Jim Chanos says this is the CHEAPEST thing in the Stock Market (transcript here)- Dan Nathan, Guy Adami, and Jim Chanos

Jim Chanos: I think all things being equal, yeah. But I would actually deflect the question and say one of the things that by 1999 could have told you you were getting in the later innings of the tech bubble in the late 90s, was when you began to see a big drop off in the quality of the earnings of the big tech guys like Lucent and Cisco, whatever. And a number of these companies got into the business of not only doing barter transactions, but also having venture arms invest in companies who then bought their products.

Guy Adami: You’re seeing that around the edges now.

Jim Chanos: I was going to say you’re beginning to see people are beginning to report on – which I think is a good thing – the fact that some of these companies now have reasonably large venture operations under the corporate umbrella and are investing in companies that are turning around and buying their products. I would also point out too, a couple of small companies like Microsoft and Google, who are increasingly capital intensive because of their data centers, who are cutting their depreciable lives, which is a one time thing that will help earnings for a while. But the longer this goes, if we start to see more and more big-cap tech companies begin to use more and more fun and games to make their earnings estimates, then the parallel with ‘99, 2000 is going to be hard to miss…

…Guy Adami: If you’re fine, we’ll play another game, as I mentioned earlier. Over the weekend we heard from a couple United States senators, Lindsey Graham, John Cornyn, both said effectively – I’m paraphrasing – “bomb Tehran” or something of that effect. That was out there. I am shocked that the reaction of the market was as muted as it was. So my question is concerning geopolitical risk, which is seemingly as bad as it’s been, I want to say, in the last 30 or so years, yet no impact whatsoever on the broader market.

Jim Chanos: Middle east strife hasn’t made an impact on markets since ‘73, ‘74. So for people that are looking Middle East issues, most investors just go, “it’s a mess, we’re going to be there, kind of, there’s going to be terrorism.” It doesn’t factor in. I do think that something happening in the Pacific, would be a much bigger thing.

Guy Adami: What is that thing that happens in the Pacific? Our relationship with China is probably the worst it’s been in 50 years. You can debate it. I happen to believe that’s the case. Obviously the saber rattling in terms of Taiwan. When President Xi was in San Francisco in the beginning of December, it came out three weeks later that he said – and again I’m paraphrasing – “We will take Taiwan by whatever means necessary.” That came out in the press I think in mid-December. So that’s out there as well. I mean, nobody seems to be focused on it. Maybe again, they think it’s just rhetoric. What are your thoughts on that?

Jim Chanos: I think that the real risk, and we’ve been saying this for a while, is that he gets more aggressive in foreign adventures to distract people from what’s going on domestically in the economy. And the fact of the matter is they cannot get the domestic economy going, because of all the things that we’ve discussed down through the last 15 years and that the model is a bad model and it’s coming to the end of its useful life and they don’t want to address the realities of changing their economic model, which is based on investment in property. And so I don’t know what he does, but boy, the rhetoric is not good and he has made threats. And the curtain dropping there would be something, I think.

Guy Adami: So I brought this up and actually the people agree, disagree. I’m curious about your thoughts. A lot of people think that because of the weakness in China, it makes them less inclined to do something with Taiwan. My pushback would be it makes them more inclined, I think for the reasons you decided, sort of taking your eye off the ball as to what the problems are and then creating sort of a bit of a divergence for lack of a better word.

Jim Chanos: To Xi Jinping, the deal with the citizenry was, “Don’t get involved in politics, the Communist Party knows best, but we will give you prosperity.” In the last five to arguably 10 years, the prosperity engine has slowed down and sputtered, and now it’s becoming, “Support us nationally, in nationalism and patriotism and the greater China.” And that’s a change. That’s a big change. I think that the economy struggling makes the risks worse, not less.

Dan Nathan: Jim, you’ve been making a fairly bearish case about China…

Jim Chanos: Yeah, you might say so.

Dan Nathan: …for a decade. I’m looking at the Shanghai Composite. It’s really trading where it was a decade ago. And then if you think about US companies and all the excitement over this last decade about access to a Chinese consumer that is growing at a scale that we’ve never seen, but then if you look at really how the Chinese consumer has been exposed to risk assets, it’s been in the very thing that you’ve been warning about for a decade, and that is commercial real estate and residential real estate. So they’ve had much more exposure to real estate, both commercial and residential, than they have to the stock market.

Jim Chanos: Much greater.

Dan Nathan: Okay, so when you see a headline like we saw last week, that the Chinese are going to command the SOEs to repatriate maybe $300 billion and put it into the stock market, the stock market rallied, and then it sold back off. Wouldn’t they have much better use of putting that to kind of stem – we saw the China Evergrande story and stuff like that. Is this finally coming undone right now?

Jim Chanos: I don’t know that it’s coming undone. I think you’re just seeing the flaws in the model, which is the Chinese stock market, when we did our bear call on China, the FXI was $41. I think it’s $22, so it’s almost been cut in half since 2009. But if you actually look at the market cap of the Chinese stock market, it’s up now. So what’s the paradox? The paradox is they’re diluting the hell out of you. There’s so much agency risk in China, it’s not funny. And who’s the patsy? Western investors are the patsy. They’ve provided capital over and over again through the VIE structure, which we’ve talked about till we’re blue in the face, which is a complete fraud. And because China sold them on this growth and you want to be part of our growth and whatever, meanwhile, you’ve done nothing but basically provide capital for them to do other things. Having said all that, the problem, the property market dwarfs everything. After US treasuries, it’s the most important asset class in the world, Chinese property. It doesn’t get the attention it should. And that’s where China has its savings. That’s where the Chinese populace is counting on the price of their flat to provide for their retirement and their kids. And if that doesn’t happen and if that doesn’t pan out, then you’re going to have political issues.

5. A beginner’s guide to accounting fraud (and how to get away with it), Part V – Leo Perry

Back in 2017 I ran a job ad that read:

“In 2016 a police investigation of the collapse of a business closed with a public prosecutor recommending more than a dozen individuals be charged with fraud. One of those named as a suspect is the CEO of a UK PLC with a current market capitalisation of several hundred million. A formal indictment could be handed down any day. Name the company.”

The answer was internet of everything stock Telit Communications. In 2015 Avigdor Kelner, founder and former Chairman, had been sentenced to two years in jail for bribing politicians in Israel. He’d previously been arrested in 2007 in relation to alleged insider trading involving several investments made by Polar Investments, including Telit, although no charges were brought.

But that wasn’t the cat I had in mind in the ad, it was then current CEO Oozi Cats. And the 2016 investigation wasn’t his biggest problem. Italian newspaper Il Fatto Quotidiano reported later in 2017 that he was a fugitive from US justice, having done a runner from the country after being indicted for wire fraud in the 1990s!

Oozi and his wife had allegedly been charged for their part in a land flipping scam. Co-conspirators Wayne Weisler and Susan Taylor pled guilty to operating a scheme designed to defraud mortgage companies by inflating the apparent value of a property through a series of related party transactions, and then borrowing against this artificially high value. The scheme used a Massachusetts entity named Dolphinvest. The company’s Articles of Organization show it was incorporated by Weisler, Taylor and one Uzi Katz.

Now I’m guessing Oozi (or is it Uzi again now?) would probably say he was wrongly charged. That may be so. I’m not casting any aspersions here. I don’t know and I don’t care. What matters for us is that this particular story from his past wasn’t easy to find, even though there were details available online. Partly that was because he had changed how he spelt the anglicized version of his name (from Uzi to Oozi, which was obviously odd to an Israeli friend). But mostly because searching for Uzi Katz on Google brought up dozens of websites about people in Boston. There were sites with titles like “Professor of English Literature from Boston – Uzi Katz”, “Uzi Katz, civil engineer from Boston” and just plain “Uzi Katz of Boston”. My own favourite was “Uzi Katz, Boston Dancer”.

The websites seemed like pretty obvious fakes. As in, they did not appear to be about real people. I mean the blogspot for one linked to a Google+ profile with a photo – which Google Images showed was a picture of Ravi Ramamoorthi, Professor of Computer Science at the University of California.

Maybe, just maybe, these websites were designed to create a smokescreen. The fact that the registered contact for one had the email address reputation@seo-properties.com (seo being short for search engine optimisation) didn’t exactly dispel this impression. Or perhaps it was all just a coincidence and there really are a lot Uzis in Boston. Whatever way it happened, the result was the same. Stories about the Uzi Katz in Boston that got charged with wire fraud were buried way down the search rankings, behind all the dancing professors.

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We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general. 

Here are the articles for the week ending 04 February 2024:

1. China Wants To Ditch The Dollar – Zongyuan Zoe Liu

Ganzhou also hosts the Ganzhou Rare Metal Exchange, where China’s renminbi currency is used to quote prices for spot trading of tungsten, rare earth products and critical minerals like cobalt that are essential to the clean energy transition.

The metal exchange, established in 2019 with the approval of the State Council, now operates as a subsidiary of China Rare Earth Group. It is China’s second mineral exchange, which was established to use the renminbi to price and trade minerals and rare earth products.

The first such exchange, the Baotou Rare Earth Products Exchange, which started operating in 2014, is jointly owned by 14 major Chinese rare earth suppliers and was explicitly set up, at least in part, to increase China’s overall role in pricing rare earth products. To that end, China also launched two renminbi-denominated exchanges — oil futures in 2018 and copper futures in 2020 — on the Shanghai International Energy Exchange.

By establishing commodities exchanges across its industrial cities, China aims to boost the use and power of the renminbi in global commodities pricing to establish an alternative global financial system that is less reliant on the almighty dollar. This effort also involves regional cooperation with China’s neighbors and non-Western multilateral partnerships to develop regional currency arrangements and enhance the use of local currencies in international trade and investment.

In China’s telling, these strategies are less about offense — trying to dethrone the U.S. dollar or replacing it in the global system with the renminbi — and more about defense: strengthening China’s financial security and reducing its geo-economic vulnerabilities within the existing dollar-dominated global economic and financial system. Beijing wants to minimize its exposure to a potential dollar liquidity crunch and ensure its continued access to global capital markets even during times of geopolitical crisis.

No Chinese leaders have publicly expressed an intention to dethrone the dollar despite escalating geopolitical and trade tensions between the U.S. and China beginning in 2018. However, as those tensions persist, Chinese financial regulators and scholars have explicitly expressed concerns about Beijing’s vulnerabilities and urged government officials to step up efforts to protect the financial system…

…Since President Xi Jinping came to power in 2013, he has repeatedly emphasized worst-case scenario thinking to “prevent macro-risks that may delay or interrupt the process of the great rejuvenation of the Chinese nation.”

From Xi’s vantage point, China’s state-owned financial institutions and enterprises must inoculate themselves against potential international sanctions in the event of a military conflict with the West over Taiwan. That concern has only grown more urgent after China witnessed the collective sanctions imposed by the West on Russian entities and individuals to punish President Vladimir Putin for his war against Ukraine.

The West’s decision to freeze Russian foreign exchange reserves has caused particular consternation in Chinese policy circles. Chinese economist Yu Yongding described such a move as “a blatant breach of…trust” and proof of the United States’ “willingness to stop playing by the rules.”…

…Since President Xi Jinping came to power in 2013, he has repeatedly emphasized worst-case scenario thinking to “prevent macro-risks that may delay or interrupt the process of the great rejuvenation of the Chinese nation.”

From Xi’s vantage point, China’s state-owned financial institutions and enterprises must inoculate themselves against potential international sanctions in the event of a military conflict with the West over Taiwan. That concern has only grown more urgent after China witnessed the collective sanctions imposed by the West on Russian entities and individuals to punish President Vladimir Putin for his war against Ukraine.

The West’s decision to freeze Russian foreign exchange reserves has caused particular consternation in Chinese policy circles. Chinese economist Yu Yongding described such a move as “a blatant breach of…trust” and proof of the United States’ “willingness to stop playing by the rules.”…

…At the September 2022 SCO Summit, Xi explicitly proposed expanding the use of local currencies in trade settlement to promote regional integration, strengthening the development of local-currency cross-border payment and settlement systems and promoting the establishment of an SCO development bank to help shepherd such changes. SCO members agreed on a “roadmap” to accomplish these goals.

In a December 2022 address to the China-Gulf Cooperation Council (GCC) Summit, Xi emphasized his hope that China and members of the GCC should increase the use of renminbi for oil and natural gas trading and settlement through the Shanghai Petroleum and Natural Gas Exchange (SHPGX) in the next three to five years.

Since Xi’s speech, Chinese national oil and gas companies have accelerated initiatives to use the renminbi, instead of the U.S. dollar, in their international fossil fuels transactions through SHPGX. In March 2023, an important step towards the de-dollarization of energy trading occurred when China National Offshore Oil Corporation — known as CNOOC, China’s largest offshore oil and gas field operator — used the renminbi to complete the transaction of importing 65,000 metric tons of liquefied natural gas (LNG) from TotalEnergies SE, a French multinational oil and gas company, through SHPGX. The LNG was produced in the United Arab Emirates, a member of the GCC, carried by a Liberian-flagged LNG tanker Mraweh, and finished unloading in May at the CNOOC Guangdong Dapeng LNG receiving station.

This transaction was the world’s first cross-border LNG trade settled using the renminbi. Since then, CNOOC has executed more renminbi-settled transactions using the renminbi through SHPGX. In October, PetroChina, the largest oil and gas producer and distributor in China, settled a purchase of one million barrels of crude oil using the digital renminbi through SHPGX, marking the first cross-border oil transaction using the country’s central bank’s digital currency…

…Among SCO members, China has since signed bilateral currency swap agreements with Uzbekistan, Kazakhstan, Russia, Tajikistan and Pakistan. China also now has swap agreements with SCO observer and dialogue partner countries Mongolia, Turkey and Armenia; last March, Saudi Arabia committed to joining as a dialogue partner and a full member in the near future. While China doesn’t have an agreement with Kyrgyzstan, which is in the SCO, Kyrgyzstan’s national bank signed a letter of intent in September 2015, stating it aims to work with the PBoC toward establishing a bilateral currency swap.

China’s support for the expansion of SCO and BRICS over the last two years to include major commodities-exporting countries like Iran, Saudi Arabia, the United Arab Emirates, among others, suggests it is eyeing new opportunities to accelerate renminbi use in commodities trading.

The expansion has also given SCO and BRICS added significance as political forces in the shaping of commodity markets. SCO members include major hydrocarbon and minerals exporters in Central Asia like Kazakhstan and Uzbekistan, Russia and its newest member as of last year, Iran.

SCO also includes major commodities importers like China and India. In this context, as a non-Western group of countries, SCO potentially represents a potent coalition of exporters and importers of commodities centered around using the renminbi to finance the entire commodities lifecycle from production to trade to consumption…

…Chinese economists have argued that the ultimate goal of renminbi internationalization should be to have central banks and major international financial institutions worldwide willingly hold large amounts of renminbi for international transactions so that China’s currency can become an international reserve currency alongside the U.S. dollar and the euro.

Since then, the Chinese government has put resources into developing a renminbi-based financial infrastructure for cross-border settlement. In 2015, it launched the Cross-Border Interbank Payment System (CIPS) to improve the convenience of using the renminbi in international transactions by providing onshore renminbi clearance and settlement services.

CIPS allows global banks to clear cross-border renminbi transactions onshore instead of through offshore renminbi clearing banks, providing a one-stop alternative to the combination of the SWIFT system — a secure messaging system used by major banks to send financial information to one another — and the New York-based Clearing House Interbank Payments System.

However, CIPS is not a complete departure from SWIFT and still uses SWIFT’s standards to connect with the global system. It has adopted the ISO 20022 international payments messaging standard to be interoperable with other payment systems as well as with correspondent banks around the world.

By adopting existing cross-border messaging standards, China aims to make CIPS a critical piece of the world’s existing financial infrastructure to promote international use of the renminbi. By 2023, CIPS’s annual business transaction volume reached 123 trillion renminbi (roughly $17.3 trillion), according to data on the CIPS website. CIPS now has 139 direct participants and 1,345 indirect participants worldwide, most of which are foreign branches of Chinese banks.

The Chinese government has also used subtle but strategic initiatives to increase the global appeal of its currency and deepen the market depth of renminbi-denominated assets. Despite hesitations around liberalizing China’s capital account to allow capital to move freely in and out of the country, Chinese authorities have worked to broaden international acceptance of renminbi bonds as collateral.

In March 2021, the International Swaps and Derivatives Association (ISDA), a New York-based group composed primarily of the world’s largest banks, together with the China Central Depository and Clearing Corporation, the Beijing-based central depository for all Chinese government bonds, released a whitepaper detailing the usage of Chinese government bonds as an initial margin in derivatives contracts.

