Accrued Revenue: The Ultimate Cash-Sucker

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Hope you had a great week! Last week we discussed deferred revenue and why we should understand it. This week we’re examining its evil cousin: accrued revenue. There’s a lot in common. But here’s the key difference:

    • Deferred Revenue = job not complete but cash received
    • Accrued Revenue = job complete but cash not received

Alright let’s dive in.

What Is “Accrued Revenue”?

Accrued revenue occurs when a company completes a service or delivers a product but hasn’t Accrued revenue is when a company completes a service or delivers a product but hasn’t received payment for that product or service. Let’s use our lemonade stand as an example.

If we sell a glass of $1 lemonade to a customer that promises to pay us tomorrow, that’s $1 of accrued revenue. We’ve completed the task of delivering our goods to the customer. Now we wait for reimbursement.

Why does this happen? You can thank GAAP accounting. GAAP accounting states that a company must recognize revenue at the time it’s earned. Not when the company receives the cash.

This is an important distinction. Most companies perform services and provide goods without accepting the cash up front. Think of manufacturing companies. Usually these companies supply parts and widgets on a Net-30 basis.

In other words, the customer (who receives the widget) has 30 days to pay for that widget.

You might know accrued revenue as another name, accounts receivable.

Mechanics of Accrued Revenue on Financial Statements

Accrued revenue hits the financial statement in two ways: the balance sheet and income statement. As soon as a sale takes place, the company recognizes that sale as revenue on the income statement.

If we don’t receive cash at the point of sale, we have to also record an increase in the accounts receivables account on the balance sheet.

When the customer pays for the goods or service, we reduce that dollar amount on the accounts receivable account and increase the company’s cash amount on the balance sheet.

The Importance of Accrued Revenue

Understanding accrued revenue is important because it offers us clues to the underlying health of a business. It allows us to spot cash-flow issues before they reach an earnings transcript or analyst write-up.

Remember: when in doubt, follow the cash

Here’s what you need to know about accrued revenue analysis:

    • Rising accrued revenues = bad sign
    • Shrinking accrued revenues = good sign

Rising accrued levels means the company’s having trouble collecting cash for goods and services it already performed.

Lower accrued revenues means the company’s collecting more cash from goods and services than it’s recording.

We want to buy businesses that reduce accrued revenues over time and avoid those that grow such balances. Doing so will save us a lot of money and stress over time.

If you have any questions feel free to reach out.

Small-cap Value Set To Outperform [DIRTY DOZEN]


There’s no asset class too much money won’t spoil. ~Barton Biggs via A Hedge Fund Tale of Reach and Grasp

Good morning!

In this week’s Dirty Dozen [CHART PACK] we look at the latest Global Fund Manager Survey, talk some more about ALL the cash that large funds are sitting on and why that’s bullish for stocks, and then make the case for why rising free-cash flows will drive a reacceleration of stock buybacks in the coming quarters. Plus, we discuss some really interesting charts showing demographic splits and what they could mean for the equity risk premia, plus a whole lot more…

Let’s dive in.

***click charts to enlarge***

  1. The September BofA Global Fund Manager Survey came out last week. Below is the summary with key takeaways highlighted by me.


  1. The UK, energy, banks, staples, and Japan are the contrarian longs.


  1. Markets are a pendulum swinging from one extreme to another…


  1. The last few weeks I’ve been noting the wide dispersion in extreme positioning amongst players in this market. Retail and small funds are extremely long while large institutions/hedge funds have missed out on the incredible rally off the March lows and are subsequently sitting on significant piles of cash (as noted in the most recent BofA FMS).

Well, here’s another chart confirming the large piles of cash. UBS writes “US active fund positioning is 1.8stdev below average… Cash levels are still elevated. Institutional money market flows tend to follow the Fed rate with a 1yr lag, and the cut to zero earlier this year should mean more cash flows to equities over coming months. Cash levels are supportive at levels as a % of equity plus bond market cap not seen since 2012.”

This is one of many reasons why the downside in equity markets is likely limited over the short-term and the longer-term path of least resistance remains up.


  1. Buybacks are a key part of our macro equity framework. Buybacks are supported by free cash flows and cheap debt. This is why the below chart is so important. Buybacks have been anemic year-to-date, but with aggregate SPX FCF up 20% YoY we should see that trend start to reverse over the next two quarters (chart from UBS).


  1. These are very interesting charts from UBS. The chart on the left shows the population growth by cohort (35-55 and 65+) on a YoY basis. As you can see, the 35-55 age group is inflecting higher while retiree growth has peaked and is set to rapidly slow. This is important because the younger cohort tends to own more equities as a % of investment versus the 65+ group which is more heavily weighted towards less risky assets.

The chart on the right shows the correlation between the growth difference of the two cohorts (gold line) and the equity risk premium (blue). If this correlation continues to hold then we should see the equity risk premium — which is currently well above its long-term average — narrow significantly. And since the Fed is unlikely to let yields rise, that means higher equity valuations are in order.


  1. The last two months I’ve been making the bull case for small-cap outperformance. Here’s a chart from UBS showing the connection between relative small-cap/SPX dividend yields and performance… If history is any guide, we should see small-caps step on the gas soon.


  1. Small-cap value is my favorite place to look for names right now as both factors should continue to materially outperform over the coming quarters.


  1. I’m not convinced that we’re going to see a secular turning point in relative performance though. That would require a sustainable jump in inflation and a steepening of the curve. But we should at the least see a tradeable multi-month reversion play.


  1. A lot of value plays are dependent on rising commodity prices. And commodity prices are dependent on the US dollar, which I expect to trade lower over the coming year(s) — although, I’m still looking for that tradeable bounce!

