Poor Charlie

My most treasured book, brimming with scribbles and dog-eared pages, is 'Poor Charlie’s Almanack'. A gift from my mother thinking it was ‘The City’ version of 'Rugby Almanack'. It’s more than just a book - it’s a life and business manual, especially for decision-making. In finance, we often overlook that our end product isn’t a fund or flashy returns –  it’s a well-considered decision. Behind every price point, lies a decision either made or augmented by a human. So understanding the decision-making process is paramount, much like how a surgeon’s or pilot’s methodology is crucial in their respective fields. And to help the guardians of our wealth make better decisions, here are some tips from the author of said book, and one of the best ‘decision-makers’ to have lived: Vice Chairman of Berkshire Hathaway Charlie Munger (RIP), who died this week.

Munger’s masterstrokes: lessons for life

The Magic of Compounding: Munger emphasizes the exponential power of compounding in life, learning, and business. Patience and perseverance are key. Ignore this and "then you go through a long life like a one-legged man in an ass-kicking contest".

Inversion: Approaching problems backward is a Munger hallmark. It’s about avoiding pitfalls rather than just striving for success. "Tell me where I’m going to die so that I never go there". Know what to avoid, the things that can go wrong or lead to failure (the ‘dumb stuff’), rather than just focusing on what needs to be done to succeed.

Avoid Stupidity over Seeking Brilliance: It’s often more fruitful to avoid dumb decisions than to chase brilliance - think of the amateur tennis player losing points. Figure out where you’ve got edge then stay in your lane. Be patient. Strike at the fat pitch. Win by not losing. (Oh Charlie, where we you when I sunk all that money into Ocean Power, Zimbabwean gold mines, WeWork and Bulgarian property?)

Be Informed, Not Opinionated: Munger insists on understanding counterarguments thoroughly before forming opinions - a practice shared by many successful investors, like Soros who would actively seek what was wrong in his assumptions, being overjoyed if he found error (thus decreasing the risk of losing capital). Sounds easy, but it’s really hard for you must overcome a formidable enemy: your ego.

Incentives are Everything: Understanding incentives is crucial for predicting outcomes. They’re the silent drivers of human behavior. "Show me the incentive, I’ll show you the outcome". (Oh Charlie, why didn’t Jeremy (Hunt) act on recent proposals for enhancing UK financial industry competitiveness such as those in our last article – perhaps he didn’t ‘get the memo’?) I’ll send another…

Memo to Jeremy

To: Jeremy Hunt, UK Chancellor of the Exchequer:

From reading your recent Autumn Statement, it seems you didn’t wholly take on board the proposals in our previous edition of The Weekender. I suggest reading a copy of Poor Charlie’s Almanack; particularly relevant are sections on The Power of Incentives and Understanding Compound Interest. I’m not sure that selling the public shares in NatWest will achieve your objective of encouraging equity participation; for that to work you must be convinced the shares will rise in order to create the excitement and attraction that only price can provide. As future returns are a function of starting valuation, and given it’s not exclusively in your hands, the key will be deciding on what price makes it attractive. That, and this is not the 1980s, when the likes of BT, BA, British Gas and Rolls Royce had plenty of opportunities to create efficiencies once in the hands of private shareholders.

I believe that if we fix the FTSE, all else will follow. And the best way to do that is through incentives, the most powerful, compounding tax-exempt returns over a very long time. So, bring back BRISA and educate the public on the powers of compounding. While tax-deferred gains are good (ref: pension savings) tax-exempt ones are even greater.

Munger on investment consultants

Munger, always sharp-tongued about bankers and consultants, quipped, "if anybody offers you anything with a big commission and a 200-page prospectus, don’t buy it". This rings especially true in the tumultuous VC fund arena. While some alternatives merit attention, others, like Private Equity, are losing their allure due to regulatory demands for transparency. Removing the ‘mystery’ could remove the margin. Moreover, the ability to smooth returns – a key attraction of the asset class – is now under threat via regulator pressure for more frequent valuations. Absent such, allocators could be adding portfolio risk by increasing correlations. Commodities, like gold, or equities in these commodities might be safer bets. They’re less dependent on leverage and are free from the burdens of regulatory scrutiny and investor saturation. They will benefit from commodity appreciation, pay-out handsome dividends and might also benefit, perhaps ironically, from the push to report Scope 3 emissions. If little else this could shed light on the real scarcity in technology’s value chain, which may not be in the software or IP, but in raw materials and processes producing them. Ref: the Observer Effect, where the mere observation of value can affect the actual value.

