Welcome back to the Lumida Ledger. Here’s a preview of what we cover this week:

• Macro: Higher for Longer is Consensus  

• Markets: Quality Dividend Stocks Outperforming, Warren Buffet & Risk Adjusted Return Investing

• Company Earnings: Earnings Revisions Spreads, Bank Earnings, Pepsi, Fastenal, Dominos

• AI: Bank of America Constructive on AI Beyond Nvidia  

• Digital Assets: BTC vs. ETH, Where to Position, Endowment Style Investing

We exchanged views on the outlook of America with former Coinbase executive Balaji Srinivasan. This exchange had 1.6 MM+ views.

Our thesis remains that America is not in decline.

Any great power must lead in the following KPIs: technology, military, banking, demographics and entrepreneurship.

Somehow this became non-consensus?

That isn’t to say there aren’t issues and concerns. We detail them in the thread.

But don’t let your ideology or anger lead to losing perspective.

There is no close 2nd rival to the United States - and it shows in investment returns.

We encourage you to read Ram’s Tweet and Balaji’s response. It’s quite the exchange.

Also, we enjoyed this conversation with Paradigm discussing the ETF news and crypto markets.

We covered a lot of technical ground here: how we see BTC vs. ETH, where to position in ETH, and endowment style investing.

Thanks to Coindesk and Miguel Kudry of L1 Advisors for the shoutout in Coindesk’s Crypto for Advisors newsletter.

Macro

‘Higher for Longer’ Is now Consensus

I retired the ‘higher for longer’ moniker this Monday, and shared the rationale in the last newsletter.

Simple reasoning: It became consensus. And technical supply/demand issues eventually give way to fundamentals.

So far so good… The 10-year was at 4.9% last Friday and it’s at 4.6% now.

TLT, an ETF consisting of long-term bonds, is up this week. (That said, we greatly prefer owning Private Credit rather than long-term bonds where the pre-tax returns are 12 to 18%).

Note, we still expect inflation will be higher for longer.

Indeed, we saw that the inflation rate remained steady and elevated for the second day in a row.

Relatedly, what people are missing is that the economy is stronger than people think. That’s why the Citigroup economic surprise index remains above the zero line.

We do think the economy will slow and is slowing - rate hikes will show up - but (i) the terming out of debt, and (ii) holdover stimulus, and (iii) CHIPs and IRA Act are stimulative.

Markets

There was a lot of fear in markets this Monday morning due to the senseless violence last weekend.

When markets are down Monday morning, that’s usually a sign of retail investors getting scared over the weekend.

We did the opposite. We pulled the trigger and bought semiconductors based on the weakness.

We shared our strategy last weekend and followed through - picking up names like Broadcom and ASML.

There are a lot of reasons to be fearful of investing. Don’t let your amygdala (the fear center) get the best of you.

Investing is a profession. It takes skills, research, discipline and focus.

I’m reminded of this chart, every time I think about selling assets in light of geopolitical events.

The conflict should elevate energy prices. That will help our energy positions. As we’ve said many times, energy continues to be a strong diversifier and performance driver for equity portfolios.

Why Quality Dividend Stocks are Outperforming

Underneath the surface, value strategies are gaining ground.

This is notable. Historically, value stocks have outperformed growth stocks over decades of market history. That changed during the 2010s era of ultra-low rates and quantitative easing.

Dividend Stocks are now Beating the S&P 500

Since 2004, a basket of dividend stocks has outperformed the S&P 500 by a total of 69%.

In 2008, this basket dramatically outperformed the S&P 500. The dividend stock portfolio experienced a 9.4% drawdown as compared to the S&P which had a 37% drawdown.

Since 2012, when the Fed ramped up QE, dividend stocks have underperformed the S&P. That makes sense as lower long-term rates should benefit longer-duration growth stocks.

All stocks are a claim on future cashflows. Even tech stocks that don’t issue dividends will eventually do so.

Since the Fed rate hike campaign in 2021, dividend stocks have outperformed the S&P by about ~10% in 2 years.

I expect this trend will continue. Value is quietly coming back after lagging growth stocks for so long.

