I said in my previous newsletter that markets would move further and faster than ever given all the algorithmic and machine-based trading, and boy, did I get that one right. Unfortunately, I also said that it was a "yellow flag" environment, and, while that was true for a short while, the bounce off the March low has been extraordinary. The takeaways for me are threefold: first is a reinforcement in my belief that owning, and staying with, the right companies provides the best chance for investment success; second is that trading/investing based on media or headlines is useless, and third is that volatility is the friend of the long term investor.
"It ain’t what you don't know that gets you into trouble. It’s what you know for sure that just ain't so."- Mark Twain
Literally every person I've spoken with about the markets has said something to the effect that "this rally makes no sense." While that may appear to be true today, I am reminded of Richard Russell's comment that "the markets make the news, not the other way around." Recently, John Normand of the JP Morgan cross-asset strategy team said "May should mark the end of the shortest but deepest recession in a century" (source Financial Times May 23-24). Perhaps the market has been forecasting that.
I don't know the ultimate outcome of the current situation. On one hand central banks around the world have purchased $6trn of assets to support markets while on the other hand there is the giant unknown of earnings and whether markets will give 2020 a “hall pass.”
My"north star" throughout has been that this crisis has accelerated many preexisting trends, and that that those trends will remain even after the economy opens up. I continue to favor companies/industries where rapid/monumental change is happening.
Performance is pretty good, hard to match the past few years
Through May 22, 2020 has been a mixed year for Peattie Capital clients. On the negative side, most accounts are down low/mid-single digits, with two outliers down about 8%. These two outliers have significant exposure to Independence Holding Co ("IHC"), which is down 35% year-to-date. On the plus side, several accounts have gained low/mid-single digits. The total return of the S&P 500 through May 22 is roughly -8%.
An abundance of good performers
Several core holdings in PCM portfolios have been terrific in 2020. Microsoft ("MSFT"), Alphabet ("GOOG") Adobe (“ADBE”) and PayPal ("PYPL") are all core positions and I expect to continue holding them.
IHC is a microcap insurance company which I have owned for several years. In April, the company announced a 1mm share tender offer at $27, which expired last week. IHC has a book value of $31, no debt, lots of cash, and has steadily increased its dividend for the past eight years. As such, I had no interest in selling at $27. After the tender expired, IHC announced preliminary results that only 36,000 shares had been tendered and that they would resume their existing buyback program for nearly 1.7mm shares. IHC could buyback 2mm of the approximately 14.8mm currently outstanding. This year’s price decline is a short term drag on performance for several PCM accounts, but I believe the shares will recover.
I also continue to like China, but between the Luckin Coffee fraud case, a variety of short sellers questioning accounting standards, and the President's relentless attacks, shares of the few Chinese companies in PCM portfolios have been somewhat volatile. One strong performer is Pinduoduo ("PDD") which reported huge numbers last week and the shares jumped 15%. For the year, PDD has gained about 85%. PDD was founded only five years ago and already is China’s second largest ecommerce company with over 600mm annual users (source: Ark Research).
A couple new additions
Recently I added Twitter (“TWTR”) as I believe the two new additions to the Board (one from Elliott Associates and one from Silver Lake Partners) will either help the company finds ways to monetize assets or they will push for a sale of the company. Personally I have begun using Twitter as my "go to "news source, and I have found it informative, reliable, and timely. TWTR will benefit from the return to "normal" (think live sports) and 2020 is also an election year.
Broadly speaking, the regulatory questions surrounding mega tech companies aren’t a game changer as far as I’m concerned, and arguably might be beneficial to existing shareholders. Personally I would welcome more transparency about say, YouTube, for example.
The timing of my TWTR shares hasn’t been great, as the President’s attack on social media companies this week has pressured shares. Still, the track record of Elliott and Silver Lake are phenomenal, and this tempest is probably driving even more users to the platform. I remain optimistic about the investment even though TWTR is controversial right now.
Over the past year or so I have become increasingly comfortable with Ark Research, and have added them to my stable of research providers. Ark specializes in disruptors, and has been very bullish on Tesla ("TSLA"), among others. Originally I dismissed TSLA because I didn’t feel comfortable with Elon Musk, and also because I thought other car manufacturers would be able to provide a compelling product as well. However, recently I have begun adding TSLA shares.
I'm feeling better about Musk, and I think the world is heading towards electric/hybrid, where TSLA cars are extremely popular and increasingly affordable. I base that on numerous conversations with TSLA owners, all of whom LOVE their car, and TSLA’s surprising ability to ramp up deliveries.
Ark recently put a $7,000 price target on TSLA, and added that shares could get there in the next few years. That seems aggressive, but ARK has been pounding the table on TSLA for a couple years and so far everything has unfolded pretty much as they have said. Stay tuned.
Please feel free to contact me with any questions or comments.
Last year's phenomenal performance, when most accounts gained well over 50%, seems a distant memory with today's coronavirus outbreak and the S&P 500 down about 8% through March 6. Peattie Capital accounts have performed relatively better, with most accounts down roughly 5%. Past performance is not a guarantee of future returns.
It's been my experience that the faster markets fall, the higher correlations go, or, said another way, the more likely everything will go down together. The last week of February there were two 80% "down days" (down volume as a % of total volume) and two 90% down days, and I don't recall ever seeing that happen, even in the financial crisis of 2008-2009.