A big part of my dollar bear thesis is the end of Core Domination and a reversion in capital flows from the highly crowded US equity market, back out to the periphery. The chart below shows that US stocks are near an all-time record high as a share of the MSCI global index.


  1. The USD bear thesis is broadly supported by the relative growth outlook as well. (chart via Nomura).


  1. But I wonder if relative COVID trends begin to affect the FX majors at all. If you watch the mainstream media, you wouldn’t know it but the relative trends in daily cases are much worse in Europe than they are in the US as of late.


Stay safe out there and keep your head on a swivel.

GoodRX (GDRX) S-1 Breakdown Analysis

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GoodRX (GDRX) filed their S-1 earlier this week. I read It so you don’t have to (but you should). Here’s a thread on what I found interesting, fascinating and down-right incredible from the company. I’m starting at zero. Follow along here

GDRX Facts & Figures

  • #1 most downloaded medical app
  • 4.9M Monthly Active Users
  • 80%+ Repeat Activity
  • $20B+ in Consumer Savings
  • 150B daily pricing data points
  • 4 platform offerings
  • Est. Market Cap: ~$9.9B

Business Overview

Mission: To help Americans get the healthcare they need at a price they can afford.
So far it’s working (really) well.
The company estimates 18M of their customers could NOT have afforded to fill their Rx without the company’s savings tools.

How GoodRX Makes Money

Receives fees from partners, which is mostly Pharmacy Benefit Managers (PBMs) when customer uses GDRX code.
Fees are % of fees that partners earn OR a fixed payment per transaction.
Recurring nature to GDRX model as code is saved to consumer profile. 

Financial Results

  • GMV via prescription offering: $2.5B
  • Compounded annual revenue growth rate: 57% since 2016
  • Generated $388M Revenue in 2019
  • Generated $66M Net Income in 2019
  • 2019 Adj. EBITDA: $160M

Solving Healthcare Consumer Issues

GoodRX notes 5 major healthcare consumer “lacks” in its S-1:
  • Lack of Consumer-focused solutions
  • Lack of Affordability
  • Lack of Transparency
  • Lack of Access to Care
  • Lack of Resources for Healthcare pros

GDRX Total Addressable Market

GoodRX estimates their TAM around $800B. That’s a HUGE number.
Here’s how it breaks down:
  • $524B Prescription Care
  • $30B Pharma manufacturer solutions
  • $250B Telehealth
Initial Surprises: Telehealth is nearly 32% of TAM

The GoodRX Value Proposition

It’s the coveted win-win-win:
– Consumers: Simpler, more affordable Rxs
– Healthcare Pros: Increased medication adherence and greater price transparency (also links w/ EHR)
– Healthcare Co’s: Reach & provide affordable solutions (Rxs) to customers

What Makes GoodRX Different

There’s six strengths that reinforce GoodRX’s powerful network effects:
  1. Leading platform
  2. Trusted Brand
  3. Scaled & Growing Network
  4. Consumer-focus
  5. Extensible Platform
  6. Cash generative monetization model
See image for descriptions…

Analyzing Income Statement

– GDRX grew revenue from $99M in 2016 to $388M in 2019 (crazy growth)
– Biggest operating expense currently: SG&A, which was 46% of revenues last year
– Operating Margin: 36% (real nice)
– Pre-Tax Earnings: $83M (21% margin)
– EPS grew from -$0.11 to $0.19 in four years (w/ growing share count)
– 2019 EPS of $0.19 is computed using weighted average shares post-IPO.
– Six-month ended YoY: $0.09 vs. $0.15 in 2020 on $15M more income
– SBC: <1% of revenues

Analyzing Balance Sheet

– $126M in actual cash
– If you adjust for the pro-forma IPO, they get nearly $800M in cash
– Total Debt (incl. LT debt): $700M
– Total Est. Capitalization: $1.078B
– Financed Biz via Cash from Ops (crazy, right?)
See breakdown below …
(Debt & Contractual Obligations)
  • <1YR: $41M
  • 1-3YR: $85.6M
  • 3-5YR: $82.7M
  • >5YR: $711M

GDRX Key Operating Metrics

One of the most important KPI’s to measure for GDRX is Monthly Active Users (MAU).
GDRX’s MAU trend is absolutely incredible:
– 2016: 718k
– 2017: 1.28M
– 2018: 2.02M
– 2019: 3.18M
– 2020: 4.88M

Where Will Future Growth Come From?

GDRX outlines 3 ways to grow revs outside Rx codes:
– Subscription offerings: Gold, Kroger Savings
– Pharma Manufacturing Solutions: Provide low-cost solutions to expensive brand-name meds
– Telehealth: Online visits / marketplace

Recap: How To Track GDRX Bull Thesis

– Monitor MAU growth & Repeat Activity
– Size + Strength of Healthcare Partner Network
– Growth of Platform & Telehealth

Meet The Founders (Letter Analysis)

– Making healthcare easy is *crazy* hard
– Consumers (insured or not) needed tools to help
– Reduce cost of nearly every generic drug by >70%
– Prices are less than typical insurance

Thinking About GDRX Valuation

At the current estimated IPO price and shares, GDRX will trade roughly:
– 25x 2019 Revenues
– 62x 2019 EBITDA
– 119x 2019 Pre-tax Profits
They’re also growing 57% compounded since 2016.

Deferred Revenue: Don’t Miss The Next SaaS Winner

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Hope you’ve had a great week! We paused our accounting series to highlight our Collective membership service. Doors closed last Sunday. If you didn’t get in but remain interested, shoot me an email.

I know, you missed your weekly dose of accounting knowledge.

