Economic Year in Review, The Art of Stock Picking & Insights from Joel Greenblatt's Special Situations Classes
Market Talk, Edition 65, December 18th 2022
Once every second Sunday I will curate the most interesting things I have consumed during the previous two weeks. These will be bucketed into 5x must-reads (works I wish to highlight and comment on) and other items of interest (an assortment of other works I have consumed).
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Comments from Me
The weather is now sub-zero, the jumpers I don have become thicker, and my central heating is seldom off. I believe the rapid step change in weather conditions caused me to fall sick, as most do this time of year. As a result, I spent much of my time reading this week, with insufficient mental clarity to write. I have a few things in the pipeline, however.
Recent Publications: Memos I have shared since the last Market Talk.
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5x Must Reads
In every edition of Market Talk, I share a number of readings that I have consumed over the past two weeks. Here are 5 that I found particularly enjoyable or insightful. Note, that these articles are not listed in order of perceived value.
To access the suggested article, click the purple link after the source subheading.
1) The 2022 Economic Year-in-Review: Illustrated in 11 Charts
Source: (Apricitas Economics)
A succinct and simple idea from; portray the wild year that has occurred with respect to the macroeconomy in eleven, aesthetically pleasing, charts. Covering everything from inflation, economic growth, housing, energy costs, supply chains, yields, savings, demand destruction, to the labour market, this is a great five-minute read to refresh your memory as we head into 2023.
A few days after this review was posted, we got word that disinflation entered the US economy with November CPI data coming in cooler than expected across all fronts. US CPI came in at 7.1% YoY; down from 7.7% in October and below the 7.3% estimate. “This progress comes on two fronts: the immaculate disinflation coming from price declines in energy and core goods as supply chains normalize, and the intentional disinflation coming from the Federal Reserve’s tighter monetary policy working through the economy. On the first front, price declines in gasoline and motor vehicles have played a critical role over the last few months, and on the second front declines in aggregate income and demand are slowly passing through to the broader economy.”
Joey followed up with a couple of short articles, titled ‘Progress in the Fight Against Inflation’ and ‘The 2023 Macro Outlook’ which hum along to the same tune and I feel are worth your time too.
“Inflation has dominated the economy this year, and the economic outlook depends in large part on the path of inflation and the amount of pain required to get inflation back on track. Market-based measures of inflation expectations were put back into normal levels by the rapid increases in interest rates, but recession risks also increased dramatically at the same time. The Federal Reserve has projected a 1% increase in the unemployment rate by this time next year, something that has almost always accompanied a recession. Still, the most important thing to keep in mind is that economic outcome variance has radically increased during the pandemic—so many of the events that defined 2022, like the war in Ukraine or the highly restrictive lockdowns in China, were not easy to forecast in 2021. 2023 at least promises to be another year for the history books.”
2) Three Lectures by Warren Buffett to the Notre Dame University
Source: (Warren Buffett)
In 1991 Warren Buffett presented a series of three lectures to a group of fortunate MBA students, undergraduates, and faculty members of Notre Dame University in what makes for a goldmine of lessons from the astute veteran. Steve Jobs would say that "simple can be harder than complex" and part of why I enjoy reading materials like this is Buffett just makes everything seem so damn simple. Of course, it’s not, but it’s a pleasure to read because of his ability to make it seem like so. It’s always refreshing to me to remember that one of the greatest investors in the world doesn’t feel the need to cloud his commentary with a cloak of complexity; doing so is a tell-tale sign of insecurity.
The lectures span 39 pages in length, but the curators, Tilson Partners, kindly plucked out ~9 pages worth of interesting segments that hit on themes like; keys to investment success, the tests of a great business, the importance of management, the perils of leverage, and more.
“You shouldn’t buy a stock, in my view, for any other reason than the fact that you think it’s selling for less than it’s worth, considering all the factors about the business. I used to tell the stock exchange people that before a person bought 100 shares of General Motors they should have to write out on a [piece of paper]: “I’m buying 100 shares of General Motors at X” and multiply that by the number of shares “and therefore General Motors is worth more than $32 billion” or whatever it multiplies out to, “because ... [fill in the reasons]” And if they couldn’t answer that question, their order wouldn’t be accepted. That test should be applied. I should never buy anything unless I can fill out that piece of paper. I may be wrong, but I would know the answer to that. “I’m buying Coca Cola right now, 660 million shares of stock, a little under $50. The whole company costs me about $32 billion dollars.” Before you buy 100 shares of stock at $48 you ought to be able to answer “I’m paying $32 billion today for the Coca Cola Company because...” [Banging the podium for emphasis.] If you can’t answer that question, you shouldn’t buy it.”
3) Joel Greenblatt’s Special Situation Investing Classes at Columbia University Business School
Length: Dense AF
Source: (Columbia University Business School)
Joel Greenblatt started off in the hedge fund space, founding Gotham Capital with $7 million in capital in the mid-1980s. There, he focused on spinoffs, corporate restructurings, and other special situations. It was said that between 1985 and 1994 (he returned capital to outside investors in 1995) he generated about 30% CAGR net of all fees; following which he continued to run the fund but closed to outside investors. Gotham Funds (Gotham Capital’s successor) still exists today. You may, instead, know Greenblatt through two of his more popular books; ‘the little book that beats the market’ and ‘you can be a stock market genius’. Nonetheless, sometime in the mid-1990s, he began teaching value and special situations classes to MBA students at Columbia University’s business school. These class notes and supplemental materials from some of the lectures that I share today are written by an investor who audited Greenblatt’s Special Situation Class at Columbia’s Graduate Business Program from 2002 through 2006.
