Things Won’t Always Be This Way...

Once we get used to things going a certain way, we tend to think they’ll just keep going. And the longer they keep going, the easier it is to get complacent and the harder it is to prepare for things going differently. But in life and in investment -- as experienced investors well know -- few things last forever. As esteemed investor Howard Marks of Oaktree Capital recently remarked: “Just when it looks like the trend will happen forever is probably the time it has to stop, because it has done so for so long. This is an area for contrarian thinking.”

Contrarian thinking isn’t easy – nor is it always right. But it is useful. Good investors should be forcing themselves to do what doesn’t come naturally. What’s natural and comfortable for most people is to think the future will be like the present. What’s hard and uncomfortable is to break from the common narratives and think of alternatives. Even if the contrary thinking isn’t right, it does help to avoid sleepwalking into the future -- especially when it comes to the mostly widely held beliefs, where history tells us the biggest surprises come.

Rob Arnott of Research Affiliates recently reminded Barron’s readers that it once looked like the 10 biggest stocks during the technology boom of 2000 could do no wrong, but they then went on to deliver, on average, negative returns for the next 19 years. His pithy reminder: “People forget that disruptors get disrupted.”

So if we look at the world today, what are some of the mostly widely held narratives where we might want to think alternatively? One is the ascendancy of U.S stocks – and especially the largest ones – which have trounced the rest of the world. U.S. stocks have had a golden era over the decade since the financial crisis. But as Ben Inker of investment manager GMO said in his last quarterly letter, it hasn’t been all U.S. stocks. It’s been the largest – perhaps because of increasing industry concentration. Small companies haven’t done as well.

Inker thinks the environment that gave rise to U.S. large-cap stocks can’t continue, and that going forward, they’ll be among the worst performing assets. His favored asset class? Emerging markets – especially emerging market value stocks. In other words, the worst will become first, as GMO’s 7-year forecast shows below. Interestingly, Rob Arnott also expects emerging market stocks to be the highest-returning asset class of the future, while U.S. stocks and U.S. bonds will be the worst.

And speaking of U.S. bonds, that’s another area where most of the world seems to be crowded on one side. Bonds do great in periods of low inflation or deflation, and that’s what we’ve had for a long time – along with an incredible four-decade bull market for bonds.

But can it continue? It’s hard to believe it can go on forever. It’s true that there are some powerful long-term deflationary forces: Population growth is declining (thereby lowering growth), and technology and the wizardry of businesses like Amazon are all massively deflationary. But it would be wise not to write off inflation altogether, contrary though the thought is. For one thing, if unemployment in the U.S. persists longer, wage gains could take off. Regulation of big tech also could throw some sand in the wheels of deflation. And of course, there are tariffs. Anything that is de-globalizing and fractures the world’s supply chains into regional ones could lead to higher prices.

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What Happens When Public Transit Becomes Free?...

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Have you heard that in Tallinn, Estonia, public transportation is free for residents? Not only has it been free since 2013, but it also works great. According to The Economist, “The buses are on time, the trams are shiny and new, and passengers usually get a seat.” And that’s not all. Far from draining city finances – go figure – the city is turning a profit. Allan Alaküla, the Head of Tallinn’s EU office, says, “There’s no doubt that we not only cover the costs, but also come out with a surplus. We earned double as much as we have lost since introducing free public transport.”

Tallinn is a tech hub with a reputation for innovation, so perhaps its free public transit experiment isn’t surprising. But who knew that by 2016, Tallinn could declare a profit of €20 million a year?

This is how it works: As long as you are registered as a resident of the city, if you buy something called a “green card” for €2, you can ride the city’s entire network of trams, buses and trains at no cost. Visitors still need to pay to ride the system. Single-ride paper tickets are €2 and electronic QR tickets are €1, though you can also get a day ticket or other passes that appeal to tourists. In any case, Tallinn’s system has been such a success that Estonia now is extending free transport across the country.

For Tallinn, the finances have worked out because since it introduced free public transit, some 30,000 people have stepped up to become new city residents. Residency entails paying the municipality €1000 -- a tax that more than makes up for the loss in ticket sales and leaves funds for refurbishing tram lines and keeping things spic and span. Essentially, Tallinn’s “free-riders” pay for transportation in the cost of their residency.

