Reading Roundup: July 2022

This month we read:

• Just Keep Buying: Proven Ways To Save Money And Build Your Wealth by Nick Maggiulli

• When Genius Failed by Roger Lowenstein

• Strong Men Armed: The United States Marines Against Japan by Robert Leckie

• The Tao Jones Averages by Ben Goodspeed

• The Subtle Art of Not Giving a F*ck by Mark Manson

• A Moveable Feast by Ernest Hemingway

• Final Spin: A Novel by Jocko Willink

---

When Genius Failed by Roger Lowenstein

This book epitomizes the old story about the six foot tall man who drowned in a river that was 5 feet deep on average. It’s the story about a high-flying hedge fund that basically espouses everything that Matt and I aspire not to be.

In the early 1990’s a former group of all star bond arbitragers broke away from Solomon Brothers after the U.S. Treasury auction scandals and launched a hedge fund called Long Term Capital Management. LTCM was run by geniuses when measured by IQ points. The team was filled with PhDs and brilliant mathematicians that believed in the "Efficient Market Hypothesis” and their ability to model bond yields and spreads. Without going into too much boring detail, their core strategy was to exploit small and short term differences in bond spreads that they expected to narrow and profit from this arbitrage. Oh, and use a TON of leverage to enhance returns.

The firm launched with several billion dollars of institutional capital and great fanfare among the investment community. They used their size and, frankly, arrogance to bully Wall Street banks and brokers who wanted a piece of the action. LTCM was able to get incredibly generous credit terms by not disclosing the size and scope of their trades, leverage, or strategy to any one bank but by spreading their business across a number of financial service providers. Many large institutions were also invested in the fund creating a major conflict of interest. For the first few years, returns were spectacular and LTCMs managers were the toast of Wall Street. Then everything unraveled.

LTCM firmly believed that it’s models that predicted bond spreads and volatility were gospel. They were supremely confident that they couldn’t lose more than a few million dollars on any given day, and maybe 20% in the worst case any given year.

The problem was, all of the assumptions were based on historical data, and the future doesn’t always behave like the past. In the summer of 1998 a foreign credit crisis sparked by Russian debt caused bond spreads to widen and volatility to spike. All of LTCMs core strategies moved against it. A small move in spreads was magnified into crippling losses for the fund because of the magnificent level of leverage. Heading in to the meltdown LTCM was leveraged more than 30-1! As their equity melted away leverage approached 100 to 1.

Needless to say, the fund collapsed and almost pulled several investment banks down with it given the mass use of derivatives and the interconnectedness (unbeknownst to the banks) of its trades. After failing to convince Warren Buffett to rescue the fund for pennies on the dollar the Fed had to organize an emergency bailout between a consortium of major Wall Street banks. This did not go over well with the general public.

The worst part is, LTCM was right about the direction of spreads (they eventually tightened like their models said they would), but due to excessive leverage they couldn’t survive the move in between. We always try to avoid path dependency when making investments and this is precisely why.

Here’s what the returns from inception looked like for the fund:

Nice job guys.

For the first few years investors made more than 4x their money. That gain promptly evaporated in a few months to about 30 cents on the dollar for original investors. The principals lost everything thanks to excessive leverage in the firm and their personal lives.

It turns out the geniuses had outsmarted themselves.

A ton of lessons in 1998 turned out not to be lessons at all, as the same problems that plagued LTCM resurfaced in a huge way during the financial crisis of ‘08. History rhymes.

Dan

---

Just Keep Buying: Proven Ways To Save Money And Build Your Wealth by Nick Maggiulli

Nick Maggiulli offers a quantitative approach to personal finance in Just Keep Buying. The first half of the book covers saving money. The second half covers investing. Maggiulli has no sacred cows. He uses simple math and historical data investigate the conventional wisdom surrounding saving and investing.

Maggiulli concludes that nothing beats dollar-cost averaging into stocks and holding them for the long run. To prove it, Maggiulli backtested two strategies.

• Dollar-Cost Average (DCA) — Buy $100 of stocks every month for 40 years.

• Buy The Dip (BTD) — Save $100 a month and wait to buy the dip (anything less than an all-time high). The catch is that the BTD investor is an omniscient God that buys the dip’s low every single time.

Buy the Dip underperforms DCA in more than 70% of the 40-year periods starting from 1920 to 1980. This is true despite the fact that you know exactly when the market will hit a bottom. Even God couldn’t beat dollar-cost averaging!

Why is this true? Because buying the dip only works when you know that a severe decline is coming and you can time it perfectly. The problem is that severe market declines don’t happen too often. In U.S. market history severe dips have only taken place in the 1930s, 1970s, and 2000s. That’s rare. This means that Buy the Dip only has a small chance of beating DCA.

