Tag Archives: investing

Amazon, Google, and Facebook: Bigger is Better

Why giants thrive
The power of technology, globalisation and regulation

This is why a simple investing strategy that goes ‘long’ equal weight the three biggest, fastest growing, and most successful tech companies (AMZN FB and GOOG) has done so well. Is past performance indicative of future results? No, but as far as strategies go, it’s hard to beat.

If someone says an investment strategy is ‘fail safe’ usually that’s an indication that it’s time to run to the exits, but Facebook, Amazon, and Google are exceptions, just by virtue of their immensely strong fundamentals and the fact that after a decade or longer no one has been able to come up with viable alternatives to compete with them. I remember in 2004 during the Google IPO, pundits said that anyone could come up with a ‘Google alternative’…lol 12 years later and we’re still waiting. Or in 2008-2012, predictions of a ‘Facebook alternative’, which of course has yet to happen and likely never will.

In capitalism 2.0, Bigger is better.

Just because Myspace lost to Facebook doesn’t mean Facebook will suffer a similar fate.

Airbnb, Uber, and Snapchat…all more valuable than ever, with no viable competitors on the horizon, and their valuations and market growth just keep rising, year after year, to no end, despite endless predictions by pundits of a bubble.

Contrary to popular belief, predictions of collapse are actually as common, if not more so, than predictions of a continuation of a trend. During the 80′s – 2000′s housing boom, predictions of a housing bubble were commonplace. Predicting the 2006 housing crash does not make one a contrarian, because such bearish predictions were actually as common as predictions of the housing market rising. If that seems backward, it’s because the media as of 2008 has given more attention those those who predicted a bubble. For example, Michael Lewis’ bestseller The Big Short, about how some canny traders made a fortune betting against the mortgage market. But the media also ignores all the forecasters were wrong all the way up, only to be right purely by chance in 2008. Likewise, during the 90′s dotcom bubble the media gave more attention to those who were predicting higher prices, but there were still roughly the same number of people who were predicting lower prices, but it’s just that they were mostly ignored, creating a false consensus that everyone was euphoric.

From a market perspective, the number of sellers (pessimists) has to roughly equal the number of buyers (optimists). For prices to keep rising, you need people to sell to the buyers.

These huge tech companies companies don’t need to innovate that much, rather they have market dominance and effortlessly print money through their ad platforms and other services. As the Economist article mentions, they tend to be very well insulated from global economic events (unlike the energy sector or financial sector), and these huge tech companies are also especially well suited to take advantage of global markets. Google, Facebook, and Amazon derive a significant chunk of their revenue overseas. And they can use foreign markets, loopholes, and other accounting schemes to dodge regulations and taxes that are unavoidable for smaller companies.

Up until the late 2000′s, major tech companies seem to have a about a decade of solid growth and stock price appreciation, before tapering and contracting or even collapsing (Cisco, Oracle, Sega, Sony, Atari, 3com, Research in Motion, etc.), but nowadays, as of 2004 or so, major tech companies seem to do a much better job at retaining their growth, market share, and share price appreciation.

Also, the stock market has done a much better job of quickly punishing losers (gopro, fitbit, etc.) but also rewarding winners. The investing landscape is much more choosy and selective, which could explain why active management is having such a hard time in an otherwise very strong bull market. It’s not like the late 90′s when all tech stocks were indiscriminately bid higher. You have the pick the cream of the crop or you will fail. You have all these experts who manage millions or even billions of dollars and they are just as clueless as average investors.

Post-2008 Wealth Creation: A Guide, Part 4

This is the penultimate installment of the post-2008 wealth creation guide. In part three, I discussed shorting inverse leveraged funds like SPXU and SPXS, which are 3x inverse versions of the S&P 500. As of 7/20/2016, SPXU is trading at 23.50. Shorting $10,000 worth would require shorting 425 shares. If it drops 20% to $18.8, your unrealized profit is $2,000. However, because it’s a 3x fund, if the S&P 500 were to drop 5%, you would lose around $1,500 ~ 435($23.5*1.15-$23.5). The ‘decay formula’ given earlier will give a more exact answer. There is a high degree of path dependency that typicality, over many months, helps the short seller, which is why shorting these leveraged inverse ETFs good strategy in most market conditions.

So the big problem, though, are large loses should the market fall a lot. There is a way around this, to some extent. It’s far from perfect but it helps a lot.

