Posts in category: Noticias

Wednesday 27th of July 2022

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Last week, we introduced the first of our ‘false narratives’ in financial markets, de-globalisation...

We explained why we think ideas like this in markets can be so appealing, offering simple explanations for what is going on in a complex, often random, world. The risk of false narratives is that they can lead investors astray, allocating capital to what they think is a major trend but what could be, in fact, an overbought trade with significant hidden risks.

Parsing out the true from the false narratives is critical for success for long-term investors. Spotting false narratives can also offer investors unique investment opportunities to bet against them.

This week, the false narrative we want to challenge is a controversial one (to say the least). Fossil fuels, most notably oil, gas and coal, are increasingly considered ancient history by many participants in financial markets.

This idea spreads beyond finance even, to politics and the wider media, where the growing consensus is one in which fossil fuels will play no role in the future global economy.

The argument ...

The argument goes something like this: the burning of fossil fuels to generate energy is causing climate change and as such, the only solution is to accelerate the transition away from these sources of energy. The latest generation of renewables, solar and wind power, are now much cheaper than fossil fuels, while battery storage and energy efficiency (better insulation in homes, for example), together can replace the energy we derive from burning fossil fuels.

Thus, given the green alternatives are now cheaper than fossil fuels and readily available, their days are numbered, oil, gas and coal are going away as an energy source and we can expect to see their demise in the next 5-10 years. Put more simply, fossil fuels are ‘bad’ and we just need to replace them, simple.

This is, no doubt, an appealing prospect from the perspective of anyone who cares about solving climate change. It’s a story we would love to believe, if only it were true. Solving climate change in less than a decade, and with alternatives sitting on the shelf ready to be rolled out at scale. It sounds great!

The draw of this narrative is powerful. So powerful in fact, that most major market participants have bought into it. Many of the world’s largest investment and pension funds have committed to fully, or at least mostly, divesting from fossil fuel stocks and avoid investing in the sector altogether.

Millions more retail investors have become engaged in investing ‘ethically’, with oil and gas stocks often top of the list of investments to avoid. This ‘divestment’ movement, driven by the narrative of fossil fuels being ‘bad’, has been powerful enough to starve the fossil fuel industry of investment capital over the past decade, making it increasingly difficult for those companies to raise capital on international markets.

What’s more, it has sent a strong signal to the management teams of fossil fuel producers that investing in new supply will not be rewarded, in fact it may even be punished by markets. So that is what pretty much every major fossil fuel company has done. They have restricted investment in new supply and instead re-invested cash flows into renewables projects or in returns to shareholders.

The idea that fossil fuels are ‘bad’, and will go away soon, is probably the most consequential and potentially pernicious false narrative in markets today.

Dominion Capital Strategies

Firstly, energy is good. It facilitates improvements in quality of life. Around 800 million people today have no access to electricity. 2.4 billion people generate heat for cooking and hot water by burning biomass (wood, animal dung, crop waste) on open fires. This alone causes 3 million premature deaths every year in low income countries from household air pollution. Bringing electricity to those without it, bringing safer forms of energy for cooking, these are not trivial matters but transformational for half of the world’s population. And as things stand, renewables cannot do it.

It is no coincidence that the countries where these populations reside are continuing to invest heavily in fossil fuel power generation. Bringing electricity and safer sources of energy, to lift hundreds of millions of people out of poverty, requires vast amounts of reliable, low cost power.

Coal, oil and gas, still offer a relatively cheap and quick way to bring large amounts of energy to large populations, reliably. Renewables can be low cost, but only in certain places at certain times, while power storage is at least a decade away from being a meaningful place to store excess renewables power for use when the sun isn’t shining, or wind isn’t blowing.

Whether we in the West like it or not, developing countries are going to keep developing, and this means vast amounts of new energy demand coming from billions of new, emerging, middle class global citizens. Renewables will play a part in this story, but so too will fossil fuels, and so too will technologies like nuclear power.

Further, the concept that fossil fuels are ‘bad’, is so oversimplified it’s arguably infantile. The fossil fuel industry powered the industrial revolution and the twentieth century, the single biggest leap in human living standards in the history of our species. Those who think that was bad are welcome to prove it and try living without electricity, modern healthcare, etc.

The end result of this powerful false narrative is the energy shortages we are currently experiencing globally today. Years of underinvestment by fossil fuel producers in supply, in response to their demonisation in modern culture and divestment by ESG-minded investors, means that there is very little new supply available to meet global demand.

Meanwhile renewables, with all the will in the world, are nowhere near being in a position to take up the slack and replace fossil fuels in a significant way. We’ll have to wait another decade (at least) for that.

