End of the recovery?
Bank of America, an investment house whose research we follow and value, produced a European equity strategy report on Friday with the title “Running out of recovery fuel”. Below are the major considerations of the American house:
1) After a strong third quarter, economic growth is expected to flex fairly quickly from the fourth quarter.
2) Cyclical momentum is already running out in the US and will soon run out in Europe as well.
3) China, which has started to reduce economic stimuli, will not be able to support the global economy.
The conclusions are a downgrade of the European stock market from overweight to neutral and a drastic reduction in cyclical exposure, luxury, autos, capital goods and commodities. Utilities go from being neutral to overweight. Consumer staples and pharmaceuticals remain underweight, the former on valuations and the latter on dollar negativity and regulatory fears. Banks and the value sector remain overweight.
The broker’s view is based on a top-down analysis, while we limit ourselves to bottom-up analysis.
We can say from our observations that:
1) Auto, luxury, capital goods, steel and commodities appear expensive and we have already sold them to a large extent. 
In the automotive sector, we are left with special situations such as Renault, BAIC, Valeo, Continental and a bit of Volkswagen. The first two are turnaround stories, while the others are electric mobility or ADAS players not recognized by the market as such. In capital goods, we remain on Asian stories while the sector in Europe is fully valued. Luxury is expensive and has, in our opinion, ended its cycle of super-growth linked to globalization. We are now entering a new post-globalization phase and the sector is facing further high-growth that is difficult to achieve. We believe that steel is now riding a different cycle, with more demand (infrastructure) and less competition. However, the prices reached can be defined as adequate and we are waiting for phases of volatility to return. Commodities will also benefit in our view from a long cycle, linked to the infrastructure revolution of the next 10 years. However, the price of some commodities reflects short-term bottlenecks that will soon be reabsorbed. We remain invested in very diversified and solid players in addition to nickel, vanadium and graphite specialists.
2) Many utilities stocks are trading at extremely attractive prices, in particular those renewable energy and infrastructure players that are not recognized (e.g. Engie and E.ON respectively).
3) Regarding banks, as discussed in last week’s newsletter, we agree with BofA that they present an extremely attractive risk/benefit profile.
4) On consumer staples we agree. The sector is very expensive, seen as defensive and bond proxy. It is better to stay with niche players with more attractive valuations who can benefit from current trends (ethical farming, vegetarianism, veganism). For pharmaceuticals, we are more positive, in particular big pharma has attractive valuations and potential room for corporate action. We believe that Covid has reduced the risks related to a reduction in the fat margins they realise in the US following potential legislative interventions, although, it is true that the sector is sensitive to the dollar, this represents for us a natural hedge against our controlled exposure to the greenbacks.
5) On value we clearly agree and reiterate that the gap between value and growth has never been so wide and unjustified. Value will continue to close the gap as soon as it becomes clear that the current strong recovery will not turn into a recession, but that growth will continue to be driven by infrastructure, more benign regulation and reduced Chinese competition. The depressed valuation level at which we can buy quality stocks today will be difficult to understand in a few years. Particularly when compared to the high valuation level at which growth companies are voraciously bought today, many of which will inevitably turn out to be shooting stars over time.
Electric cars, it’s taking off…
Ever since we’ve been watching the industry, starting in2014, we’ve been imagining the famous S-curve of penetration 
of the big new technologies that we’ve repeatedly reported on in our industry videos and presentations, waiting for the long part of the letter, which is when the technology becomes mass market. We’re getting into that now. All the traffic lights we had identified are now green: number of available models, sexy available models, autonomy, price, subsidies, recharging network, limitations to diesel vehicles entering cities.
All green!
At the end of last year, electric vehicle (BEV+PHEV) penetration stood at 6%, in line with our early charts. We are on track for a year-end penetration of 11%, again in line with our estimates and still far from the estimates of the consulting firms. A study against the grain, in that it is significantly more positive than the market, again from Bank of America, released in late June, points to 2025 as the year when there could be a clear imbalance between battery supply and demand. While we are pleased to read this, we believe it may be evident as early as next year and will last at least a couple of years. We also reiterate that by the end of 2025 the potential penetration is huge (Niche 65/70% Vs BofA, by far the most positive among institutional observers, indicating a range between 25% and 50%), if only there were enough batteries to sell…
We attach below the chart from the first presentation we did as Niche AM dating back to 2018 overlaid on top of the revised one from last year. As you can see, apart from a small tweak in the Covid area, it remains unchanged.