As you might imagine, the notes contain a mixture of verbatim copying of various quotes and slides from the presentation, mixed in with the author’s own commentary and notes. However, from the quantity that I have read thus far, I find the author’s notes to be impartial, helpful, and coherent. There are over 300 pages of work here, spread over the course of several years and terms, so there is some minor repetition, but a little repetition never hurt anyone. I believe this is a great paper to hold onto, and to revisit, in order that you might provoke some new ideas or areas for further research.
“It is very clear—pick any company you want--the price is very volatile over short periods of time. It does not make sense to me that the values are nearly as volatile as the prices and therein lies what should be a great opportunity. All these companies which have fairly established businesses (Disney, Boeing, Wal-Mart) the values are not fluctuating nearly as widely as the prices. There should be great opportunity, yet there are not many winners in the market. The reason why that is in the final analysis why do the price fluctuate so widely when values can’t possibly? I will tell you the answer I have come up with: The answer is I don’t know and I don’t care. We could waste a lot of time about psychology but it always happens and it continues to happen. I don’t know and I don’t care. I just want to take advantage of it. We could sit there and figure it all out, but I like to keep it simple. It happens; it continues to happen; the opportunities are there. I don’t know why it happens and I don’t care—I just want to take advantage of prices away from value.”
4) Charlie Munger’s ‘Art of Stock Picking’
Source: (Graham & Doddsville)
A pretty well-known text at this point, but one that I only recently discovered myself, Charlie Munger’s the ‘Art of Stock Picking’. This eighteen-page prologue can be consumed in one sitting and, as well as containing several mini case studies to exemplify his points, contains a great deal of solid advice on the psychological side of stock picking. One of my favourite passages is the one I have shared below; where he comments on Buffett's punch card analogy, swinging big on your best ideas, and the misaligned incentives of investment management.
He continues to ask “how many insights do you need?” in a lifetime, proposing that the answer is actually quite few. This is contrary to the investment management industry, where they employ hundreds of analysts to generate thousands of “winning ideas”. Observing the average fund’s performance vs the S&P 500 will demonstrate that, most of the time, this is an unworthy cause. Whatsmore, if you believe in the Pareto principle then it’s more likely that the vast majority of an investor’s returns will come from a small subset of their “best ideas” over the long run. Another insight I enjoy was Munger’s assertion that accounting can take you only so far.
“Obviously, you have to know accounting. It's the language of practical business life. But you have to know enough about it to understand its limitations ‑ because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations. For example, everyone can see that you have to more or less just guess at the useful life of a jet aeroplane or anything like that. Just because you express the depreciation rate in neat numbers doesn't make it anything you really know.”
This reminded me that an investor can conduct all the extensive due diligence they want, but if they exhibit poor judgement, it's worthless.
“The elementary part of psychology ‑ the psychology of misjudgment, as I call it is a terribly important thing to learn. There are about 20 little principles. And they interact, so it gets slightly complicated. But the guts of it is unbelievably important. Terribly smart people make totally bonkers mistakes by failing to pay heed to it. In fact, I've done it several times during the last two or three years in a very important way. You never get totally over making silly mistakes. There's another saying that comes from Pascal which I've always considered one of the really accurate observations in the history of thought. Pascal said in essence, "The mind of man at one and the same time is both the glory and the shame of the universe." And that's exactly right. It has this enormous power. However, it also has these standard malfunctions that often cause it to reach wrong conclusions. It also makes man extraordinarily subject to manipulation by others.”
5) The Ultimate Investing Principles and Checklist
Length: Dense AF
Source: (Focussed Compounding)
The guys at Focussed Compounding curate a lot of great stuff and suggested that despite having “no idea who created this document” they believe it’s “one of the best investing resources on the internet”. I wouldn’t personally go so far, as it’s somewhat of a hodgepodge of materials, frameworks, notes on process, etc, from acclaimed investors; thrown together like it’s been inside a washing machine for three hours. That said, I think it is very useful as a form of discovery, inspiration, or guidance on areas and/or investors you may wish to study in the future. For that reason, I have thrown it into 5x must-reads this week.
Other Items of Interest
• Kevin G: Compilation of everything Dan Loeb
• Stratechery: Consoles & Competition
• Howard Marks: Sea Change
•: Bank Retailing
• Chris Mayer: 100 Bagger
•: Loonshots, How to Nurture Crazy Ideas
•: A Conversation on Quality Investing with Christian Billinger
Company Related Write-Ups
•(META): WhatsApp, Meta's Next Growth Engine
•(META): The Zuckerberg Flop
•(UA): An Apparel Short With Several Ways To Win
•(MSCI): MSCI Write-Up
•(BP): The Upstream History of Her Majesty's BP
•(HD): "Intense Focus" ($)
•(EVO): Evolution AB – A ‘sin’ stock with healthy returns
•(DDOG/NET): Going Deep on Cloudflare and Datadog with Mostly Borrowed Ideas
•: The 2022 Economic Year-in-Review
•: Progress in the Fight Against Inflation
•: The 2023 Macro Outlook
•: Vietnam, It's time to level up
•: Generation Rent
•: Has the Rally Peaked?
•: Is the Fed Broke?
•: A breeding ground for the GFC
•: One of the most frequently cited risks to stocks in 2023 is 'overstated'
•: TKer's 2022 word of the year, 'Pain'
Thanks for the shoutout!
Another great curation edition. Hopefully we will get another one on the last day of 2022 :) Get well soon Conor.
Taking this opportunity, we want to thank you for your support throughout this year and for sharing our work 🙏