Maggiulli’s most though-provoking conclusion is that maxing out retirement accounts are far less beneficial than it initially seems. He says:

• Always contribute to 401ks up to the employer match. An employer match is “like free money.”

• A non-taxable account will outperform a taxable account by 0.5-1.0% per year, depending on the portfolio’s turnover. 0.5% if the taxable account is truly buy-and-hold with no trading, and 1.0% if the account turns over annually.

• The average all-in cost for the typical 401(k) plan in the U.S. was 0.45% in 2019.

Net, a 401(k) will outperform a taxable account by 0.05-0.55%, depending on turnover. This isn’t a lot considering that a 401(k) locks up your money until age 59.5. For some, the optionality of accessing their cash, such as for a down payment on a house, is worth the 0.05-0.55% headwind a taxable account faces.

Matt

---

The Subtle Art of Not Giving a F*ck: A Counterintuitive Approach to Living a Good Life by Mark Manson

One of my favorite investors, Vitaliy Katsenelson, swears by this book and claims it changed the way he views the world. I have to agree; it’s a great book full of insights both professionally and personally.

Manson delivers some insightful pieces of advice many of which tangentially relate to how to invest successfully. Among my favorite ideas are:

• Don’t avoid problems. Rather, seek to spend your time finding problems that are fun to solve. After all, life is just jumping from one problem to the next and the best you can hope for is upgrading your problems over time and find satisfaction in solving them.

“Happiness comes from solving problems. The keyword here is “solving". If you’re avoiding your problems or feel like you don’t have any problems, then you’re going to make yourself miserable. If you feel like you have problems that you can’t solve, you will likewise make yourself miserable. The secret sauce is in the solving of the problems, not in not having problems in the first place.”

• Separate fault from responsibility. You don’t control what happens to you in many cases. You control 100% how you respond to things. You may not be to blame for a situation you’re in, but it still is your responsibility to respond correctly. In investing, you can’t control the price of a stock, you can control which stocks you buy and how you respond to fluctuations in those stocks, and how much risk you decide to take. Manson uses poker as an analogy (much like Annie Duke), but investing works too.

“We all get dealt cards. Some of us get better cards than others. And while it’s easy to get hung up on our cards, and feel we got screwed over, the real game lies in the choices we make with those cards, the risks we decide to take, and the consequences we choose to live with. People who consistently make the best choices in the situations they’re given are the ones who eventually come out ahead in poker, just as in life. And it’s not necessarily the people with the best cards.”

There’s a lot of other helpful ways to reframe life and business, some appropriate for an investment blog and some less so, so go take a read and see for yourself!

Dan

---

The Tao Jones Averages by Ben Goodspeed

This book was written by my great-uncle Ben Goodspeed. While it was published in the early 1980s I only recently discovered it, but thought it was quite interesting. Turns out he shares a lot of the same psychological views towards investing as I do, and the book emphasizes avoiding common pitfalls in investing from only using one side of your brain.

Left brain thinkers tend to think linearly, using numbers, and try to jam everything into a predictable formula. Right brainers trust their gut feel, utilize instincts, and “see” patterns based on experience and observation. Wall Street is generally run by left brain dominated thinkers who believe the world is more predictable than it is (hence the down-to-the-penny quarterly earnings estimates from the model-happy analysts).

Goodspeed emphasizes a whole-brained approach to investing in an effort to avoid blind spots that can arise from sticking to a one-side only strategy. There’s an old saying that goes “to a man with a hammer every problem looks pretty much like a nail”. It’s a bad idea to be the man with a hammer in investing or business. It’s important to know which way your biases lean and work to counter them to avoid falling victim to a one size fits all approach.

Dan

---

Strong Men Armed: The United States Marines Against Japan by Robert Leckie

If you, like me, are fascinated by the extremes of the human condition, you won’t find a much better book than this.

Strong Men Armed is a military history of the Marine’s WW2 campaign from Guadalcanal to Okinawa. Author Robert Leckie served in the 1st Marines as a machine gunner and scout at Guadalcanal, Cape Gloucester, and Peleliu. His autobiography, Helmet For My Pillow, is one of my favorites and served as the basis for HBO’s The Pacific, which was a follow-up to Band Of Brothers.

The book offers a play-by-play chronicle from a boots-on-the-ground perspective of each battle. It is a thrilling narrative and moving tribute the thousands of young Marines who laid down their life on godforsaken coral atolls so that others may live. As Admiral Chester Nimitz once said, "Uncommon valor was a common virtue." The book serves as a reminder that freedom isn’t free and that the veneer of society is thin.