This past September, the Hong Kong Exchanges and Clearing (HKEX) and London Stock Exchange started to study the use of Chinese government bonds as eligible collateral for derivatives contracts as a way to reduce Asia’s heavy reliance on cash for margins on derivatives trades. Chinese institutions have also teamed up with leading resource-rich economies to make renminbi-denominated assets more attractive for international investors…

…China’s promotion of an alternative financial system is not about cheering on the demise of the U.S. dollar, but rather about creating an alternative financial system without a dominant currency in which the renminbi is accepted without bias. China has a strong incentive to prevent the dollar’s collapse because it would likely be the largest financial loser should the dollar depreciate. The majority of China’s over $3 trillion in foreign exchange reserves are invested in U.S. bonds and the lion’s share of Chinese sovereign fund portfolios are tied to dollar-based Western markets.

2. TIP602: Same As Ever w/ Morgan Housel – Clay Finck and Morgan Housel

[00:09:27] Clay Finck: He states, risk is what’s left over after you’ve thought of everything. And I just absolutely love this chapter. It’s Everyone wants to know what’s going to happen. What’s the stock market going to do? Interest rates, the Fed. You state the biggest risk and the most important news story of the next 10 years will be something nobody’s talking about today.

[00:09:45] Clay Finck: No matter what year you’re reading this book, that truth will remain.

[00:09:49] Morgan Housel: Yeah one way I think about this is I wrote Psychology of Money, my first book. I wrote most of it in late 2019. So obviously that was weeks or months from COVID completely throwing our life upside down, everybody’s life upside down.

[00:10:02] Morgan Housel: And I and everybody else had no clue about it. We were completely oblivious to what was going on. Staring at us in the face of that at that point, and I think what you can say, what is the biggest news story globally of 2023 of last year? It was, I think most people would say it was Israel Hamas, which is another thing.

[00:10:17] Morgan Housel: If you go to January of 2023, nobody was talking about that. No one was putting that on their radar. Even the day before it happened, virtually no one was talking about it, thinking about it, forecasting it. So it’s always been like that. You can say that for this year. The biggest news story of 2024 is something that you and I are not talking about today that we cannot see coming.

[00:10:35] Morgan Housel: Someone, I just saw this on Twitter just a couple hours ago. I thought it was really good. I’m paraphrasing it, but it was like, if you are making a decision tree or like a list of probabilities and you say, there’s a 20 percent chance of this happening and a 30 percent chance of that happening. If you’re just going through probabilities like that seems like a smart thing to do.

[00:10:51] Morgan Housel: But if all of your probabilities add up to a hundred, then you’re doing it wrong. Because what you are implicitly saying is that every potential possible outcome that there’s going to be. So I think the best you can do in any of these is if your known probabilities and you can think of should add up to 80 or something like that.

[00:11:07] Morgan Housel: Maybe it’s 90. You should always, you always have to leave a percentage chance for something could happen that I cannot even fathom. That I can’t even, no matter how creative I try to get, there can be a risk out there that I cannot even envision. And of course you should do that because that’s how it’s always been.

[00:11:21] Morgan Housel: The biggest news stories of modern times are things like the Great Depression, Pearl Harbor, World War II, 9 11, Lehman Brothers going bankrupt, COVID of course. And the common denominator of all of those is that you could not have seen them coming, at least in their specific nature of how they arrived and what they did, until they happened.

[00:11:37] Morgan Housel: And so it’s always going to be like that. It’s very uncomfortable to come to terms with that, to come to terms with how uncertain and unpredictable the world can be. But I think if you study history, you can’t come to any other conclusion.

[00:11:48] Clay Finck: What I find so fascinating about this is the biggest sort of disasters are those that no one expects, no one forecasted, no one projected.

[00:11:57] Clay Finck: You mentioned in your book that it seems that zero economists predicted the Great Depression. It’s no wonder it was so bad. No one was prepared for it. No one expected it to come. And COVID is very similar. And you’ve lived through the great financial crisis, likely an investor at that time.

[00:12:13] Clay Finck: Did it feel like no one was saw it coming and it was just a total disaster and much worse than anyone could have ever imagined.

[00:12:20] Morgan Housel: See, that’s a little bit different. That’s different than 9 11 because as recently, as re as early as 2003, there were people who are ringing alarm bells about how fragile the economy was and over leverage and whatnot.

[00:12:32] Morgan Housel: So that it’s not, nobody saw it coming. That’s not quite, that’s not quite true, but a lot of the people who quote unquote, saw it coming. When it did happen, it happened for reasons that they could not fathom. So for example, a lot of people, I won’t name names, but as in 2005, 6, 7, they said a giant recession is coming and it’s going to be caused by hyper, it’s going to lead to hyperinflation and interest rates are going to go to double digits.

[00:12:53] Morgan Housel: The exact opposite happened. So what do you do in that situation where they saw trouble coming, but it happened for the exact opposite reason than they saw it coming? That they envisioned. It’s there’s all these weird nuances there where it’s not black and white. There’s also what really sent the financial crisis into hyperdrive was Lehman Brothers going bankrupt.

[00:13:09] Morgan Housel: But there’s all these alternative histories of a lot of people forget that as Lehman Brothers is going down, Barclays was like hours away from buying it. And that deal fell through and Lehman Brothers went bankrupt. But there’s this alternative history of what if Barclays had bought Lehman Brothers and we escaped all of that.

[00:13:23] Morgan Housel: And the economy just zoomed to recovery after that. There’s all these different possibilities. And I think the takeaway from that is you couldn’t have seen it coming. Even if you saw trouble, you saw brewing in the financial crisis. Nobody in their right mind could have known exactly how it was going to play out.

[00:13:35] Morgan Housel: And I think that’s true, even not only during, but after the financial crisis, it was so common if you were an investor in 2009. To say, look, stocks are still overvalued. We’re in the quote unquote, new normal of low growth. That was a phrase that was always thrown around. The CAPE ratio is still just still too high.

[00:13:52] Morgan Housel: Expect lower returns. That was what virtually everybody was saying. I’m not going to say everybody. Of course, there are some people who saw it differently, but that was the very common narrative. And it made sense. If people were saying that you’re like, yeah, that makes a lot of sense. But what happened?

[00:14:04] Morgan Housel: The stock market tripled over the next three years. It was a, ended up being like the best three year period to be an investor in modern times. And so that, that’s a very common story throughout history too, is that the narrative at the moment, that makes sense that the majority of people cling to in hindsight looks ridiculous.

[00:14:19] Morgan Housel: And so we see that a lot across and it’ll be like that going forward whenever the next recession is, of course…

…[00:39:37] Clay Finck: I also wanted to tie in here, the emotional side of investing. The Buffett quote is be greedy when others are fearful and fearful when others are greedy. But you talk about in your book how this is much easier.

[00:39:51] Clay Finck: said than done. And it’s just so hard to put ourselves mentally fast forward in that type of situation when stocks have fallen, it’s the time to buy. And another problem is that when stocks fall, there’s usually a good reason why they’re falling. And I go back to March, 2020, and I had friends calling me at work, telling me how much money they’re making by shorting the market.

[00:40:10] Clay Finck: And yeah, this coronavirus going around and just the emotions just flood in. And it’s just so hard to act rational when those emotions are at play. You write in your book, hard times make people do and think things they’d never imagine when things are calm. And March 2020 was the complete opposite of calm.

[00:40:29] Clay Finck: Talk to us about how our views and goals can quickly change when our environment’s changing.

[00:40:35] Morgan Housel: I think if I today, right now, when the economy and the stock market are pretty strong and prosperous, if I said, Clay, how would you feel if the market fell 30%? Most people would say, I’d view that as an opportunity.

[00:40:45] Morgan Housel: That’d be great. The stocks that I love would be cheaper. I’d be a buying opportunity. That’d be great. Okay. And for some people that really is the case. But then if I said, Hey, Clay, the market falls 30 percent because there’s a pandemic that might kill you and your family and your kids school to shut down and you have to work from home and the government’s a mess, it’s going to run a 6 trillion deficit to try to figure this out.

[00:41:04] Morgan Housel: How do you feel in that situation? You might be like, most people will say, Oh, in that world, or once they experienced that world feels very different. Or if I said, Hey, the market fell 30 percent because there was a terrorist attack on nine 11. And all the experts think that was just scratching the surface of what’s to come.

[00:41:19] Morgan Housel: Do you feel bullish now? A lot of people will say no, they don’t feel. So once you add in the context of why the market fell, most people will realize that it’s much easier to quote Buffett than it is to actually be somebody like Buffett. I experienced this myself. I had some of the smartest people who I knew in March and April of 2020.

[00:41:35] Morgan Housel: Some of the conver I remember two specific conversations. One was somebody who said, Hey, look, there’s about 2 trillion of capital in the entire banking industry. You do not need to be creative to imagine how all of that’s going to be wiped out. The entire capital of the entire banking industry is going to be wiped out.

[00:41:48] Morgan Housel: And I remember thinking that and being like, yeah, no, you don’t. If the entire economy is shut down for three months, all of that capital is gone. The entire banking sector is insolvent. Obviously that did not happen. But when I heard that, I was like, no, that actually makes sense. I don’t know if that’s the base case scenario, but that’s not far fetched.

[00:42:03] Morgan Housel: I also remember during that period of COVID when it was like, no one’s really going to be making their mortgage payments when everyone is on lockdown that people are like, look, the entire non banking lending sector, non bank lending mortgage sector is all going to collapse. And that’s 80 percent of the originations market.

[00:42:17] Morgan Housel: 80 percent of mortgage originations are going to be out of business in two weeks. And I remember piecing that together and be like, that makes sense too. That didn’t happen either. But during this period, Which was in hindsight, and even at the time, you could have seen look, this is the opportunity of a lifetime.

[00:42:30] Morgan Housel: The market fell 50 percent in a short period of time. This is gonna be a great opportunity. When you add in the context, both the health consequences and the potential economic consequences. It’s a much different situation. I would even say to finish this up, this is maybe the most important part about, I think it was in early February, 2020, Warren Buffett went on CNBC and they’re talking about, Hey, there’s all these rumbles about a virus.

[00:42:51] Morgan Housel: Like, where do you get it? Like the market’s starting to fall. What’s going on? And Buffett said, I don’t want to, I’m paraphrasing here. This is not a direct quote, but He said, I don’t know how I’m going to invest in the next month, but I guarantee you, I’m not going to be selling. That’s what he said.

[00:43:03] Morgan Housel: Two weeks later, he dumped every airline stock that he owned. So even in this situation, somebody like Buffett, the originator of the phrase be greedy when others are fearful. When he added in the context of what was happening to the airline industry during the lockdown, he determined, and I think in hindsight, it was probably the right decision to sell those stocks.

[00:43:19] Morgan Housel: And some people have pointed out too that part of the reason that he sold him is that the government could not have bailed out the airlines if he was the largest shareholder, so people asked him to sell those stocks. It is a complicated thing, but once you add in the context of why the market’s falling, most people realize that their risk tolerance is actually much less than they thought.

3. What I Learned When I Stopped Watching the Stock Market – Jason Zweig

I’m back at my regular post at The Wall Street Journal after being away on book leave. That long hiatus disengaged me from the daily hubbub of markets so I could frame investing ideas in a longer historical and broader psychological perspective…

…When my last regular column ran last May 26, the S&P 500 was already up 10.3% in 2023—right in line with the long-term average annual return of U.S. stocks. “Let’s just call it a year right here,” I recall muttering to myself.

That was the last thing I remember. From that day to this week, I tuned out the daily noise of fluctuations in stocks, bonds, commodities and economic indicators…

…It’s a good thing the market gods ignored me, as they always do. Even though I thought a 10.3% return in five months was plenty for an entire year, the S&P 500 finished 2023 up more than 26%, including dividends.

When you don’t watch the market every day, you can finally see with unquestionable clarity that what you would have expected to happen didn’t. The unexpected did.

Had you told me war would break out in the Middle East in October and last for months, I would have been sad but unsurprised. Had you added that crude oil would—after a fleeting surge—finish 2023 at a lower price than the day I left, I would have been amazed…

…You probably can’t disappear for seven months, but you can pretend you did. Hal Hershfield, a psychologist at the University of California, Los Angeles and author of “Your Future Self: How to Make Tomorrow Better Today,” urges investors to “use the tools of mental time travel to escape the tyranny of the present.”

He means that envisioning how you will feel about your actions tomorrow can help prevent you from overreacting today…

…For general templates of such letters, see the “Future Self Tool” at consumerfinance.gov.

Research suggests this technique can help you avoid making decisions you might later regret—and can reduce the anxiety stirred up by negative news.

I’ve long thought financial advisers should encourage this approach to help clients make deliberate and durable decisions. Now I think it’s worth trying on yourself, too.

4. An Interview with Arm CEO Rene Haas – Ben Thompson and Rene Haas

RH: Yeah, two things are key. It’s very, very small, it takes longer to fabricate. So what may have taken you 12 weeks to put a product into production now may take you 26 weeks. That’s a big, big jump in terms of the lead required.

Then you look at these SoCs that are using Arm, back in the day, if we were putting 12 to 16 CPUs into an SoC, that was considered a lot. You now look at some of the recent chips being announced, just look at the Microsoft Cobalt, their recent CPU that they announced using Arm, 128 CPU cores into that SoC. That is a lot of work for someone building an SoC to figure out how those 128 CPUs are going to work together. What’s the cache coherent network look like? What does the interconnect look like? What does the mesh look like?

So what we felt was if we can provide more of that solution, i.e., stitching together all of the system IP, the GPU, the CPU, an NPU, anything around the processor fabric, we could fundamentally allow the customers to get to market much, much faster.

So we started this initiative towards what we call compute subsystems, which was really about developing the overall platform, which not only helps us in terms of getting an SoC to market faster, but it also allows us to work more quickly in terms of the software ecosystem. We can start to think about what gets product in the hands of developers sooner, or what gets the products in the hands of people who are developing the application software, people who are doing the OS work.

So for a myriad of reasons, it just made a ton of sense for us to go up and do that and we’ve started that with our hyperscalers, with our cloud compute, but we see it applicable to almost all the markets, whether it’s a cell phone, whether it is a laptop, whether it is an automotive ADAS [Advanced Driver-Assistance System] system. The same rules of apply, these are complex compute subsystems. The chips take a long time to build. If you can shave off any amount of development time that helps the people get the chips out faster, that’s huge value. What we are seeing is in some cases where it may have taken two years to get a chip to tape out, we’ve cut that in half. One customer came back and said, “Look, you’ve saved us 80 man-years in terms of efforts.” So across the board, we’ve seen pretty strong validation that this is the right thing to do.

Just to get to the nuts and bolts a little bit, you mentioned the savings in terms of design time and things getting smaller and how long it takes to fab a chip. Is this also just a matter of, there’s a lot of reports about interference and stuff like that, particularly when you’re getting even down to 3 nanometers or 2 nanometers in particular. Is that a real driver as well? Would this opportunity be presenting itself absent the real challenges that are coming along in terms of smaller and smaller size chips and the increased design challenges that are coming with that, particularly around interference?

RH: You follow technology for a living, so you know this well. Like everything with these type of things, a number of things need to come together at once. When you have these long cycle times to build the chips, the complexity in closing timing loops, you’re trying to drive the maximum power efficiency, you’re trying to maximize the ultimate work you’re doing with the libraries. Again, with these subsystems, we will not only handle everything in terms of validation and verification, but we’ll do the tuning for the process. So if folks want to make sure they can get that ultimate last mile of performance, that’s just a lot of work that needs to be done that if Arm is doing it with a platform that we control — because it’s our IP, right?

Right.

RH: At the end of the day, it is around the compute subsystem and computer architecture that we’ve delivered, it’s highly beneficial. So again, in the old days you could kind of throw all this stuff over the wall and people could just pull it together and make it work, but the world has changed a lot in terms of just the complexity of these chips, and one thing that’s not relenting is people want to get products out fast. The markets will move really, really quickly and I think actually we’re seeing them moving even faster now. When you look what’s going on with generative AI and everything relative to these multimodal models and large language models, you have so many moving parts relative to what it takes to develop a product. It’s really, really critical to maximize on efficiency of time to market…

… I’m curious because on one respect, a lot of consolidation at one part of the value chain would potentially increase the opportunity for competition in others. You could see how consolidation would play well to say, RISC-V prospects in that regard, open source is as modular and open as you could get. On the other hand, is that sort of drive in a value chain of consolidation at one point, driving modulation the other, is that just overcome by the complexity involved, such that there’s rooms for multiple highly consolidated aspects of this chain? TSMC is pretty centralized as far as things go, and you just feel optimistic that at this point in time, the ecosystem from a software perspective, Arm is x86, 15 years ago on the PC side, and even if you theoretically want to do something different, there’s so much software to build, your lead is just going to be much larger.

RH: I think so, but it’s a very, very good question because it’s a little difficult I think to look backwards to kind of predict the future. One of the things we’re seeing around the future innovation that’s really a gate to innovation is this massive capital investment required, and it’s not just in building a chip, not just in building a fab, it’s not who has enough money to go off and buy new ASML EUV machines.