Notwithstanding the above, today it is possible to be exposed to this sector in a value way: the EV/EBITDA of the Pharus Electric Mobility Niches fund is around 5 times and below 2 times the tangible book.
NicheAM – EV penetration estimates presented in 2018
NicheAM – EV penetration estimates presented at the end of 2020
Source: NicheAM
Value investing – Anthony Bolton
Undoubtedly the greatest British value manager of his time, John Bolton managed the Fidelity Special Situations fund for 27 years, from 1980 to 2007, recording a spectacular average annual outperformance of 6%.
Fundamental, value and deep value, contrarian focused on small and mid-caps, Bolton’s approach is apparently simple, but what makes him unique is his passion and dedication (“the job of manager absorbs directly and indirectly all the days and evenings, weekends included”). His methodology, (he wrote down his company meetings in his notebook and during his career he collected 87 of them containing about 10000
discussions with the management of the companies in which he invested), his inability to feel euphoria or fear, the drivers of market volatility and irrational behaviour (“… I recognize that I am a rather impassive individual”), his humility (“in the end I am only right 55/60% of the time…”) and his capacity for imagination. (Bolton used to compare investments to chess, being able to foresee the different scenarios and be ready to face them is essential).
Many times American hedge funds tried to take him away from Fidelity, but Bolton believed that their greed was the enemy of the patience essential in value investing.
Anthony Bolton’s rules are simple:
1) Avoid overcrowded sectors. Bolton focuses solely on value stocks and likes to quote Benjamin Graham’s famous passage written in the 1970s:
“Growth stocks seem impressive as well as exciting. It seems so reasonable to own them that they carry little career risk (for professional PMs). As a result, they have underperformed by 1.5% per year for the past 50 years. Value stocks, on the other hand, belong to boring, struggling, and below-average companies. In hindsight, their continued underperformance seems to have been predictable and thus carries significant career risk. To compensate for this career risk and lower fundamental quality, value stocks have outperformed by 1.5% per year.”
Having reported this quote we feel it is useful to do a refresher between value and growth. In the 10 years following the publication of this now famous Graham quote, the gap widened again. From 1993 to 1999, during the TMT bubble, the outperformance of growth was violent, but it was completely reabsorbed from 1999 to 2007. The great financial crisis together with globalization led to a lasting polarization of growth, with areas in strong and prolonged expansion and areas in strong and prolonged decline. This led to a major reopening between value and growth in favour of the latter. Covid depressed growth expectations and accelerated the divergence again. Today what is worth little (value) is worth even less as the market is in a secular decline, although this part of the market represents the bulk of our economy. At the same time, what is worth a lot (growth) is creatively valued because the market is experiencing secular growth without the risk of commoditization or competition, which seems quite unreasonable.
The trend of the last fifteen years makes Graham’s statement even more interesting, and the opportunity on the value front even more irresistible.
Performance of a Value Portfolio compared to a Growth Portfolio 1926-2020
Source: CIM – Tom Hardy
Relative performance of Value and Growth 1993-2021
Source: Pacer advisors – Tom Hardy
Relative Performance Value and Growth September 2020 – July 2021
Source: NicheAM, Thomson Reuters
2) Diversify. Bolton NEVER invests more than 4% of NAV in any one company.
3) Always take the time to read financial statements. IN FULL. The devil is often in the details.
4) Don’t invest where management has a history of lack of transparency or exaggerated greed behind them unless they are leaving. People don’t change.
5) Always talk about the companies you are investing in with the customers of those companies, their competitors, suppliers and employees.
6) Read and listen to everything negative that is written and said about the companies in which you invest.
7) Always analyse the major investors in the companies where you are investing. If there are fundamental investors with a serious process of analysis this can be helpful.
8) Watch stock prices no more than once a week.
9) Forget about cost prices.
10) Ask yourself monthly what you would do with the securities in your portfolio if you had to rebuild your portfolio from scratch. Be prepared to sell a security if a better opportunity is found. If you are able to have a lot of investment ideas and follow them carefully, better: a long portfolio reduces risk and offers more operational flexibility.
