In equity investing there are many different strategies available to investors to choose from when allocating. We can pick specific regions, like European or North American equities. We can choose between actively managed vs. passively managed strategies. We can even pick specific sectors or trends to invest in, for example, an equity fund strategy that only invests in stocks linked to renewable energy, or to artificial intelligence.
These strategy choices are usually mutually exclusive. If we decide to allocate investor capital to an emerging market equity fund, then we would expect no US stocks to be included in that strategy. Similarly, a passive fund investment, by definition, has no active human involvement in stock picking, the passive strategy only invests according to the relevant index.
Two of the most important and widely used equity strategies available to investors are: (i) growth investing, and (ii) value investing.
Growth investing is a strategy based on investing in stocks with underlying businesses that are growing at a much faster rate than the broader economy, and typically also growing faster than the average stock in a major index like S&P 500 or Euro Stoxx 600.
Value investing is a strategy focussed on buying equities trading on low valuations, typically much lower than the average of a major market index, where there is perceived to be a ‘mispricing’ by the market. When buying stocks using a value methodology, the investor is taking a view that the current market price for the stock is much lower than the real underlying value of the business.
Generally, growth and value strategies are considered mutually exclusive, like our earlier examples. In fact, the entire professional investment industry thinks this way. Major pension funds, for example, when allocating their investor capital to equities will often split their equity allocations between ‘growth’ and ‘value’ equities, just as they will split allocations between ‘European’ and ‘US’ stocks.
This entrenched way of thinking in the investment industry is interesting to us, because we think it opens up an opportunity to do things differently and offer investors something unique.
We believe that growth and value strategies are not, necessarily, mutually exclusive. It is possible for a stock to exhibit the characteristics of both!
Imagine a company that owns a powerful digital advertising business, which has seen exceptional growth over the past decade. As traditional advertising continues to migrate to the digital world, via targeted advertising, this company’s leading platform is the first choice for many marketing teams increasing spend on digital adverts. This same business, because of some short-term concerns around the economy, sees its stock sell-off by 75% in one year, during a broader market sell-off in equities. After this the stock trades on an earnings multiple (a measure of valuation) of just 8x, half the valuation of the market index average.
This example company is exhibiting the characteristics of a growth stock, given its high growth digital advertising business and the likely prospect that it continues to grow for many years to come. But it also exhibits the characteristics of a value stock, given the very low valuation it trades on relative to the market and relative to the quality of the business.
The example we gave is a real investment in two of our investment funds at Dominion, and after buying it at these depressed valuations, it has increased in price by c. +100%.
Growth and value do not, we believe, have to be thought of as mutually exclusive. Investors do not necessarily have to choose between them. It is possible to have the best of both worlds, to ‘have your cake and eat it’, and invest in companies exhibiting the desired characteristics of both growth and value strategies.
This is exactly the approach we take at Dominion to the Global Trends strategy, led by the Global Trends Managed Fund. We search for stocks offering investors the best of both worlds, companies with high quality businesses that are growing, while also trading on valuations that are especially attractive and offer significant upside.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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The situation in the US is currently hard...
Political turmoil and an increasingly divided society. Rising crime levels in major cities, life expectancies declining, higher levels of drug addiction. Ballooning levels of government debt and money printing to fund its obligations at home and abroad.
The current state of affairs in the United States is challenging to say the very least.
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At the same time China continues its rise as an economic and military superpower, its influence around the world growing.
The domestic political and economic challenges facing the United States today, combined with the emergence of a major challenger in the form of China, have led many to take the view that America is going through a period of relative decline. Its position as the pre-eminent economic, political, military, and cultural superpower will be steadily eroded and replaced as its society and economy underperform a resurgent China. Some are even suggesting we could see a civil war in the United States and a collapse of the US dollar as the world’s reserve currency.
Pretty worrying stuff if you own US assets in your portfolio!
We believe very strongly that not only is this idea of America’s decline premature, it is just plain wrong and, what’s more, believing it is a major risk to your investment returns.
When making portfolio allocation decisions, a belief that the United States is in terminal decline might very likely lead an investor to reduce or even completely remove exposure to (for example) US equities from their investment portfolio. If America is on the path to economic stagnation, or worse, why own US assets?
To take our thinking on this issue a step further, not only do we think this narrative of American decline is wrong, we believe that ‘peak America’, the greatest period of American innovation, dynamism, economic prowess, this is ahead of us.
Much to the chagrin of many European intellectuals (and Ray Dalio) the United States of the 2030s and 2040s, we argue, is likely to be an even more dominant force in the global economy. Rather than being replaced by the emergence of new major global powers like China, India, and eventually regions like West Africa, these new powers will compliment and reenforce America’s position in the world.
How can we be so confident in taking this view?
What basis do we have to take such a strong view about the future, when the future is so uncertain?
As long-term investors, we spend a lot of time looking deep into the future to try and assess how to position portfolios and investments, focussing as much as possible on the dynamics of long-term trends and avoiding, as much as possible, being biased by short-term news flow and volatility.
