3 Trends I’m Skeptical Of

Uncluttering my head:

Millennials are gonna rent/disrupt/do startups/live in mega-cities forever: Nuh uh. At most, this is a new phase of life that Gen-X started but Millennials made mainstream. A period of exploration in your 20’s, like a personal/professional post-college grad school for non-grad school people where you get paid a little and pay too much for an apartment. There was a time when “teenage years” were a foreign concept too. Disrupting/startups and mega-cities as a catch-all hope for everything is a trend that’s peaking.

Washington obsession: Demographics suggests that outside of swinging Presidential elections, Millennials will not have a meaningful impact on national politics for another 15 years. It’s understandable that after the financial crisis, Obama’s election, Obamacare, and the debt ceiling/austerity stuff that people would be focused on DC. But, relative to the coverage it gets, DC probably won’t be very important until at least the post-redistricting election in 2022. An outrageous call to make, but that’s my view. Trust and 21st century institutions are likely to be built from the bottom-up. “Eat local” has been a thing for awhile, followed by “drink local.” Now mixed-use developments and walkability are all the rage. Local governments and school boards are next. State government thereafter. The evolution of digital-first journalism will help with all of this. Everything in its time.

The Inequality/Low Inflation Narrative: From the perspective of single-family construction and first-time homebuyers, the housing recovery still has not begun. Baby Boomers are beginning to retire in big numbers. Both of these trends will lead to wage growth, more inflation, and a pickup in tax revenues — higher wage growth, tax revenues as a share of GDP, and cost of capital will all pressure the corporate sector’s share of GDP. This will remain a political narrative for quite some time but this multi-decade trend is reversing.

TV and Emotional Certainty, Digital Media and Dispassionate Data Journalism

We’re at an interesting juncture in media right now. TV, the dominant news medium in the US for 40-50 years, is still powerful but in decline, while digital media is ascendant but still rough around the edges. It’s a rare window in time where we’re able to look at both and see their strengths and weaknesses before the outcome appears inevitable.

The epitome of television media is something like an NFL studio show. It goes something like this:

Talking Head #1, chortling: “And that’s why TOM BRADY IS THE MOST CLUTCH QUARTERBACK OF ALL TIME!!”

Talking Head #2, outraged: “WHAT! YOU’RE CRAZY! Brady would be nothing without Belichick!”

For digital media, I’d submit that right now it’s probably FiveThirtyEight, at least in terms of providing a contrast. This is the antithesis of what TV does:

If the average story is about 10 feet tall, then New York’s buildings, stacked on top of one another, stand about 1,155,230 feet (we’re not including spires). That’s roughly 218 miles high. That’s about 10 miles shy of reaching the International Space Station.”

TV is great at providing emotional certainty, and knows how to create compelling narratives and frames that draw viewers in. Going on TV with statistics, probabilities, and nuance feels awkward, as anyone who’s ever been on TV can attest.

Digital journalism, in some cases, seems to be going in the opposite direction. A deluge of data, much of it meaningless and lacking significance. A check on the harmful false narratives of TV.

Digital journalism still lives in the shadow of TV, so it makes sense that much of it serves as either a complement to or a backlash against TV. Once we move into a post-television media era and digital journalism no longer feels the need to care about TV at all, it’s be interesting to see who its dominant voices are and how it shapes its narratives and frames. Next decade.

Why FiveThirtyEight Has Given Me a New Appreciation for Hackish Op-Ed Writers

"Sending Email Via Carrier Pigeon"

"Why the Obamacare Rollout Spells DOOM for Democrats"

Of the two headlines above, one falls on Nate Silver “upper left” data-driven journalistic quadrant while the other falls on its hackish lower right.

But I’m clicking the second one.

First, I’m going to start out by saying that I was a fan of Nate’s at Baseball Prospectus, I was a fan of his political project, and I have no doubt that he and his team will figure this out. But part of the essence of news to me has to be relevant, timely, and meaningful. I have to care. That’s the soul of good journalism. I read stuff all the time that I know is unsubstantiated and/or likely wrong as long as the subject interests me and I find it relevant to my worldview (hedgehog stuff).

Part of the rhythm of FiveThirtyEight will take time, like how Bill Simmons developed his mailbag concepts, draft day diaries, and the like.

But if the site ends up being mostly 500-800 word quick hits on random topics, no matter how quantitatively sound, it probably won’t be a regular part of my reading diet.