But we’re back baby! This week we’re covering Deferred Revenue. It’s an important topic in the age of SaaS business models. If we don’t understand it, we’ll pass on an amazing business.

Let’s dive in.

What Is “Deferred Revenue”?

Deferred revenue is money a company receives before delivering those goods or services. Think of it like an advancement payment. Like we mentioned above, deferred revenue is common in the SaaS space. But older, more blue-collar industries also use deferred revenue.

Let’s use lawn care as an example. A lawn care company might need a 50% down payment before they even get to your property. They haven’t performed any service, yet have your money.

That’s deferred revenue.

Where Does It Sit on The Financial Statement?

Now it’s time to get into the weeds. Since deferred revenue isn’t “earned” in the traditional sense — we can’t show it on the income statement. So where does it hide? The liabilities section of the balance sheet.

At first glance, that sounds weird. Why should potential income live as a liability? Think about it this way. It’s like an IOU with another company for future services. You are liable as a company to perform those services or deliver those products.

If we don’t, we’ll lose that revenue and face a potential lawsuit. Let’s look at an example of this with a name we’re currently digging into at the Collective.

I’ve highlighted the deferred revenue section on the liabilities side (note: also called “unearned revenue”):

Now that we know where it sits, let’s learn why it’s important to track.

Why Should We Study Deferred Revenue?

There’s two reasons we should study deferred revenue if a company has it. First, we can plot the long-term growth of a company’s deferred revenue. We don’t want a dramatic increase in deferred revenue. A high deferred revenue balance signals underlying issues. Does the business have problems bringing products to market? Is there something wrong with distribution?

Second, it helps us value SaaS businesses that might show little in current revenues. If we ignore deferred revenue, we could miss a good software business. Accounting for deferred revenue allows us to model what the company may earn once it’s collected on those revenues.

Next week we’ll look at Deferred Revenue’s cousin, Accrued Revenue.

If you have any questions feel free to reach out.

Why Inflation ISN’T Coming [DIRTY DOZEN]


Thinking in bets starts with recognizing that there are exactly two things that determine how our lives turn out: the quality of our decisions and luck. Learning to recognize the difference between the two is what thinking in bets is all about. ~ Annie Duke via Thinking in Bets

Good morning!

In this week’s Dirty Dozen [CHART PACK] we look at US economic news sentiment and dive into what might be behind the divergence between the fundamental narratives and market prices. We then cover the inflation outlook and discuss why the Inflationistas are wrong before jumping into the schizophrenic positioning we’re seeing in the market and how its being driven by Fed policy, plus more…

Let’s dive in.

***click charts to enlarge***

  1. In last week’s Dozen I shared some studies which showed that measures of journalistic sentiment and narratives are at 80-year lows here in the US. So according to our newspapers we’re living in era that’s worse than those experienced during the depths of WWII. This week I was looking at the San Francisco Fed’s News Sentiment model which they describe as a “high frequency measure of economic sentiment constructed from economic related news across 16 major US newspapers.”

What’s interesting about today is the large divergence between economic news sentiment and markets. The index is more indicative of a continuing bear market — that has yet to hit a sentiment extreme — yet the SPX keeps trucking along.


  1. The current sentiment and positioning picture is about as schizophrenic as I’ve ever seen it. While retail robinhooders are leveraging and hodl’ing, large hedge funders are sitting in piles of cash. And this Risky vs Safe Fund Flows chart from GS paints a completely different picture than all the talk we’re hearing about “market euphoria”.


  1. GS’s Risk Appetite Indicator is only back to neutral after hitting its most bearish extreme on record.


  1. While at the same time, US option positioning is the most bullish in history (chart via GS).


  1. Citi published a great slide deck last week titled “Investing Under the Money Tree” that attempts to explain some of this phenomenon. First, they point out the futility of average inflation targeting (ait) since it’s not like these bankers have much credibility in that space anyways…


  1. And the Inflationistas that are pointing to how all the money creation is going to spur inflation should have a look at these charts.


  1. The author points out that one of the drivers of this disinflationary world is the fact that the majority of our investment goes into scalable sectors (such as IP, software R&D etc…) where prices tend to go down over time, rather than up.


  1. Instead of credit driving real growth or inflation, it inflates asset prices. This creates an increasingly financialized world where deflationary pressures are actually growing instead of diminishing.


  1. And so we end up with a schizophrenic market. Where most are bearish because, well, our economic trajectory isn’t great. So they sit in large amounts of cash and safe assets. But… since there’s little to no return on these assets, they’re forced to allocate increasing amounts of their portfolio further out the risk curve. A kind of barbell approach, which is why call options are being bought and we have the “largest long risk ever in the Global CDS market” (chart via BofA).


  1. This is why the value factor has performed so poorly. In fact, it’s seen its worst 10-year run in history (chart via BofA). Value needs strong nominal growth to outperform.


  1. BofA points out that “A few key macro variables explain the ongoing mortification of value stocks. The 10-year Treasury yield, the ISM Purchasing Managers Index, and the 5-year forward 5-year inflation breakeven rate account for 79% of the variation in growth vs. value in recent decades.”

According to BofA’s models, “for value to recover its losses this year, Treasury yields would have to rise from 0.7% to 1.8%, PMIs would have to remain in expansion territory, and breakevens would have to rise from 1.9% to 2.5%.”


  1. This week we’re watching for breakout confirmation of a US dollar retrace. USDSEK is one of our favorite setups for the swing trade. You can read up more on my dollar thesis here and here.


Stay safe out there and keep your head on a swivel.