Let’s take a look, for example, at foundation models and everything going on with generative AI and training. Right now, Nvidia is an amazing position because of just the pure access to GPU technology and how expensive it is now, how scarce it is. That in and of itself, starts to lead to an area of, “Well, you’ve got all kinds of interesting open source models and people in the open source community working with things like Llama. But if people can’t get access to the GPUs and actually training, then who wins?” So, right now you’ve got the Big King.

We saw an excellent example of that in the last few months. He who controls the GPUs controls the world, at least for now.

RH: Correct. So, then when you start to think about — I like to think that Arm is an amazing place because any one of these application areas, we’ve got a huge, huge installed software base and we’ve got a very, very powerful position on power efficiency. So, when I think about where the puck is going relative to an alternative architecture, let’s say, you’ve got to look at either, “Do I have a 10x advantage in performance or a 10x advantage in terms of cost?”. And right now, I think in the areas where Arm is really good at, people would have to look at it really hard and say, “Is it worth the investment to go port everything I’ve got to an alternative architecture? What is the ultimate benefit that I get to the application space?”.

I think what’s really fascinating about everything going on with generative AI right now is I think you’re just seeing huge amount of resources coming into all kinds of development around training and inference, that will drive the growth here, so I think that’s actually where the growth is going to come. I think Arm is in a great place there. Obviously I’m biased but I think when you think about everything that’s going on with generative AI training, all those inference workloads are pretty good for the CPU, and history has sort of shown us that over time, as you add, and we saw this, whether it’s floating point heading into the CPU, or vector extensions, the CPU start to add more and more of the base functionality it allows with some of the workloads and I think you’ll see that in this space…

…Fast forward to where I am now, I don’t spend a lot of time when I talk to people inside of engineering or product groups about, “Hey, who’s catching us from behind?”, I try to think far more about where the world’s going to be in five to ten years. If you think about where the world’s going to be in five to ten years and you focus as much as you can, you’re not going to get it specifically right, obviously, but you want to be directionally investing in that area so when things land in your space, you’re going to be in a good spot.

Take case in point, predicting what the mobile phone is going to look like in 2034, ten years from now, and trying to make sure I do everything defensively to make sure that we’re in a great position is kind of nutty because if you go back to 2008 when the smartphone was invented, folks who were trying to think about protecting what the future phone looked like would have been out of position. Where I really focus on, Ben, is just where are things going and where do we need to invest?

Again, I know this AI drum that gets, people at times try to think, “Oh my God, how many times you got to hear the word ‘AI’?” — obviously, on one level AI is not new, anything that was going on relative to voice recognition or data translation, obviously that was all AI. I think AGI and everything around generative AI that can think and reason, that’s a pretty compelling place, and whether that takes place in five years, ten years, fifteen years, I don’t think anyone can argue that an investment in that space isn’t going to provide huge benefit down the road. I think Arm is a compute platform, I want to be sure that we’ve got everything correct from either an infrastructure standpoint, instructions at architecture standpoint, everything around the subsystem to be able to capture that.

Do you feel pretty confident? I think that you’re trying to sort of tie all of your stuff together to a greater extent, but companies could bring their own neural processor. Google obviously does that at a very sort of small-scale example, scales as far as terms of numbers, not scale in terms of importance of AI obviously, but is this really core to your thesis that as opposed to you needing to bring up a super competitive sort of NPU that, to your point, about the extensions and floating point, which I think is a great analogy, this is all going to be built into the CPU, so regardless, you’re going to need — even if the mobile phone market doesn’t grow just because of the number or it’s limited to this number of humans on earth, that is still going to be a significant opportunity or do you think you have to bring up additional separate IP? Or is this idea of it all being separate meaningless in the long run?

RH: It’s not going to be a one-size-fits-all kind of situation. Today, there’s a lot of investment going on training these very, very large models on highly networked GPUs. Even when you start talking about inference in the cloud, what matters is compute, but less around the interconnect between all of those systems, which is why CPUs over time in the cloud may find themselves to be very, very good solutions without having a GPU necessarily connected to it.You’re going to have a CPU in the cloud no matter what, so at some point it probably makes sense to consolidate.

RH: While Grace Hopper is a fantastic design from Nvidia, there’s a lot of people who I know are asking for, “Just give me Grace and don’t give me the Hopper when I go off and run inference.”…

…But when you see announcements like Microsoft Cobalt — after Graviton was announced, we had a lot of folks saying, “Well, they did it for their own reasons, and there’s not going to be much level of scale.” I would say continue to launch these very, very significant product announcements from company moving to the Arm architecture and I think you’ll see more and more of those over the next 12 to 18 months. And really, those are indicators, whether it’s in the automotive space, in the AI space, look for things, and I can’t tease this out too much, but my example of floating point instructions moving into the CPU, watch for those things on the AI front because that’ll tell you the direction of travel that says, “Yeah, this is moving that way.” I can assure you that we’re not going to stop doing these subsystems, and you’re going to see more and more announcements coming out on those.

5. A beginner’s guide to accounting fraud (and how to get away with it): Part IV – Leo Perry

In September 2011 Quindell (at the time trading as Quindell Portfolio PLC) acquired a business called Quindell Solutions Limited (QSL).

QSL had previously been a subsidiary of Quindell Limited, which in turn reverse merged into Mission Capital in May 2011, to form the then listed business called Quindell. All clear?

In 2009 Quindell sold QSL to its CEO Rob Terry in for a pound. Companies House filings show it had a slightly negative book value at the end of 2009 and again in 2010; sales, costs and cashflow were all nil. So QSL was an empty shell.

In 2011 Quindell re-acquired QSL for two hundred and fifty grand in cash (£251,000 to be precise). At the time it was wholly owned by Quob Park Limited, which was in turn wholly owned by Rob Terry. Quob Park’s previous name was Quindell Portfolio Limited.

If you’re still following, Rob and his wife Louise Terry were both Directors of Quindell (the PLC) and of QLS / Quob Park when the acquisition took place. But it wasn’t disclosed as a related party transaction. I mean this was AIM after all.

So it looks a lot like Quindell made a large undisclosed payment to its CEO, for an empty shell company that it had sold to the same CEO two and a half years earlier – for a pound. Perhaps, surely, there was some great innovation at QSL in the mean time that justified the cost. But there didn’t have to be. And in our case there won’t be…

…I’ve seen a few listed companies stretching the limits of credulity between actual and maintenance capex. But none ever topped a marketing firm I was short about 15 years ago. Beginning in 2005, a little before it listed in London (yes, on AIM) the company went on an investment binge. Capitalised spending rose from only a few percent of sales to over half, and stayed around 20% for the next 5 years.

There are a few ways an investor can get some insight into that number, without even looking to see what it’s spent on. One is to compare it with similar companies. If you looked at the kind of business this management wanted you to believe they were competing with – mobile ad networks like, say, Millennial Media – you were in for a surprise. Millenial spent about 3% of sales on capex.

But you didn’t even need to get that specific. A fifth of sales going into capex is a lot for almost any established business. So another way of making sense of it is to ask what kind of operation needs that level of investment? Before you go and search for the answer, have a guess at what the most capital intensive companies are (I went for transport infrastructure, things like toll roads and airports). If you did screen for companies that had capex over 20% of sales back then you ended up with a pretty short list (leaving out start-ups with little or no revenue, which were mostly biotechs and junior miners). The list was more utilities and telcos than transport as it turned out, but there were a few airports (and some airlines as well). Shockingly no advertising agencies made the cut.

The best clue that the investment was bogus, though, was what the company stated it was spending it on. Software, sure. But not code they developed themselves, this was programming bought off the shelf. When I asked management to break it down the best example they could give was Microsoft licenses!

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. We currently have a vested interest in Microsoft. Holdings are subject to change at any time.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general. 

Here are the articles for the week ending 28 January 2024:

1. Mark Dow – A Behavioural Macro View – Eric Golden and Mark Dow

Eric: [00:08:06] I appreciate you making the arguments here. The notion of the narratives, ones that I want to get into was the Fed. Since 2008, it feels like — the Fed was a topic of discussion. It seems to come and go and be more important to people. And it seems to be one of the central narratives that people go to. I’m curious on your view. You’ve talked in the past about the Fed might not have as much control as people give it credit for, but it sure gets a lot of the headlines as if it does have some complete control over which way the markets go every day.

Mark: [00:08:37] Yes. Well, first thing, it helps with content production. There are a lot of — CNBC and Bloomberg and a lot of people who produce content for a living, they need to say something. So the Fed is kind of the explanation of last resort, sometimes the first resort, but you always can point to something the Fed did and make a plausible argument that that’s what’s driving things. The second is when people are wrong, it’s much easier to say, no, listen, I would have been right in my bearish call, but the Fed cheated. They printed money or they did this.

Even now over the course of this year, as the Fed has shrunk its balance sheet and raised the interest rates by 500 basis points, people are trying to argue., well, this component of the balance sheet is changing, whether it’s the treasury, a general account or the reverse repo facility or whatever it happens to be, they want to say this is liquidity-driven because in a sense that exculpates their fundamental analysis that didn’t play out.

So it creates a lot of emphasis on it. But the big story this year and the one I’ve been talking about in our Behavioral Macro a lot, my subscription Twitter feed, is monetary policy didn’t turn out to be as powerful as everyone thought. And that’s where you made your money.

And there are three main reasons why monetary policy hasn’t been as powerful as people thought. There’s the behavioral reason, the secular reason and the cyclical reason. Just from a cyclical standpoint, we kind of know the story by now. We didn’t a year ago. And I got a lot of pushback on Twitter when I was talking about it.

But now I think everyone has recognized that the initial conditions matter a lot. The quality of the balance sheets in the household sector and the corporate sector and in particular, the financial sector were in much better shape than they were, the GFC, which is kind of the most recent memory people have, right?

So people have kind of been waiting for us to cyclically reproduce that cascading, deleveraging process that we had back then because that’s our PTSD, that’s in our memory. But the initial conditions were a lot better, and therefore, it didn’t happen.

And the recessions tend to happen when it’s about speed, much further level. So if you can deleverage — so basically, recessions happen when people get too far out over their skis taking risk because they got overly optimistic. And then for some reason, people say, oh, wait, I’m really out over my skis now, and things may not be playing out exactly what I thought, and they need to retrench.

So if they’re really out over their skis, they have to cut back on their investments rapidly, they have to fire people rapidly, households have to tighten their budgets, financial entities have to sell assets. All these things happen at once. And when they happen at once, it becomes self-reinforcing.

So if you go from unemployment of three to unemployment of six in two months, it panics people and leads to more layoffs at a faster rate. People go further and they don’t feel like they have the time or the luxury. And the same thing when they’re reducing the average on their balance sheets or households to cut back on their budget, that happens fast.

And then demand has cut back and then more people need to be laid off and it feeds on itself. It’s a self-reinforcing process until it burns out. If you go from 3% unemployment to 6% unemployment over two years, then it’s a more orderly process.

And you don’t get the fire sales and you don’t get the panics. That self-reinforcing feedback loop is a lot weaker, a lot less likely to get into recession. So that’s kind of how I look at this. And since our initial conditions were pretty strong, I didn’t think getting into one of those really aggressive feedback loops was very likely.

The secular reason is the Fed controls a lot less of money supply, if you want to call it that, than it used to. Over the past 30 years, we’ve had global financialization, global financial deepening, however you want to refer to it. And way back in the day, basically, the monetary system was the Fed and banks.

So the banks would issue credit and give you a deposit on the other side. So they would issue the money in the form of deposits into existence. That was the primary form of money creation, not the Fed, but the banks and the Fed supervised this process. They wanted to make sure that the banks were staying within regulatory parameters. They also had other objectives that they needed to fill.

What’s happened over the past 30 years, 40 years is we’ve had an explosion of things like repo and euro dollars. If you want to call them chattel banks or what have you, these guys also create money. When you do a repo, you’re basically liquefying an asset. You’re taking the asset on your books and you’re making it liquid by borrowing against it, and you take that money, and you spend it. That’s money creation.

Euro dollar is the same thing. Fed does not control these processes, not nearly as much as it controlled the system back when it was just kind of the Fed and banks. So a lot more of the system is beyond the reach of the Fed. And if you followed me at all on Twitter, you know that the price incentives using interest rate is a really, really blunt tool, right? It doesn’t always work that well.

And great examples of this are we have the biggest or at least the highest valuations in the stock market in my lifetime, probably ever, in 1999 and 2000 in the dot-com bubble when the Fed funds rate was 5% and 10-year was 7%, and we couldn’t even spell QE.

And we had the nastiest vintages of mortgages extended 2005, 2006, 2007, when the Fed funds rate was also around 5%, and we didn’t have QE. So it’s not as interest rate sensitive as people think. Because if you think you’re going to make 200% in a year or 300% over five years, whatever it happens to be, the difference between borrowing at 3% and 6%, it’s the same number for you. And that’s what happens. And also, when people are very fearful they become price insensitive too.

So just raising the interest rate — unless you go to really, really high levels, obviously, like Paul Volcker did. And within reasonable levels, it just doesn’t turn the dial that much on lending. Lehman had 33 turns of leverage when the Fed funds rate was at 5%. From a secular standpoint, the Fed just doesn’t control the money creation process nearly as much as it used to.

And then behaviorally, we’re all kind of conditioned to think that lower interest rates and higher interest rates have a really big effect. So we were kind of bracing for it. So everyone saw the Fed raised rates aggressively and that led people to say, okay, well, recession is coming for sure.

And we kind of had a precession where everybody saw the rates going up, they expected a recession was going to come in, but it wasn’t coming, but they started a little by little paring back and investing a little bit less, hiring a little bit less. We saw that the back orders for labor declined, all that kind of stuff.

So ultimately, that means people are less out over their skis as the process plays out. So you’re kind of deleveraging in a gradual sense. So we’re kind of braced for it because people will believe deeply that that’s what would happen, and then it didn’t happen.

Eric: [00:15:24] The way you think about the world, it feels clear. I think that for other people, it kind of breaks their brain a little bit that when you say in your example of the monetary policy of unemployment going from 3% to 6%, and the difference is it happens fast or slow.

If you had told people in advance — I think this is always still funding about hard markets are or how humbling they are. The Fed is going to raise rates. This is what’s going to happen. Many people assume this would be disastrous. It would cause a recession. The housing market would break. Like all these bad things would happen and here we are coming into the end of ’23, and I think every asset class is up in the face of that. So that kind of breaks people’s brains. Why do we get that so wrong?

Mark: [00:16:06] Well, I think these are the reasons I was just talking about, people overestimate the power of monetary policy. And they thought the inflation that we had was much more monetary than it wasn’t monetary at all. It was obvious entirely COVID. It was fiscal but people — they have this — we were trained. Milton Friedman said that kind of mindset, people think the high-powered money and the loanable funds model, none of which only worked that way.

Like I said, banks issue money into circulation via deposits. That’s how the bulk of money gets created. In exceptional circumstances, the Fed can expand and contract its balance sheet because there’s a demand for liquidity. So whenever it wants to deleverage, banks need a lot of dollars for settlement. They need to settle with each other.

So the demand goes up a lot like back in the day when we were more agrarian economy and the Fed around harvest time had to produce big boxes of money and send them out to the hinterland so that transactions could get done. The Fed provides the elasticity in the monetary system for rapid expansion and contraction of demand for cash. That’s kind of their role and the banks are supposed to issue the dollars into circulation via credit.

Most people don’t get that. Once you get it, once you understand endogenous credit, then things make a lot more sense to you, but the wrong model has been drilled into people’s heads so thoroughly and it makes a much intuitive sense that people — even though it’s wrong, that it’s hard for people to get past it.

Eric: [00:17:26] So if people are looking at — if they’re looking at the wrong way, when you get something like quantitative easing, quantitative tightening, this idea that the Fed could impact the market and even more powerful, the irony is what you’re saying is so not a consensus, which is why I love it that coming out of 2008, it was the Fed was even more powerful than they’ve ever been before and that they have the implication on the market. So if the QE isn’t really whatever one thinks it is, is that because it’s really just moving money between the banks and the Fed

Mark: [00:17:58] Yes, basically. I mean, the way the mechanics work, you can call it printing money, and I think that leads to a lazy thought process because some people kind of take it literally unless you press them to go, oh, it’s not literally printing money, but really, it’s just an asset swap.

So think about it in the simplest way possible. You have a 60-40 portfolio. Just — to make it simple, your 60% is in an S&P ETF, and your 40% is in T-bills. So you got your risk money, your 60%, and your risk-free money, you’re ballast as it were. So the Fed comes in and they buy all your T-bills, and they give you a deposit at the Fed, which yields roughly the same thing.

