November, 2019. At the risk of sounding like a broken record, many of the things I mentioned in the August newsletter largely remain true today. That is, 2019 continues to be a stellar year for Peattie Capital portfolios, although the past few months the relative outperformance is not quite as substantial as it had been. Accounts are still well ahead of the overall market, but not by as much as they were a couple months ago. Please keep in mind that past performance does not guarantee future returns.
Through November 4, most accounts have gained roughly 30%, compared to a 24% total return for the S&P 500. A couple "constraint-free" accounts have gained over 40%, and the best performer is up nearly 50%. Performance has been driven by stock selection, as any number of positions have gained over 50% and several have gained much more than that. Based on what I know today, I expect to continue to own most existing positions.
For now, the tailwinds are still good
I've said repeatedly that I am far more interested in individual stocks (and industries) than in the economy at large and other global macroeconomic and political issues. That said, my thumbnail take is that the US economy is in decent shape despite a somewhat slower GDP growth rate of +1.9% (formerly 2.1%). In addition, employment remains healthy, and the Federal Reserve remains "market friendly".
I also note that the yield curve is positively sloped (no longer kinked), while an inverted yield curve can be a precursor to recession.
To be sure there are both short-term and long-term challenges. For example, manufacturing and housing turnover have been soft recently and longer term the US is burdened with overwhelming debt, never-ending increases in health care and education costs, and a Federal Reserve that is seemingly "out of ammunition" to fight the next recession, whenever it comes. Inflation has been quiet, but if it were to appear that would bring higher rates which would be a serious headwind for equities.
According to a November 1 FT article "Fate of Borgias should act as a warning signal for US establishment" (Author:Edward Luce) "the net worth of the median US household in 2016 was $97,300" and "America's wealthiest 400 families are worth the same as the bottom 300m people combined." Needless to say, income inequality is alive, well, and growing.
(I am going to add a "bonus" long term challenge which is that until recently I had never heard a child of a sitting president refer to her (him) self as a "First Daughter", and it vaguely suggests to me that access to those in power is for sale, more so than ever before.)
I appreciate that parts of the world are experiencing slowdowns, and that there are any number of economic and political concerns both here and abroad. Nonetheless I believe that owning companies that are undergoing change not yet reflected in the market price, companies that are underfollowed and may not be in any index, and companies that can "make their own weather" will provide long-term investment success. The "Land of tall trees", if you will. I prefer to own companies that will grow and appreciate based their own news flow and earnings and not by whether an ETF manager has to put to work funds that have come his/her way.
Favorable calendar, for now
November is the beginning of the best six-month period for the markets and the third year of a presidential cycle tends to be a good one, so it's reasonable to think that 2019 will finish favorably. Broadly speaking, election years tend to be more choppy, at least until the election is over, and I expect Presidential tweets to be "good news" ("We're about to sign a fabulous deal with China!!" e.g.), especially if the President falls behind in the polls. Overall, I would expect good stock picking to be increasingly important next year, and I would be surprised to see indices gain another 20-25% in 2020.
Growth vs. value reversing?
A few years ago I began emphasizing a more growth-oriented approach as I became persuaded that the "digital revolution" would provide numerous investment opportunities. So far, that has been true, and being involved in the "growth" sector of the economy has been wonderfully profitable for Peattie Capital clients.
That is not to say that I consider myself a growth manager; I don't. I consider myself a generalist, who made a tactical decision to emphasize growth. Someday that may change, and I note that after a very lengthy period of growth outperformin value, for the past few weeks value has been outperforming growth.
Morgan Stanley and the 60/40 split
Back when rates were much higher (think early 1980's), a traditional 60/40 equities/bonds mix produced double digit returns and more recently it produced a 6% return, according to recent Morgan Stanley research (source: Barron's November 4). However from today's levels it's a much different story, and Morgan Stanley predicts that such a portfolio will produce only a 2.8% annual return for the next decade, about half what it has been the past decade.
The earnings story: mostly hits....
In May's letter I mentioned that Microsoft ("MSFT") and Alphabet ("GOOG"), two core holdings, had excellent reports and that shares responded favorably. Ditto that comment here. At some point valuation will be an issue, but the longer-term trends such as migration to the cloud and all things digital are very much in place and arguably still have a lengthy runway.