The solution is to buy treasury bonds such as TLT (an ETF proxy for the 30-year treasury bond), which tend to be inversely related to equities. This means if the S&P 500 falls 1% for the day, maybe the 30-year bond will rise .6%, offsetting some of the loss. This results in smoother returns and smaller dips, as shown below:

In 2008, the hypothetical bond-stock portfolio only lost 20-25% vs. a 40% loss for the S&P 500.

Like the S&P 500, bond ETFs pay dividends (about 3% a year for the 30-year bond proxy TLT), and this compounding affect helps immensely. This also helps when you are shorting inverse leveraged bond ETFs like TMV, the inverse 3x version of TLT. Since 30-year bonds pay 3% a year, TMV decays 9% a year just from the yield alone.

Like SPXU and SPXS, the ‘decay formula’ gives an annual decay of around 13% for TMV. Adding the yield decay, and the total is around 20% per year, even for a flat bond market.

Like SPXU, TMV is in a state of constant decay. It cannot retain any of its gains for very long and keeps going lower:

Same for PST, an ETF that is a 2x inverse of the 10-year treasury bond:

Its decay is even smoother than the 30-year one…strait to zero.

So what happens if someone shorts, allocating 50% of the portfolio value to short SPXU and 50% to short TMV, and then rebalancing it quarterly?

Turned $100 into $1,300 after seven years. The sharpe (a measurement of risk-adjusted returns) is about 1.7, twice as good as the S&P 500. This is about as good as any strategy that does not involve exceedingly high leverage. This assumes that bonds and stocks both perform well, but even if they are flat, the 20% annual decay still gives a total compounded return of 250% over seven years. This also ignores transaction costs. When those are factored in, the performance diminishes a little bit.

A common retort is that ‘stocks and bonds have been in a bull market since the early 80s’ but, going as far back to the 1930′s, 10-year T. Bond produce positive yearly returns 80% of the time, according to Annual Returns on Stock, T.Bonds and T.Bills: 1928 – Current.

Post-2008 Wealth Creation: A Guide, Part 1

Entrepreneurship is too hard, America’s ‘pioneer spirit’ is gone, and the news is pretty much a waste of time. Blogging, writing, etc. also mostly a waste of time and usually doesn’t make money.

In our post-2008 winner-take-all, bigger-is-better economy and society, instead of trying to compete directly with the big and rich, why not piggyback off their success by buying the same rapidly appreciating asset classes that they use to become rich? That leaves two ways to make a decent passive income, or even wealth: real estate (which I already discussed several times here) and investing, also a popular topic here. Both of these take advantage of low interest rates, which boost asset classes. I imagine hundreds of millions of dollars of venture capital could have not been squandered on such duds as Ello (remember that?) trying to compete with Facebook or Google, by instead investing the money in index funds or real estate or returning the money to the investors.

Pre-2008 wealth creation: jobs (enough good-paying jobs, for all levels of intellect and credentials), entrepreneurship, investing (all stocks, all sectors), venture capital (all tech industries), real estate (all regions).

Post-2008 wealth creation: fewer jobs (but lots of low-paying service sector jobs, lots of credentialism and competition for medium-paying and even low-paying jobs, as the middle class gets squeezed and pushed to the periphery), real estate (especially in high-end regions like the Bay Area, Manhattan, Orange County, etc.; less expensive regions have failed to recover fully), investing (only index funds, large cap stocks with market dominance, NOT small or medium-sized individual stocks), venture capital (mostly Web 2.0, and only Uber, Snapchat, Air BNB, Dropbox, Pinterest, Slack, and a handful of others).

It’s obvious that wealth creation in post-2008 society is much more selective, choosy, and concentrated in fewer industries and sectors. It’s much easier to make mistakes when the targets are smaller. What worked decades ago likely will not work anymore.

From Post-2008 Capitalism: A Guide:

But overall, when pundits proclaim ‘capitalism is dead/dying’, they may be referring to an antiquated meaning or idealization of capitalism that does not take into account how capitalism is changing, but this does not mean capitalism is dead -hardly by any stretch of the imagination – instead, it’s evolving to a more efficient, technological, network-driven, ad-based, winner-take-all version of capitalism that we have now. Capitalism, like much of the post-2008 economy, has become bifurcated, with winners being high-IQ capitalists and ‘high-IQ’ capitalist endeavors, and less intelligent people and ‘low-IQ’ businesses are struggling.

