Allen's Analysis Blog

Weekly Market Comment

August 30, 2019

“It’s sad. But I also have a lot of clarity.” – Andrew Luck, who elected for an early retirement from football at the age of 29

When negotiating, it is usually unwise to convey weakness, regardless of how strong your position is. After a long day, Trump let down his tough guy façade and candidly admitted to having “second thoughts” about escalating the trade war. The man is facing a lot of pressure in part because he overlooked enlisting his G7 counterparts in the fight and mounting evidence that it is negatively affecting the economy both abroad and at home. While consumer spending has been robust, consumer sentiment has fallen to its lowest level since the month of the U.S. election and has retreated at its fastest pace in six years.

Germany, an exporting powerhouse, is suffering from lower Chinese demand as a direct result of the trade war and faces American threats of car tariffs in the meantime. Evidence suggests their economy, the 4th largest in the world and largest in Europe, may be tipping into a recession. Business confidence in that country sits at a seven year low after its fifth monthly decline.

Geopolitical risk analyst’s such as Ian Bremmer, have long argued that Xi Jinping does not have a lot of incentive to change China’s bold (and highly leveraged) but so far successful economic model when he is betting there may be a changing of the U.S. guard next year. As well, ordering American companies to exit doing business in China is unrealistic, but the Chinese government ordering its citizens to stop buying American goods is not.

Last week we pointed to Japan and their negotiating strategy with the US as being potentially a successful path to the completion of a trade deal. During the G-7 summit, Japan and the US agreed on a trade deal framework.

Unlike Japan, when it comes to China, one thing is for sure: nobody knows how this all will play out.

Which probably helps explain why Warren Buffett’s Berkshire is sitting on about 59% cash ($122 billion). He is mostly a “bottom-up” stock picker (focusing on a company’s specific merits), but he does pay attention to the “top-down” macro-economic picture as well. As Bloomberg points out below, his single favourite metric is the market capitalization-to-GDP ratio. That is, the total value of the stock market divided by America’s gross domestic product (one year of economic output and used to measure the size of the whole economy).

Buffett Gauge graph

We also know that small-cap stocks tend to turn lead large-cap stocks into a sell-off/bear market/ recession. The Russell 2000 – a broad measure of American small-cap stocks - is down 14% since the September peak of last year. While nobody knows for sure if we will see a recession or bear market soon, we do know small-caps always lead the way into bear markets. A bear market is defined a drop of 20% or more, something small-caps are getting perilously close to.

Russell 2000 Index

Russell 2000 index graph

Energy Department released a report saying that wind power installations are “robust” and prices are “falling”. In fact, wind power now generates a record 7% of America’s electricity and this is only going to rise. Bloomberg estimates the world will glean half its power from wind and solar by 2050. Profits and continued technological advancements are making this happen, not ideology. And if such a 30-year predictions strike you as too lofty, remember that wind power, solar and even home computers were virtually non-existent 30 years ago.

As it happens, several of our Legacy accounts own Innergex, Boralex, Algonquin and Northland which we recently purchased after selling Fortis (which we were up 30% on, plus dividends, but the valuation climbed to historic cycle peak levels). All of these companies have varying degrees of wind turbine assets, all of them pay above average dividends and all of them (save for Northland, which we just bought) have been clear winners in our portfolios. Most importantly, they are profitable businesses that are growing.

Musings Beyond The Markets

Star NFL quarterback Andrew Luck did something few people would have contemplated: walking away from a successful career and an estimated $500 million in future earnings while at the top of his professional game.

Luck follows the New England Patriots star Rob Gronkowski, who retired in March, also at the age of 29.

Most people work because they have to keep the money flowing to live. They don’t have the financial bandwidth to walk away. And when people do manage to earn big money, its usually after many years of hard preparation and dedication to earn it. Work becomes an ingrained part of their self-image as well as a calcified habit. Moreover, successful earners tend to develop increasingly expensive tastes that correlate to their heightened spending power. The treadmill moves faster and registers more miles traversed, but so does the caloric consumption this requires.

Luck has earned an estimated $100 million and probably lives well within his means. Gronkowski earned $53.4 million, and only spent the $3.4 million earned from endorsements. He was well aware of the horror stories of former players going financially broke.

Luck’s father, Oliver Luck, also played in the NFL. The junior Luck would have seen first-hand what many of his father’s buddies endured after years of excessive physical punishment. The famed NFL running back Emmitt Smith once compared it to getting into a car accident, multiple times per game.

Fans and the owners want their sporting gladiators to hit and play as hard as possible for as long as possible. Relatively recent scientific insights into the negative effects of CTE (as star player Rob Gronkowski referenced this week, who also retired at the age of 29 after 9 years in the NFL) and other long-term bodily harm be damned.

But life, like investing, is all about risk-reward ratios. We get on an airplane because we believe the risk of it crashing is small enough relative to the reward of making it to our destination intact.

But how much of our physical and mental well-being – as well as current happiness – are we willing to give up for more money, prestige and/or excitement? Luck and Gronk have tens of millions of after-tax reasons to exit their profession’s dangerous rat-race.

Kudos to anyone who has the courage to walk away in a bid to better their quality of life. It’s a bit like Warren Buffett belief in shrinking a business if it stands to make it more profitable. Similar with cutting losses, preserving what’s left and moving on. It’s not always appropriate but when it is, it should be done.

Andrew Luck is lucky and he knows it. He’s calling it quits before his luck inevitably runs out. All too many successful professional NFL players go on to live profoundly unlucky lives in their later years, well after the fans have stopped cheering for them.

Notable reads:

Word of the Week

ablate (v.) – to surgically remove. “PRN’s Phase III/Pivotal trial data showed that TULSA-PRO is able to ablate either the entire prostate or specific focal regions, all while preserving the sensitive nerve bundles that are in close proximity to the organ.” – Rahul Sarugaser, Raymond James research analyst.

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