Are you going to change your 60-40 allocation because of that? Are you going to go out and buy Tesla stock with that money? Not unless something else changes in your mind and you think you need to take more risk, which is possible, but it’s a totally separate decision.

But that’s what really happens. The Fed liquefies the system and allows for settlements to take place amongst themselves. Now the way QE is supposed to work in theory, and I think a lot of the people who put it in place way back when, if they were to review what happened now, they would say, okay, it didn’t hurt, but it was a lot less powerful than we thought it might be. It’s supposed to work in two ways.

One is what they call the portfolio rebalancing effect. And that is Fed buys bonds, takes them out of circulation. The people who own those bonds, say, I should probably replace that duration in my portfolio, so maybe I’ll buy some government-backed mortgages. So same risk temperature more or less, but it’s a little bit — just a hair out the risk spectrum. And some guys might say, well, yes, I’ll buy some high-grade debt, some high-quality corporate debt, a little bit further out the risk spectrum.

But you also have to keep in mind that most of the people from whom the Fed is buying these bonds, it’s not in their mandate to go out and buy equities, right? They’re buying it from like PIMCO. They’re buying it from fidelity bond funds, and they’re buying it from these guys who have a very clear mandate, and they don’t buy equity.

So that kind of effect is not that strong, first of all. I mean it’s kind of there, but it’s indistinguishable from the natural process of people moving out the risk spectrum with time. And we can talk about that later because it’s a super important point, how risk appetite works over the course of a cycle. This marginal effect is really indistinguishable from this bigger effect, I think, of people over time moving out the risk spectrum during a cycle until we get to that point where we are too far out over their skis, and we have to bring it back.

The second channel is the idea that by taking duration out of the system, it will lower the yields on bonds and that will stimulate lending and things like that. But as I like to say, you can lead a banker to liquidity, but you can’t make it lend. You need the risk appetite for people to lend.

And it’s not even clear how much QE lowered interest rates because we know from a flow standpoint, during QE1, QE2, QE3, every time these things got rolled out and the Fed was buying bonds, the yields were going higher, and they were going higher primarily because of the placebo effect. People believed that the Fed intervening was protecting the downside on the economy.

And therefore, they said, okay, I’m selling bonds and I’m buying equities. That behavioral effect based on perceived change in economic outlook was much more powerful than the mechanistic buying from QE. And this is why I was saying back in September, I said as soon as we get a whiff of slowdown in the economy and inflation cools off, all this talk about supply and fiscal unsustainability is just going to disappear, which is exactly what happened.

So it’s not that these effects don’t matter. It’s — they get swamped by changes in demand triggered by changes in the economic outlook, our perception of growth. So from a flow perspective, it didn’t work. In fact, it worked the other way. Yields tended to go higher when the Fed did QE.

So does it work from a stock perspective? If they buy enough bonds and take them out of circulation, it drives interest rates down? Maybe a little bit. But it’s really hard to say. Look at what’s happened now. We’ve — the Fed balance sheet is down by $1.3 trillion.

So whatever people say about repos or the TGA, the Fed owns $1.3 trillion less of securities, of bonds and mortgages. And we’ve raised rates 500 basis points. And for sure, the 10-year treasury has not gone up 500 basis points. It’s gone up by a lot less than that.

So it’s hard to argue that anything other than economic expectations is the primary driver, yields further out the curve. So it was an experiment worth doing, and a lot of people don’t get this. The first QE was really about the plumbing. They were trying to make sure that the pipes worked, that markets didn’t get gummed up, that things could work smoothly. It wasn’t about, at least the first two-thirds of it, wasn’t about trying to boost economic demand or activity, that came later.

But what QE unambiguously does is in times when there’s a surge in demand for transactional balances like back in the agricultural days when they shipped out those boxes, the Fed provides the elasticity to make sure the payments can flow through the system and the dry cleaner in Cedar Rapids can make payroll. That’s kind of how it’s supposed to work.

But it’s just not very powerful when compared to the changes in economic outlook. This is why supply rarely — and people talk about bitcoin and fixed supply. What matters is demand. Demand is really what swings and supply is rarely the issue. That’s why QE and Q2 are — this is my second time through it.

So I still have the scars from 2008 telling people that QE wasn’t going to cause inflation, and people looked at me like I had 3 eyes, and I remember I was working at hedge fund, we lost a client because of that and a couple of prospects.

I remember one guy telling after having a meeting — I used to get sent to a lot of the meetings because I was good at explaining the economics and a lot of the guys I worked with were flow traders who are maybe not as articulate and kind of had intuition and good risk management, but couldn’t explain things as well to clients.

And I remember explaining the things to a particular client, and afterwards, I heard from the owner of the hedge fund, he came back and he said, “This is what he said, Mark,” he was laughing about it. He said, “Mark is really smart, but he’s just going to get you guys killed with his view on inflation,” and they ended up not investing with us largely for that reason.

But anyway, I’ve been through this a couple of times, and I just retweeted a tweet today that I sent out back in August. You know the depth of the market in August of 2022, saying, if we get to all-time highs anytime within the next 12 months or by the end of 2023, we can eliminate, for sure, the QT effect that so many people fear. And that was kind of peak fear of QT because the market was going down and a lot of people ascribed it to QT. It just doesn’t have that kind of effect.

Eric: [00:24:32] The thing that I remembered was during ’08 when it was going down and being so close to the center of it all, you realized how bad it was. And the reason why — I have two parts here. One is I do remember when QE first happened, it did feel like — and maybe the Fed still has this power that when the system seizes up, it really is the only thing that can reliquefy the system that it has this power to say — if the Fed didn’t step in, in a way, I felt like it would have been significantly worse.

But then after it happened — this is the second part of that question. I remember something like 40 of the greatest investors of all time because I was early in my investing career. I think I’ve been there for about three or four years. All of a sudden, we see the world collapse and then they unleashed this thing, which it felt like it’s saved everything.

It truly felt like it worked, but nobody knew the ramifications. And the smart money — there was this Wall Street Journal article, where 40 of the top hedge funds said, we’re going to go into inflation because of this, because we just unleashed like Pandora’s box. So why are you so confident at that moment.

Mark: [00:25:34] Yes. It was 2010, and I looked at the list, and there are a lot of prominent economists on there and investors and I remember Cliff Asness was on there and Jim Chanos and other names that guys on the Street would recognize. And I was confident because I knew how it worked.

And my time at the IMF, I climbed into so many different central banks and economies, I got to understand the plumbing in a way that most theoretical guys don’t and most Wall Street guys don’t. They kind of gloss over this and they said they had someone summarize Milton Friedman for them, and they think they understand monetary policy. This has been an eye-opening experience for a lot of people.

But if your balance sheet is broken, it doesn’t matter how much liquidity the Fed provides. You’re not going to lend it out, you’re going to fix your balance sheet first. That’s just common sense. And the mechanics don’t work that way anyway. That Fed doesn’t give you money and you lend it out.

Like I was saying earlier, the way it works is the bank makes a loan and then gives you a deposit and their limits are governed by the regulatory framework. They have capital requirements. They have liquidity requirements. They have leverage requirements. They have to stay within those.

But the banks are chartered to issue money, create money through deposits. That’s how it started in 1863 with the National Banking Act. The Fed came in 1913 and started to supervise the process because it became clear that the banks weren’t very good at it either. The banks aren’t going to be taking risk in creating deposits and issuing money if their balance sheets are busted. That for me was just the easiest.

And listen, everybody talks about the power of interest rates, but we had 0 interest rates, and we had ZIRP and QE for four, five years before people started taking any risk at all because you have to fix your balance sheet first. Maybe this is the right moment to talk about it, but risk appetite is driven much less by the price of money than it is by the other factors.

And the two factors can really boil it down to something easy to communicate. The two factors are — I call JPMorgan’s famous quote where he says, “Nothing so undermines a man’s financial judgment as seeing his neighbor get rich.” That means once your situation is okay and you see people around you making money, you say I’m going to make money, too. And then you end up with a stripper in Florida that owns five homes with Megan Mortgages, and the system blows up.

So that’s how it tends to work. We look around — prices go up a little bit and we look around, we see other people making money, then we take a little bit more risk and we see prices go up more. This is why, as I said earlier, nothing brings out the buyers like higher prices. That’s really how Wall Street works. Now from a macro standpoint that matches that is Hyman Minsky’s financial instability hypothesis, and it’s basically stability breeds instability.

So it’s kind of the same thing. Everyone starts making money. The banks look around their [indiscernible] to keep up with Goldman Sachs, and they start underwriting riskier mortgages and everybody starts doing it. It’s not because they think the Fed is going to bail them out or anybody is going to bail them out. No one is going to make a loan apart because I think the Fed is going to come in at $0.40 on the dollar and bail them out. No one wants to take that loss.

What happens is the optimism and the greed blinds people to downside risk. Anybody who’s been in the room, and I have been in these rooms, right, over my career with the risk committees and how people are making these risk decisions, it’s not because they miscalculated the downside, but I think they’re protected somehow since they’re ignoring it. Their greed and their competitive pressure leads them to take too much risk.

I remember Stanley Mack from Morgan Stanley shortly after the Global Financial Crisis was being interviewed on a Bloomberg forum. He told the story of a client of his who’s a good friend and a long-term client, called and asked for a loan and Stanley Mack said, I can’t do that. It’s just not responsible. It’s too much leverage or whatever the reasons were. He said it wasn’t the right thing to do.

And this was the guy whom he had a really good relationship, long term, both personally and professionally. And he said, as soon as I hang up the phone, I knew he was going to Merrill Lynch to get that loan, and he did. So it’s really the competitive pressures and being blinded by greed that leads people to take all the risks, not because they think their downside is protected.

And Hyman Minsky kind of says, all these things end up — when you’re stable, people start taking a little by little more risk, and then you end up — it ends up bringing instability because in a capitalist system, we take things too far. And we should. That’s how we get innovation. We’re supposed to be taking risk, and we’re supposed to be failing.

The Fed’s job is not to stop bubbles and keep us from doing it. The Fed’s job is to make sure that the guardrails of the regulatory system are in place so that collateral damage on to innocent people doesn’t happen.

And this is what they did when you were saying earlier, they stepped in and they flooded the system with a settlement liquidity so that everyone’s transactions could clear and so that you and I didn’t have to go out in our pajamas at three in the morning, waiting in front of an ATM machine in line, hoping that there’d still be money in there when we get up in the front of the line.

2. This Is What’s Driving the Big Surge in US Oil Production – Tracy Alloway, Joe Weisenthal, Stacey Rene, and Javier Blas 

Javier (03:15):

We had record levels, and it’s just an incredible number. As Tracy said, if you look just at what we say is ‘crude oil,’ it’s more than 13 million barrels a day. But if you add on top of that number other things that go into the oil, liquids streams or condensates and NGLs (natural gas liquids), a bit of ethanol, etc., etc. — we are well above 20 million barrels a day of oil production that compares to a hundred million worldwide.

So you put everything together, the US is producing one in five barrels of oil consumed. That is just an incredibly high number. And it doesn’t seem to be stopping. Probably it’s going to slow down a bit in 2024, but it’s going to continue to go up.

Tracy (04:04):

Okay, where is all that new oil actually coming from? Because it’s been a while since I’ve brought up the rig count chart. But if you look at the rig count chart, this is such a fun one because you can see the big humps of the early 2010s and then the big slide into 2015, and now it seems kind of flat. So there’s been some increase between 2020 and 2022. The number of new rigs being drilled has gone up, but it’s not like we’re seeing a boom in new gas rigs and new explorations. So where is all this oil coming from?

Javier (04:43):

Well, it’s coming from the very same places that it was coming about 10 years ago, but it’s coming in some way, and for lack of a better word, better. So it’s coming from Texas, it’s coming from New Mexico, and it’s coming a bit from North Dakota, Oklahoma, etc., etc. It’s coming from the shale regions of the United States.

But if we were to say ‘where’ in just one single or two, or in this case, three single words, it’s Texas and New Mexico. That’s where the new oil is coming. And you are right Tracy, the recount is not significantly up. Actually, you look at [it] from a loan perspective, it’s lower than it was during the previous booms of shale.

But it’s just that the oil companies in Texas and New Mexico have [gotten] very good at extracting more oil from those rigs, from those wells that they’re drilling. And they’re also doing much longer wells. If you think about how a shale oil well looks like, it first goes down vertically and then it just turns around 90 degrees and it goes horizontal for a while. At the beginning, those horizontal wells were relatively short. Perhaps a quarter of a mile, half a mile at most. Now they’re going as much as three miles horizontally. They can get a lot more oil than they were able to do a few years back…

…Joe (07:04):

So that really held up well. So what’s changed since 2016 Javier? Tech?

Javier (07:09):

Technologically-wise, we can drill longer, particularly the laterals. We can pump fracking fluids at a higher pressure. And companies are also very good at doing this super quick. Previously our well could have taken 30 days — now it takes 10. Companies and the crews have gotten very good at doing it. And that means that they can do it cheaply. And that’s the funny part of the whole boom of 2023 and 2024, a difference of the previous ones. Companies are making money and investors are making money. So everyone is loving it. This is the first time, and this is what really terrorized OPEC, that shale oil is growing and making money at the same time. And that’s a big problem if you are in Saudi Arabia.

Tracy (07:56):

Definitely want to get to the possible response from OPEC. But just in terms of technology, one of the things, and the reason I brought up that story, was the idea of standardization. So,before you used to have all these bespoke custom fittings for oil rigs or platforms or whatever. But then, I think there was actually an industry-wide effort or attempt to start standardizing some of these things so you didn’t have to order a bespoke component for every single oil project that you were doing. And that seems to have helped make things go faster — to Javier’s point and also brought down costs. Javier, how much of a big deal is that in the industry?

Javier (08:36):

It is a big deal. It has happened everywhere in the oil industry. Let me give you my favorite anecdote of a standardization in the oil industry. So you are working on a North Sea oil platform, this is offshore outside Norway and the United Kingdom. You need to paint a lot of the stuff yellow, kind of yellow [for] danger, very visible etc., etc. Very stormy areas of the wall. The North Sea fog, it’s not the kind of place that you really want to spend an evening in winter there.

So every company has their own shade of yellow. There were 19 different kinds of yellow to paint things in the North Sea. Each company has their own shade with their own specification, and it was just ridiculous. So at one point, a few engineers in the industry got together and said ‘Well, this is a bit ridiculous. I mean, can we not just do a yellow North Sea?’

And so they got together and everyone decided this is the shade of yellow that we’re going to use. And now everyone is painting everything that they need to paint in yellow with the same shade. That at a much bigger scale has happened across the oil industry. Everything has got a standard. And companies within themselves, they like to do everything bespoke. They really, in some way, gold-plated a lot of projects. So each well was a bit different to the other one. Now, companies are designing one single design. And when they have really thought ‘Okay, this is it. This really works very well, now copy and paste for the next 25, 50, 100 wells’ — that has cut costs significantly…

…Joe (10:39):

Yeah. They’re all looking at the different Pantone shades, but got to do so in a legal way. All right, let’s talk about the capital markets aspect because it did seem like, you know, the way people thought about it was that the industry had to face a choice. Would it be pursuing volume or would it be pursuing profitability? And as you’ve just said, there seems to be this very weird situation in which volume is ramping and productivity is sustained. How is that happening and how sustainable is that?

Javier (11:06):

Well, to the question of how long and how sustainable — I’m going to be honest, I don’t know. I thought that production growth would have a slowdown in 2023 and it never happened. It did the opposite, it accelerated. You look [at] every oil executive, if you look at the forecasters of the industry, everyone is saying it’s going to slow down in 2024. But also they said the same for 2023, and they were wrong.

So we’ll see what happens, really. But yes, I mean the industry went into this new era thinking about profitability. So everyone cut CapEx, everyone tried to get more efficient. And everyone thought that production growth was going to slow down because the focus was profitability. The fact that they were able to grow quite strongly came [as] a bit of a surprise to the industry. And then everyone kind of celebrated it.

But here there is a very important question. If OPEC has not cut production to make room for all this new shale oil from the United States, prices will have come down. And then the industry would have faced the same kind of dilemma of the past. You are producing too much, then the prices come down, your profitability comes down, and then you have a problem. So a lot of these that we are putting based on efficiency, it’s true. But if not for OPEC cutting production and keeping prices above $70 a barrel, then shale companies will be in trouble.

Tracy (12:47):

One thing I’m really curious about is who is actually funding production now versus, say, in the early 2010s.

Joe (12:56):

And just to add onto that a little bit, is there any difference between private and publicly-traded domestic US players?

Javier (13:02):

Okay, so let’s in parts. On Tracy’s question, who is funding this? Well back 10 years ago, five years ago, it was Wall Street. It was a mix of equity and credit markets which were funding all of this growth through different instruments. I mean sometimes it was just issuing fresh equity. Sometimes it was bonds, high-yield bonds, reserve lending where a bank is lending to an oil company based on the reserves underground; more or less like a mortgage rather than a house. You mortgage the oil reserves that they’re underground.