The Marines faced an entrenched enemy that vowed to fight to extinction — and did. All but three of the Marine’s victories required the complete annihilation of the Japanese forces.

...For the aged commander of Saipan sat down to a farewell feast of canned crabmeat and saki. At ten o’clock he had finished. He arose and said: “It makes no difference whether I die today or tomorrow, so I will die first. I will meet my staff at Yasakuni Shrine.”

He walked slowly to a flat rock. He cleaned it off and sat down. He faced the misty East and bowed gravely. He raised his glittering samurai saber in salute and cried, “Tenno Heika! Banzai!”

He pressed the point of his blade into his breast and the moment he had drawn blood his adjutant shot him in the head.

This book is much more graphic than the HBO series and goes into much more detail. It isn’t for the faint of heart and won’t make a good beach read. And yet, it is absolutely worth reading. If we forget what has happened, it may repeat.

If you like Strong Men Armed, I also recommend The Pacific on HBO, Helmet For My Pillow, With The Old Breed, and Dan Carlin’s Supernova In The East.

Matt

---

A Moveable Feast by Ernest Hemingway

I was fortunate to spend most of July in Paris. Naturally, I felt compelled to re-read A Moveable Feast. The book is Hemingway’s reminiscence of his early days living in Paris.

Paris in the 1920’s offered a lot of value - wonderful food at affordable prices. Artists came from all over the world. Many became household names — Ernest Hemingway, F. Scott Fitzgerald, James Joyce, and Ezra Pound, to name a few.

Here are a few of my favorite passages:

If you are lucky enough to have lived in Paris as a young man, then wherever you go for the rest of your life, it stays with you, for Paris is a moveable feast.

With so many trees in the city, you could see the spring coming each day until a night of warm wind would bring it suddenly in one morning. Sometimes the heavy cold rains would beat it back so that it would seem that it would never come and that you were losing a season out of your life. This was the only truly sad time in Paris because it was unnatural. You expected to be sad in the fall. Part of you died each year when the leaves fell from the trees and their branches were bare against the wind and the cold, wintry light. But you knew there would always be the spring, as you knew the river would flow again after it was frozen. When the cold rains kept on and killed the spring, it was as though a young person had died for no reason.

In those days, though, the spring always came finally but it was frightening that it had nearly failed.

Never to go on trips with anyone you do not love.

As I ate the oysters with their strong taste of the sea and their faint metallic taste that the cold white wine washed away, leaving only the sea taste and the succulent texture, and as I drank their cold liquid from each shell and washed it down with the crisp taste of the wine, I lost the empty feeling and began to be happy and to make plans.

There is never any ending to Paris and the memory of each person who has lived in it differs from that of any other. We always returned to it no matter who we were or how it was changed or with what difficulties, or ease, it could be reached. Paris was always worth it and you received return for whatever you brought to it. But this is how Paris was in the early days when we were very poor and very happy.

Matt

---

Final Spin: A Novel by Jocko Willink

Final Spin is Jocko Willink’s first novel. Jocko is best known for his excellent books on leadership and his podcast about the military. If you haven’t read Extreme Ownership, I highly recommend it. Final Spin is completely different. It is a fun, short, and easy read.

The book explores the tension between the main character’s intentions (good) and the outcome of his decisions (bad). Humans often judge others by their actions, but judge themselves by their intentions.

The corollary in the stock market is that good decisions don’t always produce good outcomes. A disconnect between process and outcome can occur whenever a process is subject to randomness. The solution is to build a margin of safety into any decisions which could be affected by randomness. Johnny, the story’s protagonist, didn’t, and paid the price.

Matt

---

The Best Of The Rest

• Charlie Munger interview excerpts with the Australian Financial Review

• New York Times — Is the World Really Falling Apart, or Does It Just Feel That Way? “Many of the positive changes are about prevention. No one notices the wars that don’t happen, the family members who aren’t claimed by disease, the children who don’t die in infancy.”

• Memo from Howard Marks: I beg to Differ

• Lou Simpson — Letters To GEICO Shareholders

• Sahil Bloom — The Six Principles Of Incentive Design

• Morgan Housel — Five Lessons From History. “In investing, saying ‘I will be greedy when others are fearful’ is easier said than done, because people underestimate how much their views and goals can change when markets fall apart.”

• Business Breakdowns: Charles Schwab, the $8 Trillion Gorilla

• Overcoming Initial Resistance by the Rational Walk

• Farnam Street’s AutoZone Case Study

---

If you would like to invest with Eagle Point Capital or connect with us, please email info@eaglepointcap.com. Thank you for reading!

Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.