The Virtuous Circle Between Overvalued Top Line Growth and Advertising Dollars

Trulia’s Launching a $45 million ad campaign. Why? Because Zillow’s doing it. And because top-line growth is all the market cares about right now. It’s this:

What this means is market valuations are incentivizing companies to pour their profits into marketing/advertising, growing their top line at the expense of the bottom line. This represents a boon for the likes of Google, Facebook, Twitter, and others.

I just ran this idea by a friend who responded, “Reminds me of 2001 in a way, where everyone’s explosive growth meant people bought massive amounts of equipment from each other.”

In the social age, “equipment” = “attention.”

Don’t know when this will matter, but it will, eventually.

The Problem With Forward Guidance — Pricing the Exit

Good question from Brian Jordan (@jordanbrianl) — why will ending forward guidance, whether it happens this month, this quarter, or this year — be such an issue for markets?

Because of the incentive structure and positioning dynamics inherent in a fat roll created by a steep yield curve, itself a product of forward guidance.

Look at the table below — these are end of Friday closes for eurodollars futures contracts starting in December, 2014 and going out to December, 2016. For reference, the price of the June, 2014 contract is 99.75. If we get no rate hikes between now and the end of the year, the December, 2014 contract will go out around 99.75, so if you go long the Dec14 contract then you stand to make 0.075/contract if you just wait for 6 months. That’s the roll.

Now go farther out. Look at the September and December, 2016 contracts. Sept’s at 98.275. Dec is at 98.01. Due to the passage of time, all else equal (which it’s never the case), the price of that December contract will appreciate the longer it seems like forward guidance will last. If we push out rate hikes another quarter, you could stand to make the entire difference between Sept and Dec, 0.265. We could get a couple bad jobs prints and you could stand to make even more. That’s pretty compelling in a low yield world.

Conversely, if you want to bet on forward guidance ending, and you’re wrong or early (which is the same as being wrong), you’re paying a lot of money to make that bet.

If that’s all confusing, try this analogy. You’ve got a 90-year old and you’ve got a life insurance policy that will pay $100 upon their death. The premium on that is $12/year. So your break-even if you buy that contract is them living for another 8.33 years. Should you buy or sell the contract?

I’m no actuary, but my guess is the average 90-year old isn’t expected to live for 8+ years. But if you buy the insurance and nothing happens for a year (and who’d expect a relatively healthy 90-year old to drop dead in a year? I mean, what’s another 365 days?), you pay $12. Investment managers don’t like paying carry, they like receiving carry. And on the other hand, if you sell the insurance and our 90-year old can just make it another year, you can collect $12. And then maybe you close your position after you collect that premium (or heck, even 3 or 6 months worth). Let the next guy worry about it. This isn’t a hold to maturity thing.

I’m far from the world’s foremost expert on eurodollars pricing, but that’s the structural dynamic in play. Due to the incentive structure of markets and participants, it’s a lot harder to justify paying a steep roll when payoff is uncertain than it is to find participants, some would say suckers, willing to collect that roll and take a gamble on that catalyst happening after they’ve exited their position.

But eventually, the catalyst will occur, and when that happens, the rush to the exits out of eurodollars won’t be pretty.

Market Thoughts: Valuations, Alibaba, EM, Risks

A few thoughts on a Saturday morning:

First, valuations. There’s some unease as valuations in the US continue to creep up. This is as good a representation of what’s going on as anything:

Median forward P/E’s are high. Makes sense to be getting more cautious, or at least thinking about stock/sector selection and what the driver of appreciation should be from here. If the driver of valuations has been low interest rates, low labor costs, and global growth, I’d probably be more cautious than if the driver of appreciation is related to household borrowing/spending. Remember, if rates go up, it’s because something got better — make sure that the thing you own is that “better.”

IPO’s — This is probably the biggest red flag out there I see. IPO’s are coming public at more and more questionable valuations. I’m sure Castlight Health (CSLT) is a wonderful company, but if you’re buying this for anything other than the momentum/hedge fund beat-and-raise game you probably need to think about it eventually being able to handle a valuation multiple of 4-5x revenues, which, at its current valuation, would mean $700-900mm/year. It did $13mm last year. I’m a long-term optimist but I don’t know if I’m that much of an optimist.

