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Yesterday’s markets were fairly quiet until Walmart (WMT) cut its profit outlook and warned that U.S. consumers are buckling under inflation pressures. Going to be an interesting rest of the week as investors digest this news, we watch further earnings reports, and a Fed rate announcement.

Today, we’ll also discuss the investing strategies of Nick Sleep that allowed him to “retire” at 45, discuss Russia’s strategic economic war against the European Union, and learn about the Rule of 72. All this and more in just 5 minutes to read.

Get curious and read on!

IN THE NEWS

📉 Amazon sinks after Walmart Cuts Profit Outlook (WSJ)

Explained:

• Walmart warned that higher fuel and food prices are causing consumers to cut back on spending. Price markdowns are taking place for the retailer as they have been saddled with too many unsold goods. The price reductions will likely cause a second quarter earnings report of missed profit expectations.
• The announcement sent Walmart shares tumbling nearly 10% in after-hours trading, while Amazon, who will announce earnings Thursday, dropped 4%. More than $100 billion was erased from stock market value in total for the two retailers.

What to know:

• The Walmart announcement may be a preview of more cause for concern as several global brands will be making quarterly earnings reports including McDonald’s (MCD), Procter & Gamble (PG), General Motors (GM), and Visa (V). Given how much volume Walmart does, they might be a good indicator of consumer spending and the overall health of the economy.
• It will be interesting to see how Jerome Powell and the Fed react to this news. A 75-basis point (0.75%) interest rate hike was expected to be announced on Wednesday.

 

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⛽ Europe Faces a Gas Squeeze from Russia (Reuters)

Explained:

• European Union (EU) countries approved an emergency plan to curb gas demand by 15% until next March, as they prepare for further reductions in supply from Russia. Russia’s Gasprom announced it would cut the flow of gas to Germany from the Nord Stream 1 pipeline by 20%.
• EU officials claim Putin is weaponizing gas deliveries and retaliating for economic sanctions imposed on Russia. It is a strategic game attempting to weaken the West’s resolve to give military and financial aid to Ukraine.

What to know:

• Gas prices jumped 12% in Europe on Monday based on the announcement. They have more than doubled this year and are expected to continue to rise as winter approaches if Russia continues to cut supplies of gas.
• The International Monetary Fund warned a Russian gas cut could plunge European economies into recession as fuel prices rise and consumers cut back on spending.

 

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Yardeni Says S&P 500 Has Bottomed (Bloomberg)

Explained:

• Market veteran, Ed Yardeni, says we’ve seen the worst for this bear market. “It’s never easy to pick a bottom in the stock market, but I’m going to give it a try.” In his view, the plunge of the S&P 500 to 3,666 likely marked the bottom for 2022. This is a big claim to make ahead of Big Tech earnings reports and a likely Fed rate hike.

What to know:

• Yardeni may be someone worth listening to as he has nailed predicting the bottoms in the bear markets of 1982 and 2009, while keeping in mind that no one can truly time the market. He says resilient corporate earnings and a healthy outlook for U.S. consumers bodes well for a turnaround.
• The S&P 500 has climbed 8% since its mid-June low after sinking more than 20% during the first half of 2022. Yardeni is in the minority on calling the bottom now as a Bank of America survey showed money managers have cut their equity exposure to the lowest levels since the 2008 financial crisis.

 

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DIVE DEEPER: How To Grow Your Portfolio – Tips from Nick Sleep

If you studied the early years of Nick Sleep and Qais Zakaria (Zak), you likely wouldn’t have pegged them to become future investing legends. Nick studied to become a landscape architect and worked in the field early in his career before he was fired, and found the work boring and uninspiring. Zak grew up in Iran and dreamt of becoming a meteorologist. He, too, was let go from one of his early jobs out of college.

Unlikely as it may seem, these two paired up to form Nomad Investment Partnership and began investing in 2001. Over 13 years, the fund returned 921.1% versus 116.9% for the MSCI World Index and 149% for the S&P 500. $1 million would have grown to $2.17 million over the 13 years in an MSCI World Index fund. Someone with foresight to put their money with Nick and Zak, would have $10.21 million, and could have retired at 45 just like Nick Sleep did.

Nick and Zak shut down the fund in 2014, returned the money to their investors, and became involved in the “caring” pursuits. How did Nomad generate so much alpha (the excess return of an investment relative to the return of a benchmark index)? Here are some of their investing tenets that allowed them to compound money at an incredible rate:

Scaled Economics Shared (SES) – One of the most powerful compounding tools is scaled economics shared, a term coined by Sleep and Zakaria. The strategy of SES creates a perpetual growth machine where a company benefitting from economies of scale chooses to lower its prices and improve its offerings to customers to win market share over the long term. As SES businesses grow larger, it becomes harder for competitors to offer as much value to customers. This creates a flywheel effect that becomes unstoppable.

