Blue Elephant Capital Management

50 Shades of… ‘Yertle the Turtle’?

Given the proximity to Valentine’s Day, and having heard of everyone pre-purchasing their tickets to “Fifty Shades of Grey,” I was inspired to write about something obvious this week – Yertle the Turtle. For anyone not generally familiar, Yertle is a Dr. Seuss character – the king of a small, quiet pond where all is well. Of course, he decides that the higher he climbs and the more he can see, the further his rule as King of the Turtles extends. As he piles up more and more turtles, he forgets that the most important part of his rule are the turtles holding him up, notably Mack, at the very bottom of the pile, who is none-too-pleased about his predicament. We can all guess or remember the ending – Mack burps, Yertle falls and is left as “King of the Mud. That is all he can see.”

Having read this book to my children recently, I was struck by how relevant it was to succeeding in the marketplace lending arena, as is our focus at Blue Elephant. I’m not sure I need to list 50 similarities, but here are a few:

  1. Marketplace lenders – At first, Yertle piles nine turtles up and happily finds “I’m king of a cow! And I’m king of a mule!” Life is pretty good at the early stages, but the desire to climb higher despite the risks is tough to work through. Our strategy of lending across multiple platforms is related to this – each platform will eventually have its own growing pains, whether due to increasingly aggressive lending or simply because the business cycle turns and causes pain. I’m not suggesting that platforms will behave like our friend Yertle, but as an investor there are many reasons why diversification is necessary. By having unique access to different and uncorrelated lenders, we have the ability to not climb too high on any one stack – something that we think will be important over the coming years.
  2. Interest rates – To be fair, anyone who has followed my thought pieces (www.bluelep.com/viewpoints) will find very little about this topic. Oddly enough, my introduction to capital markets was as a US Treasury trader years ago. We’ve not worried a ton about interest rates moving higher at Blue Elephant, which has been the correct view (note: it has been the correct view for almost 30 years!). Not happy with his nine turtle stack, Yertle moves on to piling up 200. From the top, the move from 9 to 200 turtles is an obvious positive. “He could see forty miles from his throne in the sky.” I’d imagine that to anyone in the stack or watching from below, the structural integrity was more questionable. As global interest rates fall towards zero, there is a mathematical limit that should push investors out of traditional fixed income product. Last year, the long bond returned over 20%. To do that again, 30-year rates in the US would have to fall below 2% — a rate that must be consistent with subpar growth and/or deflation for an extended period. My point isn’t that rates must go higher – it is that there are fewer and fewer reasons to invest in traditional fixed income regardless of the direction of interest rates. This is good for non-traditional fixed income investors like Blue Elephant but is likely to cause more volatility going forward.
  3. Central banks – As Yertle climbs higher and higher, he is finally brought down when he tries to out climb the moon – “Say, what IS that thing/ That dares to be higher than Yertle the King?” As Central Banks run out of ways out out-ease each other, I do worry that we are closer to the moon than is healthy. There is no doubt that markets are addicted to the practice – note how the European equity markets have outperformed since the announcement of the ECB’s program – despite the growing fear that QE is not a path towards sustainable growth. Asset prices will continue to inflate so long as growth stays positive, but the risk grows on a daily basis as more investors are forced out of cash into artificially inflated assets.
  4. The question of “Mack” – Yertle’s reign ends when Mack, at the very bottom, burps. “And his burp shook the throne of the king!” At any point in any market cycle, we can make a list of the potential ‘Mack’ moments ahead. Some obvious choices now would be Greece, the Ukraine, Middle East, oil prices, Fed rate hike, currency wars gone wrong – I could go on. Unfortunately, the Mack Moment that actually occurs isn’t on the obvious list. All we know for sure is that for whatever reason, Yertle doesn’t get to be king forever.

I am not trying to be a Valentine’s Day downer, though admittedly my list isn’t meant to be uplifting. There is a silver lining – “of course… all the turtles are free/ As turtles and, maybe, all creatures should be.” Sticking to the investment theme, in markets we are always aware that the path ahead is treacherous and unknown – yet we invest anyway because we are free to set our own portfolio allocation, goals and risk limits. By examining the turtle stacks and determining which are the most precarious, we hopefully make smarter decisions than if we pretended that everything was perfect. As I write, the S&P is close to all-time highs with interest rates close to all time lows – that’s an excellent outcome for most investors. There’s the silver lining.

Just make sure nobody burps. Not on Valentine’s Day anyway.