Alibaba raising perhaps $15 billion in its IPO reminds me of Facebook in June of 2012. No, not the finger-pointing botched launch, but rather that $15 billion is a lot of money that needs to flow into a newly-listed company that won’t be in any indices for awhile. That money won’t be coming out of cash, it’ll probably be coming out of Facebook and Tesla and Twitter and LinkedIn, other similar companies with high market caps. Look at how tech stocks performed leading up to the Facebook launch — it wasn’t pretty. So if you’re in those types of names I’d think about this a bit.

Emerging markets: I’m not really an EM guy. I’ve taken some swings here and there but I’m clearly the dumb money in that game. That being said, clearly stress is elevated in EM land these days, which has manifested itself this year through the price of gold, rates/FX, and I believe even US equity implied volatility. I’d hate to run an EM fund — when there’s stress in your sandbox you’ve gotta reach for liquid hedges, which often means stuff in US markets. When you’re in an environment where EM is stressed but the US is relatively okay it’s a bad combination. That being said, if you can take advantage of EM stress by selling volatility in safer asset classes I think it’s worth exploring.

Risks: EM is a risk I have no good tools to assess, though clearly volatility is elevated here. The Russell 2000/Tesla/fuel cell/biotech/IPO complex looks fairly frothy to me. I continue to think reaction to the eventual removal of forward guidance in the US could pose problems, though that view may be more appreciated than I believe. Downside risk to core US output and earnings remains minimal in my view, though that doesn’t mean valuations on stuff at 18x earnings can’t go to 15-16x earnings.

Have a good weekend.

Deep Down, We Crave Institutions

Look at these clowns! Can’t modern society do better than get young men to aspire to be Justin Bieber or a member of Jersey Shore? Ugggggh!

But later in the article, these lines stand out:

"The institutions that gave British men a sense of wellbeing have been ripped apart…Because of this, British men have tried to reimagine masculinity, in a hyper-realised, childish, desperate way. A new kind of machismo, built on fake bravado and vanity.”

As an ’80s baby, let me think of all the institutions that some have said are irrelevant in just my lifetime:

-Newspapers, TV media, record companies, personal computers, the suburbs, automobiles, home-ownership, carbon-based energy, academia, professional school (law/medicine/business), big corporations, marriage, organized religion, the government, brick & mortar retail, the NCAA, public school, entitlement programs, banks, political parties, the dollar (hi, bitcoiners!)

And I’m sure there are others. So that leaves what, riding a fixie bike with bad facial hair to get a $4 piece of toast and then send out some status messages on social media? Take away models and frameworks for people, and they turn into hedonistic, inwardly-focused wanderers (I resisted the urge to write zombies because zombies are over).

But most people don’t want to be this way forever. And we don’t all have the chops to be Steve Jobs or Jeff Bezos. Disrupting the world and making a billion dollars in the process just isn’t in the cards for the vast majority.

Nature abhors a vacuum, and society is no different. All of this frenetic energy dedicated to startups and Kickstarters and urban/density-focused living on the part of Millennials is to build new institutions suitable for the 21st century. Because deep down, that’s what we crave. Those betting on an anti-establishment, institution-free, atomized world persisting forever are making a huge mistake.

Millennials: Cyclically Cynical, But Trust Will Return

There’s a big Pew report on Millennials out, and I want to correct some misperceptions before they become too prevalent. Among the findings are that support for Obamacare has declined, mirroring declining Millennial approval for Obama in general:

The knee-jerk conclusion of this, obviously, is that Millennials are rejecting liberalism and will become reliably conservative voters as they age, or at least somewhat closer to neutral. I don’t think that’s what’s going on. As an older Millennial who was a fire-breathing libertarian for several years, I’ll share my personal perspective and evolution.

I was in college for 9/11 and the start of the Afghanistan and Iraq conflicts. When I graduated, my field of study (computer science) had busted, and in both my college town (California’s Inland Empire) and my new city of employment (San Jose), I saw a raging housing bubble brought on by, among other things, the actions and ignorance of central bankers, Wall Street, and the government. I saw two presidential administrations do little more initially than throwing money at the rich/Wall Street while Main Street suffered. I was furious with institutions for their negligence and corruption. I’ve always said that Ron Paul was the tea party before the tea party was cool.