That said, when the market bottoms, the best names will bounce back the furthest and fastest, and I believe many Peattie Capital names fit that bill.
It's tempting to raise more cash, and in IRA accounts I may do so, but for taxable accounts selling means a) creating a taxable gain, and b) figuring out when to be back in (usually the market has already bounced 20-30% before it feels "ok" to be involved).
In addition, taxable accounts already have an enormous short-term taxable gain in 2020, the result of Novartis buying The Medicines Company in early January.
So potential selling and re-positioning will be on a client-by-client basis, and I may be boxing positions also (boxing is being both long and short a company's shares simultaneously).
Plenty of issues
Broadly speaking, earnings reports for Peattie Capital holdings were good this cycle, but for the time being that won't matter as the market is responding to headlines.
From a market perspective, my single biggest fear has been a Sanders nomination, and, to be sure, that is still possible. However, the odds of that are significantly diminished after Super Tuesday.
Earnings and the economy are the next biggest concern. Credit spreads have widened, which tends to be associated with a weakening economy, and no one knows what the effects of the coronavirus will be on overall growth. Clearly, some areas/industries are being hit more than others.
As for the coronavirus, my best guess is that until we see a peak in confirmed cases in the US, there will be volatility, possibly on the scale we've seen the past few weeks, as the number of cases and locations where it has appeared are increasing.
One potential silver lining is that a number of Chinese companies have performed better than US shares recently, possibly as a result of somewhat better news out of China regarding containment of the virus. A March 6 headline in the FT states "Wuhan appears to stem tide of infections". In other words, eventually "this too shall pass". According to the article "residents have largely been confined to their homes for more than a month". That is unlikely in the US, and I suspect things will get worse before they get better.
Another potential benefit is that some wonderful companies have become more attractively priced, and I have a shopping list of names to own when the time is right. Many of these are down 15-20%, despite no change, or even improving operations.
It's also helpful that the Federal Reserve remains "market friendly". Not that lower interest rates will cure the coronavirus or stimulate tourism, but having a Federal Reserve ready to provide liquidity and easier financial conditions helps, at least in the short term.
One other item worth mentioning is that with the increasing presence of algorithmic/machine trading, I expect the market to go further and faster directionally than ever before.
Overall I think it's a "yellow flag" environment. There is no rush to add anything right now; I am proceeding with more caution than usual.
Growth/Change is still the best opportunity
With a 10-year Treasury note now yielding 0.8%, I think good stock picking provides the best chances for investment success, and within equities I continue to favor growth-oriented companies. I've said before, and I continue to believe, that the runway for the massive infrastructure overhaul to the cloud and the "digital revolution" is still very long, and will spawn numerous investable opportunities.
For example, software permeates every industry and company across the globe and also has no complex supply chains. Gartner estimates overall IT spending in 2020 will be $3.9 trillion, "more than enough opportunity for fantastic growth" according to Globant CEO Martin Migoya.
Globant ("GLOB"), a software company with a focus on Artificial Intelligence, is a particular favorite, not only because of the outstanding financial results but also because of the company's culture. On the call, Mr. Migoya announced a "Be Kind" initiative and the appointment of a Chief Talent and Diversity Officer to manage it who made the following comments:
"…we're facing new challenges that go beyond our business. Our planet demands us to be united in responding to climate change. At the same time, we need to take a stand in regards to inclusion and diversity…"
"Globant has made the commitment that 100% of our energy consumption will derive from renewable sources by the end of 2020……we have committed to have women and non-binary people hold 50% of our management positions by 2025. We are also going to train and inspire 2,000 women around the world in technology by that year…we want to transform the world with technology and apply our work for good, one step at a time…we have, therefore, created the AI manifesto as a guideline for our company's dos and don'ts regarding this technology, and we will encourage other companies to get on board as well."
I'm mentioning Globant for several reasons. For one, it's off the radar of many investors but its 140% return since I first bought shares two years ago dwarfs the roughly 15% total return for the S&P 500. It's the kind of company that has attracted me to growth opportunities, and demonstrates the power of good stock picking.
The "Be Kind" initiative is unique, and who knows how it will impact performance, but clearly the company is a stellar example of the trend towards ESG. I think that trend is in its early innings.
GLOB is also a good example of a growth company experiencing a slowdown in its rate of growth. I'm curious how the market will respond to that slowdown, and for now I expect to continue to hold shares as I believe the company is well positioned and delivering on many key metrics.
Conclusion: It's a different environment
Record amounts of debt, falling (now historically low) interest rates, and multiple expansion have been the driving forces of the stock market's extraordinary performance since bottoming in March 2009. Despite these wonderful tailwinds, annual GDP growth has hovered in the vicinity of 2% for years. I suppose there's something to be said for slower, consistent growth, but it's noteworthy that "this is the weakest expansion since World War II" (source: Joe Zidle, Chief Investment Strategist of Blackstone, "Looking Beyond the Volatility" March 2, 2020).
Today's forward earnings estimate is roughly 17x (source: WSJ March 6), and from these levels returns tend to be around 5% (source: Zidle). However in today's world the "e" part of the p/e ratio is more uncertain than ever.
It's also an election year, which tends to be flattish when an incumbent is running for re-election, at least until the latter part of the year when the outcome becomes more apparent.
I think the landscape is changing, and I maintain that good stock selection will be more important than ever going forward.
Thank you for being a part of Peattie Capital and feel free to contact me with any questions or comments.