As part of our research process, we also turn our long-term gaze backwards to the past. The past is a data rich, helpful guide to understanding the present and the future.
This is a good point to introduce the concept of fragile and anti-fragile systems. Developed by the mathematician and investor Nassim Taleb, a fragile system is one which suffers greatly from small levels of change in its environment. A ceramic vase quite literally is a fragile system because it experiences catastrophic effects to its structure from a small change in environment, a child pushing it over for example. Some companies or even governments are fragile. Small changes, a political uprising for example, or a new competitor with a high-quality product, are all it takes for an entire collapse in their systems (much like the ceramic vase).
An anti-fragile system is the exact opposite. This is a system that is strengthened by stress and change. A good example is safety standards in commercial air travel. Every time there is an accident, a plane crashes or skids off the runway, the investigation leads to learnings which are used to improve the safety of all other current and future aircraft. Taking a flight today is thousands of times safer vs. taking a flight in the 1970s, precisely because that system is anti-fragile, stresses, change and volatility (in the form of aircraft crashing) re-enforced and strengthened the system, with exponentially positive outcomes for passenger safety.
Dictatorships often appear to be robust structures. Very far from fragile. If we look at China today under the rule of the Chinese Communist Party, many would laugh if you called it a ‘fragile system’. But the truth is, behind the seemingly powerful façade of macho leadership, extravagant military displays, is a fundamentally weak and fragile structure which can break very suddenly.
The track record of systems like China’s is terrible!
The 20th century is a graveyard of dictatorships and autocracies who either collapsed, were overthrown, or were defeated on the battlefield by democracies. Imperial Germany, then Nazi Germany, Imperial Japan, the Soviet Union, the military Juntas of Argentina and Brazil. It’s easy to forget that Spain and Portugal were fascist dictatorships until very recently. Both have only been democracies for 40-50 years. Eastern Europe for even less time.
What’s more, and this is where we claim democracies have elements of anti-fragility, many former dictatorships, in some cases sworn enemies of democracies, are today successful democratic nations and very close allies of the United States.
It’s an incredibly powerful system that can turn former enemies into close voluntary allies! We’d like to see China under the communist party pull that one off. Vladimir Putin in Russia… yeah right.
But America has done this with two of the world’s formerly most powerful dictatorships. Japan and Germany (almost) turned the world into a global military dictatorship. America defeated both, dropping nuclear weapons on one of them, yet today Japan and Germany are two of America’s closest allies. Again, we hate to belabour the point, but we’d like to see China pull that off. We would not bet on it.
Further, after having listed just a few of the long list of failed dictatorships of the past century, how many large democracies can you name that have collapsed in the past 100 years? There are no examples.
Let’s take our thinking one step further and focus on the United States and why we think it is an anti-fragile system, a system which is strengthened by stress and volatility. In the past 200 years, the world’s most powerful and successful democracy, the United States, had a full-blown civil war, the bloodiest conflict in the country’s history. More Americans died fighting other Americans from 1861 to 1865 (the US Civil War), than died in either World War I or World War II.
Yet, within 40 years of the end of the US Civil War, the United States was a united country, had ended slavery, and had become the world’s largest economy. Within 80 years of the end of that conflict, America was the undisputed global hegemon, dominant in economy, culture, politics, and military power. This does not sound like a fragile system to us, this sounds like a system that is strengthened by stresses, even big ones like political division and war, a country with an incredible capacity for re-invention, for renewal, and for progression, especially during the tough times.
The past decade of political division, economic stress, pandemic, Trump, Biden, potentially Trump again, the rise of China, undoubtedly these are concerning and should be followed closely. But to conclude from this very short period of relative turmoil that America now faces imminent decline is, by historical standards, ridiculous.
Think of the technological marvels that have changed your life over the past 20 years… the iPhone and launch of smartphones, the internet, increasingly powerful and affordable computers. The recent launch of ChatGPT and large language models which will like change our lives very soon. These technologies are not emerging from China, let alone Russia, or India, not even from Europe (increasingly trending towards becoming an open-air museum). All (literally all) of the major technological breakthroughs of the past 20 years and even the latest ones are coming directly from America, or from closely aligned democracies (Israel, the UK, Germany). China’s covid vaccine doesn’t even work.
The United States today, despite the headwinds it faces, remains the global centre for innovation, technological development, cultural direction, and political power. The stresses it faces today will strengthen it, while (eventually) the stresses China faces will bring down its fragile system of government, just like every dictatorship before it. We’re bullish on the democratic, US-aligned China that emerges after that!
We’re highly confident underweighting US equities in portfolios (or even cutting them completely, which some investors are doing!) is a major mistake. The takeaway for investors, over the long-term, is that you must own US equities!
Underweighting US equities would have been a terrible decision over the past 100 years, especially so during past times of crisis for the United States (of which there have been many, and after which every time America came out stronger).