Perhaps post-2008 capitalism is characterized by the following ‘themes’:

1. High-IQ favoritism – both in the business/investing world and individually, with smarter people and smarter businesses succeeding over their less intelligent peers.

2. Winner-take-all/bigger-is-better (small business failure at record highs, expensive real estate regions keep getting more expensive, Web 2.0 valuations at record highs for a handful of companies, etc.).

3. Flight to quality (similar to #2) – observed in the investing world, venture capitalism, Bay Area real estate, and strength of the treasury bond market & US dollar vs. weakness of foreign peers.

From 2014, The New Gilded Age; The Post-2008 Economy, Part 4:

The best investment strategy right now (and for many, many years to come) is to take advantage of the bigger is better market environment and go long large cap tech, such as Facebook, Google and or the S&P 500, while hedging it with a combination of emerging market short positions and or small cap shorts. Or you can short ALL markets excluding the US while going long the S&P 500. Since 2014, in the wake of the fear of recession in Europe and elsewhere, we’re seeing a huge flight to safety. Fund managers are taking money out of the smallest, weakest stuff and pouring into the safest and highest quality stocks, indexes and sectors such as the S&P 500, healthcare, biotechnology, and large cap technology such as Microsoft, Google and Apple. Again, this trend will continue of the big getting bigger and companies with huge growth and zero competition being rewarded with enormous but sustainable valuations. Such high-growth companies include Facebook, Snapchat, Uber, Tesla, Dropbox, Pinterest, Tinder, and Air B&B.

So far, two years later, that strategy has paid off handsomely.

And with the S&P 500 at new record highs (in agreement with my predictions), I remain optimistic [1] as ever about the US stock market (record high profits and earnings; globalization; strong exports and consumer spending), treasury bond market (‘flight to safety’ and ‘flight to quality’ due to weakness in Europe and emerging markets; global liquidity boom), and expensive real estate (due scarcity, rich foreigners, Web 2.0 boom in Silicon Valley).

Part Two will describe the specific method I and others are using to take advantage of this.

[1] Whether it’s finance, investing, economics, or HBD, Grey Enlightenment represents a reality-based approach divorced from wishful thinking and delusions. Or you can listen to losers at Zerohedge, who haven been predicting since 2009 a bear market, bond market collapse, and hyperinflation, to no avail. Same for Peter Schiff, who has also been wrong about everything since 2009 (as usual, Mike Stathis has the best takedowns of Peter Schiff and other losers who peddle overpriced gold and other bad investments).

Source: avaresearch.com

But anyway, the stock market is driven primarily by two things: profits and earnings. It doesn’t care about about student loan debt, wealth inequality, national debt, whether Trump or Hillary becomes president, the latest media-generated crisis or scandal, Europe, or whether some pundit (including even George Soros) is bearish – as long as profits and earnings keep rising, so too will stocks. As shown below, profits and prices are correlated:

There was a large divergence in the late 90′s during the ‘tech bubble’, but such a divergence doesn’t exist now, suggesting prices are aligned with fundamentals (not a bubble).

Better or Worse?

Two contrasting viewpoints:

Pessimistic: The Truly New Year

Optimistic: Financial Fridays: The Stock Market is Bullshit

New inventions and technologies would outpace the demand for those commodities so that as we needed their functionality more, the prices would fall.

Think about computers: your price per speed and functionality in your computer has gone down every year since they’ve been invented.

ANOTHER GREAT EXAMPLE OF INNOVATION AND DEFLATION

Think about lighting your house. In the 1880s you would have to work for 15 minutes to pay for an hour of kerosene lamp usage.
Today you have to work for 1/2 a second to get an hour of reading light.

Ditto for cars. For clothing (as a percentage of your income) and even for food (as a percentage of your income – food costs have gone from about 20% of your income in 1969 to about 3% of your income. )

This is similar to the ‘utility‘ argument as a way to mitigate wealth inequality and real wage stagnation.

Of the two, my money is on the latter, not only because I agree the China fears are overblown, but the odds suggest the doom and gloom hype will pass, as it 95-99% of the time always does.

