Technologies That Will Change the World in 2019...

By all accounts we are living in a period of robust technological improvement. Innovations from smart phones to artificial intelligence are fundamentally changing lives and altering the way business is done across a wide range of industries. Historically, technological innovation has been the “secret sauce” that has fueled economic growth and the rising living standards that come along with it. But a strange thing has occurred over the last decade. Since 2007, productivity growth in the U.S. has averaged just 1.3% a year. This rate is less than half the gain recorded from 2000-2007 and well below the 2.1% annual average since 1941.

Economists have been scratching their heads trying to figure out what is behind these weak results. Some, like Martin Feldstein from Harvard, think we simply have a measurement problem. He argues that the way we measure productivity - - generally the amount of goods and services produced per hour worked - - does not capture the value associated with qualitative improvements. Google Maps, for example, does not provide a much different output than physical maps do, but it is a lot easier to use. Others, such as Northwestern University’s Robert Gordon, are less optimistic. He contends that today’s innovations do not have as much of an economic impact as blockbuster innovations of the past, like the electric light bulb. A third group argues that technological innovation occurs in waves. The wave begins with the introduction of a “general purpose” technology such as artificial intelligence. The real economic impact, however, is only felt once it is widely adopted and commercialized.

My guess is that all three of these theories play a part in the recent anemic productivity statistics. Artificial intelligence may not be the next “electric lightbulb” -- Siri dialing a phone number for me is certainly convenient but it is hardly a groundbreaking innovation. But this technology is still in its infancy and may yet prove disruptive in a number of ways.

Each year, the MIT Technology Review prints a list of the technological developments expected to have the most impact on human life. The author of this year’s list is none other than Contributing Editor and Microsoft founder Bill Gates. Mr. Gates’ emphasis this year is in keeping with Martin Feldstein’s more optimistic view of the world. Many of the developments on his list focus on improving the human condition. Just over half involve healthcare. The gut probe in a pill and wearable health monitor, for example, both are aimed at improving patient outcomes, while the self-contained toilet is focused on reducing disease in the developing world. Innovations that focus on cleaning up the environment also feature prominently on the list.

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Mr. Gates, one of the world’s leading technologists, is optimistic about the future, and his selections reflect that view. While he still thinks that much can be done to extend life, especially in some of the world’s most disadvantaged areas, he believes strongly that new technologies can help enhance personal fulfillment. This shift would represent quite an achievement if viewed from a longer term historical perspective.

The Times They Are A Changin’...

This past summer, Vermont became the ninth state to legalize marijuana and the first to do so via state legislature. Once a taboo topic, cannabis is going mainstream. A 2018 Pew Research Poll found that 62% of Americans believe that cannabis should be legalized; this is the highest number in the last 50 years.

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There is big money on the horizon here, U.S. legal sales of cannabis reached $13 billion this year and are projected to double within six years. Pile on strong medical growth prospects and you have the budding of a legitimate industry. But how can individual investors cash in on this green wave?

Access to capital is a serious issue for new companies, especially in the U.S. As long as the drug remains outlawed at the federal level, you won’t see U.S. businesses with cannabis operations listed on U.S. stock exchanges. Investors interested in these U.S. businesses must seek alternative investment structures to gain exposure. This leaves investors open to illiquid and speculative risk, two investment characteristics we find especially unappealing.

Canada on the other hand has legalized cannabis on a national scale. Companies north of the border are growing at a much faster pace since they are able to list on the Toronto stock exchange as well as U.S. exchanges like NYSE and NASDAQ, opening the floodgates for much needed capital to drive growth.

Here in the U.S., nothing quite helps stoke the flames of change like the opportunity to make some serious money. Medical marijuana sales are projected to grow by 36% per year, making it a potentially $54 billion segment by 2024. CBD, or cannabis oil, a non-psychedelic element found in cannabis, is projected to grow at 700% in the coming years! Eventually the U.S. will need to pass laws to make cannabis legal on a federal level. They will want to do this for two reasons: regulate and make money via tax revenue.

Although the hype is high and well documented, this is still an unestablished industry, so navigating the minefield may be most closely compared to the dot.com environment of the early 2000s. Back then the internet was clearly here to stay, but there were many “internet” companies that proved to be building castles in the sky, resulting in huge losses for investors wanting to get a piece of the action.

Taking up a position in any one company, especially those in new and uncertain ecosystems, is a risky proposition. The current big businesses in Canada are trading at multiples in the 100s. Most are not making money, but rather losing cash as they build up their infrastructure for potential growth ahead. This suggests that the industry is still at the beginning of what could be a hockey stick growth trajectory (see image). The next big event that will propel growth upwards could be federal legalization.

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While we see strong potential for growth here, we do not have confidence in speculative industries selling at such high multiples. The same rings true for past hot ideas like 3D printing and cryptocurrency. In the current cannabis environment it is too difficult to tell which businesses will really thrive from those bound for failure. A more calculated approach may be investing in diversified marijuana ETFs to gain total sector exposure.

The four most dangerous words in the investment world are, “This time it’s different”. Cannabis could very well go mainstream like tobacco and alcohol, but remember that cannabis has NEVER been legal during any of our lifetimes and the ship may take longer to turn around than is thought. Tread carefully here and never invest more than what you are willing to lose, especially in this space.

Why Selling Seems Harder Than Buying...

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Why is it that selling a stock can seem so much harder than buying? We admit that we feel that way, and we suspect many other investors do too.