Long-term, we’re bullish on America, we’re bullish American stocks, and we think you should be too.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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Is there any advice to better manage an investment portfolio?
Managing an investment portfolio, whether as an individual investor, as a financial advisor or a portfolio manager on behalf of investors, it is a very complicated and challenging task to perform!
There are many risks of failure to be avoided, underperformance is always a possibility, you need to balance risks of success against the risks of suffering losses. Avoiding big losses is critical, and achieving success is a slow, long-term process which is difficult to achieve.
Some of the keys to success are consistency, long-term thinking, a focus on the details, and the ability to adapt to changing circumstances.
These characteristics of success in managing investments reminds us of another notoriously difficult job: managing a professional football club!
We see many similarities between the way to construct a successful investment portfolio to the way a successful football manager, like Pep Guardiola at Manchester City, manages a successful Premier League winning team.
Pep Guardiola would never start a game with 11 strikers on the pitch, neither would he start a game with 11 defenders. Instead, he will start with some defenders, one goalkeeper (of course), perhaps five midfielders, and one striker. When Pep does this, much like an investment portfolio manager, he is balancing risk and reward, with a successful outcome in mind. For Pep, he wants to avoid losing by conceding no goals (ideally), or at worst only conceding a few goals, while also maximising the probability his team scores many goals and wins the game.
When we construct an investment portfolio, we should be doing the same thing! Retail investors should be thinking the same way too. The line-up of a football team is a helpful guide here.
An equity portfolio has its equivalent of goalkeepers and defenders, we even call them ‘defensive’ investments. These are lower risk, reliable, preferably high-quality investments which like defenders on a football team may not score any goals at all. These investments will not transform your life with incredible, 10x returns, but these investments offer limited downside risk, predictable positive price appreciation, and often predictable income flows in the form of dividends which are dependable. You have high confidence in, and can rely on, your ‘defensive’ investments.
Just like Pep Guardiola, you don’t want your entire team, your entire portfolio, to be made up solely of ‘defensive’ investments either, but you want a solid group of them to defend your investment portfolio, especially during periods of uncertainty and market volatility.
When Pep Guardiola fields his star striker Erling Haaland, he’s doing so with only one thing in mind. Haaland is a striker, he is on the pitch to score goals. He’s not there to defend, to offer protection during the bad times, he is there to win the games for the team. An investment portfolio needs some strikers, and just like a football team, you don’t want or need too many strikers either. As a manager, you need to get your striker selection right, and if you do, you don’t need many of them on the pitch. Just as with strikers at a top football club, a small number of investments with the potential to deliver very high returns can ‘win you the game’.
If you had bought Amazon stock in 2001, today you would have a 200x return on that investment, that is a +20,000% return. If 2% of your portfolio in 2001 had been invested in Amazon, the rest of your investments could have done nothing over the past 22 years, and you would still have increased your total wealth by c. +400%.
And it’s not only technology companies offering these types of portfolio transforming returns. Monster Beverage, maker of energy drinks, if you had bought its stock in 2005, today you would have made an 84x return, an increase in value of your investment +8,400%.
Even relatively small investment allocations in your portfolio to potential ‘match winners’ who could, if your investment thesis is right, deliver extraordinary returns, can transform your total investment returns for the entire portfolio. Just like a top striker scoring the winning goal.
We even have the equivalent of midfielders in a correctly constructed equity portfolio. These are, just like midfielders on a football team, performing important roles in between defensive and attacking, and some are more ‘defensive’, while others are more ‘attacking’. These investments provide an important balance between our ‘very defensive’ and ‘very attacking’ investments, some could even ‘win the game for us’ by delivering exceptional returns. Maybe not an 84x return like Monster Beverage, but perhaps a +2x or +4x return, this can still make a big difference to a portfolio with an allocation of 5% or 10% to investments like this.
Just like Pep Guardiola, the process of putting all of these positions together to create a ‘team’, as portfolio managers we are building our ‘portfolio’ of names, which can deliver success through a mix of investments performing different roles which together can deliver successful total returns over the long-term. This is the job of the active portfolio manager!
As a final note this week, as a life-long Manchester United supporter it pains me to have to use the manager of Manchester City in this case study for successful management skills.
Hopefully I don’t have to wait too long before I can use a current Manchester United manager as a prime example of management success.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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Is there a window of opportunity created by climate change?
Climate change is one of the biggest political and economic issues of our age, quite possibly the most important. The global economy’s continued reliance on burning fossil fuels to produce energy emits large volumes of greenhouse gases which are warming the planet’s climate.
Given the risks and uncertainties around the implications of climate change, (as with any political issue where fear is invoked) there are quite extreme views which are gaining traction. One of these is that a solution to climate change is to reduce total energy consumption. In other words, rising demand for energy is bad, because much of this energy is powered by fossil fuels, and as such energy consumption in and of itself is bad. We must, the argument goes, go in the other direction and cut energy consumption.