And a lot of that is still there, but a lot of the money now needed for the expansion and to finance all this new growth is coming from cash flow generation. It’s the internal cash flow of these companies. They generate enough cash to pay for all the new drilling that they’re doing to pay for all the capital investment that they need to do alongside new pipelines, etc., etc. And to pay the shareholders.

These companies now for the very first time are paying dividends. And that sounds like — well, publicly-listed companies should be paying dividends that’s like normal. Well, that was not the case a few years back. But now they generate enough cash to do all of the above.

And in terms of is there a difference? Yes. Publicly listed companies have been a bit more cautious, they have been trying to. They have the shareholders, they have Wall Street on top of them, and they have to really try to focus as much as possible on paying dividends and buying back shares. Publicly-owned [companies] don’t have that pressure, that super strong pressure. So they have done a bit more growing. And there is a suspicion in the industry that a lot of that growth was to try to maximize the amount of production that you are doing so you can sell yourself to a big player, say ExxonMobil or Chevron. And perhaps that’s not as sustainable as it looks like…

…Joe (21:02):

I think his name — he even wrote a Bloomberg Opinion column on March 20th, 2020 – Ryan Sitton was his name. The railroad commissioner who called on OPEC to coordinate with the US in constraining supply.

I want to pivot for a second and talk about the Red Sea. And we talked about it a couple weeks ago in the context of container freight. What [causes] the rising tensions there? We recently saw the US strike at Houthis assets. What does the rising tension there mean from an oil perspective?

Javier (21:34):

Well, it’s more or less a binary situation. As long as the strait of Hormuz, which is the big outlet from the Persian Gulf for countries like Kuwait or Saudi Arabia into the open markets, as long as that remains open, what’s happening on the Red Sea is of less importance. Yes, it’s going to mean an increase in cost because a lot of the oil tankers and also the LNG carriers, these are liquefied natural gas carriers. They’re going to have to divert, avoid the Red Sea and go around Africa. That adds from the Persian Gulf into Europe probably a good 10 to 15 days extra. So it is not small and it could really increase the cost of shipping, but it’s not the end of the world. And that’s why the oil market is taking it quite relaxed.

I mean, prices have barely increased over the last few days. But then you could think ‘Well, that is basically on a scale of one to 10, probably a two, maybe a three.’ What is the other scenario? Well the other scenario is the open fight with Iran, not with his proxies — the Houthis in Yemen — but actually with Iran and the strait of Hormuz somehow gets in trouble. Shipping is more difficult though it probably is not completely closed, but things get really bad. And that on a scale of one to 10, that’s probably 25. And that’s the problem. That’s what I say, it’s a bit of a binary situation at the moment. So far not so bad…

…Javier (27:19):

I think that you are putting it absolutely right. I mean, the fact that the US is exporting so much oil, and when you count crude and refined products, many weeks, the US on a gross basis is exporting more than 10 million barrels a day. Obviously at the same time, its importing a bit. So on a net basis, about 2 million barrels a day.

But the fact that the US has oil to export on a net basis more than it consumes and it can export is just mind blowing. And particularly, you know, I have been writing about this industry for 25 years. If even 10 years ago you had told me that the US was going to be exporting the amount of crude that it’s doing today, I would have said absolutely not. No way. No way this is happening…

…Javier (30:16):

Well, it’s particularly about how we trade electricity. And you think about a few years back — and by that I mean five, six years ago — a lot of the electricity market in Europe was controlled by the typical names that we all knew. The utilities that have been privatized, but used to be state-owned companies, big names like EDF (Électricité de France), RWE, etc., etc.

And the market was quite sedated. Prices were not really moving much. There was not much volatility. There were very few of the independent traders really making money trading electricity. And a few years back, in the middle of nowhere, Denmark, in a town called Aarhus, it’s a big university town in rural Denmark, a group of companies kind of started to plot how we can make money out of this market.

And they were really driven by two things that were happening in Europe. It was the liberalization of the markets. There was a lot more cross-border electricity trading in Europe. And there was also a lot more volatility in the supply of electricity in Europe because of wind and solar.

You cannot predict how much wind and solar power you’re going to get more than five days, perhaps 10 days [out]. But you know, meteorologists have a limit of how strongly the wind is going to blow or whether it’s going to be cloud covering one area of the continent or not for solar, etc., etc.

So that variability created a lot of price volatility, particularly in the very short [end] of the short-term market. I mean, electricity used to be traded one year in advance, one month in advance. And these companies kind of specialize in trading the next 30 minutes of the electricity market. You know, mid-morning, what is going to be the demand for electricity by lunchtime? That’s what they specialize in.

But, you know, the five or six top of these companies were making perhaps $100 million combined. So not a lot. And they were in the rather of the industry, but not that … In 2022, they made $5 billion. The return on equity in many names of the industry went well above 100%. In some cases, well above 250%. So let me put it this way — the companies that were making a couple of million dollars were making $10, $25, $30 million.

The guys who were making $25, $30 million before were making a couple of hundred million dollars. And the guys who were making a hundred, they just went to a billion. It was just one of the biggest booms in commodity trading profitability I have ever seen. And the piece is about these names, which outside of the industry, basically no one really knows about.

3. Lessons From the Bear Market – Michael Batnick

We did a podcast in December of 2022 at the Nasdaq MarketSite in Times Square with our friends from the On The Tape podcast. At the time, things were…not great. Inflation was skyrocketing and the fed was chasing after it to slow down consumer prices.

The stock market was cratering. And the ones getting hit the hardest are the ones everyone owned. Amazon was 55% off its high. No really, 55%. Meta was worth just one-third of what it was in the previous year. Fear was everywhere.

I asked the audience, how many of you expect a recession in 2023? Every hand in the room went up. Then I asked, how many of you think the stock market bottomed in October? Crickets.

It’s easy to say “Be greedy when others are fearful.” It’s hard to actually do it…

…It’s easy to overestimate your ability to deal with downside risk when stocks are going higher. You only discover who you really are as an investor in bear markets.

Ben and I were getting dozens of emails about triple-leveraged ETFs in 2021: “I know it’s risky but I have a long time horizon.”

I don’t think we saw a single one of those messages hit our inbox (personal emails, personal responses) in 2022…

…I, like many of you, just kept buying over the last two years. It’s not because I’m a genius, and it’s definitely not because I was bullish with every purchase. I bought in my 401(k) every other week and in my brokerage account every month because it happens automatically. Out of sight out of mind.

If I had to physically log on and execute these trades, I’m sure that I wouldn’t be as consistent as I have been. You mustn’t let your emotions determine when you buy. Like Nick first said back in 2017, Just Keep Buying.

4. A beginner’s guide to accounting fraud (and how to get away with it): Part III – Leo Perry

If you’re looking for a role model for how to serially raise capital for a business that really shouldn’t even exist in the first place, you could do a lot worse than Avanti Communications. Avanti was a startup satellite broadband operator that issued half a billion odd of equity, and about as much again in debt, in just five short years. No one seemed to care much that the business case was flawed from the start. That revenue kept falling short and customers got less and less substantial. And, of course, it didn’t matter that the accounts read like a Stephen King novel. Because you can’t get a bigger addressable market than space, can you?

How did I know Avanti was always bound to end up failing its shareholders, even before it took off? The company said so. In black and white. It told me and every other investor that bothered to look at its 2009 annual report. I know corporate filings aren’t exactly gripping but it helps if you read them. Lucky for us, it doesn’t seem like many people do.

When I‘d asked directly, management had flat out refused to disclose what the Mb capacity of its first satellite (called Hylas-1) would be “for commercial competitive reasons”. But they soon went ahead and gave it away in a press release anyway, stating that 320Mb was about 10% of the total. From there it was simple to estimate build cost per Mb, which came in around £35mn. The problem was Eutelsat, which was about to launch its own broadband satellite over Europe too. This bird, KA-SAT, was 15 times as big but only cost about 3 times as much to build. It’s unit cost was more like €4mn per Mb. That was going to be an issue for Avanti.

Don’t take my word for it, take the company’s. In its 2009 annual report Avanti already states that Hylas-1 “will be full with around 200,000 – 300,000 end user customers”, with the higher number only possible if it delivered a lot of them something not much better than a Netscape dial-up service (as in 0.5Mb per second). But even then Eutelsat had a 3.6Mb per second product in the market, for €17 a month wholesale. And had said publicly it would be keeping that price point once KA-SAT was up, but for a 10Mb per second service. Hylas-1 was going to be competing with that, but at those speeds it would be able to serve a lot less customers. It’s not quite a straight line calculation because of contention – basically congestion from other users – but it wasn’t good news for Avanti. Commercial wholesale revenue for Hylas-1 would end up end peaking at around €15mn while sell side consensus was still “modelling” four times that.

5. Data Update 3 for 2024: A Rule-breaking Year for Interest Rates – Aswath Damodaran

As you can see, while treasury rates, across maturities, jumped dramatically in 2022, their behavior diverged in 2023. At the short end of the spectrum, the three-month treasury bill rate rose from 4.42% to 5.40% during the year, but the 2-year rate decreased slightly from 4.41% to 4.23%, the ten-year rate stayed unchanged at 3.88% and the thirty-year rate barely budged, going from 3.76% to 4.03%. The fact that the treasury bond rate was 3.88% at both the start and the end of the year effectively also meant that the return on a ten-year treasury bond during 2023 was just the coupon rate of 3.88% (and no price change). 

I noted at the start of this post that the stock answer than most analysts and investors, when asked why treasury rates rose or fell during much of the last decade has been “The Fed did it”. Not only is that lazy rationalization, but it is just not true, and for many reasons. First, the only rate that the Fed actually controls is the Fed funds rate, and it is true that the Fed has been actively raising that rate in the last two years, as you can see in the graph below:

In 2022, the Fed raised the Fed funds rate seven times, with the rate rising from close to zero (lower limit of zero and an upper limit of 0.25%) to 4.25-4.50%, by the end of the year. During 2023, the Fed continued to raise rates, albeit at a slower rate, with four 0.25% raises.

Second, the argument that the Fed’s Fed Funds rate actions have triggered increases in interest rates in the last two years becomes shaky, when you take a closer look at the data. In the table below, I look at all of the Fed Fund hikes in the last two years, looking at the changes in 3-month, 2-year and 10-year rates leading into the Fed actions.  Thus, the Fed raised the Fed Funds rate on June 16, 2022 by 0.75%, to 1.75%, but the 3-month treasury bill rate had already risen by 0.74% in the weeks prior to the Fed hike,  to 1.59%.

In fact, treasury bill rates consistently rise ahead of the Fed’s actions over the two years. This may be my biases talking, but to me, it looks like it is the market that is leading the Fed, rather than the other way around.

Third, even if you are a believer that the Fed has a strong influence on rates, that effect is strongest on the shortest term rates and decays as you get to longer maturities. In 2023, for instance, for all of the stories about FOMC meeting snd the Fed raising rates, the two-year treasury declined and the ten-year did not budge. To understand what causes long term interest rates to move, I went back to my interest rate basics, and in particular, the Fisher equation breakdown of a nominal interest rate (like the US ten-year treasury rate) into expected inflation and an expected real interest rate:

Nominal Interest Rate = Expected Inflation + Expected real interest rate

If you are willing to assume that the expected real interest rate should converge on the growth rate in the real economy in the long term, you can estimate what I call an intrinsic riskfree rate:

Intrinsic Riskfree Rate = Expected Inflation + Expected real growth rate in economy…

…That said, it is remarkable how well the equation does at explaining the movements in the ten-year US treasury bond rate over time. The rise treasury bond rates in the 1970s can be clearly traced to higher inflation, and the low treasury bond rates of the last decade had far more to do with low inflation and growth, than with the Fed. In 2023, the story of the year was that inflation tapered off during the course of the year, setting to rest fears that it would stay at the elevated levels of 2022. That explains why US treasury rates stayed unchanged, even when the Fed raised the Fed Funds rate, though the 3-month rate remains a testimonial to the Fed’s power to affect short term rates.

It is undeniable that the slope of the yield curve, in the US, has been correlated with economic growth, with more upward sloping yield curves presaging higher real growth, for much of the last century. In an extension of this empirical reality, an inversion of the yield curve, with short term rates exceed long term rates, has become a sign of an impending recession. In a post a few years ago, I argued that if  the slope of the yield curve is a signal, it is one with a great deal of noise (error in prediction). If you are a skeptic about the inverted yield curves as a recession-predictor, that skepticism was strengthened in 2022 and 2023:

As you can see, the yield curve has been inverted for all of 2023, in all of its variations (the difference between the ten-year and two-year rates, the difference between the two-year rate and the 3-month rate and the difference between the ten-year rate and the 3-month T.Bill rate). At the same time, not only has a recession not made its presence felt, but the economy showed signs of strengthening towards the end of the year. It is entirely possible that there will be a recession in 2024 or even in 2025, but what good is a signal that is two or three years ahead of what it is signaling?…

…If there are lessons that can be learned from interest rate movements in 2022 and 2023, it is that notwithstanding all of the happy talk of the Fed cutting rates in the year to come, it is inflation that will again determine what will happen to interest rates, especially at the longer maturities, in 2024. If inflation continues its downward path, it is likely that we will see longer-term rates drift downwards, though it would have to be accompanied by significant weakening in the economy for rates to approach levels that we became used to, during the last decade. If inflation persists or rises, interest rates will rise, no matter what the Fed does.

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. We currently have a vested interest in Amazon and Meta Platforms. Holdings are subject to change at any time.

We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

Do subscribe for our weekly updates through the orange box in the blog (it’s on the side if you’re using a computer, and all the way at the bottom if you’re using mobile) – it’s free!

But since our readership-audience for The Good Investors is wider than our subscriber base, we think sharing the reading list regularly on the blog itself can benefit even more people. The articles we share touch on a wide range of topics, including investing, business, and the world in general. 

Here are the articles for the week ending 21 January 2024:

1. Learning from significant investment statistics of the past – Chin Hui Leong

Outfoxed by rising interest rates

Interest rates are another favourite among forecasters. In 2022, the US Federal Reserve raised interest rates from zero to between 4.25 and 4.5 per cent.

As you know, the stock market suffered one of its worst performances during this period.

When two trends coincide with one another, it is tempting to put two and two together and conclude: Interest rates rose, and therefore, that is why the stock market fell. But we cannot say the same about 2023. Last year, rates were hiked again by another percentage point to between 5.25 and 5.5 per cent. This time, the stock market staged a rally.

The contrast between 2022 and 2023 is a timely reminder that correlation is not causation. Given yourself time to learn the right lessons – preferably over multiple years, rather than the past 12 months. If you learn the wrong lessons from past events, then you will be doomed to repeat them in the future.

Outfoxed by GDP growth

Speaking of trends, China’s gross domestic product grew from around US$493 billion in 1992 to an astonishing US$18 trillion in 2022, said the World Bank. The annualised GDP growth rate for this period is almost 12 per cent.

But the same cannot be said about China’s stock market returns. The MSCI China index has recorded negative gains from its inception at end-1993 until end-2023. In other words, the rapid GDP increase did not translate into positive stock market returns even after more than 30 years.

What is the reason for this disconnect?

The underlying earnings per share for the Chinese businesses within the index barely grew for much of this period. Over the long term, stock market returns depend on business growth. Without it, you end up with flat to negative returns, as you see today…

…Invest for the long term

When you hold stocks for the long term, you will occasionally record negative returns. It is the price you pay for a positive outcome. And yet, staying invested for the long haul gives you the best chance of success.

Since 1928, there has never been a 20-year period where the S&P 500 produced negative returns, noted Carlson. What is more, if you missed the five best days (read: positive returns) in 2023, the index’s gain would almost halve from over 24 per cent to 12.6 per cent. Miss the best 15 days, and the returns would be negative.

To put these figures into context, let us assume there are 252 trading days every year. Miss five of the best days or 2 per cent of trading days and your returns could be vastly lower. Miss 15 days, or less than 6 per cent, and you could be sitting on losses.

The good news is: You do not have to do anything to stay invested for the long term. Surround yourself with like-minded friends. As the saying goes: If you want to travel fast, go alone. If you want to travel far, go together.

2. Gucci is cheap and eggs are pricey in Russia’s surreal economy – Kate de Pury

As Russia enters 2024, and the campaign for President Vladimir Putin’s inevitable re-election heats up, the regime is keen to tell a good story about the country’s ability to withstand the war. It can muster a surprising amount of evidence to support this case.

The Russian economy has not collapsed under the unprecedented sanctions of 2022, as some predicted. Oil and gas sales to the West plummeted, but higher energy prices eased the pain and the government found new buyers in Asia. The rouble depreciated sharply in 2023, but has stabilised since. Vast public spending on the war has meanwhile created jobs. Inflation remains stubborn, and a slowdown is expected in 2024 as the central bank keeps interest rates high to fight it, but Putin was able to boast last year, not implausibly, that the economy had grown by more than 3%.