11) Use the chart as an aid, to understand the history of the company. If the chart confirms the fundamental story, it is positive. If not, Bolton forces himself to do further analysis, and if the previous thesis is confirmed, he invests anyway. However, he never underestimates what other traders are doing, although he is well aware that sales trigger sales and further sales trigger coercive liquidations. When this perverse technical circle is formed, great opportunities can arise if one is calm and has made an accurate analysis of the business and the company.
12) Forget about market timing and focus on individual stories. Here he used to quote the famous phrase of Peter Lynch, his good friend and colleague, “more money has been lost by investors trying to avoid recessions than during recessions themselves…”.
Logbook
After a difficult start to the week in the U.S., the Dow, S&P500 and Nasdaq are at highs, while the Russell (small caps) is struggling a bit to regain them. 
The same applies to value, which has been struggling for over two months towards growth.
We are now starting to enter the heart of the earning season, and corporate data is now pouring in. After little more than a week of quarterly reports, the feedback from the US is comforting, with almost 90% of companies beating estimates.
Among the companies we have in our portfolios, Intel reported a very strong quarter but released a weak outlook that weighed down the stock. We remember that Intel is significantly behind on 7 and 4 nano-millimetre chips where Taiwan Semi which manufactures for AMD, NVIDIA and many others dominates. The fear is that Intel will lose the leadership. However for now the cost/benefit of proposing such miniaturizations is still doubtful but Intel will get there. Finally being the only big chip manufacturer in the US it will not fail to enjoy protection, especially given China’s reliability and its pressure
on Taiwan. Finally, Intel will be one of the interpreters of 5G where it holds many licenses. We believe Intel has good unrecognized value at these levels. Next week it will still make headlines with a product-related event that should be interesting. We have Intel on the Pharus Asian Niches fund, in the 5G Niche at 0.4%, and in the NEF SDG fund at 1%, in the trendSDG 5G.
In Europe, Valeo, one of the most important manufacturers of powertrains and automotive electronics systems reported strong earnings figures, reduced debt to 1x EBITDA and robust orders. The company is also a major player in ADAS(Advanced Driver Assistance Systems), a sector where the week saw the acquisition of Veoneer by Canada’s Magna at good valuations. The JV with Siemens on powertrain systems for electric cars is going very well and we believe therein lies much of the unrecognized value of the company. One in three hybrid or electric cars has Valeo components fitted. Excluding this JV (which still has negative EBITDA) the company trades at 4x EV/EBITDA.
Valeo is one of the top 10 stocks in the Pharus Electric Mobility Niches fund, held in the Powertrains Niche. It is also held by the NEF SDG fund in the TrendSDG Electric Mobility (0.8%).
Nice numbers from UBS. War machine reporting nearly 20% ROTE (return on tangible equity). This bodes well for all companies exposed to wealth management as Credit Suisse reports next Thursday. We have UBS as 0.3% of the NEF SDG fund, in the TrendSDG, The Good Bank.
Next week will be the busiest week of the quarter in the U.S. with 165 companies in the S&P500 reporting and also in other areas such as Japan or Europe.
Major companies held in our portfolios reporting next week include, among the Koreans, SK Hynix, BNK Financial, Samsung SDI, Shinhan FG, SK Innovation, Samsung Electronics (already anticipated). Among the Japanese, ANA Holding, Mazda Motor, Sansha Electric, Takaoka Toko, Hitachi, Panasonic, Zeon, Central Glass, Honda Tsushin Kogyo. Among the Indonesians Lippo Malls and Matahari Department Store, Tempo Scan, Bank Mandiri, Panin Financial. In Thailand reports Bangkok Bank. Among the Europeans, BCP, Orange Belgium, Mapfre, Atos (has already anticipated), Telecom Italia, Imerys, FirstGroup, Barclays, Carrefour, Glaxo, Telefonica Deutscheland, Mediaset Espana, Metro, Eramet, Nokia, Orange, Sanofi’, Telefonica, Webuild, Engie, Fresenius, BNP, Renault, Unicredit, Natwest, IAG, A2A, RCS, ITV, Credit Suisse. Among the American ones we hold, Pfizer, Laboratory Corporation of America, First Solar, Fresh Del Monte, Bristol-Myer. Among the Chinese ones we hold only Hang Lung Group.