Rationally, it doesn’t make any sense because the process behind buying and selling are the same – two sides of the same coin, so to speak. But a recent working paper called “Selling Fast and Buying Slow” (Akepanidtaworn, Di Mascio, Imas, and Schmidt, 2018) confirms what many investors have long thought: Buying stocks is easy, but selling them is hard.

After looking at 783 portfolios and 4.4 million trades to analyze the performance of buys and sells separately, the paper found that portfolio managers display clear skill in buying, but not in selling. In fact, investor selling decisions are so poor that they underperform a no-skill strategy of randomly selecting stocks for sale -- say, by throwing darts at a dartboard.

That’s a striking result. How could it be that a skilled buyer isn’t automatically a skilled seller when buying and selling are analytically similar? If your practice is to analyze financial fundamentals and buy what is undervalued, then it seems that if you use the same fundamentals to sell what looks overvalued, you should achieve symmetrical results. And yet often it isn’t so.

One possible reason for this is that buying and selling are different exercises psychologically. According to the paper, portfolio managers rely heavily on a stock’s past return when making a sell decision -- but they do not do so when buying a new stock. For some reason, when considering a sale, past return becomes the most readily available piece of information that an investor reaches for. So while buying always is forward-looking, selling becomes backwards-looking.

That is something that’s likely to ring true for many of us. When you look anew at a stock that has dropped 20%, you tend to focus not on the price drop but on the fundamentals. But it’s a different story when you already own the stock. Suddenly, that 20% price decline makes the decision to sell, hold or add more difficult.

There are a few other interesting things here too: First, selling happens most often for stocks with extreme returns, either positive or negative, and that is often to the detriment of performance. The best and worst performing stocks get sold at a rate 50% higher than those with moderate returns -- and the portfolio managers with the greatest propensity to sell extreme-return stocks have the worst selling outcomes.

Next, selling decisions seem to be especially poor when investors are stretched or under duress because when things are going badly for the portfolio as a whole, sell decisions get worse even though buy decisions don’t.

And finally, it doesn’t appear that portfolio managers lack the fundamental skills to make good selling decisions. However, it is clear that they spend much more time thinking about buying than selling. Perhaps that is because they think their main job is to find the next great idea. Or perhaps buying is just more psychologically satisfying than selling. When you buy, the idea is fresh and optimism abounds. When you sell, you’ve already gotten mired in your own experience.

The good news is that when investors spend the time to think more about selling, they are able to port their fundamental skills over and achieve better selling outcomes. So one lesson here is simple: Just pay more attention to selling.

Another lesson is to think twice and then thrice before selling anything that has had either extremely good or terrible performance because the chances of making a mistake are especially high.

And finally, investors should find ways to keep looking forward instead of backwards when assessing stocks for sale. A recent Bloomberg Businessweek article noted that one fund takes away coverage from the original portfolio manager after a stock has had two straight quarters of earnings disappointments. That’s one interesting strategy to keep a fresh, forward-looking perspective on an underperforming stock.

Rising Debt Levels Here and Abroad…

While the economic recovery has been slower than many would have liked, it has been fairly broad based and persistent. Investors can thank the expansive fiscal and monetary polices of central banks around the globe for much of the rebound. But unfortunately, the last decade of ever lower interest rates also has fueled a buildup in debt levels. According to the Institute for International Finance (IIF), as of the third quarter of last year, global debt totaled $244 trillion or a near record 318% of GDP. Most of this increase (75%) has come from government and non-financial corporate debt issuers (see chart below). Emerging markets have seen the largest increase in corporate debt while in more mature markets, government issuers fueled the gains. The IIF statistics also reveal a persistent global shift away from traditional bank financing. This has been particularly true in emerging markets where nearly 25% of total credit to the private sector now originates outside traditional channels.

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The rise of non-bank lenders is presenting a particular challenge in China today. Over the last decade, local governments and their more than 2,000 financing companies have funded economic development projects by issuing large amounts of privately offered funds. Independent brokers and advisors, in turn, have offered these investment vehicles to individual investors. But assessing credit quality in this sector of the Chinese bond market is particularly difficult given insufficient oversight and the courts’ limited ability to enforce judgments on governments or state-backed companies. Official data estimates total local and central government debt at just under $4.5 trillion or 36% of GDP. Zhang Ming from the Chinese Academy of Social Sciences further estimates that when all forms of off-balance sheet debt are added in, the total is closer to 67% of GDP.

Provinces in far-off lands are not the only home to debt problems. Consider the case of student debt here in the U.S. The dollar amount of student loans outstanding is not overlarge when compared to other forms of consumer debt. At $1.44 trillion, it is similar to the amount of auto debt outstanding ($1.3 trillion) and well below total mortgage debt ($9.1 trillion). But the increasing delinquency rate of these loans is of real concern. As of the third quarter of 2018, 9.1% of student debt was more than 90 days overdue. Delinquency rates doubled over the 2003-2011 period and a recent study by the Brookings Institute, estimates that almost 40% of borrowers are expected to fall behind by 2023. Loan delinquency in this population of 44 million borrowers is particularly damaging to the economy; student loan borrowers are generally entering their household formation years, a period of above average consumer spending. Student debt also has the potential to negatively impact multiple generations given that many privately issued loans are not discharged at death.

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Low interest rates were likely just what was needed to get us out of the 2008-2009 financial crisis. But having elevated debt levels concentrated in specific sectors of the global economy may become a big problem if either economic growth slows or interest rates increase. Central banks around the globe are doing their best to balance the risks associated with these two outcomes.