Russia still has to import many products, which a weakened rouble makes more expensive. But those who aren’t poor seem able to absorb the price increases, at least for now. There were initial supply hiccups when Russian banks were first cut off from international transfer systems. But middle-class Muscovites found workarounds, and can now buy Western brands over the internet with little difficulty. usmall, an online marketplace, lists iPhones and Ralph Lauren children’s clothes priced in roubles, which can be bought from third-party suppliers with Russian bank cards.

Moscow shops are well stocked with designer goods. Most Western luxury brands stopped shipping to Russian stores in 2022, but when I visited tsum, the Russian equivalent of Harrods, just before Christmas, a sales assistant was proudly showing customers the newest handbags from Gucci, Chanel and Louis Vuitton. Bought in Europe and carried back to Russia in the luggage of a “personal shopper”, there weren’t many of these new-season items on the shelves, but just enough to justify the sign “2023-24 Collection”.

Some of the items on display were second-hand. The sales assistant showed off an app the store has developed to make it easy for Russian clients to re-sell unwanted luxury goods. Even a used Gucci bag isn’t exactly cheap, but because it’s priced in roubles, fluctuations in exchange rates can make it become, by the tortuous logic Muscovites follow, a bargain in euro terms. “A good deal for the Russian shopper,” the assistant said snippily…

…Elsewhere there are signs that the invasion of Ukraine may have disrupted the Russian economy more severely than the frothy party scene suggests. The Olivier salad, a mayonnaise-drenched confection of root vegetables, sausage and boiled eggs, is a staple at every table during the holidays. This winter the price of eggs suddenly rocketed (no one is quite sure why, but it may have been because farms were short of labour since so many workers have been conscripted or left the country). In some regions people cannot afford a box of six eggs and have to buy them individually. One pensioner even raised this with Putin during the president’s annual end-of-year call-in with the public. Putin promised to look into it.

3. Claudia Sahm: it’s clear now who was right – Robert Armstrong, Ethan Wu, Claudia Sahm

Unhedged: It’s true, unemployment’s great. The most relevant signals of inflation are within spitting distance of 2 per cent. But no matter how you cut it, wage growth is around 4 per cent. Is that a potential problem?

Sahm: I have not, and do not now, subscribe to the view that the inflation we have been living through since 2021 is primarily demand-driven, like Larry Summers and my friend Jason Furman did. Those folks thought we put too much money into people’s pockets and there was too much pent-up demand. If you were in that camp, you thought we needed to jack up rates and see wage growth come down.

Wages are rising at a pace that’s better than before the pandemic, which was a very good time for the economy, but we’ve moved out of the very acute labour shortages. And obviously, we want to get workers off the sidelines. To do that, you’re going to have to pay them more!

I look at inflation and say that’s because of disruptions from Covid and the war in Ukraine. And because those will eventually work out in some way, inflation will come down. That leads to very different policy prescriptions to fight inflation. And it leads to very different views on the things like whether the $1.9tn American Rescue Plan was a good idea; or whether waiting to raise rates was a good idea. If it’s all demand, then you’ve got to destroy demand. But I don’t think it’s all demand.

On wages, too, we have seen some good productivity numbers. If you’re more productive, you get paid more. And that’s coming after the crap productivity growth we had after the Great Recession. If we’re getting better productivity growth, we should not be using pre-pandemic wage growth as the baseline…

…Unhedged: You’ve called for banning the Phillips curve, the economic model positing a trade-off between inflation and unemployment. Now that we have a bit more hindsight, what’s your retrospective on the Phillips curve in this cycle? And if we ban the Phillips curve, what replaces it?

Sahm: This fundamentally goes back to a view about how much of inflation is demand versus supply. If you think it’s demand-driven inflation, you can fight that with the Fed’s tools. But how do you know how much monetary tightening to do, how much unemployment you need to get inflation down? So then you march off to the Phillips curve. There are more sophisticated versions of the Phillips curve that incorporate supply shocks. No one brought those out. The versions of the Phillips curve that were brought out in policymaking circles went back to the 1950s or 1960s — essentially just inflation versus unemployment.

The Phillips curve was used by the same people denouncing the American Rescue Plan to make statements like, “We need five years of 6 per cent unemployment.” But it goes back to why did inflation spike, demand or supply? It’s clear now who was right: it was largely supply. It was completely valid to argue in 2021 that when inflation took off, it was demand. The American Rescue Plan was big, it came after two very big fiscal relief packages and the Fed had been adamant about not raising rates. But the fact this year that inflation has notably come down and unemployment has stayed low only happens if it was mostly supply-driven.

In terms of what other model to use, backing off from the Phillips curve would have been a good idea. And then the thing that economists need to think harder about is how we think about supply shocks. Most of the effort in macroeconomic research goes into thinking about demand disruptions. The [industry gold standard] New Keynesian dynamic stochastic general equilibrium model has wedged into it a Phillips curve that can do supply shocks. But we don’t really know how to calibrate [these sorts of models].

A lot of this is art, not science. The academic stuff looks like science, but what actually is useful in the real world is much more judgment-based. But you ought to have tools that at least don’t do damage. The Phillips curve has done damage.

Unhedged: There’s a lot of worry now about excessive debt and deficits. Olivier Blanchard is saying we need to get r minus g, the real interest rate paid on debt minus the growth rate, on a sustainable trajectory. What’s your perspective on debt sustainability?

Sahm: First off, Olivier is adorable, what a great way to frame it. My view is that it’s completely misguided to have a discussion about the size of the federal debt. The entire conversation about r minus g, while maybe useful for macroeconomists to think about, ignores that it matters what we spend on. If we are on a path for higher productivity growth after the pandemic, the American Rescue Plan, the infrastructure act, the Chips act, the Inflation Reduction Act — they all get a piece of that pie.

4. A beginner’s guide to getting away with accounting fraud, part two – Leo Perry

Now normally the way it works when you sell something is you then get paid. You get cash in return. That’s what money is after all, credit to buy more stuff in return for what you sold (which, most often, is yourself). You might not get paid right away. You might allow a few weeks for your customer to cough up (which is giving actual credit). But in the end you get your money. Otherwise you’re not really selling, you’re a charity (or a slave).

But of course we’re never going to collect on the lemons we invoiced for. And that’s going to start to show on our balance sheet, thanks to the beautifully simple logic of double entry bookkeeping. This says that for every action there has to be an equal and opposite reaction (OK that’s Newton’s Third Law but it’s close enough). Booking a profit increases the value due to owners of the business. And that’s a liability because these shareholders will want to get paid one day (good luck with that). So there must be an asset to match.

In our case that asset is definitely not going to be cash. What we get instead is more and more payments receivable from our customers.

Unattainable cash proved the undoing of Bio-On. In 2019 it was one of Italy’s only tech unicorns. This was back when being a unicorn was a good thing, because there weren’t any adults in the room…

…One thing Bio-On was great at was announcing licensing deals. Collecting on them, not so much, which is why we can learn from it.

By way of example, in July 2015 it put out a press release on a deal with French sugar co-operative Cristal Union (in fact the tie-up was with a joint venture between the two companies, B-Plastic). Bio-On’s 2015 accounts show it booked €3.25mn of license revenue from this JV — and collected none of it in cash. By the end of 2017, €2.75mn was still due from B-Plastic but the accounts for the JV show no liability, or cash to pay it with.

Oddly, Bio-On accounted for its stake in the JV with a €1mn book value at the end of 2015. But it then removed the item the following year, writing off the investment but not restating its 2015 accounts. So Bio-On appeared to have invested €1mn in the JV then written that off — while collecting license fees worth, at most, only half the money it put in.

Not collecting on sales made Bio-On a pretty obvious target for investigation. In the three years to the end of 2018 it reported €65mn revenue. Receivables were €60mn.

A few months after my visit to Bologna, the activist short seller Quintessential Capital published a report that highlighted a few issues at the company. In October 2019, Bio-On’s founding CEO and chair Marco Astorri was arrested on suspicion of accounting fraud and market manipulation, shortly before the company was declared insolvent…

…I first spoke to Quintessential’s principal Gabriel Grego back in 2015, after he published a report on another business I was short, Globo. This was a UK company but it was all Greek to me. Management claimed it had a hugely successful bring-your-own-device app, GO!Enterprise, which allowed you to use your own mobile securely at work.

And apparently this had hundreds of thousands of paying users. I was a bit sceptical because its Google appstore listing showed fewer than 5000 installs. The fact that the corporate website touted Lehman Brothers as a customer in 2013 was also a bit of a red flag

On the face of it, though, Globo was having no trouble collecting on these sales. The results for the first half of 2013 reported trade receivables up by only 4 per cent, despite strong revenue growth. But then, this wasn’t exactly an apples-to-apples comparison.

You see on December 3, 2012, Globo sold control of its Greek operations to local management for €11.2mn and with it went €40mn-odd of receivables. Of course, no one was really going to pay much money for nothing much. But the consideration was deferred, so everyone was happy (for now).

5. Harley Bassman on What Investors Are Getting Wrong About the Fed – Tracy Alloway, Joe Weisenthal, and Harley Bassman

Tracy (03:58):

So I have a question to begin with and this is completely out of self-interest as a journalist who’s had to write about convexity at many times during their career and has always struggled to define it in a way that satisfies my editors who want to encapsulate a financial relationship in as few words as possible, how would you describe it?

Harley (04:20):

Convexity is an X word, so everyone gets a little rattled about that, but it’s actually rather simple. It’s just unbalanced leverage, which was also a hard concept. Let’s simplify it a little bit.

If you have a bet, you’re making a wager where you make a dollar or lose a dollar for equal up and down equal opposite payoffs, that’s zero convexity. If you make $2 and lose one, that’s positive convexity. If you could lose $3 and make $2 — negative convexity.

The reason why we hired all these PhD quants in the nineties was to basically figure out what that’s worth. Clearly, you’d rather own something that makes $2 and loses $1 than is one-to-one. And if it’s lose $3, make $2, you better get paid for that. And so all the mumbo jumbo we go do around pricing out these various paths and payoffs is just to make it a fair bet when you have these different payoff profiles. And that’s it. Convexity just means that the payoff is not linear. It’s not one-to-one…

…Let’s just go one step back. When you’re in the bond market — not equities — the bond market, you have three buttons you could push. That’s it. Duration, credit, convexity. Those are your three risks.

You start with cash, overnight cash, and anything you do past there is taking one of those three. Duration is when you get your money back. Credit is if you get it back, convexity is how you get it back. And what a bond manager is trying to do is move around those three buttons to find the best risk-return, the best value.

Presently, selling convexity in the bond market is the best thing to do out there right now.

What’s duration? It is when you get your money back. So a two-year security will move 1.8 points for a one point move. So if rates go from four to five, a two-year bond will move by 1.8 points. A 10-year by about eight points. A 30-year by maybe 17 points, you’re usually paid more to take longer maturity risk because there’s more uncertainty.

An inverted curve is kind of upside-down land because you’re getting paid less to take more risk. We could talk why that is in a little bit, but right now, duration is a very weird place to take risk right now because you’re paid less to go out the curve and by a 10-year versus a two-year versus overnight cash.

Credit right now, investment grade credit is trading about 57 basis points. So a little over half point over the yield curve. And you get that from looking at these interest rate derivatives on your Bloomberg, it’s going to be CDX five-year. That’s actually tighter, [a] smaller number than its historic average of about 65, 66. You’re paid 57 now. Junk bonds, you’re paid about 360, 350, 370, which is also much tighter than usual 440, 450, 460.

So going into credit now, that’s not a great bet. I mean, I wouldn’t say it’s a disaster, but I mean, considering we’re concerned about the possibility of over tightening, a possibility of recession which an inverted curve kind of signals. I don’t really want to go and take credit risk. Convexity, right now, the MOVE Index, which is a measure of the price of convexity the same way it’s – 

Tracy (08:22):

Which you invented, right?

Harley (08:23):

I did. It’s the VIX of bonds, plain and simple. The VIX of bonds, its average is maybe 90 or 100. It’s trading 120 now, which averages out to about maybe seven, eight basis points a day of market movement. That’s higher, much higher than its historical average. That’s the kind of trade you want to go and do…

…Joe (11:35):

When you say, okay, short convexity, what is the type of instrument that allows any trader or investor to express that idea?

Harley (11:43):

Well, the most simple strategy would be for an investor who owns a stock portfolio to go and sell covered calls. I mean, you’re selling options. You’re selling convexity when you go and you sell covered calls, what are you really doing? You’re kind of converting potential capital gains to current income. You’re limiting your upside. Your downside, of course is still large because the stock can go down a lot.

But you’re basically kind of doing a conversion there of taking risk off the table for current income. And there’s a price where you want to go and do that. And there’s prices where you don’t. When the VIX is at 40 or 50, I mean, you probably want to sell covered calls, of course you won’t do it because you’ll be in a panic. But that’s kind of the idea. And theoretically portfolio managers are supposed to have no blood in their veins, and they can go and do these various trades when the time is right…

… Harley (25:09):

If you go look at, you know, various derivatives, it indicates right now the Fed’s going to cut rates, you know, four, five, six times. So call it 120 basis points of cutting in the next year, which seems kind of crazy unless we crash market, we have a market crash.

I think what’s happening is this, I don’t think it’s the market’s predicting that rates are going to come down by a hundred and a quarter basis points. I don’t think that’s it. I think what’s happening here, it’s like an 85% chance that rates don’t move, and a 15% chance that rates go to 1%, that we have some kind of disaster. It’s a bimodal. And if you add those two things together, that’s how you get the down 125. No one’s saying 125, I think it’s zero and 400 and people are using the two-year rate or the five-year rate as an insurance policy against a bad thing happening. If you think of it in those terms, it kind of makes sense because, we only quote one number, but how do we get that number?

Joe (26:05):

Right. So the idea is if you’re long risk assets, which most people are most of the time, one way to hedge that would be to sort of make big bets on rates coming down sharply. It doesn’t mean that that’s your main view. It just means that if your bullish view is going to go wrong, a way to hedge that is to place big bets on rates.

Harley (26:26):

Yeah, well, that’s why the curve’s inverted. But I mean, I think buying 10-year rates is kind of silly right now. I mean, if you’re going to go and buy this theoretical insurance policy of the Fed doing a massive cut because of a hard landing, you want to buy the two-year rate and that’s why we created another product that’s basically a 5x levered two-year…

…Harley (28:17):

Circling back to the duration, credit, convexity idea. Duration is ‘I buy it here, it ends up there.’ Credit, ‘I buy it here. It ends up there.’ It doesn’t matter how it gets to the final destination. Convexity is path dependent. It matters how you get there.

And so what we’re arguing about now is not where we’re going to be, but how we get there. And I’m saying that we’re going to get there much slower than the market thinks, and I want to go and invest accordingly. And if I do that, this is where mortgage bonds come in.

I’ll say, if you want the big prediction, here it is. The Fed wants a 2% inflation rate. They’ll get it eventually, I presume. They’re going to put the funds rate at two and a half, 50 over for a 50 basis point real return. Historically, if you’re a, bond geezer like I am, funds rate to two-years, 50 basis points. So now we’re at three, 2s-10s, a hundred basis points. So now we’re at four.

So we’re kind of looking at, the 10-year right now is what? 380, 390, 404? Whatever it is. I mean, it’s done. You stick a fork in it, man, the 10s aren’t moving. And I think with the 30-year rate, it probably goes up from here as the curve resteepens again, all the action’s the front end, that’s where all the action is going to be when it happens.

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We’ve constantly been sharing a list of our recent reads in our weekly emails for The Good Investors.

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Here are the articles for the week ending 14 January 2024:

1. The Impact of Shipping Disruptions in the Red Sea – Tracy Alloway, Joe Weisenthal, Mohsis Andam, and Craig Fuller

Joe (04:00):

There really is a lot to talk about, but why don’t we start off with the disruptions in the Red Sea. Why don’t you characterize, as you see it, the situation right now?

Craig (04:10):

So, I think there’s the short term anxiety that exists in terms of the safety of the crews, the dependability of the global supply chain. A lot of short-term concern, but I think the bigger story [that] is going to play out over the next couple of years is we’re now reaching a point in history where global trade and global shipping is no longer as dependable or as predictable as it has been really since the post Cold War period. Civilian ships are being fired upon. And this is an unusual development that we haven’t seen for really many decades…

…Tracy (04:46):

So walk us through the importance of the Red Sea route. What kind of ships are actually going up and down?…

…Craig (04:59):

There’s a lot of oil and gas, obviously being in the Middle East, it has a lot of exposure to oil and gas and the derivative products that come out of that portion of the world. But it’s also one of the major trade lanes for container flows. And so, think of what moves in container. It’s largely manufactured and consumer goods that are largely dependent upon containers. A lot of these products are coming from Asia, and particularly China into Europe, some products going to the United States East Coast. But the predominance of the products that move through the Suez in the container freight is largely related to products out of Asia, going to Europe for European consumption.

