HEDERA THOUGHTS
To the reader:
"""
It currently anticipates an interest rate decrease of over 150 basis points
before the end of 2024! --- 2023 annual letter
"""
In the note written at the end of last year, I mentioned that market
expectations regarding interest rate cuts were swinging from one extreme to
another. Interestingly, the overall expectation swings back to the mid-point (again)
thanks to the Federal Reserve's efforts this year. Given the ever-changing nature of
market predictions, it's clear that investing based on macroeconomic forecasts
is not my game.
Before discussing what I have learned and thought in the first half of 2024, I'd
like to share my portfolio performance since the last note.
Year Pre-tax[1] SPY QQQ
2018 (25.64%) (8.07%) (10.73%)
2019 7.28% 28.65% 37.27%
2020 21.54% 15.09% 45.14%
2021 58.53% 28.79% 28.63%
2022 (12.33%) (20.28%) (34.16%)
2023 30.92% 24.11% 52.22%
2024 12.92%[2] 15.14% 19.01%
Total 199% 200% 273%
1) All returns for the baseline are pre-tax and do not account for dividends.
2) The current tax liability may decrease the return to just 10.34%.
3) All newly committed capital is assumed to be contributed at the beginning of
year. As a result, the actual yield should be slightly higher than the values
stated here.
Although the positive yield seems modest compared to the benchmark, it has been
a challenging half-year for me. As the old Chinese saying goes, lessons are
the best teachers. Below I list a few highlights based on what I did in the
first half year.
* Top correct decision: Sold those I didn't understand, including SNPS,
CDNS, and BYD.
* Top incorrect decision: Bought Adobe when it was clearly overpriced.
* Top lucky thing: Bought BYD at its lowest point.
The two primary positions I'm currently holding are Adobe and TSM, with a 30%
leverage on the latter while the margin interest is around 6%.
Trees Never Grow to the Sky
I came across this phrase in Howard Marks' memo written before the tech bubble
burst around 2000. While humans have a long history dating back to the first
migrations out of Africa, our financial history is much shorter, starting with
the opening of the first brokerage in Amsterdam in 1680. Since then, we have
experienced countless bubbles and bursts, yet we seldom learn from them.
Consider the South Sea crisis in England, the Great Depression in 1929, the
farmer market crash in the 1960s, the tech bubble in the late 1990s, the real
estate bubbles in Japan and the United States, and the ongoing bubble burst in China
(I distinctly remember people saying, "House prices never go down" in 2014 when
I was a college student in Canton).
In the financial world, one rule remains unbroken: for anything, whether it be
an asset class, interest rates, or business growth under both socialism and
capitalism, trees never grow to the sky. Specifically, interest rates cannot
stay below zero or remain at low levels forever. Asset prices fluctuate around
their fundamental values; they may stay excessively high for a long time, but
not indefinitely. Additionally, it is rare for a traditional enterprise in the
capitalism world to grow much faster than the overall GDP of its country.
It just doesn't make sense.
Buy what you know and understand.
As Li Lu mentioned in one of his interviews, the most important thing in our
business is intellectual honesty. This means:
* Know what you know.
* Know what you don't know.
* Know what you don't have to know.
* Realize that there is always the possibility that "you don't know that you
don't know."
To succeed in investment, we must be humble and accept that we are ignorant in
many areas. For example, I admit that I don't know what the interest rate will
be next month, quarter, or year, or whether the neutral interest rate has been
elevated. I don't understand the "dead cross" pattern in stock price charts or
the nuances of pair trading.
As the overall market becomes more concentrated on top tech companies and the
primary indexes hit new highs repeatedly in the past month, I have observed
more people treating investment like gambling. They buy TLT based on the
assumption that the Fed will cut interest rates before the end of the year
without understanding the difference between short-term and long-term interest
rates. They buy hot stocks expecting continuous price increases, hoping that
someday someone will buy their stock at a much higher price. They purchase
derivatives such as options or even futures, thinking they fully understand the
pricing mechanics and assuming zero risk when buying so-called covered calls.
Again, the biggest risk in investment is not the financial instrument itself.
It's buying what you don't understand regardless of the price itself. On the
contrary, the least risk is putting all your stake in something you understand
while the entire market makes a huge mistake.
