wknd
notes


                                                                   wknd notes: The Curious Case of Compounding

wknd notes: We've Been Looking for the Enemy

wknd notes: We've Been Looking for the Enemy
February 07, 2024
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wknd notes: Stress is an Earned Privilege

wknd notes: Stress is an Earned Privilege
January 21, 2024
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wknd notes: Lit Like A Solar Flare

wknd notes: Lit Like A Solar Flare
January 14, 2024
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wknd
notes

Each Sunday morning for over a decade, One River’s CIO, Eric Peters, has published “Wknd Notes.” It is an unorthodox take on markets, politics, and policy that’s widely read across our industry and within global policy/political circles. Eric has written for as long as he has traded and the discipline is part of his investment process. Drawing on wide-ranging, multi-disciplinary research, historical study, and discussions with interesting characters throughout the world, Eric collects those things he finds most thought-provoking each week and distills them into a concise letter. At times the ideas and views are consistent with his own, but just as often, they challenge his positions and it is this openness to opposing views that helps him maintain a flexible mind in the search for emerging opportunities and risks. His writing is a reflection of how he thinks, and as such it is as focused on identifying the right questions to ask as it is on seeking answers. The publication of this work is Eric’s way of exchanging ideas/information and developing dialogue with a network grown over his thirty-one-year career.

wknd notes: The Curious Case of Compounding

“If you don’t get hurt, a kid your age should live to 100. And with medical advances, you might live way longer,” I told my oldest, four years ago. He was 18 and had just made a nine-year commitment, it was sinking in. “It’s true that nine years is 50% of your life so far, but it’ll be small fraction of your lifetime,” I said. He nodded, a literal kid, linear. “Decisions early in life manifest in ways that you can’t yet see, but by the time you’re my age, the differences can grow to be so wide it almost seems impossible,” I explained. “It’s why you always put in the extra 15%. Jump at opportunities. Take profits along the way. That makes you mentally stronger, allows you to take more risk, and it all keeps compounding.”

 

Overall: Premier Li Qiang asked authorities to take more “forceful” actions to stabilize China’s stock market. The Shanghai Composite had just hit a five-year low, a level it first hit in 2007. Since joining the World Trade Organization in 2001, China’s GDP has grown 13.6x, increasing from about $1.3trln to an estimated $17.7trln in 2023 (a gain of $16.4trln). That is a compound annual growth rate (CAGR) of 12.5%, in nominal terms. Over that same 22-year period, the Shanghai Composite has only doubled, rising from 1431 to 2910, a CAGR of 3.3%. That’s a stunning economic/equity difference, and reflects all sorts of dynamics, including massive share issuance which has lifted China’s overall market capitalization even as share prices languish, money leaking out of the system due to abysmal corporate governance, gross misallocation of capital, etc. But in a communist system, the economic priority has clearly not been equity-owner prosperity. China’s stock market performance may provide a glimpse of how equities fare in a system where laborers are prioritized relative to capital owners. At least that’s how I’ve always thought about it. The US is of course the inverse. Since 2001, US nominal GDP grew from $10.3trln to $27.4trln (a gain of $17.1trln). That’s a CAGR of 4.6%. The S&P 500 index has produced a 4.2% CAGR during that period, so it is now 2.5x where it was in 2001 (the S&P 500 total return, including dividends, is 4.4x for a 7.0% CAGR). So, US GDP is 2.7x where it was in 2001 while China’s GDP is 13.6x. But the Shanghai Composite is only 2x its 2001 level while the S&P 500 is 2.5x. I suppose that difference is the rough cost of lifting 500-600mm peasants out of poverty, which is what Beijing accomplished since 2001. A remarkable achievement for humanity. We see America’s inverse in our rust belt, wealth inequality, opioids, obesity, falling lifespans, rising political/social division. The stresses on both systems are manifesting in toxic ways. And as investors, we must be increasingly sensitive to signs that the Chinese and US economic/equity relationships mean revert. While remembering that we are almost always paid to bet that winners keep winning, and losers keep losing.