Tracy (05:36):

What other routes are available for that kind of trade?

Craig (05:40):

Well, you have to go around South Africa, and so you’re really adding thousands of miles of additional distance when you aren’t able to cut through the shortcut that is the Suez. I mean, [the] Suez Canal has cut out an enormous amount of distance that geographically the ships have historically had to go around with the Suez. It was able to sort of expedite trade flow from Asia, in particularly to Europe. We do benefit from it in North America, but a much smaller percent of the freight that we depend on in the United States is dependent upon the Suez.

Joe (06:16):

What is the historical role of the US Navy in securing or protecting some of these routes, and what are we seeing from US defense officials now at this acute moment?

Craig (06:29):

There’s a lot of conversation in geopolitical circles about whether the Navy’s role has changed or shifted or is no longer effective in the role that it was believed to be played for the last, really since World War II. So if you think about it, the United States has the largest navy in the world. It’s also a one of the only Blue Water navies that can go anywhere to defend any place on the planet. And that’s really the call to fame.

Joe (06:57):

Sorry, what does it mean “Blue Water?”

Craig (06:58):

It means that they can go into deep oceans…

…They can be anywhere. Basically, there’s no place on the planet that the Navy and the Marines can’t actually reach. And so, the whole purpose of that is to protect trade lanes. That is one of the primary calls of the US Navy is its role is to protect commerce and ensure global trade and really the world. And China has mostly benefited from that, [the] US Navy’s role of protecting sea from things like pirates and state sponsors that want to attack global trade.

And the question now is in a post-, we’re now in this sort of new generation of trade, what does it mean? There’s a lot more protectionism that happens with US policy. And really to be able to defend the role of the US Navy being able to protect all aspects of it with geopolitical tensions in East Asia means that we may not have the resources to actually protect all aspects of trade the way that we did at one point in time.

Joe (08:02):

Just real quickly, pirates and pirate attacks, and you mentioned them, they’re somewhat common. They’re in the news, but what’s different about this is that it’s missiles being fired. They’re not trying to steal the cargo. These are military attacks on private corporation.

Craig (08:23):

These are military techniques…

…Craig (08:26):

We’ve seen helicopters actually land on tops of ships and actually take cruise hostage by way of helicopter. It looks like a SWAT. You probably have seen the video floating around where it looks like a SWAT video. Where they’re flying in and they’re basically taking over a ship through use of a helicopter. We’re seeing situations where, as you mentioned, they’re using missile technology, military grade technologies, which is an unusual development. And then with the proliferation of drones, you now have a low cost way to actually avoid some of the defenses that are set up to protect these ships that they’re able to reach them without, without obstruction.

And I think that has changed the game. And look, we can argue whether these are truly state sponsored or not, but at the end of the day they have access to military grade technology and they are using this to attack civilian vessels. And their goal is to disrupt global trade.

Tracy (09:23):

This was going to be my next question, which is, even if the Navy said, yes, absolutely, we’re going to go in, we’re going to protect all the ships. How much can they actually do in the face of that kind of threat, which has new technology that they’re clearly using, but is also very, very flexible in terms of what it can do?

Craig (09:45):

I think the question is at what cost? Because, I think the US has the capabilities to largely defend every ship or the ships that we have decided to defend. But at what cost? I mean, you’re looking at a missile, anti-missile technologies, a million dollars. We’re firing these defense missiles off at a million dollars apiece, and you’re fighting a drone that cost a couple thousand dollars. I mean, at some point there is a massive tax on US consumers and the US economy for us to do this. And the question is what is our appetite to continue to fund this type of defense technology when the United States is not the primary beneficiary of that type of trade.

Tracy (10:25):

And on a similar note, I’m always curious about the decision-making process to not go through a certain route. So, Maersk said it wasn’t going to go through the Red Sea anymore after the missile was fired. What are the factors that go into making that type of decision? And then if the Navy were to say tomorrow that “We’re going to escort all of these ships”, would that completely address their concerns? Would they [say], “Okay, yes, we’re going to resume this route”?

Craig (10:52):

It’s a great question because, I don’t know that the US with all of our other geopolitical commitments, particularly around China and what’s happening around Taiwan. I mean, the Chinese want our Navies in the Middle East. That’s where they want them because [that] enables them to have an enormous amount of power over East Asia. They want us moving our assets and being distracted in the Middle East. So they actually win geopolitically in terms of their power over their region by moving, forcing us to be distracted in the Middle East. But I don’t know that we have all the resources to defend every single ship from these attacks. And ultimately, what the container lines have to really think about is what’s the cost of a ship? You’re talking hundreds of millions of dollars. What’s the cost of a cargo, again, measured in probably billions of dollars when we a look at a 20,000 TEU (Twenty-foot equivalent unit) ship. And then you have the insurance companies which are saying, “Hey, we’re not going to insure these ships that go through these channels.” And that means that ultimately Maersk and others have to look at alternative routes. They will obviously protect their crews. The crews do understand that, the nature of their jobs is on occasion they put themselves in harm’s way. And we’ve seen that with the movie with Tom Hanks plays as the Captain…

…Joe (28:26):

Well, I’m glad you mentioned the freight tech companies because that’s where I was going to go next. So we already said, we already know it was bad for a lot of companies in 2023. But, going back to 2021, 2022, we got interested in freight, obviously on the Odd Lots podcast, that was also a big year for tech and tech investing.

A lot of VCs suddenly probably woke up to this idea, this world we’re like ‘Oh, the freight industry looks like a mess. I’m sure if we just apply our software magic, we can solve all of these problems.’ We saw some really huge fundraising, but then also in 2023, we saw the reversal of it. So we saw the freight brokerage, Convoy, just basically completely go out of business. I think we saw a pretty big downturn at Flexport. We’ve had their CEO Ryan Peterson on the show a couple of times.

What happened with freight tech? What were the theses maybe of the investors who were going in, they’re [thinking] ‘Oh we can solve this.’ And what reality did they run into that maybe it’s a bit harder to solve some of these problems then they may have assumed?

Craig (29:31):

You know, they were playing the Uber, Lyft, even Airbnb playbooks, which is, ‘Hey, I have this capacity and I can go out and create a digital app. If I could disrupt the taxi industry the way Uber did. Then I could also disrupt the trucking industry.”…

…Craig (29:47):

Here’s the problem, is that the investors that really drove the high valuations didn’t understand freight. They didn’t understand the boom and bust cycle. Convoy arguably had the best roster. Like, it had a dream team of investors. I mean, you had Bill Gates, Jeff Bezos, you had Reid Hoffman, you had the who’s who of sort of Silicon Valley and legacy tech that were investors. I mean, it was the best lineup of investors of probably any company in supply chain you could possibly have. And yet that did not help them survive.

And the reason is that really the investors and the management team, when it first raised money and got into this business, did not understand how cyclical this industry is and how fungible the capacity is. So if I want to disrupt the taxi industry, the reason that that works is I have all of these consumers sitting at home with their cars that are idle 90% of the time. That can create incremental capacity in and out of a market. So as the market surges, you can have, and Uber has piloted this with their search pricing, they will send out messages to their drivers and say, ‘Hey, there’ a football game in town, or there’s a big event in town, please come out and get three to four or five X your normal rate.’ And they’ve created this sort of surge flexible capacity model that works really well in a business like Uber and personal transportation.

The problem in trucking is there is none of that excess capacity sitting against the fence that can flex in and out of a market. And so what ultimately happened is that they were able to apply some digitization to the dispatch process and to the driver management process. But that was incremental. And one would argue, and Brad Jacobs has argued that the incumbents were doing the same thing, is that effectively all of these companies were spending billions of dollars to build technology that everyone else was also building. And not just existing companies like XPO and CH Robinson, but you also had all these tech vendors, companies that provide software that were also building technology that they could sell to hundreds of companies.

All this was happening at the same time. And effectively what Convoy did not understand early on, which I think they certainly understood at the late part of the cycle, a late part of their business is that freight is commodity, it’s highly fungible. The capacity is highly fungible. And no matter how much money I spend acquiring the capacity, there is nothing to keep that capacity from going to the next highest bidder. And because of that, all of the money that they wasted in acquisition costs to acquire capacity was effectively meaningless at the end of the day because that capacity could be found elsewhere….

…Craig (37:35):

So it’s interesting because Brad talked about the fact that when he got in this industry 10 years ago it was largely humans and then over time it had digitized. And I think the statement was he had 97% of its freight was electronic. That very well may be the case for his business. Think of XPO’s role in the business. It’s a big really predominantly, in its focus on LTL, which means it has very large enterprise shippers, big commitments. It’s able to digitize a lot of the transactions. And most of the bigger trucking companies are digital. Like if you go look at Knight-Swift’s operation, okay, look at Schneider’s operation, go look at Old Dominion.

Joe (38:13):

And so that is like placing an order on a thing and it automatically…

Craig (38:15):

That’s right. Okay. And that’s what the big companies want to do. Okay. Is they actually want to eliminate human contact as much as possible. Yeah. Because that’s how they’re able to optimize the, the model. They use technology to do electronic transactions and that is, that probably represents 20% of the business. It’s the cream of the crop business. It’s the business that every company wants because it’s the high volume shippers, dependable volume and…

Joe (38:41):

Standardized lanes, standardized shippers, standardized carriers. Over and over.

Craig (38:45):

Exactly. Highly predictable. Yeah. Highly consistent business. And if you’re building a network, then that’s what you want. Because I can depend on it day in, day out. That’s what the larger companies focus on. I see. And if, if you ask the CEO of Knight-Swift, you would probably get a similar answer about how much of its freight is electronically tendered. CH Robinson the largest freight broker in the country publishes that 78% of its freight doesn’t have a human touch. But the reality is, Joe, is that the hundreds of thousands of freight broker people that are out there making up, at least, the numbers are as high as registered freight brokers in the 60 to 80,000 numbers. We track and think there’s about 5,000 high scale freight brokers that do more than about $10 million in revenue a year. They’re still predominantly human-based and what they’re dealing with are the exceptions…

…Craig (39:39):

So what happens is, a large volume shipper takes 95% of its freight and sends it over to the XPOs and the CH Robinsons and the Knight-Swifts. And so they get all of the electronic stuff dispatched. What’s left over is the really hard to manage. It’s either a lane that nobody wants, it’s somebody who literally chop shops price on every single load. It’s a commodity that nobody wants. And you’ll see in the meme, if you go on Twitter or on X, you see all the memes and freight making fun of the kinds of freight that nobody wants. This is the type of freight that’s left over.

Joe (40:13):

What’s an example of a type of freight that no one wants to deal with?

Craig (40:16):

Grocery. Driver unload…

…Craig (40:21):

Well, it’s typically going to a grocery store. It takes a long time to unload it. They’re miserable because they’re in a cold trailer, in a refrigerated trailer, they have to use something called a Lumper. A Lumper is, I pay somebody at the dock to unload me, or the driver has to unload themselves. They can take eight to 10 hours to load at a farm. They go into a farm facility or distribution center because they’re all hand loaded. Think of like a crate of tomatoes or oranges or something. A lot of it’s loaded not on pallets, but actually sort of flow loaded. So this is undesirable freight for a lot of these guys. It has really tight transit times. So that’s a type of undesirable freight.

Flatbed, which is hauled to project sites. You’re not going to a warehouse, but you’re going to a construction site that has to be manually unloaded. It can take sometimes hours or longer where the truck’s got to sit. And so there’s a lot of freight that’s just undesired. And that’s where a lot of the freight brokers, the humans still take and manage a lot of these sort of long tail transactions. That isn’t the world that an XPO plays in. That is the world that the predominance of your freight brokerage…

…Joe (48:18):

One last quick question. I’m going to pivot. Founder and CEO of FreightWaves. We always talk to you about freight. You also have this whole other business and aviation media and other aviation assets. I want to do like an hour with you at some point. Talk about that. But just real quickly, is it really true that there’s more airports than McDonald’s in United States?

Craig (48:36):

This is an insane stat that no one, I think everyone finds it hard to believe. So if you take the total amount of private, this includes private airports and public airports. So most people think of airports, I’m thinking of like JFK and LaGuardia and Newark. The predominance, the vast majority of airports in the United States are actually privately owned airports or community owned airports. Places that have very small runways of a thousand to 2000, 3000 feet can’t accommodate even a jet. They’re accommodating small aircraft. Yeah. There’s 19,000 of those. And I think the number on McDonald’s is like 16,000…

…Craig (49:26):

People think that private airports is all about jets. And they always think it’s like really rich people. But the predominance of the folks that use these small airports are farmers and their agriculture. And our entire [agriculture] ecosystem is dependent upon airplanes and bees, but airplanes to do things. And so a lot of the airports are used in places out in the heartland for farming. They’re also used for things like mining extraction and stuff. And so the vast majority of those airports are very small airports that most people will never see, will never notice unless they get in a small airplane.

2. My Parents’ Dementia Felt Like the End of Joy. Then Came the Robots – Kat McGowan

WHEN MY MOM was finally, officially diagnosed with dementia in 2020, her geriatric psychiatrist told me that there was no effective treatment. The best thing to do was to keep her physically, intellectually, and socially engaged every day for the rest of her life. Oh, OK. No biggie. The doc was telling me that medicine was done with us. My mother’s fate was now in our hands…

…Beyond physical comfort, my goal as their caregiver was to help them to feel like themselves, even as that self evolved. I vowed to help them live their remaining years with joy and meaning. That’s not so much a matter of medicine as it is a concern of the heart and spirit. I couldn’t figure this part out on my own, and everyone I talked to thought it was a weird thing to worry about.

Until I found the robot-makers.

I’m not talking about the people building machines to help someone put on their pants. Or electronic Karens that monitor an old person’s behavior then “correct” for mistakes, like a bossy Alexa: “Good afternoon! You haven’t taken your medicine yet.” Or gadgets with touchscreens that can be hard for old people to use…

… Instead, the roboticists I learned about are trained in anthropology, psychology, design, and other human-centric fields. They partner with people with dementia, who do not want robots to solve the alleged problem of being old. They want technology for joy and for flourishing, even as they near the end of life. Among the people I met were Indiana University Bloomington roboticist Selma Šabanović, who is developing a robot to bring more meaning into life, while in the Netherlands, Eindhoven University of Technology’s Rens Brankaert is creating warm technology to enhance human connection. These technologists in turn introduced me to grassroots dementia activists who are shaking off the doom loops of despair…

…The robot-makers are a shaft of light at the bottom of the well. The gizmos they’re working on may be far in the future, but these scientists and engineers are already inventing something more important: a new attitude about dementia. They look head-on at this human experience and see creative opportunities, new ways to connect, new ways to have fun. And, of course, they have cool robots. Lots and lots of robots. With those machines, they’re trying to answer the question I’m obsessed with: What could a good life with dementia look like?

THE ROBOT’S TORSO and limbs are chubby and white. It seems to be naked except for blue briefs below its pot belly, although it does not have nipples. It is only 2 feet tall. Its face, a rectangular screen, blinks on. Two black ovals and a manga smile appear.

“Hello! I am QT, your robot friend,” it says. It says this to everyone, because that’s its job. QT raises both arms in a touchdown gesture. The motors whir. They sound expensive.

It might look and sound sort of familiar if you know anything about humanoid social robots—contraptions built to respond to us in ways we recognize. You may also remember their long history of market failures. RIP Kuri, Cozmo, Asimo, Jibo, Pepper, and the rest of their expensive, overpromising metal kin. QT is not like them. It is not a consumer product; it’s a research device equipped with microphones, a 3D camera, face recognition, and data recording capabilities, built by a Luxembourgian company for scientists like Šabanović to deploy in studies. She’s using QT to explore ikigai, a Japanese word that roughly translates to a reason for living or sense of meaning in life, but also includes a feeling of social purpose and everyday joy. Doing a favor for a neighbor can create ikigai, as can a hard week’s work. Even reflecting on life achievements can bring it on. Her team, funded by Toyota Research Institute, is tinkering with QT to see what kind of robot socializing—reminiscing, maybe, or planning activities, or perhaps just a certain line of conversation—might give someone a burst of that good feeling…

…One challenge is that dementia is never the same for any two people. There are different varieties, such as Alzheimer’s, frontotemporal dementia, and Lewy body disease, and they are dynamic, changing with time. Some people have no problem with memory but struggle with words; others make strange decisions. Many say their perception of time changes, or their senses become more acute. Some people are angrier, some calmer, and others lose all filters and say whatever they think…

… Today, Hsu will demo a storytelling game between person and machine. Eventually QT will retain enough information to make the game personalized for each participant. For now, the point is to test QT’s evolving conversational skills to see what behaviors and responses people will accept from a robot and which come across as confusing or rude. I’m excited to see how this plays out. I’m expecting spicy reactions. People with dementia can be a tough audience, with little tolerance for encounters that are annoying or hard to understand…

…Soon, Maryellen, an energetic woman in a red IU ball cap, walks in and takes a seat across from the robot. Maryellen has enjoyed talking to QT in the past, but she’s having an off day. She’s nervous. “I’m in early Alzheimer’s, so sometimes I get things wrong,” she apologizes.