Cogent Communications ("CCOI") increased its quarterly dividend to $0.64, an increase of 14% from last year. This is the 29th consecutive quarterly increase, and shares of CCOI have returned about 40% so far in 2019. EPAM had yet nother solid quarter, and shares jumped 7% after the company reported on November 6. For the year, shares have gained about 65%.
IDEXX Labs ("IDXX") is one of my favorite companies as it the leader in the "humanization of pets", and I mentioned in May that John Ayers, Chairman, President and CEO, was on medical leave after a serious bicycle accident. The company hasn't missed a beat, however, and shares jumped after they reported earnings. Most appealing about IDXX is the significant (20%+) of revenues they spend on R&D, much of which is on developing tests and testing equipment for vets, which they then sell in a "razor and razor blade" model. Despite the heavy R&D spend, IDXX generates significant free cash, estimated this year to be approximately 65% of net income. It's a very expensive stock, but worth owning, at least for now.
After taking down estimates slightly after their Q2 report, PayPal ("PYPL") shares dropped about 20% in Q3. However, the Q3 earnings report was much better and the story is on track. I still like PYPL very much as they are in the middle of several very powerful trends and recently announced more international expansion. I've trimmed positions a bit, and PYPL remains a 3% position (ish) in most accounts.
A couple misses....
On the downside, several months ago Howard Hughes ("HHC") announced it had hired advisors to review strategic options and shares bounced to about $130 from $105. Subsequently HHC announced it would undergo a restructuring, rather than sell itself, and shares fell right back to about $110. In addition, the single largest shareholder, and Chairman, sold half his position, and I have concluded that there are better investment opportunities elsewhere and sold the position.
Sealed Air ("SEE") has been restructuring ("reinventing") itself for a couple years now and took down numbers when they reported, triggering an 8% selloff. I think patience is extremely important in investing, but I am beginning to run low on it with SEE.
And a couple new names on the radar
I think the China tariff related headlines have masked investment opportunities there, and I have begun looking at a couple emerging companies who operate solely in China, but shares are listed on US exchanges. As I've said many time, volatility is the friend of the long-term investor.
HUYA Inc. ("HUYA") is a Chinese gaming and streaming company, specializing in esports. GDS Holdings ("GDS") provides datacenter and IT infrastructure services to large enterprise clients. By some estimates, the Chinese data center market is 10 years behind similar businesses in the US and Europe (source: Value Investor Insight October 31, 2019).
Both these companies are investing heavily and not yet profitable, and as such are not for every Peattie Capital client. However, they are extemely fast growing, and positioned very well for continued growth. They both report earnings during the week of November 10, and I will be paying close attention.
Update on The Medicines Company ("MDCO")
MDCO continues to deliver positive test results for Inclisiran, their drug which treats various forms of cardiovascular disease, the world's largest cause of death. The CEO began the October 30 earnings call by stating that 47,000 people die daily from cardiovascular disease(s).
In a September Barron's article, one of MDCO's shareholders speculated that the company would be a takeover target, and put a $100 year-end price target on the shares. The same shareholder reiterated his point of view at a Barron's sponsored biotech breakfast a few days later. I have no idea if that will happen, but a $4.5bn market cap would fit nicely for a larger drug company. MDCO has exclusive global rights to Inclisiran until 2034, and stated on the call "We have all strategic optionality in front of us and we're very excited by those options." My conclusion is that shares are worth holding, even after their 185% gain already in 2019, regardless of a potential takeover.
MDCO is presenting data on November 16 and 18 at the American Heart Association Conference in Philadelphia, so this one could have some near-term volatility. In addition, the company expects to file documents with the FDA in Q4, and in Europe in the first half of 2020. Eventually I would expect significant value creation here, whether it's in the near future or somewhere down the road.
I am giving serious thought to changing Peattie Capital's "no lockup" policy by requiring new clients to keep assets here for some period of time, say, 24 months. In addition, while I will remain flexible and "user friendly" there may be limits as to how much I can accommodate individual portfolio constraints.
Please don't hesitate to contact me with questions or comments or to let me know if you'd like to be removed from distribution.