A Good Company vs. A Good Investment
This is the largest lesson I've learned in the last half year. When making
investment decisions, I strongly believe in one thing:
"To succeed in investment, you need to buy good assets at reasonable prices."
However, there are different ways to interpret this. For example, Warren Buffett
emphasizes "good assets," while Howard Marks places more weight on "reasonable
prices," particularly in the context of investment-ranking debt and
convertibles.
More importantly, human beings usually focus on "good assets" and forget
about "reasonable prices," which is a common cause of bubbles throughout
financial history. That's what I want to emphasize today: a good company
doesn't necessarily mean a good investment. Conversely, a mediocre or even
near-bankruptcy company doesn't necessarily mean a bad investment.
Earlier this year, OpenAI released demos of their text-to-video model, SORA,
sparking great discussions in the creative and tech industries. When the
sluggish stock market began "realizing" the potential negative impact on Adobe,
its stock price plummeted. After doing some research and talking to their
employees, I believed that SORA would bring more opportunities rather than
destroy them for Adobe. As a result, I started building net positions in Adobe.
However, this turned out to be a right but too-ahead decision: Adobe's stock
dropped a further 20% following a series of negatives, such as
disappointing Q2 revenue forecasts and bleak earnings results from other
software companies like Salesforce and Autodesk.
So what did I learn from this? It's the margin of safety. Even if I'm 101% sure
that I'm buying a good company with an excellent business model and management
of integrity, I still need to leave a sufficiently large buffer space in case
there's even a tiny chance that I'm wrong.
Watch the cow, not the persons.
Don't be sheep.
Facts vs opinions.
I read the first sentence from the book "Earnings Quality." The author's father,
a cow broker, told him this when they went to a farm together to find the
highest-quality cow. At the farm, cow sellers always claimed their cows were
the best and worth a fortune. Similarly, in any market, there are always people
who are trying to allure you to buy some assets in the price they desire.
Moreover, as I observed in the first half of the year, most people I've
encountered are simply sheep: they repeat what they are told and follow what
the surrounding group does when hearing thunders. Most importantly, they usually
can't differentiate between facts and opinions. (Even biased facts are also
opinions to some extent.)
Don't trust analysts & auditors & accountants
Before I started building my position in Adobe, I read numerous valuation
analyses and comments on the company from Wall Street and various research
institutions. Believe it or not, most of them are just nonsense. How can I base
my investment on a team that cover 10 companies or even more, relying purely
on "facts" taken from other possibly unreliable sources?
For more detailed information, you can refer to chapters 1, 2, and 3 in "Quality
of Earnings" or some early memos from Howard Marks, which include statistical
data on the prediction accuracy of those famous Wall Street analysts.
1000 -> 900 vs. 100 -> 90 vs. 1 -> 0.9
This is another important lesson I've drawn from observing the market since this year.
Essentially, a stockholder loses the same amount of money when the stock price
plummets from 1000 to 900 as when it drops from 1 to 0.9. However, at first
glance, people always feel that the former is more painful, which is not true
at all. The possibility of losing everything always exists, regardless of the
stock price.
Miscellaneous
In the second half of the year, I plan to explore more arbitrage opportunities
in the market. I will elaborate on the rationale behind this further in the
annual letter.
Last but not least, I would like to share what books I've read or am currently
reading so far.
1. Berkshire Hathaway Letters to Shareholders, 1957 ~ 2024
2. Freakonomics
3. Principles of Marketing by Philip Kotler
4. Poor Chrlie's Almanack
5. One Up On WallStreet
6. Berkshire Hathaway Shareholder Meeting Notes, 1994 ~ 2023
7. The Ten Comandments for Business Failure
8. Besiness Adventures: Twelve Classic Tales from the World of WallStreet.
9. The Innovator's Dilemma
10.Guns, Germs, and Steel
11.Analysis for Financial Management by Robert C Higgins
12.Wealth of Nation by Adam Smith
13.Influence by Cialdini
14.Howard Marks Memos from 1990 to 2008
15.Li Lu on Discussion of Modernization
16.Creativity, Inc
17.The ride of a life time by Robert Iger
Hedera
Jun 29, 2024
* Thanks to ChatGPT for polishing the whole letter.