The robot asks her to select an image from a tablet and make up a story. Maryellen gamely plays along, spinning a tale: A woman, maybe a student, walks alone in the autumn woods.

“Interesting,” says QT. “Have you experienced something like this before?”

“I have,” Maryellen says. “We have beautiful trees around Bloomington.” The robot stays silent, a smile plastered across its screen. QT has terrible timing, pausing too long when it should speak, interrupting when it should listen. We all share an apologetic laugh over the machine’s bad manners. Maryellen is patient, speaking to QT as if it were a dim-witted child. She understands that the robot is not trying to be a jerk.

Today’s robot-human chat is objectively dull, but it also feels like a breath of fresh air. Everyone in this room takes Maryellen seriously. Instead of dismissing her pauses and uncertainty as symptoms, the scientists pay careful attention to what she says and does.

Next enters Phil, a man with a tidy brush mustache, neatly dressed in chinos and a short-sleeve button-down printed with vintage cars. After taking a seat across from the robot, he chimes in with QT to sing “Take Me Out to the Ball Game.” He faces the machine, but he’s playing to us, mugging and rolling his eyes. Song over, he first teases Hsu, then another resident, then pretty much every woman in the room. In other circumstances he’d be patronized or “diverted”—someone would attempt to distract him. Instead, we join him in being silly, joking about the situation and the robot.

QT pipes up with another round of awkward conversation (“I love the song. Do you?”), and Phil replies with a combination of graciousness and sass (“You sing very well. Did you have that recorded, maaaybe?”). Hsu asks Phil how he felt talking to the machine. “Like I’m a fool talking to nothing,” he says sharply. “I know it’s not a real person.” Theatrically, he turns to the robot. “You’re not real … are you?” He winks, and laughs uproariously.

He likes the robot? He doesn’t? It’ll be the team’s job to figure out these enigmatic yet relatable reactions. The three of us plus robot pack up and head back to Šabanović’s R-House Lab at the university. In the big conference room there, her team will converge, students of informatics, data science, computer vision, and psychology. They’ll pick apart Maryellen’s kindness and hesitation and Phil’s glee and annoyance, looking for their next task, the next skill QT needs to learn…

…In 2005 she spent time with the pioneering roboticist Takanori Shibata at Japan’s National Institute of Advanced Industrial Science and Technology and his robot seal pup Paro. Handcrafted, the little critter responded to speech and touch by bleating—it was programmed with actual seal pup cries—closing its eyes, and flipping its tail and flippers. It was one of very few robots at the time that could be used outside the lab without expert assistance.

Even at this early stage, elderly people were the target audience. The researchers took the machine to care homes, and Šabanović was startled to see the effect. “People would suddenly light up, start talking to it, tell you stories about their life,” she says. Shibata’s studies, then and later, showed that the cuddly seal improved quality of life; it got people to interact more, reduced stress, and eased depression.

So Šabanović joined the emerging field of human-robot interaction. Her experiments since have explored how we project our “techno-scientific imaginaries”—our cultural baggage, fears, and fantasies—onto these hunks of metal and plastic. Sort of like if Isaac Asimov became an experimental psychologist.

In one early study, she brought Paro into a nursing home to study how the device turned wallflowers into butterflies. Most residents would ignore the seal pup until other people showed up—then it would become an icebreaker or a social lure. They’d gather to touch it. They’d comment on its sounds and movements, laughing. The robot, she saw, seemed to open a door to other people…

…A PAIR OF round, white blobs sit side by side, each the size and shape of a pumpkin. Every 10 minutes or so, the orbs croak like frogs, or chirp like crickets, and sparkle with light. They want your attention. Pick one up, and depending on whether you stroke it, tap it, or shake it, it will respond with noise and light. If the orbs are set to “spring” mode, and you stroke one, it will sing like a bird and blush from white to pink. If you ignore the second blob, it will act jealous, flushing red. If your friend then picks up orb number two, they will mimic each other’s light and sound, encouraging you to play together.

The blobs are called Sam, and together they form a social robot boiled down to its essence: an invitation to connect. Sam is one of the otherworldly creations emerging from the Dementia and Technology Expertise Centre at the Eindhoven University of Technology in the Netherlands. Rens Brankaert and his colleagues don’t call this—or the other things they make—a robot. They call it warm technology. “We want to contribute to the warmth between people,” he says. And to create gadgets that a wider range of people would enjoy using…

…One of the warmest technologies from the Eindhoven group and their collaborators is Vita, a patchwork pillow with vinyl panels. Pass your hand over a patch and a sensor detects your presence, playing a personalized, familiar soundscape: a stroll down a cobblestoned street in the rain, maybe, or the clatter of coffee cups and servers and spoons at a café. Family members and caregivers select the sounds they think will resonate with the user. Over years of testing, the pillow has been fine-tuned, and Brankaert is currently talking to a partner to produce it and bring it to market.

In one demonstration, a white-haired woman sits quietly, looking dreamy, or very possibly sleepy. “Good morning,” says her daughter, but the woman does not respond. The daughter places the pillow on her mother’s lap and guides her mother’s hand over a large yellow patch. The chorus of the World War II chestnut “We’ll Meet Again” emerges. The older woman’s eyes brighten, and a smile of recognition creeps over her face. She begins to sing.

What is this pillow gadget for? It doesn’t restore her speech or fix her memory or replace anything she no longer can do. It helps the two of them find each other again across the dim and confusing terrain of dementia…

…You learn a lot about people by hanging out with robots. QT made it plain to me how much human interaction depends on tiny movements and subtle changes in timing. Even when armed with the latest artificial intelligence language models, QT can’t play the social game. Its face expresses emotion, it understands words and spits out sentences, and it “volleys,” following up your answer with another question. Still, I give it a D+…

…It’s four days before Christmas, and QT is visiting Jill’s House again, decked out in a Santa hat and a forest-green pinny for this visit. With the help of ChatGPT, QT is now more fun to talk to. A few dozen residents, family members, and staff are here, plus much of Šabanović’s team. Šabanović’s 3-year-old daughter, Nora, is nestled on her lap, carrying on the family legacy. She stares shyly at the robot.

This is a holiday party rather than a formal experiment. The session soon devolves into friendly chaos, everyone talking over one another and laughing. We all chime in to sing “Here Comes Santa Claus,” the robot flapping its arms. Phil plays peek-aboo with Nora. It really does feel like a glimpse of the future—the people with dementia as just regular people, and the machine among the humans as just another guest.

3. A Framework For Spotting Value Traps – Dan Shuart

As for value traps, I like to think of them as somewhat of the anti-compounders. They display the opposite of the characteristics described above. Specifically, they demonstrate some combination of;

1. A need to retain a significant amount of the profits they generate just to maintain existing levels of profitability. In other words, they tread water or slowly drown.
2. They have very poor incremental, or even negative, returns on incremental invested capital. This results in the business retaining profits and standing still or shrinking.
3. They return too much capital to shareholders and do not reinvest in the business to an adequate degree or take on excessive leverage to fund unsustainable capital return programs…

…Here is how we look for value traps and a few real world stock examples.

Cash-in, Cash-out Framework

An initial test/filter Matt and I use to spot a potential value trap, or identify a potentially good business, is what we call the cash-in, cash-out framework. It’s simple yet very powerful.

We are trying to answer a simple two-part question: how much cash does the business reinvest and what are the returns on the reinvested cash? We prefer to work from cash flow statements, as normally cash doesn’t lie and it is much more difficult to manipulate than GAAP earnings or balance sheet figures. Just don’t forget to consider stock compensation, which is a very real expense.

I like to look at ten year increments and add up how much cash came into a business from all sources – operating cash flow, debt issuance, and share issuance – versus how much cash left the business via debt repayments, share repurchases, and dividends. Add the two together and you get the dollar amount of cash retained (from all sources) over that time period.

Next, we look at the cumulative profits over the same time period to get an idea what the reinvestment rate is as a percentage of total operating profits. Finally, by looking at the change in operating profits (often this requires some normalization) over the time period and dividing by total retained profits we can assess incremental returns on retained capital (incremental ROIC or I-ROIC). If profits grew by $1B and it took $5B of retained capital to generate that extra $1B, I-ROIC is 20% ($1B/$5B). Reinvestment rate and I-ROIC, in conjunction with shareholder yield, tell me roughly how the business has compounded in value on a per share basis…

…Verizon is puzzling to me as I would expect it to be a better business given it operates in a lightly regulated oligopoly with hard to replicate assets. Alas. The company soaked up 90% of earnings over the last ten years and barely grew for a measly 1% compounding rate. A generous debt-fueled dividend payout took business returns to an underwhelming 6%. While the yield seems attractive, a high dividend payout cannot go on forever if it’s driven by increasing levels of debt.

Macy’s has been a disaster. Left behind by better positioned specialty retailers and ecommerce businesses, Macy’s reinvested a third of profits at highly negative rates and has become far less valuable over the past decade, as you can see…

…To be clear, these stocks are cherry picked and meant to illustrate a point. I’m sure you can find a plethora of stocks that had cheap starting valuations, poor returns on capital, and still re-rated to a higher stock price for some reason over a ten year period. While those stocks undoubtedly exist, and probably in great quantity, I seriously doubt most people’s ability to reliably predict those situations for any extended period of time. I certainly couldn’t do it, it would be akin to throwing darts.

The point I’m making is, by assessing the economic fundamentals of a business whose stock may look cheap, you can implement guard rails as to whether or not you may be looking at a value trap. I’m skeptical of any stock that looks cheap but has flunked the cash-in, cash-out test over a many-year period. This filter at least gives us some hope of not fooling ourselves when we are enamored only by a cheap purchase price. Cheap businesses can be fine investments, but cheap and good businesses can be spectacular, and more importantly, limit your downside. To us, it’s also a far more replicable process, and a lot easier to stick with over the long run.

There are a few more critical other points to this discussion, as what I’ve described above is the easy part of the analysis (anyone can plug numbers into a spreadsheet).

• The historical numbers are the result of what happened over the past ten years, and what matters is what happens over the next ten years.
• Understanding what happened is easy, understanding why it happened and, more importantly, if it will continue to happen is where superior qualitative judgement and experience are required…

…Finally, using this I-ROIC framework will cause you to miss opportunities when businesses are at key inflection points and the future looks dramatically rosier than the past. That’s fine with us, because I think it causes us to “miss” more losers by keeping us out of trouble. It also means we will almost surely not find the next Amazon, but that’s not the game we are trying, or equipped, to play.

4. A beginner’s guide to accounting fraud (and how to get away with it) – Leo Perry

But now that I’ve worked out how to read accounts, and find it quite easy to spot signs of fraud, I also have some ideas for how we could run a good one of our own. And I’m not so sure there won’t be a lot more money in that line of business, if you can call it that.

The mechanics of making up sales are pretty simple. If we’re running a business and want to boost our top line, all we have to do is phone a friend. A good friend to be sure, who doesn’t ask questions. It’ll only take them a few hours to do the paperwork for setting up a shell company and then we have our customer, one we can invoice whatever we want. We have our fake sales (and I’m pretty sure our mate has done nothing wrong, in the eyes of the law).

You might think that sounds too easy, that someone would spot the problem and the con would quickly fall apart.

Well back in 2014 I explained what I thought looked like the most obvious fraud to an FT journalist. One of the things that caught my eye about Wirecard was the accounts of a company it bought in Singapore. Tucked away in the notes were references to specific customers — like Ashazi Services. [1] This was a Bahrain entity with no apparent operating business. A dormant shell that had never filed financials. Even the product Wirecard said it was licensing to it, the Elastic Platform, seemed to be a fiction (at least I never found any other mention of it by the company):…

…Dan McCrum, the FT journalist I met with, went to visit what there was of Ashazi as a part of a long-running series of Alphaville posts on Wirecard. And the whole scam did come crashing down . . . a mere six years later…

…Even if some over-eager analyst does turn up at our sham customer, we can always move the goalposts. A few years ago I asked a Chinese-speaking colleague to visit some companies on the mainland. These were businesses that were reported to have signed purchase agreements with a western mining startup, which I was short. This startup had announced a deal to sell product a few years earlier. Then the contract was suddenly cancelled and simultaneously replaced with a similar agreement, but with a different Chinese entity — which we’ll call Tulip Industries. The deal equated to an outlay of approximately $150mn a year by the customer.

What we found at Tulip Industries was little more than a startup itself, with only a few field trials in progress. Even its most ambitious presentation forecasts involved a fraction of the product it had apparently agreed to buy. And its CEO was very clear that the deal wasn’t a firm commitment, only a loose framework. In fact he said he’d never spoken to the company that I was short, the deal was agreed through a friend in Hong Kong whose nephew worked for the miner. (He was much more committed to explaining to my colleague why China needed to invade Japan.)…

…If we don’t want to rely on a third party there’s also the DIY approach, using an entity that we control. A related party.

One of the first sets of financial statements I really struggled to reconcile with the story company management was telling was for Cupid, a UK-listed operator of dating apps and websites. I don’t know how many of its shareholders bothered to try out the sites it ran, even briefly, but I would guess not many. For anyone who did it seemed like they were too good to be true. Wherever you signed in from in the world, dozens of very keen and very attractive women would quickly get in touch. And they all happened to live nearby.

The Kyiv Post looked into how the company might be managing this back in 2013. Australian short seller John Hempton at Bronte Capital even took the trouble to log in from the most remote island in the UK (not in person, he used a virtual private network) and still found no shortage of admirers in the local area — even though the population there was small enough to all know each other. The fact that his profile stated he had syphilis apparently wasn’t a problem either.

Cupid commissioned KPMG to investigate; its report found there was “no evidence of a company-organised practice” of staff using fake profiles to encourage subscriptions.

Cupid’s accounts were not as straightforward as its business model, and shareholders seemed to have even less time for them than they did for its services.

The annual report for 2011 had a chunky £2mn receivable from a company called Amorix, which was controlled by Cupid’s founders. Cupid said Amorix owed it this money because it had been collecting customer subscriptions on its behalf. But Amorix’s own accounts showed it only had about £80,000 in the bank, and no other assets to speak of. There was no trace of the money Cupid said was being collected for it…

…The magic thing about fake sales is they are 100 per cent margin. All profit. You don’t need to go to the trouble of actually producing whatever it is you are pretending to sell, do you? So £100 in sales is £100 of profit. Hold that thought for a minute.

Now let’s think about what kind of business we want to start with to run our little fraud out of. Not a profitable one obviously. That would cost us good money to get control of in the first place, and we want nothing to lose. What we need is a business that has a lot of turnover but makes no money, but isn’t burning cash either. Something like a very low margin distribution business…

…So let’s say we go into the fruit wholesale business. We buy boxes of bananas and sell them on at cost. Why? Well, while we’re only washing our face, if we turn over £100mn in bananas who’s going to notice when we add £1mn that’s lemons? That’s still less than 1 per cent of our sales after all. But if the £1mn is fake then it’s all profit. And as we make no money shipping bananas, the fake lemons are all of our profit.

The reported value in our business now all comes from made up sales to a fictitious customer; a customer set up by a mate that no one outside our office is ever going to know about. No one can pay them a visit if they don’t know its name. And they won’t, because at that size we wouldn’t even have to mention it exists. From the outside there’s just no way to spot anything wrong in our revenue numbers.

5. Why Wasn’t there a Recession? – Michael Batnick

So, how did everyone get 2023 so wrong? Michael Cembalest hit on this in his 2024 outlook.

Monetary policy is tighter but below the level of real rates that led to prior recessions; corporate cash flow is still in good shape, unlike the cash flow deficits which preceded prior recessions; and the corporate sector termed out debt maturities before the rise in rates, partially immunizing itself from the interest spike that preceded prior recessions. Private sector credit creation was similar to prior cycles, but debt servicing risks are lower for companies and households that termed out maturities.

Even though the Fed aggressively raised rates, monetary policy wasn’t as restrictive as it was in the lead-up to prior recessions (not including 2020). That’s not to minimize their efforts of cooling inflation, only putting in perspective that historically, they just weren’t that tight.

And even if they raised rates to 6% or higher, it’s hard to say for sure that we would have had a recession. Almost 90% of S&P 500 debt is long-term fixed, which is why net interest costs didn’t go up with interest rates. Paradoxically, thanks to all the cash on the balance sheets actually earning something, net interest costs went down!

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Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. We currently have a vested interest in Amazon. Holdings are subject to change at any time.