 

Week-in-Review: Mon: DeSantis drops out of US presidential election – endorses Trump, China’s Premier Li asked authorities to take more “forceful” measure to stabilize the stock market, Netanyahu rejects Hamas offer to return hostages to end the war, US lawmakers ban defense department purchase of Chinese batteries, PBOC kept 1y and 5y LPR unch as exp, China says it may retaliate against US’s ‘hegemonic’ chip war, Trump’s defamation lawsuit delayed due to sick juror, US leading index -0.1% (-0.3%e), S&P +0.2%; Tue: BOJ unch as exp / lowers infl forecast from 2.4% to 2.8% / Ueda sounds marginally more hawkish than exp, China considering 2T CNY ($278b) stabilization fund to arrest stock market decline, Turkey approves Sweden’s NATO bid (leaving Hungary as the sole holdout), UK Public Sector borrowing 7.8b (14.1b exp), EU cons conf -16.1 (-14.3e), US Richmond Fed mfg -15 (-8e), S&P +0.3%; Wed: China announces 50bp RRR cut in early Feb ($139b of liquidity added), BOC unch as exp / strikes dovish tone, Trump wins NH primary, Fed announces changes to BTFP borrowing rate to close arbitrage that has emerged as 1y rates have fallen, Russian plane allegedly carrying Ukrainian POW crashes – killing 65, N. Korea fired multiple cruises missiles into ocean, strong beat from NFLX subscriptions, Alaska Air CEO says loose bolts found in ‘many’ Boeing jets, N. Zealand CPI 4.7% as exp, EU PMI mfg 46.6 (44.7e) / serv 48.4 (49.0e) / comp 47.9 (48.0e), UK PMI mfg 47.3 (46.7e) / serv 53.8 (53.2e) / comp 52.5 (52.1e), US PMI mfg 50.3 (47.6e) / serv 52.9 (51.5e)  / comp 52.3 (51.0e), S&P +0.1%; Thu: US 4Q GDP 3.3% (2%e), ECB unch as exp / opens the door to spring or summer cuts, Turkey CB hikes 250bp as exp / says required tightness achieved, Norges bank unch as exp, S. Africa CB unch as exp / dovish tone, TSLA disappoints / guides volumes lower due to higher rates, Indonesia’s FinMin considers resigning amid President Widodo’s “behind the scenes” efforts to secure a successor ahead of upcoming election, INTC misses, S. Korea 4Q GDP 2.2% (2.1%e), Germany IFO exp 83.5 (84.8e) / business climate 85.2 (86.6e), S. Africa PPI 4% (4.3%e), Mexico Unemp 2.61% as exp, US Personal cons 2.8% (2.5%e) / Durable goods 0% (1.5%e), US Initial claims 214k (200k e), US New home sales 664k (649k e), US KC fed mfg -9 (-3e), S&P +0.5%; Fri: ECB’s Vujcic and Kazaks point out that easing too early would be grave error, ECB’s Simkus says less optimistic than the mkt of an April cut, US warns of possible ‘lethal’ N. Korean military action in coming months, BOJ mins referenced discussion on when to exit NIRP w/out reaching consensus, China announced more plans to guide targeted stimulus into important sectors, White house halted approval of new licenses to export US LNG, Japan Tokyo CPI 1.6% (2.0%e) / Core 3.1% (3.4%e), UK cons conf -19 (-21e), Germany cons conf -29.7 (-24.6e), Hungary unemp 4.2% as exp, EU M3 0.1% (-0.7%e), Brazil IPCA infl 4.47% (4.63%e), US personal inc 0.3% MoM as exp / spending 0.7% (0.5%e), US PCE deflator 2.6% as exp / Core deflator 2.9% (3.0%e), US pending home sales 8.3% MoM (2%e), S&P -0.1%.