The environment is important and combatting climate change is important. We agree on that. But human development and wellbeing is also very important too. Billions of people live in poverty or conditions close to poverty and we believe strongly that those people deserve better lives, higher incomes, and higher standards of living. We would hope even the most ardent environmentalist would agree with this sentiment.
Human development is inextricably linked to energy consumption. If we plot each country in the world on a chart, with GDP (income) per capita on the x-axis and electricity consumption per capita on the y-axis, what we see is a very strong correlation between income per capita (a powerful measure of living standards) and electricity consumption. As living standards rise, so too does electricity and energy consumption to facilitate those higher living standards. One is not possible without the other.
This image was created and is owned by Dominion Capital Strategies, 17th April, 2023.
Dominion has produced this chart plotting all of the world’s countries onto it. And there is a glaring gap, a large area of empty space on the bottom right of this chart. The bottom right of the chart represents high income per capita (high living standards) and low energy consumption. There are zero examples of any countries in this area of the chart. In other words, there are no high living standards, low energy use countries. Not one. 100% of countries with high living standards have high energy consumption per capita. 100% of countries with low living standards have low energy consumption per capita.
Let’s use some examples. Ethiopia has GDP per capita of approximately $1,000. Its corresponding electricity consumption per person is 80 kWh. Japan has GDP per capita 40x higher at c. $40,000 per person, while the average Japanese citizen consumes 94x as much energy at c. 7,500 kWh.
Even if we look at middle income countries, the differences are incredible. GDP per capita in Indonesia is approximately $4,000 and its corresponding energy consumption per capita is 1,000 kWh. To get to where China is today (let alone the US or Japan), Indonesia (population 274 million) would see its per capita income rise +400% and its energy use per capita rise +500%.
The majority of humanity, 7 billion people, live in middle and low-income countries. The development of these nations into increasingly wealthy countries with higher living standards means only one thing for energy demand and global energy consumption. It is going to go up a lot!
The idea that we can limit, or even reduce, global energy demand is a fantasy. What’s more, it is not even desirable because it would mean those living in poverty stay living in poverty. We all want the world’s poor to be lifted out of poverty, and that means more energy, not less.
But this doesn’t mean we can just forget the environment either. Climate change is real, humanity’s impact on the climate and natural world is real and getting worse, solutions are needed here.
And here is where the incredible opportunity lies for investors. Rather than burying our heads in the sand and hoping for the best, there are pragmatic solutions that can facilitate the optimal outcome here, one where global energy demand rises substantially to facilitate higher living standards for all, while also becoming much less carbon intensive and thus limiting the effects of climate change.
What’s more, the scale of this opportunity is often mis-understood. After decades of investment in renewables the global economy still only gets 4% of its energy from wind and solar. There is a very long way to go in the build out of renewables. Nuclear power (another source of zero carbon energy) generates another 4%. Again, a lot of upside here from accelerated build outs. Fossil fuels is still 77%!
Huge investment is required in electricity grid infrastructure, electric vehicles, wind turbines, solar panels, nuclear reactors and their associated supply chains, and many other technologies, businesses, and services that will be part of the story of delivering more energy for humanity with lower environmental cost.
Climate change may seem scary to many, but to us as long-term investors, we are genuinely extremely excited about the investment opportunities on offer today in this mega-trend in the global economy.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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Skittish markets in the short term...
The current investment environment continues to be challenging, with trailing one-year returns for many asset classes remaining in negative territory. Despite the recent rally in equities, markets remain skittish with many market commentators calling for further volatility and potential downside for asset prices in the coming weeks / months.
We tend to agree that in the short-term we could see further weakness in markets, see our episode from last week for more information on our thinking there.
But as investors, it is the long-term that really matters. Despite the short-term uncertainty and risk of further bouts of market weakness, for the long-term minded investor there are some very attractively valued assets available today.
In some specific areas of the commodities (and related equities) market, we believe, there are interesting dynamics that could offer differentiated returns to a diversified portfolio in 2023 and beyond.
The current demand and supply outlook for some commodities is especially interesting, while the current market valuations offer a degree of a ‘margin of safety’ for investors.
It is rare in any industry to have very much visibility on what demand levels will look like 1-year, 2-years, or more into the future. All industries and markets are inherently difficult to forecast.
We do, however, have a unique starting point today in some sectors of the economy where we can make confident predictions of what demand is likely to look like.
Climate change and the energy transition away from fossil fuels to decarbonise the global economy is a multi-trillion-dollar, multi-decade, global investment opportunity that is already happening now and is set to accelerate. Major governments around the world are committing to major spending subsidisation programs to further accelerate this transition.
What does this mean in reality?
It means upgrading and replacing electricity grids across the planet, it means vast build outs of offshore wind farms and solar projects, it means major build outs of nuclear power plant fleets and the associated infrastructure to connect these new sources of power to the grid, it means hundreds of millions of batteries rolling off of production lines every year to power new fleets of electric vehicles.