This Trend is Fragile


***The following is an excerpt from a weekly note sent out to members of our Collective on 9/3***

Let’s start this note off with a story and a lesson from one of my all-time favorite trading related books, John Percival’s The Way of the Dollar. John writes (emphasis by me):

“There is another description of the consensus-that’s-not-confirmed-by-price. It consists of two images that have become part of the ancient lore of Wall Street, the Wall of Worry, and the River of Hope. A bull market we recall, “climbs a wall of worry” ; and “a bear market flows down a river of hope”. In point of fact, the description normally only applies to the early and middle stages in bull and bear markets. So we can be very comfortable when we diagnose a wall or a river — assuming we’re climbing and flowing respectively.

“In the later stages of the trend, things change. The worriers capitulate to the up-trend; and the hopers throw in the towel and give up the fight against the bear. At this stage, in a bull market, we find die-hard bears saying that, well, we are heading for a collapse, but prices are going to go up further before they head down. And in a bear market, die-hard bulls assert that prices are far too low — but they can go lower still. The conversion process is nearing its end.

“Now we have to get a little wary, for obviously we are in the region of consensus. And this is a very dangerous region because nobody on earth can tell how far things can go. Currencies, stocks, commodities — it makes no difference. In this respect, they’re all the same.

“It is said of Joseph Kennedy, father of President John Kennedy, that when he was having his shoes shined one day in autumn 1929, he was astonished to hear the shoeshine boy tip him a hot stock that was sure to go from 160 to 2000 or whatever. That was all Joe K needed. If shoeshine boys (or elevator attendants, or hairdressers, the cover of Newsweek or whatever) were tipping stocks, it was time to get out. So Joe K started selling short and thus laid the foundation of the family fortune — so the story goes.

“But if it’s true that Joe K went short at that moment then he was lucky. The sucker buys at the top of the market; geniuses and liars sell at the top of the market; but the super-sucker sells short at what he thinks is the top of the market.

“In 1979, the then financial editor of Britain’s Daily Mail newspaper, Patrick Sargent (later to be a founder of Euromoney), called the top of the gold market at around $450. It was a perfectly sound call, in the light of the speculative heat in gold at the time especially from one who had been bullish of gold for a good time. Yet gold was to climb a further $400 by early 1980, when speculation turned from red-hot to white-hot. Imagine being short at $450! As I say, no-one on earth knows where a speculative trend will end — except with hindsight…

“This brings us to the question of how you can distinguish a minor multi-week extreme from a major multi-month or multi-year extreme. The late stages in that great dollar bull market of 1980-5 provide a clue: you watch the way the conversion process trickles down through the different categories of currency observers. In mid-1984, the world was still full of die-hard dollar bears who had considered the currency overvalued ever since 1981. Who were they? It wasn’t the dealers, who are not and do not need to be overly concerned with underlying value; nor was it the trend-followers. It was the value-oriented analysts — researchers and economists by profession — with a long-term orientation.

“What happened was that sometime during the autumn of 1984, the bearish consensus among this category turned round; and it happened relatively suddenly. You will see it quite clearly if you go back over the research material turned out by major banks at the time. “The dollar is grossly overvalued at DM 3.00, but we think it will head further up before it collapses”, that kind of thing.

“In other words, it’s just as you would expect. When the long-termers who were formerly skeptical at last capitulate to the trend, then you have a total consensus and the end is nigh for the major multi-month / multi-year move. Nigh, but not necessarily over. At this point, one of our sentiment gauges comes into its own. We have to watch market action: the way the markets react in relation to the background and to news events.”

Consensus conversion… no-one on earth knows where a speculative trend will end… and total consensus...

Some valuable lessons from John… These are things we should keep front of mind as we navigate a bull volatile market through the worst period of seasonality (September) for markets.

The Nasdaq sold off as much as 6% at one point today. Giving it its largest single-day decline since March. This action shouldn’t surprise any of us since it’s typical volatility following a major buy climax, along with the increased trend fragility and sentiment/positioning headwinds we’ve been noting these last two weeks.

The Nasdaq SQN closed last month over 3std in a Bull Volatile regime]. My bud Chris D lays out in this tweet what has happened historically following similar readings.

The outcomes are a little better when looking at just the Nasdaq during the following 30-days after an SQN reading above 3.

Here we get 7 instances over the last 25-years with 5 gains and 2 losers. The average gain is 3.69% and the average loss was 0.94%. But the peak-to-troughs moves show a much wider dispersion of outcomes.


Our Trifecta Lens gives the market a current score of -2, which is the worst reading since before the March low. It’s still far from the -6 readings that have marked past major tops, such as the one we saw in February. But it could quickly get there if we see the market move down to its lower Bollinger Band. On the other hand, it could flip back to positive.


Buy climaxes such as these are notoriously difficult to play. Speculative momentum could easily reverse this market back up tomorrow. Bears want a negative weekly close, giving them a weekly sell signal. And bulls want a reversal. This 3,510 level on the SPX  will be acting as a magnet tomorrow. Seeing as how this is a 3-day weekend, I have a feeling we might see further selling tomorrow as people look to lighten up their books.

Normally we wouldn’t even consider cutting/hedging risk at this point since the indices are still well above their lower Bollinger Band Setups. But the overextension of the tape from their 20-day averages means the market could fall a good deal before hitting its lower bands. And considering the extreme sentiment/positioning, I’m more willing to proactively hedge out some of our risk.

If today was the start of a broader 10-15% pullback, then that would put the 3,200 and 3,000 levels into play on the SPX.

So this is what we’re doing for now. We flattened out our Core 25% SPX position and put on a 25% of NAV equivalent short in the Nasdaq (NQZ2020). We also have our bond position which is acting as a counter-balance. But if this ends up being more of a reflation rotation type move, then bonds may not give us as much negative downside capture as we’d like.

