Topley’s Top Ten – October 14, 2019

Author

Matt Topley
October 14, 2019

1.Fund Flows Favor Fixed Income

Fri,Oct 11, 2019

This week’s fund flow numbers from the Investment Company Institute showed that the long, steady rotation from equity mutual funds and exchange traded funds to fixed income funds has continued. As shown below, the spread between equity fund flows and fixed income fund flows has reached a net reading of -$165.9bn over the last three months; that’s among the largest net flow out of equities and into bonds since the data starts.    Fixed income isn’t the only place that retail has been moving allocations to. As shown in the chart below, 13 week commodity fund flows have been among the largest of the periods since the data for ETF and mutual funds combined begins.

2.Negative Bond Yields Not Unusual.

With hindsight, investors earned less than inflation more than afifth of the time, and real yields below minus 2% occurred about a 10th of thetime. The results are the same for the Anglosphere as for the broader sample.

The Price of Savings Glut: NegativeRate By Matthew C. Klein

3.In 2007 China was Growing 20% Year Over Year.

Isthe World Economy Sliding Into First Recession Since 2009?

MichelleJamrisko, Enda Curran and Zoe Schneeweiss

4.Insiders Selling at Fastest Pace Since 2000.

Zerohedge

.. while insiders quietly dump stock, selling anestimated $26BN of their own stock in 2019, the fastest pace since the year 2000, when executives sold$37bn of stock amid the giddy highs of the dotcom bubble…

5.Longest Period of Easy Money in History Paused Less Than A Year Before Re-Starting.

The Fed implemented the longest period of easy money inhistory (124 straight months) from May ’08 to Aug ’18. The rate hiking cyclepushed the real Fed Funds Rate into positive territory for less than a year(Sep 2018 to Jul 2019) and they are now back to aggressively easing.

7:10 AM – 13 Oct 2019

6.Health Insurance Inflation Rising 20%

The CPI data yesterday showsthat health insurance inflation is currently rising 20%, see chart below. Formore see also here.

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Let us know if you would liketo add a colleague to this distribution list.

Torsten Sløk, Ph.D.Chief EconomistManaging DirectorDeutsche Bank Securities

7.Number of Battery Electric Vehicles.

8.Manufactuing Labor 25% Cheaper in Mexico than China.

9.Warren’s Support Broadened Within Party

Found at Barry Ritholtz The Big Picture Blog

10.Understanding your Circle of Competence: How Warren Buffett Avoids Problems

READING TIME: 4 MINUTES

Understanding your circle of competence helps you avoidproblems, identify opportunities for improvement, and learn from others.

The concept of the Circle of Competence has been used over theyears by Warren Buffett as a way to focus investors on only operating in areasthey knew best. The bones of the concept appear in his 1996 Shareholder Letter:

What an investor needs is the ability tocorrectly evaluate selected businesses. Note that word “selected”: You don’thave to be an expert on every company, or even many. You only have to be ableto evaluate companies within your circle of competence. The size of that circleis not very important; knowing its boundaries, however, is vital.

Circle Of Competence

Circle of Competence is simple: Each of us, through experienceor study, has built up useful knowledge on certain areas of the world. Someareas are understood by most of us, while some areas require a lot morespecialty to evaluate.

For example, most of us have a basic understanding of theeconomics of a restaurant: You rent or buy space, spend money to outfit theplace and then hire employees to seat, serve, cook, and clean. (And, if youdon’t want to do it yourself, manage.)

From there, it’s a matter of generating enough traffic andsetting the appropriate prices to generate a profit on the food and drinks youserve—after all of your operating expenses have been paid. Though the cuisine,atmosphere, and price points will vary by restaurant, they all have to followthe same economic formula.

That basic knowledge, along with some understanding ofaccounting and a little bit of study, would enable one to evaluate and investin any number of restaurants and restaurant chains; public or private. It’s notall that complicated.

However, can most of us say we understand the workings of amicrochip company or a biotech drug company at the same level? Perhaps not.

“I’m no genius. I’m smart in spots—but I stay aroundthose spots.”

—Tom Watson Sr., Founder of IBM

But as Buffett so eloquently put it, we do not necessarily needto understand these more esoteric areas to invest capital. Far more importantis to honestly define what we do know and stick to those areas. Our circle ofcompetence can be widened, but only slowly and over time. Mistakes are mostoften made when straying from this discipline.

Circle of Competence applies outside of investing.

Buffett describes thecircle of competence of one of his business managers, a Russian immigrant withpoor English who built the largest furniture store in Nebraska:

I couldn’t have given her $200 millionworth of Berkshire Hathaway stock when I bought the business because shedoesn’t understand stock. She understands cash. She understands furniture. Sheunderstands real estate. She doesn’t understand stocks, so she doesn’t haveanything to do with them. If you deal with Mrs. B in what I would call hercircle of competence… She is going to buy 5,000 end tables this afternoon (ifthe price is right). She is going to buy 20 different carpets in odd lots, andeverything else like that [snaps fingers] because she understands carpet. Shewouldn’t buy 100 shares of General Motors if it was at 50 cents a share.

It did not hurt Mrs. B to have such a narrow area of competence.In fact, one could argue the opposite. Her rigid devotion to that area allowedher to focus. Only with that focus could she have overcome her handicaps toachieve such extreme success.

In fact, Charlie Munger takes this concept outsideof business altogether and into the realm of life in general. The essentialquestion he sought to answer: Where should we devote our limited time in life,to achieve the most success? Charlie’s simpleprescription:

You have to figure out what your ownaptitudes are. If you play games where other people have the aptitudes and youdon’t, you’re going to lose. And that’s as close to certain as any predictionthat you can make. You have to figure out where you’ve got an edge. And you’vegot to play within your own circle of competence.

If you want to be the best tennis playerin the world, you may start out trying and soon find out that it’shopeless—that other people blow right by you. However, if you want to becomethe best plumbing contractor in Bemidji, that is probably doable by two-thirdsof you. It takes a will. It takes the intelligence. But after a while, you’dgradually know all about the plumbing business in Bemidji and master the art.That is an attainable objective, given enough discipline. And people who couldnever win a chess tournament or stand in center court in a respectable tennistournament can rise quite high in life by slowly developing a circle ofcompetence—which results partly from what they were born with and partly fromwhat they slowly develop through work.

So, the simple takeaway here is clear. If you want to improveyour odds of success in life and business, then define the perimeter of yourcircle of competence, and operate inside. Over time, work to expand that circlebut never fool yourself about where it stands today, and never be afraid to say“I don’t know.”

Circle of Competence is part of theFarnam Street latticework of mental models.