What do these aspects of the energy transition have in common? They are all very heavy users of industrial metals, in particular, copper. Copper as a metal is unique in its heat and electricity conductivity, its relative cost, and performance as a material in applications like wiring or EV batteries. The energy transition is going to be very intensive in its use of copper.
Some industry estimates indicate we may need 2-3x the current global copper supply to meet the needs of the global energy transition over the coming 20 years.
When we look at the supply of this critical metal, however, we do not see anything like the expected increase in future supply coming online over the next 10-20 years to meet this major wave of demand.
Why is that?
Copper is a relatively scarce metal in mineable deposits. It has been a useful and widely used material by civilisation for thousands of years. This means the relatively easy to access mineable deposits of copper have largely been exhausted around the world.
Each incremental new mine to produce copper is harder to access, further away from transportation infrastructure, and therefore more costly to bring online.
This creates an interesting set-up for investors willing to invest in the few companies who own high quality mining assets in the copper industry.
We know with a high degree of certainty that demand for this material is going to go up. And it is going to go up a lot!
Meanwhile there are fundamental barriers to bringing on new supplies of copper, as outlined, which restricts the ability of the global industry to raise supply as quickly as demand is rising.
When demand for any good exceeds supply, prices rise. A structural rise in prices of any product or commodity is good news for the existing suppliers of that product. In this case, the structural rise in prices of copper, driven by the coming demand supply imbalance, will be very beneficial for the owners of copper producing assets.
While markets continue to lurch from blind optimism, to deep pessimism, and then back again, obsessed with changes in the short-term, we think it wise to think a little bit longer-term and consider allocations in portfolios with a multi-year, or even as in this investment case for copper, a multi-decade time horizon. It can certainly help investors sleep a little easier!
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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Is this bear market finally over?
In the short-term there continues to be a long list of reasons to be concerned about the health of the economy and financial markets. The war in Ukraine rages on and appears to be escalating further, with little signs of either side in the conflict backing down. Inflation remains stubbornly high and central banks around the world continue to respond with higher interest rates. Those higher rates and the rapidity of the rises have resulted in an unexpected crisis among some less well capitalised / managed banks in the United States and Europe. We’ve even had another round of bail-outs to banks, reminiscent of the 2008 crisis.
This steady drumbeat of economic and confidence headwinds understandably resulted in a major bear market for equities last year. It was also a tough year for bond markets.
We are now well past the 12-month mark on this bear market cycle and so it makes sense to re-assess the stage of the cycle we’re in and how investors should be thinking about being positioned through the remainder of 2023.
The start to 2023 in equity markets has been characterised by relatively low volatility and positive moves up in many equity indexes. S&P 500 and Nasdaq are up so far in 2023 year-to-date. This positive start, however, may simply be yet another short-term rally in an otherwise downward trending bear market. We have been here before where short-term optimism has been mis-interpreted as a sustained new rally in stocks, only for markets to turn negative again.
In interest rate and bond markets, we are seeing a different story. There has been much greater volatility, with some of the sharpest moves in volatility for bond markets seen since 2020. This is an early indication that the calm in equity markets could change soon.
Further, when we look at equity markets, breadth has been coming down. What does this mean? Breadth is a measure of how many stocks in an index or stock market are participating in the broad direction of the market. High breadth means a lot of the stocks in the index are moving up, or down, together. This is a strong signal of the sustainability of that market direction. Low breadth means the opposite, and in the current market we see low breadth in this recent move.
That means most of the move up we have seen in stock indexes like Nasdaq, for example, is being driven by a small number of stocks, while many other stocks have been flat or declined. This historically has been an indicator of market fragility and potential weakness in the short-term.
All-in all, therefore, we are somewhat negative on the very short-term and see the balance of risk to the downside for equities in the short-term.
But, given that this bear market is now more than 12 months old, we expect that the next bout of market volatility and test of lows for markets could be the beginning of the final act of this bear market cycle.
It’s rare for bear market cycles to last much beyond 12-18 months, so even on this basic metric of cycle duration, we should be coming into the final phase of this cycle over the coming 6 months.
The later stages of bear markets in the past have often been interspersed with sharp short-term rallies, much like the recent rallies we have seen in equities. These are then followed by sharp declines and spikes in volatility, often more severe later in cycles.
We think long-term investors should be aware of this likely coming short-term volatility in markets because it will help inform decision making if and when it happens. Our advice is to look through the short-term volatility if it comes, remain focussed on the long-term, and use the opportunity of lower prices to add to risk assets trading on reasonable valuations.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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Investors are right to be growing weary of the investment climate today. After the worst global pandemic in a century, global financial markets have been hit by the shocks of inflation, war in Europe, higher interest rates, and now a potential banking crisis in the developed world.