We’re keeping the remainder of our positions on for now and will honor existing stops, of course. We’re going to be nimble and adjust fire as this move progresses. We don’t want to overreact and get treed nor do we want to under prepare and get caught flatfooted. We’ll send out updates as we make moves.

My base case is that this ultimately ends lower, in the 10-15% range. And I suspect we’ll start to hear the narrative of “failing CARES 2 stimulus talks” come to the fore. Congress is back in session soon and talks have reportedly hit a wall. I ultimately believe we get a bill passed, likely closer to the Dem’s target range of $2trn — nothing like a market selloff to instill some fear, do a little arm twisting, and get our valiant leaders to act!

Plus, there’s still a large amount of big hedge fund money that has sat this entire rally out (as I pointed out in this week’s Monday Dozen). I assumed they’ll use any 10-15% dip to come in and buy hard, especially if it looks like a solid CARES 2 will get passed.

Basically, my current base case is what I tweeted yesterday (below). This is just speculation of course and there are a lot of moving parts, so opinions weakly held and all that.


This note was sent out to Collective members on the 3rd. Our TL Score is now -5 for the market. That’s the most bearish reading since the start of the late February selloff, where we saw a consecutive string of -6s (which is about as bearish as our scoring gets).

This means that trend fragility is high and we should expect continued vol and further downside in the near-term until some of the negative marks in the TL score can be corrected.

If you’ve enjoyed reading this report then you should think about joining our Collective. The Collective is the anti-newsletter trading and investing service. Unlike others in this space, we at MO don’t peddle constant doom narratives or seek to confirm biases.

Our aim is simple… make high risk-adjusted returns consistently. Continuously learn while doing so, and have a lot of fun along the way. And in this regard, our record speaks for itself. This is partly why we have BY FAR the highest retention rates of any investing service in the industry. Collective members tend to stay members for a long time because there really is nothing else like us.

Our doors are open until the end of day Sunday. At which point we’ll be closing the enrollment period and won’t be opening back up for some time.

We offer differentiated research, theory and education resources, plus a killer community (Slack) filled with some of the smartest Operators from around the world. Our members are predominantly professionals but we also have a number of highly motivated retail players. The one thing we all share is a deep love for the game and an unquenchable thirst to get better.

If this sounds like you then consider signing up and checking us out. I look forward to seeing you in the group! And as always, don’t hesitate to shoot me any questions.

Click here to sign up for the Collective

Is This The Greatest Stock Market Rally of All-time? [DIRTY DOZEN]


The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance. ~ Ed Seykota

***Housekeeping note: We’re opening the doors to the Collective, our trading and investing service that delivers research, education, and community. If you’ve been enjoying our free work, you’ll love what the Collective offers. Our doors will be open till Sunday, at which point we won’t be taking on any new members for some time. If you’re interested, click on this link and sign up. And, as always, feel free to shoot me a message with any questions. I hope to see you in the group!***

Good morning!

In this week’s Dirty Dozen [CHART PACK] we look at signs suggesting oil is going to move lower in the short-term but much higher in the long-term. We then look at the ridiculous moves going on in the big tech names and compare them to past speculative bubbles before diving into a recent IB report exploring structural systematic pessimism, what it means, and what could be causing it. And finally, we end by checking out a lithium play with strong secular tailwinds, plus more…

Let’s dive in.

***click charts to enlarge***

  1. Last Wednesday, I shared this chart on the twitters and wrote “Brent oil time spread suggesting we may see a breakdown lower from its compressed range. A bounce in the $DXY would help fuel this move. Need a setup and breakout confirmation from the tape now.” The next day we got the setup and then Friday gave us the confirmation. Expect crude to move lower in the short-term. Longer-term, crude is setting up for a monster bull cycle. The Capital Cycle all but guarantees it.


  1. This chart from Citi’s Proprietary positioning/sentiment model shows the market is giving its best effort to imitate 99’ (h/t to @tihobrkan).


  1. This great chart from BCA Research shows just how silly the run in big tech stocks has gotten. It’s now at 99’-00’ Nasdaq 100 peak insanity levels. Jesse Stine talks about this craziness in his latest public letter which you can find here.


  1. So this is interesting… Employee compensation as a % of US business value-added is hockey sticking higher after being in a secular decline for the last 15+ years. I need to look into how this data is put together to see if there’s anything creating noise here but this could be a very important trend (shoot me an email if you have any insights!).


  1. BofA published a great report last week outlining the systemic pessimism that’s pervading nearly all aspects of our society. Below are a few of my favorite charts from the report.

This one is great. It shows over 200-years of global banking crises. Why the rise over the last 40-years? The answer is leverage. And that leverage is the result of the long-term debt cycle and financialization of the global economy.


  1. Check these out. The charts show the average monthly “tone” of NYT news content from 1945-2005 (left) and the tone of Summary of World Broadcasts news content from 1979-2010 (right). The y-axis is standard deviations from mean. This is quantitative proof that the media is peddling doom and gloom. The fact that the tone is more bearish now than it was at the depth of WW2 tells you everything you need to know.


  1. There’s a bit of a chicken or egg component to this pessimism. With the proportion of the US population satisfied with the US near all-time lows, is the news just feeding us citizens what we want? Confirming our biases? Or is it forming and shaping those biases? Or, is it a feedback loop of sorts?

I don’t know but I do love this quote from economist AC Pigou that’s included in the report. Pigou writes “The dying error of optimism gives birth to an error of pessimism. This new error is born, not an infant, but a giant.” Welcome to the Fourth Turning…


  1. BofA writes in the report that “Equity markets are a low 1.7x the global narrow money supply (in the lowest tertile), cumulative equity fund inflows since 2008 have been USD 425bn, while bond funds have received USD2tn, the percentage of Americans who own equities has fallen from 63% to 55% since 2004… Not exactly a ringing endorsement of optimism, or risk-seeking behavior.”