But time and experience has changed me. It began, ironically enough, with volunteering for Rand Paul in 2010, trying to promote my values at the time. Politics on any level involves sacrifice, dedication, counting on others, and compromise. If all you want to do is rage, then sure, you can stay a libertarian. But you won’t get anything done in politics.

With the Rand Paul experience over, more time passed. Europe’s failure with austerity became clear. The strength of American institutions, even as dysfunctional as they’ve been the past few years, became more clear. As the shock from 2008 passed and economic healing progressed, you could see normalcy a distant possibility. And we could get there faster if only…suddenly I was thinking about what the government could do to help, beyond conservative/libertarian talking points. The spread of data-based journalism helped tremendously.

More life change happened. I found someone and got married. Via marriage, I became a homeowner. I went into business with a friend. All of these actions make you start planning and thinking about the long-term. If you’re a young, single renter who’s unemployed or working for someone else you might not know what I’m talking about, but you will. I can’t imagine how kids change this even more.

Guillermo tweeted out a few great thoughts related to this the other night.

George W. Bush is gone. So are Greenspan and, for that matter, Bernanke. Same with Paulson and Geithner. Obama’s a lame duck. If you’re under 30, Reagan’s just a talking point used by some. Eventually, you get old enough that you can’t blame the older generation for your problems. That older generation with the keys to power becomes you. A friend of mine said it best last year while I was engaged and talking about all the changes I was feeling, “Life eventually forces responsibility on you, whether you want it or not.”

Millennials will eventually shake off the past 5 years, get jobs, buy houses, and start families. Tax revenues are on the rise. A rising generation (those under 25, call them) have no professional memory of the mistakes of policymakers, they’ve only known a world where seemingly nobody’s in power or has the authority to do anything. These people, careers and families secured, will take it upon themselves to accept that power and wield it.

Profit Margins, Labor Scarcity, Promises, and Berkshire Hathaway

"Berkshire’s promises have no equal, a fact affirmed in recent years by the actions of the world’s largest and most sophisticated insurers, some of which have wanted to shed themselves of huge and exceptionally long-lived liabilities, particularly those involving asbestos claims…No other insurers’s promise would have given Lloyd’s the comfort provided by its agreement with Berkshire. The CEO of the entity then handling Lloyd’s claims said it best: ‘Names [the original insurers at Lloyd’s] wanted to sleep easy at night, and we think we’ve just bought them the world’s best mattress.’" -2013 Berkshire Hathaway Annual Report, Page 10.

I think about employment a lot these days. Until my current endeavor, I’d had four jobs in my career. The first I left after a year for a more attractive offer. The second I got fired from after a year because while doing a competent job, I wasn’t very passionate about what I was doing and it showed. The third I left after four and a half years because the head of the firm and I both agreed that I had grown professionally as much as I could there, and I wasn’t interested in staying there any longer under the existing terms of my role. And in the fourth I wasn’t very happy with the direction the company was going in or my place within the company, and whether coincidence or not after expressing my concerns I was no longer employed a week later. Good learnings experiences all.

After ~9 years of employment I assessed my strengths and weaknesses and thought about what a good next fit for me would be. I had demonstrated that after a year or two of being a generic employee I tended to get bored or irritated with management. I wasn’t very good at carving out a role for myself in a complex organization — I suspect a lot of doctor’s sons are like this. Vision and long-term decision-making were incredibly important to me. I operated best as an independent decision-maker with a lot of flexibility in terms of who I could collaborate with and how and where I worked. Two-way trust mattered a lot. Money was important but a secondary factor. So when Guillermo and I talked about figuring out a way of working under the same virtual roof it appealed to me a lot. The value of that implicit trust/promise was worth more to me than any company or hedge fund could offer.

Which brings me back to Berkshire Hathaway. Those familiar with hedge fund economics might not understand why Todd Combs and Ted Weschler would take less money working for Berkshire than they might be able to get in the hedge fund world. But having spent half my career at a hedge fund, I totally get it. If your investment management style requires a long-term perspective, long-term patience, and long-term capital, and you know what you want to do for the rest of your career, why take a gamble on the potential for more money if you have to operate in an environment that is notoriously short-term, at times unethical, and often not loyal?

Profit margins in the corporate sector are at record highs. The multi-decade period of demographic labor scarcity on the horizon promises to give labor more bargaining power over its employers/capital than it’s had in decades. The easy assumption is that wages/profits will rebalance to give labor an increased share, reducing profit margins while possibly increasing economic growth.