Over the long-term, investing in a diversified portfolio of asset classes like equities and bonds has delivered excellent returns. But it is easy, when looking at historical returns over a long period, say 50 or 100 years, to miss the fact that in the past there were sustained periods of poor asset returns. These periods also often coincided with bouts of inflation, wars, and other major economic shocks.
Parsing out the short-term from the long-term, as a guide to successfully navigating periods like this as investors, is the subject of this week’s episode.
It is easy to fall into the trap of ‘information overload’, even at the best of times, given the amount of news and data available to people at the click of a button or tap on a phone screen. This is magnified in times of real-world stress and turmoil. The feeling of lurching from crisis to crisis can cloud investment making decisions and judgement.
This, at its heart, is a problem of short-term vs. long-term thinking.
As human beings we are biased to overweight short-term information vs. long-term. And this makes sense if you think about it. We evolved in dangerous environments where the immediate danger of wild animals, other humans, and the natural world around us, required us to respond to threats of danger and to do it quickly!
If you think you spotted a large carnivore roaming close to where your family and fellow tribe members are living, it’s very important for your survival, and the survival of the species, that humans respond to that risk.
This instinct remains important, even in the modern world, but it also creates problems for us as investors. Information inputs like, for example, a series of bank failures, or a major war in Eastern Europe, the possibility of an even bigger war in Asia over Taiwan, these can trigger similar emotional responses in our minds of ‘danger’ and ‘fear’. As with our example of spotting the large carnivore near the family encampment in pre-historic times, modern negative news stories can trigger a similar desire to ‘do something’. And this is a strong urge to ‘do something’, it comes from deep within us, we have evolved, for the right reasons, to respond to the thought of imminent danger.
Overcoming this short-term response, and instead focusing on the long-term, is a skill every investor should work on improving. While an emotional response to an imminent threat of physical harm does require an immediate response to avoid danger, such a response to a perceived threat from a geo-political risk five thousand miles away, or a bank failure five thousand miles the other way, does not require an emotional or immediate response in investment portfolios.
As investors, we should think more like a gardener. Anyone involved in that pursuit knows, intuitively, that the long-term is your friend. You take actions in the short-term to plant and maintain the garden, but this is all done with a long-term goal in mind, allowing the plants to grow and mature over time into something much greater than the cost of time and money the gardener puts into it in the first place.
Just like the gardener, as investors we must navigate the equivalent of winters, bad weather, and unexpected problems, but we must never lose sight of the long-term goal, and we must never interrupt the process of growth we triggered with our initial investments. The last thing a gardener should do in response to unexpected bad weather, is to rip up all of the plants by the root and start again!
As investors, we must remain long-term minded. The negative sentiment and uncertainty will pass, eventually, and in the meantime, we should be tending to our portfolios in a prudent way. What does that mean in practice?
It means going slow and steady through bouts of market volatility, taking time to think about the businesses and asset classes we want to own over the long-term and which will likely grow over a 5-year or 10-year period, invest in the appropriate strategies, and then allow the long-term to do the rest for you!
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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What’s going on…. and what should investors do?
In last week’s episode titled ‘Are We There Yet?’, we discussed the issue of interest rate rises and specifically, whether interest rates have risen enough to slow the economy down and bring inflation under control.
We ended the episode by giving examples of the signals investors might expect to see which would indicate financial conditions are close to that point of sufficient tightening, the main example being high profile companies unexpectedly getting into major trouble.
Although we were predicting this would happen at some point in 2023, we did not expect this to happen so quickly!
The past week has seen high profile banks in the United States and Europe, most notably SVB and Credit Suisse, come under major selling pressure and require central bank bail-outs. Many other banks have seen considerable declines in share prices as questions have been raised about the strength of their balance sheets too.
What has surprised markets is how quickly this has all happened. The dramatic events impacting the banking sector of the past week are, we would argue, a classic example of what we were talking about last week. Unexpected and high-profile business failures are a major signal that financial conditions have tightened substantially.
Let’s dig a little into the current crisis in the banking industry and explain what we think is going on.
The ultra-low interest rates of the past decade and major stimulus measures of the COVID pandemic led to a big increase in cash deposits at banks in the United States and Europe. Smaller banks like SVB in the US, with less sophisticated risk management structures and less stringent regulatory oversight, were using some of these deposits to earn income by lending out money. This is how banking works, at a very basic level. You take in deposits and pay interest out to depositors, then you lend those deposits out at a higher interest rate, and keep the difference.
The very sudden increase in interest rates in the US over the past 12 months, as part of the Federal Reserve’s fight against inflation, created a major problem for banks like SVB. The interest they were paying out to depositors had to keep rising to compete with rising rates available on deposits at other banks, meanwhile the interest they were earning on the money they had leant out was not going up as quickly, significantly reducing the profitability of the bank. As more depositors started to move their cash away from SVB to find higher rates elsewhere, rumours about the viability of the bank started to go mainstream, encouraging more SVB depositors to withdraw their cash deposits. This was an old-fashioned bank run!