The truth is, a transition of this scale away from fossil fuels was always going to take a long time. And we needed fossil fuel companies to come along on the journey with society, maintaining supplies of the fossil fuels we still need as we steadily shift to alternatives.

Sadly, this more pragmatic approach is unpopular, it doesn’t fit the ‘good’ vs ‘bad’ false dichotomy and so we appear to be continuing down the same road, which will likely only lead to even worse energy shortages than we face today.

There are two very important takeaways here for investors. First, be careful with investment products labelled as ‘green’ or ‘ethical’. These can often by invested in overcrowded investments which could fall dramatically if the false narrative of the imminent adoption of new energy technologies is not realised.

Second, fossil fuel companies are not necessarily the bogey-man, and the general dislike of them by investors and modern culture could actually offer a once-in-a-generation opportunity to invest in assets which will be producing strong cash flows for a couple more decades at least.

Taking a contrary view here could be very rewarding. 

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI. Copyright © 2022 Dominion Capital Strategies, All rights reserved

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Monday 18th of July 2022

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A narrative connects events to form a story..

 Humans have evolved to connect emotionally with stories, they give context and meaning to events, whether fictional or in the real world. Narratives can be extremely powerful, giving rise to religions with billions of followers, spawning modern nation states that span entire continents. Narratives have energized humanity’s greatest achievements and fuelled its most appalling crimes.

Narratives matter. And so it should be no surprise that they matter a lot for investors in financial markets. The movements of capital in global markets which determine prices and investment returns are directed by people who have evolved to connect emotionally with stories.

Some narratives are very helpful in contextualising a realistic view of where the world is heading. This can then determine how to allocate investments today. But some narratives can be deceptive. They offer the allure of making sense of a complex, often random, world by offering a story which seems to make sense, but is in reality false, it is not explaining what is going on despite claiming to.

False narratives in investing are dangerous as they can convince investors to move capital into, or out of, investments which appear to fit with the story being told. When false narratives become dominant, gross misallocations of capital can occur. This results in over-valued assets where false narratives support a particular asset class, and significant under-valuations elsewhere.

We will be, over the coming episodes, analysing what dominion thinks are the major false narratives in financial markets today which are growing in popularity, and explaining why we think they do not match up with reality. This week, we’ll start with the idea of de-globalisation and why we think it is alarmist, overblown, and deceptive.

The pandemic, growing hostility between China and the West, and recent supply chain disruptions have led to calls for ‘re-shoring’, the return of manufacturing to developed world nations at the expense of China.

Globalisation...

Is the process of integration of economies and supply chains across countries to form an increasingly global system of capital, goods and services. Over the past 50 years this has led to, at first manufacturing, and more recently many services jobs, to move to lower cost countries

This process has simultaneously lowered the cost of goods and services for developed world nations and acted as a catalyst for economic development for many emerging nations. This process has come at the expense of many middle- and working-class jobs in the West, especially in the US and UK, with significant political and social consequences we are still living with today.

The de-globalisation narrative goes something like this: a strong political and economic requirement to ‘re-shore’ manufacturing and raw material supply has emerged from the pandemic, as well as a result of the escalating geo-political confrontation with China.

Además, el rápido desarrollo económico de China y el envejecimiento de su población significan que su oferta de mano de obra de bajo costo se ha agotado, y los salarios tendrán que aumentar. Por lo tanto, la desglobalización se traducirá en que los productos que antes se fabricaban a bajo precio ahora tendrán que fabricarse a un precio mucho más alto en los países occidentales, o en los países alineados con Occidente.

Further, China’s rapid economic development and ageing population means its supply of low cost labour has dried up, and wages there will have to rise. De-globalisation will therefore take the form of previously cheaply manufactured goods now having to be made at a much higher price in Western nations, or Western aligned nations. This process happening across all major sectors in the economy will act as an inflationary force, pushing up prices and as a result, acting as a drag on growth in living standards, reducing international trade, and acting as a headwind for global economic development.

Now, this is a compelling story. It fits with what we see happening in the world today and sounds, at face value, like a good idea.

Maybe we should not be so reliant on China for our manufactured goods?

Also, maybe we should bring back previously lost jobs in manufacturing to the US, UK, etc.

Dominion thinks debunking this false narrative can be done quite easily. We encourage listeners and those reading this in e-mail form to go and dust off a World Atlas, or for those who are more tech savvy, do an internet search for ‘World Map’. A reasonable first observation might be: the world is really big! Second, there are a lot of countries!

The de-globalisation story seems to rest on an implied assumption that there are only a handful of countries in the world. China, and then the West.: China, y luego Occidente.

