Summer. Where to go?
Summer is here! After a capricious spring, temperatures have exploded, in the UK as well as in Italy. Holiday options seem limited for now. The English will discover places like the Highlands, Lake District and Cornwall, while the Italians will focus on the Bel Paese, too often neglected in favour of more exotic places. Looking at the market there is a mixture of hope, fear and uncertainty and that is always a good thing. The tech trend has stopped and we are trying to understand if it is a pause or a structural change of direction. Meanwhile, all kinds of fears are emerging. Inflation, government debt, sustainability of the recovery, valuations, geo-political risks and summer volatility.
In order:
– Inflation. Inflation is there and we can see it. Good thing. Much of it is linked to commodities and bottlenecks typical of these phases. We are also seeing wage pressures and we welcome that. A little healthy protectionism will help the industrial districts that have not yet been dismantled. However, we see no risk of an inflation explosion. Supply flexibility remains strong. Inflation will largely vent itself on the luxury and real estate sectors, and we hope the same for the securities sector.
– Public debt. Global public debt is high but remains sustainable. This is thanks both to interest rates being kept under control (a return to negative rates is only to be expected), to the coordination, credibility and support of the central banks, and to better growth expectations which should, very gradually, rebalance the debt/GDP ratio.
–Sustainability of the recovery. The recovery is sustainable simply because it is sustained. Sustained by accumulated savings, sustained by infrastructure plans, sustained by a political will to abandon the deflation and stagnation in which areas such as Europe and Japan had ended up.
– Geo-political risks. Tensions with Russia and China are high. But we have a serious team in the White House, because they do not engage in sensationalism and because they are ready to take effective measures to limit inappropriate attitudes on the part of these countries. And the interested parties know this. That said, geo-political risks can never be fully anticipated. The fact that today there are fears on this front means that some tension is already anticipated and this is a good thing.
– Assessments. When someone tells you that the market is overvalued, ask why. And listen carefully to the answer. Either they are referring to the growth component, or they are quoting headlines. In the latter case, they are certainly not analysing companies. There is another option: a devastating macro view linked to extreme phenomena such as wars or super-inflation. Wars cannot be predicted, never. Super-inflation phenomena are now excluded, thanks to China Ltd. All you have to do is open the Chinese taps and prices (and, alas, wages) fall.
– Summer volatility. Limited volumes and distracted people have always provided fertile ground for waves of volatility. Summer is famous for this. The first consideration is that volatility can work both ways and usually goes in the direction where it hurts the market most. So the advice is to have flexibility in both cases: don’t get scared, but rather swallow if there is an air pocket; don’t get anxious that you won’t make enough money but be ready to give something if prices go up a lot. The second is that, in the run-up to the summer, it may make tactical sense to lighten up a little in the sectors that have seen the most enthusiasm, such as autos, industrials and basic materials which, although not expensive, could be subject to volatility given the cyclical nature of their earnings. Instead, we recommend increasing exposure to structurally recovering areas such as banks, insurance, utilities, media, IT consultancy, pharmaceuticals and telecom equipment.
Harsh and sweet…
Human beings rarely fully enjoy the gifts that life gives them every day. Too busy with the ‘next thing’ to wish for, to fix, to achieve. Gift and damnation, looking ahead is the engine of progress, but it prevents us from living fully in the present. Sometimes I envy my golden retrievers who, after eating their kibble, are clearly happy for a long time. However, we go to the moon and they go to the park. For those interested in going to the moon….
One of life’s little pleasures is eating a ripe orange. When you chew it, the sourness immediately emerges, followed by an explosive wave of sweetness, which together make for a very pleasant sensation. France’s first telephone operator, Orange, shares not only its name with the fruit but also some of the sensations it brings. We are referring to the first part, the acid part. Listed in 1997, it reached 200 euros/share during the TMT bubble, then collapsed and remained in limbo for years. The company is active in 26 countries and has 260 million customers. Its first market is France, Spain is the second and Poland the third. It is also the leading African operator with activities in several French-speaking countries (Senegal, Ivory Coast, Morocco, Mali, etc.) and active in the Middle East. The company is now trading at 10x earnings, 5x EV/EBITDA and pays a juicy 6.8% dividend, of which 2/3 (50 cents) will be payable on 15 June. After that it will be even cheaper. One wonders why this stock is worth so little. A cumbersome and dangerous debt? No, this group’s debt is absolutely sustainable, as is its dividend. Falling profits? The company should be at the point of profit inflection, with France, Belgium, Poland and Africa recovering and Spain still a couple of years away from stabilising competitive pressures. Did it disappoint in the last reporting season? No, it reported in line or slightly better. Moreover, the company has, like many telcos, a strong optionality to use its franchise to monetise the digital revolution, an optionality that has been sorely neglected to date. So why in a world where rates are so low and Orange is finding a growth path again is the market holding it at 7% dividend and 10x earnings? Maybe it just takes a little patience. Autumn, the orange season, is not far away.
The “magic” of compounded growth
Baillie Gifford, a growth asset management company, is enjoying a well-deserved heyday. Having invested significantly in a number of high-growth companies, it is reaping the rewards. Its strong, concentrated investments in the likes of Tesla have delivered exceptional returns. As is often humanly the case, when things go well for us, we begin to believe that everything is 100% down to the fact that we are exceptionally good. Just as when everything goes wrong, there is a strong temptation to feel useless, guilty and insignificant. So nowadays we read repeatedly in the newspapers the speeches of managers (in particular Lawrence Burns) and university professors “consultants” of Baillie Gifford (Hendrik Bessembinder) who explain how the growth strategy is the only truly successful one. And that selling is by definition wrong. To quote them, “the lost revenue from selling a stock is theoretically infinite…” they explain. The leitmotif is that the historical data available on US indices shows that 1% of the companies are the architects of all index performance. So it makes sense to look for the next stock that will multiply by 1,000 over the next ten years instead of scrambling, as value investors do, to find companies on which to make little money. On the other hand, they explain, if a company doubles its profits for ten years in a row, it will be worth 1000 times more at the end of the ten years. The magic of compound growth, they smugly explain.
Given that value investors, although bruised after years of underperformance, do not have a ring to their nose, it is fair to point out a few things. Assuming we are phenomenal and out of a portfolio of 1,000 stocks we do not find one, but rather two, that will multiply by 1,000 over the next 10 years, we wonder about a few things.
1) During the cold spell, when legs are shaking, certainties are crumbling and university professors are going back to doing their job, are we sure that those securities will not be sold?
2) Assuming they are not sold, we wonder whether in these phases it is not, the customers who leave and the products then close, as we have seen happen at the end of several bubbles.
3) Even if this does not happen, we wonder how these two stocks, let’s imagine two Amazon in the year 2000, can be allowed to rise freely when funds, normally UCITS, have limits of 10% maximum exposure. Let us always remember that ten years in investing is a very, very long time.
One last trivial thought on the consideration that the US index has done what it has done thanks to only 1% of stocks. A consideration which, if you dig a little, as the good Andrew Dickson did (Baillie Gifford’s never-sell mantra is a song for fools | Financial Times (ft.com), is not so true … But let’s take it as such. We must remember that the index is a growth algorithm, which incorporates stocks that go up and discards those that go down. It will therefore weigh the winners more and more at the expense of the losers. Thus amplifying the positive effect of these rising stocks and not making a penny in seeking out and accumulating undervalued companies, only to sell them when the undervaluation subsides, an activity in which the value investor is perpetually busy and from which he derives all his return on investment.