This clearly isn’t a setup that will work everywhere. Still, that hasn’t stopped other cities from trying or at least thinking about it. Luxembourg is moving to free transport by March 2020. Paris is studying the possibilities. And cities from Bucharest, Romania to Chengdu, China have been in touch with Tallinn to learn from it. Tallinn’s city website even has a page dedicated to the study of free public transportation with research resources and a conference schedule.

And why not? Intuitively, free public transportation does sound great. If you can raise public ridership, you would naturally reason that you could reduce auto congestion, improve air quality, help out lower-income residents, stimulate local businesses and possibly revitalize city centers.

Unfortunately, the reality isn’t that simple, and free public transportation doesn’t always work. Several years ago, Joe Pinsker wrote in The Atlantic that even when public transport becomes free, it often doesn’t work because it doesn’t get enough people to stop driving. In the U.S., experiments in free public transportation in Denver, Trenton, and Austin all failed in that they increased ridership among those who walked or biked, but not those who drove. Likewise, Rome tried free public transit in the 1970s to alleviate heavy city traffic, but it found that this wasn’t enough to get people to abandon their cars.

Very large cities, in fact, may not be the best suited for free public transit. Smaller cities with certain layouts or college towns or resort communities where populations swell seasonally do better. And Tallinn, with a population of about half a million, may be just the right kind of city for success. It’s not a terribly crowded city, and most rides aren’t longer than 15 minutes. What’s more, Tallinn is a vibrant tech hub where residency is attractive.

But even in Tallinn, it isn’t clear that free public transportation has helped city congestion or air quality. Alaküla, the head of Tallinn’s EU office, says that congestion in the center is getting better, but this may be due partly to higher city parking fees or other factors. And while public transit ridership has increased, there isn’t good evidence on whether it’s replacing walking or driving.

Still, it’s hard to knock a city public transit system with an approval rating close to 90%. If it’s clean and you can usually get a seat, I’d say that sounds pretty good.


Can We Find a Cure for Aging?...

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According to Joseph Coughlin, an expert on aging and founder of MIT’s AgeLab, there are two simple questions that can determine how well you’ll navigate your later years: “Who’s going to change the light bulb, and how are you going to get an ice cream cone?” These appeared in a recent New Yorker article by Adam Gopnik, who visited Coughlin at his AgeLab.

These two questions pretty much cover things. The light bulb is about how you deal with the small tasks you never used to think about but that start requiring effort as you slow down and begin to ache and creak. The ice cream cone is about what you can access and enjoy in the world at large as you age. How far away is that ice cream cone? What if you can’t drive? What if you have no one who can bring the ice cream cone to you?

There’s a lot that can be done in the way we design homes, communities, products and services so that older people can live easier, fuller lives for longer. That’s one way to think about improving the experience of aging – and that’s what Coughlin, who wrote a book called The Longevity Economy, is interested in doing.

But there is another way to think about the challenges of aging. David Sinclair, a researcher on the biology of aging at Harvard Medical School, invites us to imagine this: Your doctor notices when you are 45 that your blood sugar is getting high and that you’re losing muscle mass. “Listen,” your doctor says, “I see you’re starting to age, so let me give you something for that.” That could mean holding off cancer, heart disease, dementia and other age-related illnesses for long periods of time.

As incredible as this may sound, it may no longer be so farfetched. There are dozens of companies and labs researching different pathways to extend human lifespans. Scientists already have expanded the lifespans of simple organisms like yeast and worms and extended that to animals like mice and monkeys. The study of aging is moving to the forefront of science – and it’s not the 20th century way of tackling one disease at a time, but a focus on treating aging at its source.

It all may seem a bit fantastic, but there has been a significant shift in the way we think about aging. Until very recently, we have viewed aging as a natural process – something inevitable to be accepted and managed. But now scientists are starting to think that there’s no valid reason for aging to be inevitable. They are thinking that aging might involve issues at the cellular level that can be corrected. In effect, they are thinking of aging not as a natural process, but as a disease that can be treated.

That’s a huge mental shift. The consequence is that aging research is getting much more attention than it used to. Sinclair noted in a recent interview that researchers focus on what is considered treatable, not what seems inevitable. This was true of cancer, which was considered a natural part of life for a century, but when it was shown in the 1970s that the disease process could be modified, the thinking changed.