The reality is, there are 193 countries. Even in South East Asia, China’s neck of the woods, there are multiple high population, low cost, well connected countries where manufacturing can, and already is, moving to. Vietnam (population 97 million), Thailand (70 million), Bangladesh (165 million), Indonesia (270 million!). Looking not much further from South East Asia, there’s India (population 1.4 billion). And then of course there’s Africa, current population 1.3 billion, expected to reach more than 3 billion by the 2040s.

Talk of needing to move manufacturing out of China and back to high cost developed nations seems over simplified, in our view. Why move a plant from China back to the US, when you can move it to a third country with even lower costs than China?

Further, assuming that rising labour costs in China = a global labour shortage is, at best, short-sighted, and at worst, a little ignorant. Just look at the demographics of the countries already mentioned, let alone many others we have not mentioned. There are a lot of young people around the world who want to work and will do these jobs.

The truth, we think, is that globalisation is only just getting going and has a very long way to go. And that’s a good thing. The economic miracle in China that has lifted 1 billion people out of poverty since 1990, that’s going to happen in the rest of Asia, and in Africa.

Western dreams of a return of manufacturing jobs need to face reality and focus on what they are good at, and perhaps consider fairer distributions of economic success with those who did lose out to globalisation.

What this means for investors, is that they should be cautious of any allocations which have an implied assumption of de-globalisation. Global supply chains will adapt, and they have, as discussed, a lot of options of where to move to in response to global events.

This also, we think, offers an interesting investment opportunity. Betting against the false narrative of de-globalisation means investing in those countries likely to be the next beneficiaries of globalisation continuing. That means countries like India, Indonesia, Vietnam, Thailand, Mexico, Brazil, Nigeria… these may offer investors exciting long-term opportunities.

We think, long-term, it pays to be optimistic! 

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI. Copyright © 2022 Dominion Capital Strategies, All rights reserved

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Wednesday 13th of July 2022

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News in the mainstream media on the economy and its direction are almost always behind the curve.

This is largely due to the nature of the data being relied upon to figure out what has been happening in the economy.

The most important data currently used to decide whether or not the economy is growing, by how much, and its direction, are GDP (size of the economy and its change) and unemployment data. These are complex data sets to capture and as such, they take a long time to compile and are often revised up or down many months later.

What’s more, these are backward looking data. They tell us what happened in the past, but do not necessarily work very well as forward looking indicators, data that give us insight into what will happen in the future. For investors, this means shifting investment allocations based on changes in the headline economic data (GDP, unemployment) is a bad strategy. Markets discount the future into prices today, and so most of the time, markets will have already moved before these backward looking headline economic data move.

In recent weeks many market commentators and the financial press have increasingly been talking about the risks of an economic recession in the US and Europe, with many indicating this is likely to happen at some point in 2023. Others have said this is somewhat premature, validating their more optimistic views by saying that the risk of recession is now higher but it remains unlikely. We think both views are too optimistic and are wrong.

Last week, The Federal Reserve Bank of Atalanta’s GDPNow model, which uses recent economic data to update in real-time its forecast for quarterly GDP growth in the US, forecast seasonally adjusted real GDP growth of negative 2.1% for Q2 2022. Remember, the first quarter of 2022 saw negative year-on-year growth in US GDP. If the GDPNow model from the Atlanta Fed is close to being right, then the US will record a second consecutive quarter of negative economic growth.

The technical definition of a recession is at least two consecutive negative quarters of economic growth. Taking this definition and the aforementioned GDP growth forecast as given, this would mean the US economy is already in a technical recession.

The bad news is that this means talk of recession or no recession is too late, we may already be in one. Take a look at financial markets, and with US equity markets down more than 20% so far this year and bond prices having their worst start to a year in decades, market prices appear to have gone some way to pricing this in already. Expect headlines in the mainstream media to catch up with reality in the coming weeks.

The good news here is that, as we have previously predicted on a previous episode, a recession in the US and Europe is likely to be relatively short-lived. There are no major structural issues in the economy to be concerned about, as was the case in 2008 with the global banking crisis. Another good news story here is that a slowing economy should relieve a lot of the pressure on inflation, in fact looking at commodity prices over the past 6 weeks, this is already happening (another example of forward looking data that help us understand the future not the past). Less inflationary pressure makes it more likely central banks ease up on their contractionary policy and may start talking about easing.

Given the stock market’s function of discounting the future into today’s prices, this means that we don’t need to wait for a full blown economic recovery on the other side of a technical recession before stock prices should start to move up and recover from 2022’s bear market.