The Federal Reserve last week intervened and created a new facility where it effectively is promising to underwrite all cash deposits (of any size) at every US bank. This is a major intervention and appears to have calmed some of concerns that were being raised about other banks who may have similar balance sheet exposures as SVB.
This story is far from over and we may see more unexpected revelations from banks in the coming weeks and months.
The next question is, what should investors do about this risk?
We do not think, and this is really important, that we are likely to see a banking crisis like in 2008. That was a credit driven event which put the stability of the entire global financial system on the line. Major banks today in Europe and North America are much better capitalised now than was the case back in 2007-2008. Even in the case of SVB, its assets on balance sheet were still large enough to have paid back 90-95% of all depositors cash, if the US central bank had not stepped in. The bank was in trouble, but nothing like the trouble banks were in 2008.
Investors should be careful not to panic and think we’re going to see a re-run of the last crisis. That is unlikely.
We see the recent selling in equity markets as an opportunity to incrementally add to high quality long-term investment names trading on reasonable valuations.
Most importantly, though, and again to return to our theme from last week’s episode, it is precisely these unexpected blow ups that signal to us as patient investors that we are likely entering the final phase of this bear market cycle. That could mean short-term volatility and some further price weakness, but it also means the eventual market lows could be here soon, which is an optimal time to aggressively buy risk assets. Not yet, but it’s coming.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
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Highest inflation in 40 years...
After decades of low and stable inflation, and correspondingly ever lower interest rates, 2021 saw the start of a major move up in price levels around the world. Rates of inflation had reached the highest levels in the US in forty years by June of last year.
The textbook response from central banks to elevated levels of inflation is to raise interest rates. It is by raising interest rates (and consequently the cost of debt) that acts as a break on the economy and so should cool down inflation.
Higher interest rates make capital and liquidity in the economy, all else equal, more scarce via higher cost of debt and financing capital (higher rates). This tightening in financial conditions makes it more expensive to fund capital investments, consumer spending, etc. This eventually results in a slowdown in the economy which helps to bring inflation under control via lower demand for goods and services. As aggregate demand declines, inflation comes down, and we move into the stage in the business cycle where central banks can start talking about cutting interest rates.
This is how it’s supposed to work in theory at least...
Well… it feels like it has been a while since interest rates started rising in most countries. This begs the question for us as investors: have financial conditions tightened enough yet to consistently crimp demand and bring down inflation? In other words: are we there yet?
Some of the important economic data is pointing in the right direction for a fall in aggregate demand. The US treasury yield curve is now as inverted as it has been since 2007. What does that mean? We’ll save an explanation of the yield curve for another episode, but the best way of thinking about ‘yield curve inversion’, is that as a lead indicator for the economy, it has a high hit rate when it comes to predicting economic slowdowns. And it is currently flashing red for a slowdown in demand.
What does this mean?
Here’s another economic data point. M2 money supply growth in the US is now negative. Again, we’ll save the detailed explanation for another episode of this metric, but suffice it to say that when this measure of liquidity in the US economy goes negative, that has historically been an indication that economic demand will slowdown in the future.
But… and this is a big but. There is evidence elsewhere in markets that financial conditions are not yet tight enough to bring demand and inflation down sustainably. Several widely followed indexes of financial conditions appear to indicate we remain in ‘loose’ territory. These indexes measure a range of data points to try and show how tight or loose overall financial conditions are in the wider economy. We would expect to see these indexes clearly moving into ‘tighter’ conditions if the interest rate rises of the past 12 months were fully flowing through into the economy.
Further, there are other important indicators in markets which further support the view that conditions remain ‘loose’ and have not tightened all that much just yet. Speculative manias in asset prices of the past have usually coincided with very loose monetary and financial conditions, only ending when financial conditions tighten. When we look at the most recent speculative bubbles, in some areas of the stock market and crypto-currencies, we see that prices have risen year-to-date in 2023. And they have risen by a lot! Bitcoin is up +31%, Tesla share price +68%, so far in 2023 (just over two months). That does not sound like a major tightening in financial conditions to us.
Further, there are other important indicators in markets which further support the view that conditions remain ‘loose’ and have not tightened all that much just yet. Speculative manias in asset prices of the past have usually coincided with very loose monetary and financial conditions, only ending when financial conditions tighten. When we look at the most recent speculative bubbles, in some areas of the stock market and crypto-currencies, we see that prices have risen year-to-date in 2023. And they have risen by a lot! Bitcoin is up +31%, Tesla share price +68%, so far in 2023 (just over two months). That does not sound like a major tightening in financial conditions to us.
Further, there are other signals of a major tightening that you should expect to see at that stage of the business cycle. Businesses with high levels of debt having to file for bankruptcy, for example. There is a notable dearth of news stories like this.
The short answer to the leading question in the title of this episode, therefore, is a resounding ‘no’. We’re definitely not there yet on financial conditions in the economy to be able to confidently say that we are ‘tight’ enough to have confidence in demand declining and bringing down inflation.