 

Weekly Close: S&P 500 +1.1% and VIX -0.04 at +13.26. Nikkei -0.6%, Shanghai +2.7%, Euro Stoxx +3.1%, Bovespa +1.0%, MSCI World +1.3%, and MSCI Emerging +1.5%. USD rose +9.4% vs Ethereum, +1.3% vs Chile, +1.3% vs Indonesia, +1.3% vs Russia, +0.4% vs Mexico, +0.4% vs Euro, +0.3% vs Australia, +0.3% vs Turkey, +0.2% vs Canada, +0.1% vs India, flat vs Yen, and flat vs Sterling. USD fell -1.3% vs South Africa, -1.1% vs Bitcoin, -0.4% vs Brazil, -0.2% vs China, and -0.2% vs Sweden. Gold -0.6%, Silver +0.7%, Oil +6.5%, Copper +1.7%, Iron Ore +3.3%, Corn +0.2%. 10yr Inflation Breakevens (EU -3bps at 1.96%, US -5bps at 2.29%, JP +3bps at 1.33%, and UK +3bps at 3.50%). 2yr Notes -4bps at 4.35% and 10yr Notes +1bp at 4.14%.

 

2024 Year-to-Date Close: Argentina +32.4% priced in US dollars (+34.8% priced in pesos), Turkey +8.9% priced in US dollars (+11.7% priced in lira), Colombia +5.8% in dollars (+7.3% in pesos), Greece +3.3% in dollars (+5.2% in euros), NASDAQ +3% in dollars, S&P 500 +2.5% in dollars, Hungary +2.5% (+5.7%), Netherlands +2.1% (+3.9%), Philippines +1.9% (+3.7%), Japan +1.7% (+6.8%), Russia +1.6% (+2.1%), Ireland +1.6% (+3.5%), Saudi Arabia +1.6% (+1.6%), MSCI World +1.5% in dollars, Denmark +1.1% (+3%), Euro Stoxx 50 +0.7% (+2.5%), Malaysia +0.5% (+3.5%), Czech Republic +0.2% (+2.4%), UAE -0.1% (-0.1%), Finland -0.4% (+1.4%), Germany -0.6% (+1.3%), France -0.6% (+1.2%), Switzerland -0.6% (+2.3%), Canada -1.1% (+0.8%), Austria -1.2% (+0.6%), India -1.6% (-1.7%), UK -1.7% (-1.3%), Italy -1.7% (+0.1%), Taiwan -1.9% (+0.4%), Mexico -2.1% (-0.9%), Russell -2.4% in dollars, Belgium -2.8% (-1%), New Zealand -3% (+0.9%), China -3.2% (-2.2%), Spain -3.4% (-1.6%), Singapore -4.1% (-2.5%), Indonesia -4.1% (-1.9%), Israel -4.2% (-1.4%), Norway -4.2% (-1.3%), Australia -4.2% (-0.5%), Sweden -4.9% (-1.1%), Brazil -5% (-3.9%), South Africa -5.3% (-2.7%), Venezuela -5.5% (-4.8%), Poland -5.8% (-3.5%), HK -6.5% (-6.4%), Chile -6.9% (-2.2%), Thailand -7.2% (-3.4%), Portugal -8.4% (-6.7%), Korea -10% (-6.7%).

 

Folding: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it,” said Einstein, supposedly. Patrick Kazley, on our team, had used the Einstein quote in One River’s latest whitepaper on the power of compounding. So I started nerding out on GPT-4. In the film Oppenheimer, the atomic explosion was 0.02 megatons. They named that bomb “Trinity.” 16yrs later, the Soviets detonated the 50 megaton Tsar Bomba – history’s biggest. It was 2,500x Trinity, a compound annual growth rate “CAGR” of 63%.

 

Folding II: We would fold small pieces of paper 3-4 times, spit on them, and bend them into a V-shape. We’d stretch a rubber band between thumb and forefinger, forming a basic bow. My younger brothers and I would shoot these V-shaped projectiles. Innumerable nasty welts, no one lost an eye. Practically speaking, it’s hard to fold paper more than a few times. But theoretically, if you could do it 42x, a single sheet of paper (0.0039 inches thick) would grow to be 238,855 miles high - the distance from earth to the moon. That’s a 100% compound growth rate per fold.