Still finding value in Japan, UK and Brazil

Back when we first started discussing Japan, about half the TOPIX traded below book value (BV), and about a quarter below 0.66x BV meaning their share prices needed to rise ~50% to get to 1x. (In contrast most US companies trade between 3-4x). Today, according to Bloomberg, there are still 45% (959/2157) trading below BV, with about one fifth (451/2157) below 0.66x, suggesting there is plenty of valuation headroom left, especially as BVs may be understated (assets are valued at the lesser of purchase price or market value). Remember, the Nikkei is still below where it was on Christmas eve 1989, some 33 years ago. This draws parallels to the Dow Jones Index, which took about the same time to surpass its 1929 peak. After breaking out in ‘54 it then compounded +10% for the next 11 years. Could history rhyme? The JB Low PB/Cash Rich ETF exemplifies this opportunity, showing impressive year-to-date gains but is still on 0.59x BV, 10x forward PE (from Jan 1) and paying a 3.3% divi in Yen, which is due for a better year, I believe. That’s a good starting point for any allocator thinking ahead to 2024. As is the UK, which remains detested, with fund managers as "underweight" as they've ever been. As I have mentioned previously, it feels all quite US-circa ‘81/82, just after the ‘Death of Equities’, just as rates peaked and just before 401Ks lit the touch-paper on domestic equity ownership and a 40-year bull market. Brazil too, still looks good value despite being up 24% YTD. Its' forward PE is now sub-10x, at the lower end of the 20 range. Keep in mind Brazil’s rally has occurred despite little help from China. But are we starting to see signals of Chinese restocking or reflation? Note Dry Bulk shipping costs, as expressed in the BDIY Index, having rallied +200% in 6 months. What’s that saying?

Carbon offsets, counterfactuals and indulgences

The University of California has all but dropped carbon offsets, and thinks you should too, according to this article in the MIT Technology Review. Now, I’ve no dog in this fight save the climate. In truth, I’ve also questioned offsets, which reminded me of Indulgences the Catholic Church allowed in the Middle Ages, where you could avoid penance from sin by monetary payment (see above: incentives are everything). But as the head of ESG at Hosking Partners, Roman Casini, pointed out, it’s often not those who want to keep sinning, but those with credible plans to repent (decarbonise) that use offsets to cover that which cannot yet be abated. Combined with credible offsets from projects that deliver positive economics, especially if in emerging economies, then a win-win scenario can be argued for. After all, it’s a good way to get capital from historically high-emitting and now wealthy nations to low-emitting but growing emerging nations, thus helping resolve the ‘E vs S’ tension that exists at the heart of the transition.

Finally, for advocates of Shue and Hartzmark and their push for more Engagement strategies, a final piece of that jigsaw landed this week. One of the stumbling blocks for Transition Funds has been the measurement piece. But that might be solved for thanks to Moody’s new decarbonisation tool which provides net zero assessments (or NZAs) to help assess a company’s emissions reduction profile. This could speed up adoption, where the flows from exclusion (negatively screened) to engagement (abatement or transition funds) strategy could grow tremendously, and to the benefit of those brave enough to have moved against the tide when they did.

A word on rates and seasonality

I get the logic implied by forwards markets anticipating +50bps of rate cuts from mid-24. Should disinflationary trends continue, real interest rates would continue to tighten without nominal rates tracking inflation lower. This, the economists will argue, is passive tightening and inconsistent with policy aims and the Taylor Rule. Incidentally, this is the argument used by Bill Ackman who believes at 5.5% and with inflation below 3%, real yields of +2.5% are overly restrictive into a slowdown (whether hard or soft) and election year, and so must be cut towards a more neutral rate of ~150bps. Historians will counter and say a neutral real rate of 1.5% is only consistent if comparing to the period post-QE. For fifty years before that the neutral rate was a lot higher. Higher even than where it is now.

What will resolve this? I think it’s employment, which is the print I’m watching most closely (especially construction workers, as there’s been some hoarding there). Why? Because Powell is haunted by the ghosts of ’68, where the Fed cut rates with low unemployment, creating even greater inflationary pressure when demand returned. So unless employment falls precipitously, I would be thinking about taking profits in penny stocks sorry, I mean long bonds, steepeners are probably okay still and I would continue to fade expensive duration plays, especially in equities, as we may soon transition from a rates narrative to a growth one. And remember, disinflation removes cover for corporate pricing power, and with the lagged effect of wages still to come, I suspect margins and earnings downgrades will feature for US stocks next year, and on 28x CAPE I’d prefer hunting for value elsewhere (save perhaps, the Mag7).