Recent hot inflation data releases in Spain, Australia, and the US, support this view. In fact, current financial conditions are still loose. It takes time for higher rates to feed through into properly tight financial conditions. It will come though, the US Federal Reserve is telling us that a major tightening will happen.
We can hear you asking the next question: how will we know when are there?
There will be some big clues to watch out for. Bitcoin and other crypto-currency prices are a good place to start. So long as those prices are going up or staying flat, we’re still in ‘loose’ territory. Watch out for those prices dropping dramatically as an indicator that we may, finally, be approaching an end game for tightening in financial conditions, and as such, an end game for higher inflation and higher rates.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
Have you watched our financial news reports?
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Technological advancements keep shocking us...
The rate of change in technology has been astounding over the past 200 years. Since the dawn of the industrial revolution in the late 18th century, humanity has moved from using horses and sail ships as a primary means of transportation, to mile-long diesel powered super container ships, cars, and jet powered aircraft. Even in the past 30 years, communications and IT technology have changed dramatically. A mobile phone or desktop computer more than 10 years old today is not just outdated, these products are often now incompatible with the latest generation of software and operating systems.
Change in any system creates risks and opportunities. Risks for those that were beneficiaries of the system before the change, opportunities for others. When it comes to modern technology investing, the risks and opportunities are magnified by the rapid rate of change and the scale of the market opportunity for the winners.
It is easy to see today’s technology champions as being immune to change. They appear to us as so dominant in technologies we use every day, it’s hard to imagine a new competitor or technology replacing them. But the history of capitalism is, if anything, a history of competition, innovation, and of today’s champions becoming tomorrow’s has-beens.
Kodak was once a technology champion in the United States, considered to have a dominant market position in the industry of photography and photographic film. Polaroid was considered a technological marvel in the 1970s, at its peak it employed 21,000 people and had $3 billion in annual revenues. Instantly capturing an image on film was, in the 1970s, truly revolutionary.
Nokia in the more recent past was the world’s dominant technology player in mobile phone handsets. Pretty much everyone who had a mobile phone in the early 2000s had a Nokia handset. They were the best mobile phone handsets at the time.
In the late 1990s, the dominant internet search engine was AltaVista, a mainframe computing company which used its tennis-court-sized computers to deliver what would now be considered quite poor internet search results.
What unites the companies we have mentioned here, Kodak, Polaroid, Nokia, AltaVista, is that they were all once dominant players in important technologies, and today hardly anybody uses their products or services. In the case of AltaVista and Polaroid, the companies no longer even exist.
Technological change and innovation are fantastic for the consumer and for the progress of human civilisation, but incredibly risky for investors in the companies who own and develop technologies. The next innovation may be just around the corner, and your once mighty and ‘safe’ investment in a business may soon be under pressure, or worse, go to zero.
We emphasize topics covered in last weeks news report...
Last week we referenced the incredible new language model technology supplied by OpenAI (part-owned by Microsoft), ChatGPT, which is now connected to Microsoft’s internet search engine Bing. Language model driven AI functions like this are likely to disrupt many industries, and generate the change that creates those dreaded risks and much longed-for opportunities for investors.
Dominion concluded last week’s episode by saying that taking a bet on who will have the best intellectual property, the best technology, is very difficult. To go back to the 1990s example of AltaVista, there were at the time dozens of internet search engines and it was not obvious to anyone that Google would come to dominate internet search with >90% market share today. Similarly today, it is highly uncertain as to who will win in the race to develop language models or text and speech driven AI support. For all we know, this may be a relatively easily replicated technology and it quickly becomes commoditized. Or there may be one dominant player who takes most of the market.
We also concluded last week that one good way to play a technology innovation trend like AI is to invest in the suppliers of products needed to power the trend. In this case with AI, the data centres running the computing power needed for AI require a lot of computer chips, so investing in those suppliers of computer chips trading on reasonable valuations today still offers the tailwind of the trend without taking the risk of betting on the IP winner.
"But there is another way to play a new technology trend without taking the risk of betting on winners or losers."
Dominion Capital Strategies
New technologies are typically adopted by people and businesses, and those new technologies can often-times change their nature, especially in business. Just as the internal combustion engine transformed logistics and transportation, so too AI-driven language models are likely to transform industries today that rely on interactive communications with people to solve problems.
The businesses who adopted the internal combustion engine to transport goods in the early 20th century had a major cost and business advantage over those who did not, those who still relied on horses and sail power were doomed to fail. The businesses today who adopt language model driven AI systems into to their businesses, we argue, might similarly have a major advantage over those who do not. This advantage could show up in much lower costs and higher returns vs. the competition.
Dominion Capital Strategies believes that this is another very interesting hunting ground for investment ideas where new technology (in this case, AI language models like ChatGPT) has opened up the opportunity to invest in companies set to be transformed by new technologies.
We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
Have you watched our financial news reports?
You can see the videos of our weekly financial news report on our social media:
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