Multiple pathways to counter aging are being explored. Perhaps the most interesting is cellular reprogramming, which involves introducing a combination of genes into an animal’s cell and seeing if that tissue rejuvenates as if it’s young. Essentially it is taking old cells and turning them into young cells, and it has shown promise – but just in mice, so remember it’s still early days.

A few other things to keep in mind: First, it’s not immortality that scientists are after -- people don’t want to live forever, but rather to be healthier for longer. Second, the FDA is a long way from being able to assess anti-aging therapies because it still views aging as a natural process. In contrast, the World Health Organization recently declared aging a treatable condition. Finally, there’s a lot of hype that makes it hard to separate fact from fiction. David Sinclair said that one of his challenges has been removing his face -- and Harvard’s name -- from websites for anti-aging products that he has nothing to do with and would never endorse.

Let’s Look at This Straight in the Eye...

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In conversations on Value Investing, references to the 1962 New York Mets have been coming up more often, and that’s not a good thing. The 1962 Mets are beloved for losing a staggering 120 games -- a record for the history books that spurred then-manager Casey Stengel to despair, “Can’t anybody here play this game?”

Value Investing too is on a losing streak. The common wisdom has been that Value Investing outperforms its rival Growth Investing over the long run, but over shorter periods, Growth and Value take turns doing better than the other. The problem for Value today is that it has been waiting an awfully long time for its turn, while Growth’s dominance has been impossible to ignore.

So full disclosure: We are Value Investors. We’ve always believed in buying the stocks of unpopular companies that look cheap and then staying patient until prices revert to fair value. Likewise, we have shunned the excitement of fast-moving companies and the high prices Growth Investors are willing to pay for them.

Put another way, we believe in reversion to the mean: The popular eventually become less popular and vice versa. But today we find ourselves in a world where go-go growth stocks like Amazon and Alphabet just keep going, and the downtrodden can’t seem to get a leg up in the world.

The thing about a losing streak is that you never know when it will end – or if it will -- and the longer it goes on, the more you wonder. But as Value Investors, we can’t shrink away from this. We have to look at this squarely in the eye. So what are we thinking?

First, we still firmly believe in the core principle of Value Investing, which is simply buying things when they are cheap or priced below fair value. That’s intuitive. Have you ever heard Warren Buffett’s partner Charlie Munger say, “All good investing is Value Investing, by definition”? There you have it. Investing is about what you pay for what you get, and that’s straightforward.

The struggle today is in looking at fair value the right way. We know we’re not living in the world of Benjamin Graham, the father of Value Investing who noticed that stock prices fluctuated a lot more than the value of a company’s underlying assets. Graham focused a lot on the value of a company’s assets, especially its tangible assets like factories, machinery, trucks and railcars. And while we have long done the same, we also recognize that today we’re in a world where intangibles like technology and intellectual property matter a lot.

The biggest companies today are not GM or GE. They are Microsoft, Apple, Amazon, and Facebook. Airlines and steel companies are one thing. Software or entertainment companies are another, and it’s a different game to think about what intangible assets are worth and how they turn into future cash flows. That doesn’t mean that valuation principles go out the window, but it does make the work harder. We’ve never been a fan of looking at ratios or multiples alone because investing has never been as easy as simple metrics. But today more than ever, we spend more time thinking about earnings quality and competitive position and where a company sits if its industry is being disrupted.

We also have to acknowledge that mean reversion may be a long time coming for some companies that enjoy powerful network effects. Network effects are where businesses become more valuable and powerful as more people join their ecosystems. For example, the more people that join Facebook, the more that others want to join, and the more market share Facebook can take. Or the more people that join Amazon Prime, the easier it is to spread the costs and invest in even more member benefits, which attracts more people. These situations give rise to a “winner take all” environment where winners keep winning and recovery gets harder for those who fall behind.

Nothing lasts forever and things can’t keep growing to the sky. Gravity still exists. But we also recognize there can be long-lasting value in a company’s network effects even if its price-to-earnings multiple looks high.

In sum, we think Value Investing has legs because Value Investors have been adapting to a changing world since Ben Graham first wrote Security Analysis in 1934, and they will continue to do so. Warren Buffett can buy Amazon stock, and the principle of separating price from value endures.