Here are some past examples of doom and gloom that passed:

Debt ceiling, sequester, fiscal cliff (all these passed without much incident)

Banking crisis relapse (six years later still no relapse; bank balance sheet are healthier than ever)

Fears of double dip recession & bear market (since 2009, six years later, still no recession or bear market; growth is slow, but still positive)

Ebola (came and went, as it always does, although the death toll was higher than usual)

Greece global contagion 2010-2012 (Greece never left Euro, no global economic contagion)

Fears of hyperinflation & dollar collapse (treasury yields at new lows; dollar at record highs)

‘China is slowing’ (isn’t it always?)

Euro collapse (hasn’t happened, probably won’t)

Oil prices out of control in 2008, ‘peak oil’ (oil now at near decade lows)

Wealth inequality is too high (there is little or no substantive evidence rising wealth inequality is bar for the economy will eventually pose threat to economy)

Tech 2.0 bubble (tech valuations are not nearly as high as they were in 2000)

Housing market double dip (prices keep going up, mortgage lending standards have become more stringent, subprime lending at record lows)

Russia (after a lot of headlines in early 2014, no one talks about it much any more)

Democracy is in danger/voter fatigue (ptth people are actually tired of it)

Predictions of a housing market bubble 2005-2008 (the ONE time the doom and gloom media was right…out many examples of being wrong. Had you heeded the media and sold your stocks in 2005-2008, you may have been able to buy at a much lower price in 2009.)

So what does the future hold? Who knows, but it probably won’t be as bad as many are expecting.

The New Investing Landscape

From The Reformed Broker, There is a limit

A lot of people are struggling in this market.

Here is the deal.

I’m going to divulge research that investment firms normally pay hundreds of thousands of dollars for, for free. It’s a very simple way to not lose your shirt in this schizophrenic, mean-reverting market.

First, stock picking does not work anymore *, unless by ‘stock picking’ you mean maybe a dozen or so stocks out all the thousands of stocks listed. But get it through your thick skull that unless your stock is one of those dozen, you should probably not own stocks. This market has been punishing stock pickers for too long, with stocks that perform well eventually getting pummeled (Sketcher’s shoes comes to mind, down 40% in a month). This is because fund mangers, desperate for any edge in an increasingly efficient market, pile in and out of individual stocks, creating erratic bursts of out-performance and then huge selloffs. Stock picking as always been hard, but it seems to have gotten harder. The S&P 500 is flat for the year, but most of the stocks in the index are negative, and this is due to the flight to quality as fund mangers seek only the best stocks and sectors out of thousands of losers. Anything that isn’t top quality eventually get culled.

Some say the market is rigged, but for the market to be rigged would imply that someone if making all the money, yet the performance of active management is in the dumps. That means even the experts, with their $20,000 Bloomberg terminals are as clueless as mom & pop investors. Instead, we’re seeing a race to the bottom, like a beach with some gold at the bottom and everyone is digging for this scant gold.

As for those dozen stocks, here they are:

GOOG – alphabet/google (both versions)
V – visa
MA – mastercard
NFLX – netflix
AMZN – amazon.com
NKE – nike
DIS – disney
MSFT – microsoft
FB – facebook
AAPL -apple
HD – home depot
GILD – gilead sciences

I can probably think of some more: JNJ,COST,LOW, TSLA

Amazingly, this portfolio has not only beaten the market by large margin, but each stock has a >$200 billion market cap. This proves that you get what you pay for, in that the largest companies keep doing better while the smaller ones have poorer risk-adjusted returns.

But a portfolio of a dozen stocks may be insufficiently diversified, so you can get returns that are almost as good with just these two ETFs:

QQQ (large cap tech ETF)
XLY/RTH (large cap consumer discretionary ETF)

Either 50% in QQQ and 50% in XLY or RTH

or 50% in QQQ and 25% in XLY and 20% in RTH

This will give you modest risk-adjusted edge over the S&P 500, because you’re avoiding the weak sectors like energy, material, and utilities.

Large cap tech and large cap retail have been hands-down the best performers since 2013 or so, as everything else has stumbled.

On the fence (these are alright, but not as good as above)

Financials (XLF)
Utilities (XLU)
Transports (IYT)
S&P 500 (SPY)
Dow Jones Industrial Average (DIA)
Biotech & Healthcare (IBB, XLV)
Low Volatility ETFs (RHS)

What to avoid:

Any market that is not America. That means Europe, Australia, emerging markets, and so on.