There’s a demographic component to this (growing wave of retiring baby boomers structurally have lower risk preferences i.e., prefer bonds over equities). But with negative real yields, you have to imagine its shifting those preferences much further out the risk curve.


  1. BofA’s latest Flow Show report has some good nuggets. For example, since the March lockdowns began, central banks have “bought $1.4bn of financial assets every hour” and the “market cap of Nasdaq 100 [has gone] up $1.6bn every hour.”


  1. According to BofA, the SPX is now within spitting distance of becoming the “Greatest Rally of All-Time”. It needs to cross the 3,630 level to make it official.


  1. Going back to my first chart on oil and comment on the bullish CAPEX dynamics. This chart of International Rig Counts from JPM shows supply capacity is trending to unsustainable levels.


  1. With monetary policy tapped out across the developed world, fiscal is going to become a larger part of the economic equation. And government spending on “green” energy is going to be a big part of that. One of the companies we’ve been bullish on for a while now is lithium miner Albemarle (ALB). Lithium battery capacity is expected to reach 2,450 GWh by 2029. If we get anywhere near that range, it’s going to require roughly 2mn metric tons of LCE. That’s well over 5x current demand. Lithium mines take 4-years on average to come online before they can actually deliver supply to market. Currently, there’s little demand for funding any large projects in the space. The lithium market is headed for a supply crunch. ALB stock looks like it’s starting to sniff this out. The chart is a weekly.


***Housekeeping note: We’re opening the doors to the Collective, our trading and investing service that delivers research, education, and community. If you’ve been enjoying our free work, you’ll love what the Collective offers. Our doors will be open till Sunday, at which point we won’t be taking on any new members for some time. If you’re interested, click on this link and sign up. And, as always, feel free to shoot me a message with any questions. I hope to see you in the group!***

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Stay safe out there and keep your head on a swivel.

George Soros’ Currency Framework


At any moment of time there are myriads of feedback loops at work, some of which are positive, others negative. They interact with each other, producing the irregular price patterns that prevail most of the time; but on the rare occasions that bubbles develop to their full potential, they tend to overshadow all other influences. ~ Soros

Markets, like much of nature, are composed of infinite feedback loops.

Understanding these feedback loops was one of Soros’ big analytical edges back in his prime. They’re a critical component of his theory on Reflexivity and also formed the foundation of his framework for analyzing currencies.

In this note, we’re going to explore the primary feedback loops at work in the US dollar. We’ll do this using Soros’ “currency equation”. And in doing so, we’ll see how the long-term USD bull trend is near the end of an unsustainable Core Domination paradigm. One that is ripe for reversion to the mean…

Let’s start with a review of the basics.

Like all markets, exchange rates are driven by supply and demand. Currency supply and demand can be separated into two broad categories: fundamental and speculative.

Fundamentals are things like the trade and balance sheet of the currency issuer and its fiscal and monetary policies, such as its budget deficits and its control of the money supply.

Speculative demand is centered around expectations of the relative and future value of the currency. Think exchange rate trends, interest rate differentials, and relative market opportunities.

To simplify even further. Currency supply and demand is comprised of three things:

    1. Trade
    2. Non-speculative capital transactions
    3. Speculative capital flows

Trade affects exchange rates through the balance of trade. Countries sell goods in their home currency. For other countries to buy those goods, they have to exchange their currency for the seller’s (exporter’s) currency. And vice-versa for when the country wants to import goods. This differential is referred to as the balance of trade. A trade surplus is an appreciating force on a currency and a deficit is a depreciating one.

Speculative capital flows are the buying and selling of currencies with no attached underlying asset.

Speculative capital moves in search of the highest total return. The total return is made up of:

    1. Exchange rate differentials
    2. Interest rate differentials,
    3. Local currency capital appreciation.

Of the three, exchange rates are the most important because they tend to fluctuate more than interest rates or relative market returns. It doesn’t take much of an exchange rate decline/increase to completely overshadow the return on interest rates or capital appreciation.

In the short-term (months to a few years) exchange rates are driven by speculative flows. In the long-term, economic fundamentals (trade + non-speculative capital transactions) dominate exchange rate movements. It’s the dynamic tension between these two that comprise the trends and fluctuations of currency markets.

Soros broke these factors down so he could turn them into simple logic statements (the below example is taken from his book The Alchemy of Finance). He did this in an effort to gain a better understanding of the drivers of a trend and the sustainability of that trend.

The importance of these drivers shifts over time, from regime to regime. This is one of the reasons why the FX markets are notably hard to forecast. Players are often keying off the thing that worked during the last cycle while unaware of what’s driving the current one.

The most recent USD bull market that kicked off in 11’ was driven by an equation that looked something like this.

DXY = US V > RoW V (rest-of-world) = ↑(i+e+m) → s↓ → e↑

Where US growth was stronger on a relative basis (accounting for the US safety premium) than growth in the RoW (US V > RoW V). This led to positive interest rate differentials for the dollar which drove exchange rate appreciation and brought in speculative flows (s) into US assets (stocks + bonds). This drove relative US market outperformance (m).

As a result, the dollar benefited from numerous positive feedback loops that boosted its Total Return Equation, which again, is the most important factor in driving speculative flows.

But here’s the thing… A number of these factors are no longer supportive of the positive USD feedback loop; such as relative growth, yield spreads, and recently, the trend in the exchange rate itself.

In addition, there are a number of longer-term fundamental factors, such as a deteriorating trade balance (T↓) and widening budget deficit (B↓) that are actively working against it.