The rubber band is stretched and will mean revert.

Nature is healing. That said, we do believe it’s worthwhile to own growth stocks. Just make sure the growth stocks you own are actually posting strong growth numbers.

But Aren’t Dividends Taxed Higher than Capital Gains?

Yes. But that’s not the main reason to own high quality dividend stocks as a wedge in the strategic asset allocation.

Dividend stocks have a higher risk adjusted return. Our approach is to maximize the return per unit of risk, not total return.

We believe we can generate attractive total returns through novel alternative investments: distressed CRE, early stage crypto venture, Biotech and so forth.

We want those strategies to post the big gains. We don’t need to take undue risk in a liquid portfolio.

Here’s the main idea behind risk-adjusted returns.

If a strategy has a higher return per unit of drawdown, especially during recessions, it’s a superior strategy to another strategy that has a higher total return but more drawdown risk.

Many investors would have been shaken out of owning the more volatile S&P during the 2008 lows. Then they would have missed the recovery.

Investors act on psychology, emotion, and fear.

The dividend strategy has merely a 10% drawdown. That’s much better than a 35% loss of principle.

The idea is to approach Portfolio Construction with a Risk Budgeting perspective, rather than Return Targeting.

Adherence is the issue. People are not Expected Value Optimizers for practical reasons.

In a recession, when jobs are lost, people grow risk averse.

Investors may be forced to sell investments to fund their consumption at the worst possible time.

This is the reason why stocks that are correlated to the business cycle are punished more when recessions occur.

Now, we’re still seeing out the next 10x investments - in overlooked small caps and in the Semiconductor silicon layer.

But we’re mindful about building a coherent portfolio where each strategy has a specific purpose and adds diversification to the mix.

Warren Buffet is a Risk Adjusted Return Investor

Warren Buffett is using the same framework of seeking high quality dividend producing stocks.

Buffett and his partner Charlie Munger seek businesses with a good risk adjusted return. These are businesses whose revenues do not co-vary strongly with the business cycle: insurance, consumer staples, and banks.

The demand for Wrigley’s chewing gum doesn’t change much in a recession. (And you can re-price them quickly in a high inflation environment.)

Buffett then adds leverage to increase returns, as these stocks don’t grow as quickly.

Buffett has a AAA rating. He borrows non-callable debt - not a margin loan. He also has financing in the form of a float from his insurance subsidiaries.

The CFA summary of what Buffett is doing is this: Warren Buffett has carry trades on quality, cash flowing, long duration depreciable assets financed with permanent capital & non-callable debt.

The next question is ‘How do I do this at home?’. We know Berkshire Hathaway is too big now. Size is the enemy of returns.

The strategy that best resembles Berkshire Hathaway is Private Equity investing. That’s a subset of Alternative Investments.

PE firms include KKR, Blackstone, Apollo and many more.

Unless you have a AAA rating like Berkshire, your best bet is investing in a top-flight PE manager with a good thesis.

Now, there are so many PE firms - so you have to start with a thesis.

Excess returns come from (i) a capital imbalance or an (ii) information advantage, or (iii) risk premia.

The biggest capital imbalance today is in Commercial Real estate. We’ve written about this extensively and shared research from others including KKR.

Now it takes specialized skills: sourcing from banks, on-the-ground relationships, know-how, and access to bank term financing to execute well.

This is why you’ll hear us say Distressed CRE is the highest risk adjusted return thesis today.

That brings everything full circle.

The S&P has a PE ratio that is fair value. Higher rates will place pressure on PE multiples. The better risk-adjusted return is in Distressed Commercial Real Estate.

We expect a 3 to 4x MOIC on our investment in this strategy.

Reach out if you are a qualified client and want to learn more about our preferred opportunity that is only available for a couple more weeks.

Company Earnings

The Banks kick-off earnings season this Friday.

On Twitter we wrote in a post called “The Case For Active Management”:

10/9: "I expect JP Morgan will beat earnings this Friday, and I expect overall the mega banks to report strong earnings." WSJ: "Citigroup, JPMorgan and Wells Fargo all reported quarterly earnings that came in ahead of consensus estimates. Shares in the banks gained premarket."