 

Folding III: Bill Gates dropped out of Harvard at 19. Started Microsoft in 1975 with $5k. He is now worth $140bln. That’s a 42% CAGR. Warren Buffet allegedly persuaded to Bill to sell some stock to diversify his portfolio. Had he ignored the Oracle’s advice, Bill would be even richer than Putin, and would have a net worth of $1.7trln. The CAGR that turns $5k to $1.7trln over 49 years is 49%. Stunning right? The principle that drives maniacal entrepreneurial ambition is the that great wealth is created through concentration, even if it is preserved through diversification.

 

Folding IV: Speaking of Buffett, the Oracle started in 1956 with $100,100. Having talked Gates out of $1.56trln in net worth, knocking Bill’s 49% CAGR investment in Microsoft stock to a 42% CAGR through portfolio diversification, Buffett carried on generating a 23% CAGR through 2024. That’s how Warren turned $100,100 into $116bln over 68yrs. Warren remained married of course. Divorce is a catastrophic CAGR event for committed compounders. Taxes are too, which is why estate planning is vital. Buffet pledged to gift 99% of his wealth to charity.

 

Folding V: A human embryo has a compounded daily growth rate of 12%. That’s how you grow a zygote into 37.2trln cells in 40wks. Sorry, this is the kind of utterly useless stuff that swirls in my brain. The universe has grown from the size of a basketball to being 93bln light years across over the 13.8bln years since the Big Bang. That’s a CAGR of just 0.00000046%. Surprisingly slow, right? US government debt has been growing rather faster. GPT-4 calculates a CAGR of 8.7% since 1970. Probably not a hallucination. The CAGR of US consumer prices since 1970 is roughly 4.0%. The S&P total return index has produced a 7.4% CAGR since 1970.

 

Anecdote: “Did you get your math right,” I asked Patrick. He had just sent me his whitepaper for comments. Like pretty much everyone at our firm, he’s smarter than I am. And by the time something like this gets to me, it has inevitably been heavily vetted. “Yeah, that was my reaction when I first saw the results of the analysis. I ran it a few times. Same results. Then I gave it to the quant team, the risk team too. It’s 100% correct,” he replied. “I understand the power of compounding, but the numbers are so far above my intuition that I’m struggling to visualize how this magnitude of compounding happens,” I admitted. As of Dec 2023, the S&P 500 total return index is 2.7x where it was in April 2015 (when One River went live with a few of our biggest strategies) and it is 4.7x where it was in 2007 (before we founded One River in 2013). Patrick then created six hypothetical portfolios with loads of disclaimers: S&P 500 total return index plus (1) a bond index, (2) a hedge fund index, (3) gold, (4) a trend-following index, (5) One River’s Dynamic Convexity strategy, and (6) One River’s Risk Responder’s strategy. The six portfolios required leverage, so that each one had 100% exposure to both the S&P 500 total return and the additional investment. Then Patrick assumed monthly rebalancing. For example, if the S&P fell one month, and bonds rose, then the strategy would sell some relatively expensive bonds and buy some cheap stocks. All six strategies outperformed the S&P 500 total return. But one of our strategies, in combination with the S&P 500 total return was 51.6x since 2007 (versus the S&P 500 total return being 4.7x), and 6.1x since 2015 (versus the S&P 500 total return being 2.7x). “The key insight in my analysis is that when you combine strategies that are both negatively correlated and convex, and then rebalance regularly, the compounding effects are so powerful that they are difficult to even conceptualize,” replied Patrick.

 

Here's a link to the full piece titled “Convexity, Correlation, and Compounding – Using Overlays To Improve Your Total Portfolio” on One River’s website: [click here]

 

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management

 

 

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, converse with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.

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