SES businesses delay gratification while giving their customers instant gratification. SES businesses reinvest their scaled benefits into improving the value proposition for the customer even if the financial return isn’t immediate or even guaranteed.

Examples of scaled economics shared business include Amazon, Walmart, and Costco. Sharing scale doesn’t always have to be in reduced prices. It can also include improving the customer experience by increasing selection and convenience.

Amazon and Costco, two of the best SES businesses, comprised roughly two-thirds of Nomad’s portfolio. Companies that practice scaled economies shared increase their chances of compounding for many years to come.

The Hidden Investment – Amazon regularly offers price-givebacks and gives customers lower prices of 2-10% savings compared to shopping at other places. The amount of revenue “lost” from price givebacks is not captured anywhere in the financial statements, yet, it creates a lasting consumer habit in the form of dedicated customers.

The Aggregation of Marginal Gains – Sleep prefers to invest in companies whose comparative advantage comes from doing many little things right rather than in companies that rely on just one big advantage such as brand name, location, or a patent. Companies that do many little things well are “simply harder to beat,” according to Nick.

Portfolio Inactivity – Not doing anything is, strangely, hard to do. Human beings itch to be doing something, especially fund managers who are paid to be active investment managers. Only buy new companies for your portfolio if they are clearly superior to what you own. Otherwise, do nothing.

Information Diet – Sleeps says information, like food, has an expiration date. He feels investors should de-emphasize data collection and focus more on thinking about the factors that make a business great. It can become very easy to get lured into endless data collection. Put yourself on an information diet.

Thoughts on Volatility – Resist the urge to sell your winners to add to your losers, and vice versa. Good investing is about the destination and is rarely a smooth ride. Share prices will be more volatile than enduring business values. Embrace the volatility and focus on companies with lasting value.

An Investor’s Edge – What’s your competitive advantage in investing? There are three: informational, analytical, and psychological. Of the three, only analytical and psychological are sustainable. Mr. Market is efficient, but not all the time. It is during pockets of market inefficiencies where analytical and psychological competitive advantages are most important.

Super High-Quality Thinkers – Sleep has a list of criteria for evaluating great management, which includes leaders that are intellectually honest and economically rational, able to resist growing when returns on capital are poor and have been chosen to out-think their competition and allocate capital over many years with the discipline to reinforce their competitive advantage.

Nick Sleep and Qais Zakaria didn’t rely on complex models, non-public information, or business relationships to deliver incredible returns. Instead, much like Charlie Munger, they thought deeply and developed mental models they successfully applied to the investing arena. They ran a concentrated fund, and when they closed Nomad, the fund consisted primarily of three holdings- Costco, Berkshire Hathaway, and Amazon.

This goes against the conventional wisdom of portfolio diversification, but as Sleep said, “good investing is a minority sport, which means that in order to earn better returns than everyone else we need to be doing things different to the crowd. And one of the things the crowd is not, is patient.”

There are many more nuggets of investing wisdom in the full collection of Nomad Investment Partnership letters and, like Buffett’s, they are a rewarding resource that can enhance your investment success. I encourage you to read them here. You may not retire at 45, but applying Nomad’s principles to your portfolio will certainly stack the odds in your favor.

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The Rule of 72

The Rule of 72 is a nifty tool to have in your investing arsenal. It’s a mathematical principle that estimates the time it will take for an investment to double in value. Have you ever sat down and thought about how large your portfolio could grow based on different rates of return? The Rule of 72 allows you to quickly make this calculation.

Simply take the number 72 and divide it by the interest earned on your investment to get the number of years it will take your portfolio to grow 100%. Let’s imagine you had the foresight to invest with Nick and Zak in the Nomad Investment Partnership at the fund’s inception in 2001. Let’s also say you had a portfolio of $100,000 to invest. Nomad earned an average return after fees of 18.4% per year. How long would it have taken Nick to double your money? (Cue Jeopardy Them Song)

The answer is 72 divided by 18.4 which is 3.91 years! Now imagine doing that roughly every four years. It wouldn’t take too long for your portfolio to mushroom, allowing you to follow in the footsteps of Nick and Zak and retire at a young age.

Remember that this rule applies only to compounding growth, meaning you can only use it for investments that earn compound interest, not simple interest. Compound interest is interest earned on interest, allowing your investments to grow exponentially. It is the magic of compounding that Einstein called the Eighth Wonder of the World. With simple interest, you only earn interest on the principal amount you invest.

The Rule of 72 can also be used to estimate halving time on something that’s depreciating. For example, you can use the rule to estimate how many years it takes for a currency’s buying power to erode by 50% due to inflation. Let’s imagine inflation continues at 9%. In just eight years, you’ll have lost 50% of your purchasing power (72 divided by 9).

You could also use it to estimate how much you’ll weigh if you gain weight at a rate of 12% per year. If you weigh 200 now, it will take just six years to weigh 400. Don’t do that, though! Have some fun with the Rule of 72 and figure out how long it will take you to reach your “X-number” that we discussed yesterday.

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