So now the DXY equation looks something a little more like this:

DXY = ↕(i+e)+↑(m)→ s↕ → e↕

Where the now dollar only has relative market performance (m) working in its favor.

Reflexive processes tend to follow a certain pattern. In the early stages, the trend has to be self-reinforcing, otherwise the process aborts. As the trend extends, it becomes increasingly vulnerable because the fundamentals such as trade and interest payments move against the trend, in accordance with the precepts of classical analysis, and the trend becomes increasingly dependent on the prevailing bias. Eventually, a turning point is reached and, in a full-fledged sequence, a self-reinforcing process starts operating in the opposite direction. ~ Soros

And as we can see in the chart below, this sole-remaining USD bull pillar of relative market performance is historically stretched.

(Note: Benign Circles in the US are characterized by low inflation, an easy Fed, a strong dollar, and US outperformance. While US Vicious Circles are marked by above-trend inflation, a weak dollar, and US underperformance.)

This is one of those things that means little in the short-term but a lot in the long-term.

The fact is that capital concentration is likely near its zenith here in the US. The valuation premium placed on US financial assets is over 1.5std above its long-term average. And it now no longer has the supportive tailwinds of positive growth, yield, or exchange rate differentials.

So at this point, the primary thing preventing the dollar from completely tipping over is relative US asset outperformance, or rather the bullish trend in tech. And this speculative trend that has driven Domination by the Core is itself being driven by stimulus-funded trend followers.

Understanding this, we’ll know the time is ripe for the real start of the USD bear market when the trend in US tech begins to bend — which I suspect will come sooner rather than later. That will mark the extinguishment of the final bullish USD supportive leg and the start of a new regime. One balanced by capital flows back to the periphery (RoW) and a Vicious Circle for the US.

This new regime will be led by commodities, emerging markets, cyclicals, value, etc… And it will kickstart a number of monster cyclical trends.

Finally, I should note that this will just be a standard cyclical turn in the dollar. And in no way does it reflect the greenback’s status as the world’s reserve currency. I’ll write in a follow-up note about why that’s not a serious risk.

In the meantime, DXY is nearing significant support. We should see a bounce soon — failure to do so would be an important signal. Newton’s 1st Law reigns though and a chart in consolidation tends to stay in consolidation. So we need to wait for a range breakout to confirm that a new regime has arrived.

Stay safe out there and keep your head on a swivel.

Other Income Analysis: Spot Danger Before You Invest

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Last we discussed R&D costs and whether we should expense or capitalize such investments. You can check that out here.

This week we’re shifting gears and focusing on a reader’s request: Other Income

I love this topic and can’t wait to dive in.

Let’s go!

What Is “Other Income”?

Remove line items on an income statement and you see nothing but revenues, expenses and bottom-line income. If that were the case, we’d have no hierarchy of income streams.

But GAAP does separate the income statement by line items. And we do have a hierarchy of income streams.

This is where we see the term other income. What is other income? In short, its earnings generated outside normal business operations. The keyphrase here is normal business operations.

Such earnings include:

    • Interest
    • Gains on investments
    • Sale of long-term fixed assets
    • One-time gains on credits

It’s one thing to know this exists. But why does it matter?

Why Should We Care?

It’s important to know where and how a company generates profits. The more a business earns outside its normal operations, the less reliable the income.

If a company can’t generate profits from its core business we shouldn’t buy it. But many investors buy companies that look cheap thanks to one-time other income gains.

Why do they buy them? Quantitative value screens. Think about it. Screens don’t discern between “other income” and “core income”. All they see is the bottom-line number. A company that generated a large other income gain will look cheap on that basis.

“Other Income” Example: Facebook (FB)

Let’s use FB as an example for other income. Check out FB’s last two years’ income statement numbers (via TIKR):

The line items highlighted in blue are sources of other income.

You can see that it doesn’t matter in FB’s case. They generated nearly $24B in core operating income in 2019. $800M in Other Income is a simple rounding error.

But that’s not the point. The point is to train your eye to look for these line items. Because not every company looks like FB.

How To Gauge Other Income Severity

Other income analysis is important. It tells us whether a company generates most of its earnings from its core business. Or if other (unreliable) streams of income bolster the bottom-line.

Here’s a quick heuristic to gauge whether a company’s other income is something to worry about.

Other Income Ratio: “Other Income” / Operating Income

This ratio reveals how much of a company’s total operating income comes from its other income sources. Higher ratios signal less reliable income streams.

But again, everything comes with a caveat.

The best way to run this ratio is over time on a rolling basis. We shouldn’t punish companies for true one-time asset sales or restructurings.

Examine this ratio over the last five years. What’s the trend? Is it consistent? These questions help pinpoint exactly how the company truly makes their nut.

If you have any questions feel free to reach out.

How Wide Is the Equity Risk Premium? [DIRTY DOZEN]


This will all end badly, we’ve not the slightest doubt, and the only question is when. Probably not tomorrow, as we say. But that’s as far out as we’ll go. ~ Alan Abelson,  “Up and Down Wall Street,” Barron’s, May 24, 1993 (Dow Jones Industrial Average at 3492) via Niederhoffer’s “Practical Speculation”, chapter “The Cult of the Bear”

Good morning!

In this week’s Dirty Dozen [CHART PACK] we look at sentiment and positioning across player types, we then dive into the technicals and discuss why overbought usually becomes more overbought. We talk about the fat risk premia on offer + liquidity that is driving the moves in risk assets. And finally, we end with a look at the cheapest assets on offer plus a Florida real estate play breaking out of a MASSIVE base…

Let’s dive in.