Any stock or ETF that deals with precious metals, coal, commodities, shipping, mining, energy, drilling, oil, and so on.

Emerging market currencies and bonds

Junk bonds that have energy exposure

Small caps (the small cap premium is dead)

Medium caps (medium cap premium also dead)

Materials (XLB)

Individual stocks (unless it’s one of the twelve listed, any any single stock should not make up more than 1/12 of the portfolio)

The usual objection is, ‘what if the lagging stuff comes back?’ Historically, going back decades, consumer discretionary and tech have been among the strongest sectors. So even if the lagging sectors recover, the expected value with the strongest sectors is still higher.

Again, this is not rocket science. This is brain-dead easy, yet so many people keep getting this market wrong, trying to pick fallen stocks or bottom fishing for lagging sectors in the hope they will come back to life, which they seldom, if ever, do…

* Individual stocks can work if you only allocate a tiny percentage of your portfolio for each stock, and no more than 5% of the total portfolio. I like FNMA and FNMAS as barbell strategies, meaning that these will either become worthless if the government shuts them down or rise 500% or more should they be privatized. The expected value is positive, but there is still a definite risk of losing everything.

Stock Market Rebounds

Back in August and September during the stock market plunge, I recommended going long here and again here.

Sure enough, stocks have surged since then, with the S&P 500 up about 9% since my reiteration to buy the dip:

The portfolio I ‘manage’ is up 20% this year, vs. 2% for the S&P 500:

By ‘manage’, I tell the client which ETFs and stocks to buy in exchange for a cut of the profits. The historical returns are about 50% per year. This is better performance than probably any active management in existence on an absolute and probably risk-adjusted basis, too. AQR management, for example, a billion-dollar active management firm which is staffed by a team of PHD quants, cannot get these kind of returns. No one else can, and that’s why it’s proprietary. It’s not that my methods are sophisticated (they aren’t), it’s that almost everyone else is so bad.

A bet against the stock market is a bet against IQ, a bet against the best and the brightest who power capitalism and innovation, as well as a bet against the indefatigable American consumer. It means you’re betting against high-IQ tech companies like Google, Facebook, Apple, Visa, Mastercard, Cisco, Oracle, Netflix, Amazon, and Microsoft – that’s a bet no sober individual should ever make.

US stocks have outperformed pretty much all asset classes, going as far back as the 19th century:

(Graph courtesy of the Mega Foundation’s investing page)

Do the fools on Zerohedge think their alarmist nonsense can override 100+ years of gains, can override 100+ years of innovation and free market capitalism by America’s best and brightest? If you get your financial advice from losers, you will have loser returns, sulking under a cloud of self-pity and resentment waiting for the crisis that will never come, the black swan that will never arrive. Doom and gloom, conspiracy theories are a coping mechanism for the unsuccessful to reconcile mediocrity by shifting the blame unto nebulous entities instead of the ‘self’. If I fail, it’s because some shadow entity is keeping me down – not low-IQ, poor work ethic, or lack of talent.

Precious metals and bitcoin are fine for a diversified portfolio, but they should not be your entire portfolio.

Betting against the stock market and America means betting against companies like Home Depot, Target, Costco, Lowes, Nike, and Disney – all which are posting record profits & earnings quarter after quarter due to consumer spending and exports. Disney is a play on obesity and population growth, neither of which shows any signs of slowing. Disney makes billions of dollars a year exporting its intellectual property all over the world, in addition to billions of dollars from sedentary youths watching Disney programs and movies and parents buying merchandise. It’s not that I personally like this trend, as these obese kids will add to healthcare costs down the road, but it’s the way it is. Google is play on the propensity of the Left Side of the Bell Curve to click contextual ads. Facebook, which is run by high-IQ people, also makes its money from the left of the Bell Curve (to click the ads), as do most companies. As I said, there’s a lot of room on the bottom – a lot of money to be made from the Left Side. But you also have companies like Amazon, which is laying the infrastructure that is powering the trillion-dollar ecommerce economy. Investing in companies like Google, Amazon, and Facebook is like investing in the company built the Matrix in the eponymous movie, and I’m sure it would be a good investment considering that everyone is plugged into it. The aforementioned stocks are up 20-30% since August and, despite their $300+ billion dollar market caps, have much further upside. I been telling folks to buy these stocks (Amazon, Mastercard, Visa, and Google) since 2011 and Facebook since the IPO. But you have these doom and gloom liberals who want the economy to fail so that the rich lose money and there is less wealth inequality. At the same time, you have idiots like Peter Schiff and Karl Denninger that keep repeating this hyperinflation/end the fed nonsense. That’s why the populist movements of the left and right are stuck, they keep coming up empty handed as the status quo keeps prevailing. Subscribing to liberalism is like believing in man-made global warming. It’s like believing you can grow an economy by overtaxing its most productive members.