What we need are ‘green shoots’, evidence of a turning point in forward looking economic data points and evidence that central banks are considering pivoting away from contractionary policy to fight inflation and are moving towards expansionary policy to support the economy.

Dominion Capital Strategies

This is where China comes in as an interesting case study for why forward-looking indicators matter more for investors than backward looking data like GDP or unemployment.

Despite the very negative headlines today about China’s economy, with some prominent investors even calling China ‘uninvestable, we have seen some forward-looking indicators start to move in a positive direction for several months now, a bullish signal for the trajectory of the Chinese economy later in 2022.

We have also heard increasingly positive commentary from the Chinese government and central bank about policy easing, expansionary fiscal and monetary policy to support the economy. These positive inflections in forward looking data points makes us incrementally positive on the outlook for Chinese stocks, despite the backward-looking data (GDP, unemployment) continuing to look bad. Chinese technology stocks have rallied +38% since May, validating to some extent, the point we are making here.

We will be looking for similar characteristics in the data coming out of Europe and the US as a guide to when we can expect their bear markets in stocks to switch into a bull market recovery. We’re not there yet, but it is getting closer.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI. Copyright © 2022 Dominion Capital Strategies, All rights reserved

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Monday 5th of July 2022

Market volatility remains elevated ...

With ongoing concerns about inflation and weakness in the economy weighing on market sentiment. For the stock market, this means volatility is likely to continue and (to echo last week’s episode) we probably have not yet seen the lows in this bear market for stocks.

Periods of market churn like we are currently living through typically punish speculators but can greatly reward the patient and long-term minded investor. When prices are falling, all else equal, the investment outlook for all investment opportunities has improved.

However, there is a huge difference between a bad investment opportunity being less bad, because the price has come down, versus a high-quality investment opportunity which is even more attractive now with a lower price.

An example from outside the stock market is probably useful now. Imagine first, an advertisement for a gambling website, or betting store, close to where you may live. One day a new offer is presented with an 80% reduction in the price of placing large bets. All else equal, this is a better offer than before, but this is still a bad investment even after the 80% reduction in price. It’s a bet, plain and simple, it is risky and should be avoided, especially with large sums of one’s savings or investment capital. These are our ‘falling knives’.

Now imagine a high-quality residential property close to where you live. You know it well, it is spacious, in a nice and pleasant area to live and is in high demand. One day this property is on sale for 80% off its previous price. This is an example of a ‘fallen angel’.

Financial markets today are full of both falling knives and fallen angels, with prices of everything coming down, offering investors a wide array of opportunities to ‘buy the dip’ across multiple asset classes and individual stocks.

Some of these are very risky ‘falling knives’, where the lower price on offer does not necessarily mean investors should go anywhere near. Bitcoin and crypto currencies are a good example of this. Bitcoin is down 71% from its highs in 2021, Ethereum, another popular crypto asset, is down 75%. Many speculators argue this makes them better investment opportunities now. We would argue these are falling knives and trying to catch them would be a grave mistake. Any price above zero for cryptos in our view is too high.

Many stocks also exhibit similar characteristics, still trading on very high valuations despite major declines in share price. Tesla stock is down 45% from its highs last year. Compared with cryptos, at least investors own something in the real world with Tesla stock, in this case an electric car manufacturing business, but again, speculators are tempted to start buying Tesla stock at these now lower prices. Again, we caution against catching a falling knife here, as valuation levels still remain eye wateringly high relative to other auto companies and other more reasonably priced assets in the stock market.

Sadly, many retail investors in particular are falling into the trap of putting new money to work in these and other similarly risky assets, buying the dip and adding capital to speculate on prices of over-priced assets.

Price declines alone do not make great investments.

What matters is price relative to underlying value and the cash flows the asset you are buying will generate.

Some asset prices are down and rightly so, they were just too damned high and should be avoided even at much lower prices.

Finding the fallen angels, or at least investing in strategies where this is a stated aim, is where investors should now, we believe, be focusing their energy.

Some of the leading businesses in the world today, in previous market downturns, traded down 50% or more, seeing prices decline along with the rest of the market index at the time. Amazon was down 85% from its peak in the 2001-2002 sell-off. These price declines of our ‘fallen angels’ were accompanied by major declines in the price of the ‘hype stocks’ of the day, which never recovered.

These ‘fallen angels’, when bought at or close to market lows, turned out to be the best investments of the subsequent two decades. Amazon bought in March of 2001 would today have generated a 200-times return (in other words a $10,000 investment would be worth $2 million after 20 years).

The current market turmoil will be creating similar opportunities for the long-term minded investor. 

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI. Copyright © 2022 Dominion Capital Strategies, All rights reserved

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