But there’s more to employee compensation and satisfaction than wages. Schedule flexibility matters. Workplace flexibility matters. The implicit or explicit promises of employers matter. Trust is a form of goodwill not found on any balance sheet. This is a cultural thing that will take time to appreciate, and not everyone will get it. But, and there’s no good way to quantify this, companies worthy of that trust may find it easier to maintain present profit margins more than profit margin skeptics appreciate.

1940’s-mid 2000’s Demographics vs 2010+ Demographics

Conversations with @adamcarstens, @BurghDiaspora, @petesaunders3, and others in recent weeks have crystallized a lot of the demographics thoughts that have been jumbling around in my head and have made their way sporadically into tweets. Here’s my dump of these thoughts:

1940’s-mid 2000’s: Entering the 1940’s, America was a country on the verge of a huge demographic transformation. While the country was urbanizing, much of that change had been put on hold by the Great Depression and World War II. The South was still largely agrarian. The North was industrial, with its cities anchored by manufacturing. Blacks and whites lived apart. The country’s infrastructure had not yet been shaped for cars like it would be in the decades to come. Here’s what happened:

As the Greatest Generation returned from the war, it kicked off the baby boom. Crowding in cities brought blacks in closer proximity to whites, creating tensions that other macro factors — the movement of manufacturing to the suburbs, then overseas, plus the growth of cars and highways — led to the growth of suburbia. Air conditioning facilitated the growth of the Sunbelt. College education became a mainstream good, which led some cities (Boston, New York, Chicago, San Francisco) to transition from manufacturing to information-based economies. The busting of American urban manufacturing created hardship for the Rust Belt and other cities that previously relied on that industry for employment. In general, it was a period of geographic expansion [the post-1990 Sunbelt, financed by Wall Street, built by Hispanics], with highways, cheap oil, and a labor glut from the Baby Boomer generation powering growth. Manufacturing-based cities and urban blacks were the big losers while the educated, those employed in finance and tech, and suburban and Sunbelt whites were the big winners.

Post-2010: The epicenter of the 2006-09 housing bust was in the subprime, Sunbelt exurb. The areas that have roared back the strongest are tied to high tech, the most-educated Millennials, and the global super-rich. We hear a lot about walkability, transit, and mixed-use too. But what are the huge demographic trends that will shape the next several decades and are different from what have come before?

-White stagnation: If your model relies on young [non-Mormon] whites or white households you’re in trouble. These are no-growth areas for as far as the eye can see. It doesn’t mean you can’t survive, but you’ll have to adapt. I’m looking at you, New England, higher education, and the Republican Party.

-Lack of transportation infrastructure growth, and hence lack of geographic footprint expansion: some cities will do some things here and there, but it’ll be at least another decade until liberal, transit/infrastructure-supportive Millennials are in electoral positions of power to do things here. For at least the next 10 years, it’s unlikely that we’ll be expanding the boundaries of our major metro areas beyond where they already are.

-The new cultural Baby Boomers — educated Hispanics: Forget the ’60s culture war part of the Baby Boomers. What characterizes Baby Boomers? They got an education where their parents didn’t. They had a lot fewer kids than their parents did. They had much higher incomes than their parents did. And there are a lot of them. This is a good description of current Hispanic kids. If your growth relied on young, educated, materialistic whites, this is your best hope to plug your demographic gap. Again, I’m looking at you New England, higher education, and the Republican Party.

-Labor scarcity: I wish you could see this the way I see it. I don’t think any of us fully appreciate how big of a deal this is going to be. Birthrates are plummeting around the globe. By the time we need to build 1.5-2 million houses again it’s not clear where we’re going to find the workers to build the houses. The Hispanic-American and Mexican birthrates have plummeted. Educational attainment is surging. Can we find Asians to build houses? Africans? Both continents may be doing their own major building projects over the next few decades. The loss of the Baby Boomers from the workforce will impact some geographies and sectors more than others. Large corporations in particular appear to be at risk. AT&T has 250,000 employees. Say the average employee tenure is 8 years. That means that every year they have to replace 30,000 employees. In a talent-starved economy that’s a liability. If you’re a company, smaller and younger is better, but we’ll have to think about tactics to encourage either employee stability or business models that remain robust if key employees leave.

Anyway, that’s what I’ve got for now.