Will the market go lower? Yes, eventually it will. But if you heed these fear mongers, like those fools who say to always rent instead of buy a home, after many years you will have nothing to show for it.

Buy The Dip

As everyone is freaking out about stocks falling, a buying opportunity has presented itself:

The pattern now is reminiscent of the selling in late 2011 which, in retrospect, was a good buying opportunity as the market proceeded to rally another 70%.

The big concern right now is over supposed economic weakness in China. But aside from that, there aren’t any new developments in the US economy to justify another bear market, or at least nothing in the data has meaningfully changed between today and a month ago when the market was 12% higher. 99% of what’s said by the financial media is just rumors and fear intended to boost advertising dollars and ratings. The doom and gloom media is trying to create narratives when, in fact, most of this selling has no underlying structural cause and is just noise. Capitalism is not dying. Economically, China is still doing better than the vast majority of emerging markets. Stock prices of high-IQ companies like Amazon, Google , Facebook, and Tesla will keep rising. Consumers will keep consuming. Valuations for Uber and Snapchat will not fall. Bay Area homes will keep being expensive , including my neighborhood where prices keep going up.

As for myself, my stock account is negative for the year, so it’s not like I can pretend to be unharmed in all of this, although I only keep some of my money in stocks. Deeply regretting not buying TQQQ on the dip at $75 couple days ago, and it’s now at $91. Had I done some things differently, I would have about $2,000 more dollars now on the account, and while it isn’t that much money, it’s still a personal failure on my part in not choosing the better trade. Yeah, they say the grass is always greener ….blah blah, but I want to get to the point where every decision is an optimal one.

If you have a sizable sum of money, Bay Area real estate may be better than stocks. You get a much smoother rate of return. But that’s not an option for the vast majority of people, since the homes in that region are expensive and scarce. That’s the ‘depressing’ reality about investing: the easier it is to invest in something, typically the worse the returns for the average person. A lot of people who buy stocks lose money; there are too many stocks and sectors to choose from, and most of them are bad. To bypass this inherent difficulty of choosing stocks, it’s recommended buying index fund ETFs or sector ETFs, which are described below.

As mentioned before, my favorite sectors:

Retail (XLY,RETL,RTH)

Healthcare (XLV)

Large-cap technology (QQQ)

Payment processing (Mastercard, Visa, Paypal; there is no ETF for these)

Least favorite sectors:

Energy (XLE)

Commodities (GLD,USO)

Emerging markets (EEM)

Miners, oil shippers, and drillers (Misc.)

Emerging market currencies & bond funds (Misc.)

Junk bonds (JNK)

High yield misc. funds (MORL)

These sectors to to be macro-sensitive, meaning that they are susceptible to changes in the US dollar or emerging market GDP growth. These sectors also have too much volatility and poor returns. A junk bond can pay 7%a year, but the volatility is too high for a small return that can be erased in a few weeks of bad trading.

30-yr Treasury bonds (TLT)

Treasury bonds are also pretty good, since the weakness in China and the overall stock market malaise will delay any rake hike until 2016. A lot of people, who don’t how bonds work, don’t know the difference between a treasury bond and a junk bond. A high yield or risky bond* is a ‘risk-off’ asset, meaning it generally does badly during periods of economic weakness or fear. This is due to the flight to safety, which causes people to move money out of riskier assets into safer ones such as short-term government debt. A treasury bond is the opposite : they tend to do well during periods of panic, so if you plan on diversifying or hedging by buying bonds, make sure you are buying the right kind. When there is a flight to safety, money goes out of riskier junk bonds and into the safest ones of all: treasury bonds.

* this includes junk bonds, leveraged bond funds, emerging market bonds, REITs,

Tesla’s Big Surprise. Don’t Bet Against High-IQ.