One of the ways to offset your brain’s fear center is to inform decision making with data & analytics.

The time to be fearful was when:

• the S&P PE ratio levitated 4 points on no YOY earnings growth

• ‘soft landing’ hit peak narrative in July (narrative can’t get better than that)

• retail investors are buying calls options and junk stocks

• Powell was scheduled to deliver another “pain” talk at Jackson Hole

Now the Pendulum has swung the other way:

• analysts have revised down earnings (Analysts expect 0% YOY growth)

• ‘higher for longer’ hit peak narrative, including fears of a recession emerging

• sentiment is bearish

• Retail investors are buying puts instead of call options (fear is elevated)

This study shows the performance of stocks during Earnings Season.

A lot of stocks are oversold

Their charts are falling off the page.

This chart is about a week old - the main point is we should expect a recovery this quarter with earnings season and a strong consumer as a catalyst.

Earnings Revision Spreads Are Also Bullish

Analysts are overly bearish.

The pace of analyst EPS revisions as tracked by Bloomberg in the lead-up to earnings season have historically been inversely correlated to the performance of the S&P 500 during the reporting period.

That’s a mouthful.

What that means is when analysts lower earnings significantly, markets outperform. It’s easier for markets to surprise on the upside.

Crowded Short Positioning

CTAs are also bearish. They are trend followers. After 2 months, they put on a large number of short positions.

Those will have to be reversed.

Ironically, the more short interest in the market, the more support the market has. All shorts have to cover.

We’re also seeing data from the Prime Brokers that Long Only managers have stopped selling. Selling exhaustion is emerging.

This data is contrarian bullish when near extremes.

Bank Earnings

JP Morgan crushed earnings. We predicted that on Twitter this Monday.

Take a look at JP Morgan’s Consumer Bank performance. This is the crown jewel of JP Morgan.

The largest bank in the world reported a 41% return on equity.

Imagine if you had a business where if you put in $1,000,000 the next year you have $1,410,000. And you held that business for 20 years.

That’s what JPM’s consumer bank is doing.

We think there’s a great opportunity to buy a small private bank and build the next First Republic or JP Morgan. Except make it modern in every aspect.

If you’d like to learn more or be a part of that journey send us a note.

This week, JPMorgan has launched its Tokenized Collateral Network (TCN), a blockchain-driven application that allows clients to employ tokenized assets as collateral.

The first TCN transaction involved clients BlackRock and Barclays.

Pepsi Earnings

• Beats Earnings by ~4% & Beats Revenue by ~0.2%

• ~$23Bn in total revenue, up ~5% QoQ & up ~6% YoY

• Raises full-year constant currency EPS growth guidance to 13%

• Expects organic revenue growth of 4% to 6% in 2024

See here for our full recap.

Fastenal Earnings

• Beats Earnings by ~4% & Meets Revenue expectations

• ~$1.8 Bn in total revenue, down ~2% QoQ & up ~2% YoY

• Despite softer demand and reduced revenues, Fastenal's Q3 2023 unit sales grew

See here for our full recap.

Dominos Earnings

• Beats Earnings by ~27% & Misses Revenue by ~2.34%

• ~$1.03 Bn in total revenue, down ~2% QoQ & down ~4% YoY

• Domino's has been facing challenges, evident from the YoY revenue decline and its inability to surpass revenue estimates recently

See here for our full recap.

AI

Bank of America released a report that is constructive on the potential for AI

We have a chart below if you want to scan the pretty pictures.

Our thesis is to focus on the Silicon Layer. Overweight Capex Receivers rather than CapEx payers.

Digital Assets

We recommend listening to this podcast to get our thoughts on Digital Assets.

We covered a lot of technical ground here: how we see BTC vs. ETH, where to position in ETH, and endowment style investing.

Work with us: we are are looking for a client associate to help us with sales and client service support. Send referrals here.

Meme of the Week

Quote of the Week

"The greatest enemies of the equity investor are expenses and emotions." - John C. Bogle

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