Sunday Finds + 3 Thoughts From Last Week
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Welcome to Chit Chat Money’s Sunday Finds + 3 Thoughts From Last Week. In this newsletter you will find three topics I thought about last week, links to shows we’ve recently released, and links to some interesting articles, podcasts, and tweets. Check out the archive here.
Chit Chat Money Podcasts From Last Week
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1. The news on China…not great
It has been a bad week for the CCP. A trust with over $100 billion in assets may blow up, the world is waking up to its overbuilding on infrastructure (therefore artificially pumping GDP), and the U.S. just got South Korea and Japan to officially meet at Camp David.
Oh, and don’t forget that its birth numbers are still falling off a cliff:
Its citizens are still relatively poor, youth unemployment is off the charts (not great for suppressing rebellion!), and general economic growth is stagnating…all while the government unsustainably builds infrastructure:
Here’s a shocking quote:
Guizhou, one of the poorest provinces in the country with GDP per capita of less than $7,200 last year, boasts more than 1,700 bridges and 11 airports, more than the total number of airports in China’s top four cities. The province had an estimated $388 billion in outstanding debt at the end of 2022, and in April had to ask for aid from the central government to shore up its finances.
This was a lot of confirmation bias for me as I think it is prudent for investors to reduce their exposure to China as much as they can.
2. Nothing is truly passive
Vanguard bases its [small cap ]fund on an index from CRSP, the Center for Research in Security Prices—spun off from a project at the University of Chicago that collected stock-price data through history. CRSP’s definition of large stocks includes those in the top 85% of the entire market, as measured by market value. The rest are downgraded to the status of “small.”
Back in 1983, the top 85% included more than 800 firms, so smaller companies were true tiddlers. Today it captures only 385 companies. Divvy things up the other way round for another way to think about it: The biggest 500 companies now make up about 90% of all market value, up from 75% in 1983.
So you are an individual investor trying to get in on “small caps” because you read they historically outperform the market. You then look up a small-cap index fund or ETF to passively get exposure to this alpha without actually doing work on individual companies.
Turns out you are buying a group of stocks based on a lot of decisions humans are making. These include:
Deciding to base your small-cap cutoff on market value
Defining small-cap as everything below 15% in market value (why not 14%? or 16%?)
Deciding what index to start off with in the first place
I bet there are some other “un-passive” decisions made by the fund not discussed in the article, too.
And you are (likely) going to compare your performance to the S&P 500 or Nasdaq 100 when buying this fund. How do the people on those index committees decide what companies to include? That’s right, they also just made up some rules out of thin air:
The overlap with the S&P 500 is further confused by S&P’s rules, which give its index committee leeway on which companies to choose, and require firms to have made a profit before inclusion. Not all the 500 biggest qualify for the S&P 500 as a result.
Nothing is truly passive. Some things can get close from a practical perspective, such as a market cap-weighted world index, but those “passive” funds still have people making decisions on what to include for investors.
But wait, isn’t this all based on the historical evidence that small-caps outperform? Yeah, turns out that may have just been noise:
But what to do about all of this? I think — with more and more people throwing money into “passive” funds — the best strategy will be to look for stocks that are excluded from popular indices and have smart capital allocators at the helm.
A consistently cheap earnings multiple and a management team pouring earnings into buybacks eventually lead to market outperformance.
This is what we are trying to learn more about on the podcast this month.
3. So, Adyen had a rough week
Never not shocking when a stock drops 40% in a day:
I like Adyen’s business. Luckily, we have avoided buying shares because of its premium valuation. I think the stock is still too expensive at these prices, but it is a lot more palatable than earlier this week.
All the crazy competitive behavior in fintech land keeps me thinking: Why not just own Visa, Mastercard, and American Express and call it a day? At the right price, of course, but those seem like the slam dunk winners from all of these digital payments investments.
Next week, we are recording a show on Discover Financial. They seem to be disliked for various reasons, but are a classic share cannibal and will definitely benefit from the digital payments tailwind, all else being equal:
See you next week,
Brett
***Our fund, Arch Capital, may own securities discussed in this newsletter. Check our holdings page and read our full disclosure to learn more.***
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3 Intriguing Reads
Plugging our 1H 2023 Investor Update, focusing on Ally Financial:
Ally Financial has a long history but has only recently been an independent consumer bank. It began as the lending arm of General Motors during the automotive boom of the 1920s. When General Motors filed for bankruptcy during the Great Recession in 2009, its financial arm was spun out as a separate entity, and what we know today as Ally Financial was born.
Welcome to Flyover Stocks - Flyover Stocks
Why Flyover Stocks? First, it’s an appreciation of being in Ohio – part of “flyover country,” which for the uninitiated is often a pejorative term used to describe the states in between the coasts. I view investing from Ohio as an advantage. Second, I’ve turned over a lot of rocks in my investing career, and I’m continuously surprised by how many quality companies I’ve either missed or failed to appreciate when I initially found them. If other investors fly over them, there might be “coiled spring” opportunities to unlock value among these names. Eventually, investors catch onto great fundamentals.
Retired NFL star Michael Oher, whose supposed adoption out of grinding poverty by a wealthy, white family was immortalized in the 2009 movie "The Blind Side," petitioned a Tennessee court Monday with allegations that a central element of the story was a lie concocted by the family to enrich itself at his expense.
1 Good Podcast
Smart, Funny, and Insightful Tweets:
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