Tesla stock (TSLA) surged today (and in the after hours) on an announcement of a mystery product line, as tweeted by CEO Elon Musk:

Due to hype and growth potential from the Nevada battery factory, Tesla stock could go to $250 soon*…don’t bet against high-IQ and rich people, as exemplified by Tesla and the booming web 2.0 scene. Unless you enjoy losing money, don’t bet against the fed, free markets, or the consumer. Those who have bet against high-IQ companies like Facebook, Tesla, Google, and Apple have been taken to the cleaners.

To put this theory to test, I compared the 5-year performance of what I perceive to be highest-IQ sector, the QQQ (Nasdaq 100 technology index in purple), and compared it with the lowest-IQ/most ‘blue collar’ one, the energy sector (XLE in green and red).

The two were almost tied, until the oil crash of 2014:

The energy sector is also more volatile, plunging in 2011 due to fears of a global recession stemming from Europe’s debt crisis. Technology, being that it’s not macro-sensitive, held up very well. Although the left goes on about Exxon’s record profits, profit margins for the tech sector are much higher.

So why has the energy sector fared so poorly? It comes down to IQ. Would you rather bet on the Beverly Hill Billy Oil Company or Microsoft? It’s obvious. The reason is two fold: first, low-IQ people (low IQ relative to tech CEOs and employees) gravitate to the most volatile, profit-thin, macro-sensitive industries such as energy, home building, and commodities because they aren’t smart enough to get into high-tech.

Second, because they aren’t smart they have poor common sense, are spendthrift, and incestuous/nepotistic (hiring on ‘people skills’ and family or college connections – not talent and intellect). But what about petroleum and chemical engineers? Yes, they are smart, but tech companies, especially web 2.0 and internet, tend to be staffed entirely by people as smart as engineers, and these smart people directly influence how the company is run. In the low-IQ sectors, the smartest people have little influence on executive operations.

In the Fall and Winter of 2014, the entire energy sector got annihilated as oil plunged $90 to $45, due to over-expansion and leverage. A lot of these energy companies were profitable provided oil was above some threshold (like $70 or so), and they borrowed heavily to expand operations on the assumption oil prices would remain high. This highlights the problem with the blue collar sectors: volatility from macro factors and incompetence/poor planning due to low-IQ management. For example, the CEO of Chesapeake Energy Corporation, Aubrey McClendon, ran his company into the ground as the stock fell from a high of $70 in 2008 to as low as $15, until his resignation on April 1, 2013:

On April 18, 2012, a Reuters report revealed that McClendon borrowed as much as $1.1 billion against his personal stake in thousands of company wells, raising the potential for conflicts of interest and raised questions on the corporate governance and business ethics of Chesapeake Energy’s senior management.[24] On May 1, 2012, Chesapeake’s board announced that an independent, non-executive chairman would be named and that McClendon would relinquish his position as chairman of the Chesapeake Energy board.[25] On February 20, 2013, Dow Jones reported that a Chesapeake board review of millions of pages of documents and more than 50 interviews of Chesapeake and third-party personnel found no improper conduct, no improper benefit to McClendon and no increased cost to the company.[26]

On June 7, 2012, Reuters reported that McClendon had used Chesapeake employees to perform $3 million of personal work, including engineering and accounting support and the repair of his house, in 2010.[27] McClendon’s employment contract expressly permitted such personal services by company employees and provided the formula for reimbursement of associated salary and other company costs.[28] According to Chesapeake’s proxy statement filed with the SEC on May 11, 2012, McClendon reimbursed the company for all but $250,000 of the employee costs.[19] The Reuters account also stated that McClendon had used corporate planes for non-business-related travel for the McClendons’ family and friends.[27] “For safety, security and efficiency” reasons, McClendon’s employment agreement authorized the personal use of company aircraft by McClendon, his immediate family members and guests.[29]
).

But you see this divergence of performance not just between low-IQ v.s. high-IQ sectors, but between entire countries. Compared to other nations that are struggling with slow growth, corruption and inflation, one reason why America has done well is because we do have a meritocracy that rewards the best and the brightest, and most policy makers – especially the fed and Republicans – are reasonably competent. There is room for improvement though, in that it wouldn’t hurt to have more high-IQ people in government.

* Disclaimer: I do not own Tesla, and this is not an endorsement to buy Tesla.