***click charts to enlarge***

  1. Last week I shared the Investors Intelligence Bull-Bear chart showing the spread was at its widest point since the Jan 18’ blowoff top. This week we’re going to run through some more sentiment and positioning charts to see how they breakdown across investor types. Here’s the NAAIM Average Exposure Index which measures the reported equity exposure amongst professional money managers. It typically reflects more tactical positioning. It recently hit its highest level since December of 17’ and its third highest point in the survey’s history.


  1. The “Fed has the market’s back” has become a consensus take. This narrative combined with stimulus money and WFH has led to a large rise in speculative activity amongst retail traders. Here’s a chart from SentimenTrader showing Call Open Buys – Put Open Buys (adjusted as % of NYSE Volume) is at an all-time record high.


  1. But there’s one group that stands apart from this speculative orgy and that’s large asset allocators/hedge funds. The chart below shows the general equity exposure amongst this slower-moving class of money managers. It’s still in post-recession/bear market low territory. And even more notable, is how long they’ve been under-invested for. If you think they’re the “smart money” then you could take this as a bearish sign. Or this could be thought of as still yet an untapped source of potential equity demand should they soon shift their risk preferences — I lean towards the latter.


  1. The SPX is above its weekly Bollinger Band and about to knock into the topside of its 2 ½ year broadening triangle pattern. It’s in a buy climax and buy climaxes last longer than many expect them to. Though we’re moving into the weakest month of the year (September) and trend fragility is high — due to sentiment/positioning and divergences in credit — momentum still favors further upside over for now.


  1. I saw variants of this chart being passed around showing the spread between the Nasdaq and its 200-day moving average. The funny thing though was that all of those charts only went back to 2003, making the spread look more extreme than it is. So here’s the full chart… This is not to say that tech stocks aren’t extremely overbought. They are. The point is is that overbought is not evidence enough to be bearish, since an overbought market almost always becomes more so. Keep in mind Bob Farrell’s rule number 4 (from his 10 rules) which states that: “Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”


  1. In financial markets, everything is relative… The perceived value of equities is dependent on the expected return on bonds. Nothing is valued in a vacuum and it’s the spread between assets that drives positioning flows and the abundance of liquidity in the system that determines the amplitude of the relative moves. And that is why it pays to look at risk premiums over P/E ratios. Here’s Credit Suisse making the case for ERP:

Why investors must look at the ERP not P/E: The ERP gives a much more realistic assessment of valuation than P/E if real bond yields are below the terminal real growth rate…The Fed believes that r* (the equilibrium real short rate) is 1.3% below the terminal growth rate. Currently, the TIPS yield is nearly 2% below the terminal growth rate and we think can move to be c3% below. Importantly, it seems highly likely to us that the TIPS yield will stay depressed for the next decade (as that seems the most politically and economically acceptable route to allow government debt to GDP to stabilize and unemployment to fall to low levels). The aggregate policy setting (fiscal, monetary, and corporate lending conditions) are twice as loose as they were at the peak of the GFC, allowing inflation to return while bond yields are capped.”

I don’t share their same conviction regarding inflation trends over the next decade. That whiffs of hubris to me considering how wide the cone of probabilities is today in regards to potential fiscal and monetary policy experiments. But… the ERP is still plenty wide on equities and well above the point that marks most major market tops.


  1. And here’s another chart form CS showing that the composite (fiscal + monetary) policy score is twice as loose today as it was during the GFC. Liquidity is strong…


  1. Last week I put out the first piece in a series I’m doing on the dollar (here’s the link). The second installment will hit your inboxes in a day or two. Anyways, in the write-up, I talked about how I am looking for a short-term reversal soon because the dollar is overextended, bearish sentiment and positioning are crowded, and rising US bond yields are supportive of the move.

So far, the DXY has failed to rally and it in fact looks like it might break lower from its current consolidation. I’m okay with this since we’re short USD through a couple of pairs. Here’s a chart I’m watching closely. It’s a weekly of the breadth of cross dollar pairs. The green zone represents majorly oversold levels. The key though is that you want to see breadth turn and confirm a move higher. Right now it’s pointing straight down which favors the bear case in the near-term.


  1. Last week I did a short twitter thread on the topic of Bubble Rotation from Lars Tvede’s excellent book “Business Cycles: history, theory and investment reality.” There are some useful heuristics in there that’ll help you figure out where the next “bubbles” are likely to spawn. I’m personally looking at commodities, which are trading at all-time lows relative to the market (chart via GMO).


  1. They are going to have massive Capital Cycle tailwinds over the coming decade. According to GMO, CAPEX has been cut by more than 40% over the last decade. We’re tracking some exciting opportunities and are just patiently waiting for the market to signal that the time is ripe.


  1. Buybacks are a critical input in the cyclical market equation. This is why the below chart from @TimmerFidelity is concerning. Buybacks are extremely depressed this year. And it’s unlikely the bull market can extend its run much further if this key source of demand remains tepid.


  1. We’ve been quite bullish on real estate plays at MO, as there are a number of strong secular tailwinds for the sector. One play, that we’re considering adding to our book is St. Joe (JOE). I read a number of bullish writeups on the company years ago as it was a faddish value stock for a time. I’ve kept it on my radar since but it’s been a dead money chart until only recently. The monthly chart below shows the stock is about to close at 6-year highs.

The company owns a massive portfolio of mixed-use land in Florida. Much of that acreage is prime beachfront real estate. Their developments are benefitting from a boost in demand due to long-term migration shifts with people seeking out nicer climates, lower taxes, and more rural living. You can find an older writeup on the stock done by our friend Kuppy over at his blog, Adventures in Capitalism.


Stay safe out there and keep your head on a swivel.