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weekly update 1/5/2019

Over the past month we've sent one or more of the below links to a handful of clients and patrons. We'll continue updates in periodic posts about what we're thinking and reading.

What we're thinking

Things that aren't supposed to happen happen all the time.

Are we headed for recession? Below is a quick excerpt from our 2018 year-end letter (which we'll send out later this month):

What causes recession? High levels of debt? Defaults? Reduced consumer spending? Reduced CAPEX? Increasing cost of capital? Increasing fear? These are often mentioned as de facto recessionary drivers and they certainly play a role. But take a moment to think about what drives these drivers. What causes defaults, fear, lower CAPEX, reduced consumer spending, and so on?... Many touted metrics may be more concurrent with (and therefore signs of) recession than underlying causes of recession.
We tend to think recessions can (and should) be predicted. Economies are made up of people. They act like a biological or geological system that adapts to feedback. Much of that feedback becomes a self-reinforcing loop, providing a false sense of security (e.g. we haven’t had a hurricane in many years, so we won’t worry too much about building codes) or fear.

General

Niall Ferguson discusses why nothing seems to be working politically or in markets these days. Ferguson also discusses the trade issue.


Investing

Stories tend to guide our thinking/believing in markets. Morgan Housel makes the case that the more prices go up the less we think something is overpriced. On the flipside, the more prices decline the less willing we are to buy.


Schroders calculates that value investing has outperformed (vs. growth) for nearly all of the past 80+ years. Two primary periods it has underperformed? The last few years of the "dot com" bubble and... [wait for it]... the past decade. Which is more likely: that value investing no longer works or that we've been living through a highly unusual period? I'm guessing the latter. I'll expand on this topic in our end of year letter (released in January).


One of my new favorite phrases comes from Samantha McLemore, Bill Miller’s co-manager at Miller Value. She says “volatility is the price you pay for performance.”


Economics/Markets

Quick history of U.S. GDP growth by year and bear markets.

As of November 19, legendary investor Bill Miller thought the "health of the economy was outstanding" and earnings growth was looking good. He hasn't updated his thoughts since. I'm betting he (like the rest of us) spent the better part of the holiday season trying to figure out what we're missing. For instance, as of November, new housing permits remained solid.


The U.S. hasn't had a budget surplus in 20 years. Here's an overview of national debt problem.


For those worried about the yield curve:


Regarding recent market turmoil, here's some wisdom from some of our favorite thinkers:


The problem is that most people don't really understand the financial markets, so their natural default is the rate of return. That's the ultimate tell. And if you're telling them something that disagrees with the ultimate tell, that's darn tough.

…the fascinating thing about financial markets is that bad behavior is typically rewarded near-term. [We sell fairly valued or overpriced positions] then the market goes up the next day and the day after that... Of course, flip side when the market's crashing and you're saying, we have to start investing and they put that marginal investment dollar in there and then the next day they're down-- so that immediate action and then whatever the market does is so often contrary to what humans like. We like to be rewarded for doing the right thing or what we think is the right thing. And when you get punished, you think, I did the wrong thing. That's a really big deal when you think about how that affects investor behavior.

- David Hay, RealVision (Dec. 2018):


Investing runs counter to our human nature and it is “one of the really tricky things about the investment world. It's very different from a lot of things we deal with, day in and day out. If you talk to a businessman, a businessman is going to feed the winners and kill the losers. But in the investment world, when you've got a winner you should be suspicious about what's next. And if you've got a loser, you should be hopeful—although not naively hopeful.”

- David Swensen, March 2009, interview in Yale Alumni Magazine

The ability to risk looking like an idiot, at least in the short term, is necessary for being different. If you look like everyone else, you never look like a fool. Of course, you also never outperform everyone else.

- Shane Parrish (fs.blog), Second-Order Thinking