Posts tagged: KNG International Advisors

Monday 31st of July 2023

Analysing the financial market...

We are a couple of weeks into earnings season for the second quarter of 2023, with most of the world’s major listed businesses reporting financial statements and management commentary. With most companies still yet to report it is early in the season but, nonetheless, we have seen and heard enough so far to make some conclusions.

China’s discretionary consumer has arrived, albeit a little late. We are seeing a solid recovery in the Chinese consumer, led by higher income consumers in traditional luxuries earlier in the year, we are seeing evidence now of a broader improvement in spending across other product and service areas like mid-tier apparel and sportswear, and travel and leisure.

US ‘aspirational consumer’ is weakening in traditional luxury. We have heard now from multiple global luxury goods companies that in the US, consumers in the ‘aspirational’ category, those on incomes who can afford the lower pricing tiers of products, are slowing down their spending on this product category. Meanwhile, however, the US high income consumer is doing fine.

A major global catering business we follow is not seeing slowing in the US economy. In Sports and Leisure spending remains strong: “strength is continuing… We’re not seeing any signs of weakness thus far” according to management. This supports the view that where there is weakness in the US consumer, it remains restricted to physical products like traditional luxury goods and is yet to impact experiential or services spending, which remains strong.

Advertising spending is not dropping off a cliff, as you would expect to happen in a recession. Google Search growth accelerated, driven by retail advertising spend, while Meta (digital advertising business) reported very strong results. Despite the slowdown late last year in digital advertising, we have not seen the apocalypse predicted by many in advertising spend driven by weaker macro. Spending remains solid in the industry, especially in digital advertising with the large online platforms who offer the highest return on investment for advertisers.

Cloud spend growth is still strong across geographies and sectors. The two major cloud service providers to have reported results so far this season (Microsoft, Google) have shown continued strong growth in demand for cloud services across the economy and across regions. There is little evidence of a major slowdown in enterprise spending on cloud computing, far from it. We may see some moderation in growth rates, but nothing like the cliff edge drop expected earlier in this market cycle.

Conclusion: there is no evidence yet of a recessionary slowing in the economy. If there were we would expect to start seeing consistent patterns across sectors of the economy of slowing demand. We are seeing pockets of this, but it is limited and not consistent. The evidence continues to point to a ‘soft landing’ or ‘no landing’ scenario for the economy.

This is good for equities!

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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Monday 24th of July 2023

Listen to this financial market update by playing this audio...

But valuations and strategy still matter...

Equity markets are undoubtedly in a bullish mood, with positive market sentiment and a broadening out of the rally in stock prices in recent weeks.

What was a narrow rally in stocks during the first half of 2023, with a small number of large technology names dragging stock indexes up, has widened to include many other index constituents across different sectors of the economy.

Better than expected economic data releases and lower than expected inflation prints have supported this broadening out of the stock rally. Measures of positive / negative surprises on economic data are at their highest level in two years, indicating consistent beats on expectations. This has historically been a positive lead indicator for short-term stock returns.

The stock rally coincides with investor sentiment hitting the highest levels since 2021. This is an increasingly popular rally with wider participation from retail and institutional investors alike.

Higher asset prices have two important short-term effects on the economy that we should consider.

First, it makes those consumers who own stocks feel more confident. The asset side of their balance sheets is going up and so they feel more confident to spend a greater portion of their disposable income and save less. This extra spending hits the economy quickly. We are already seeing this effect in consumer sentiment data from the US, with some measures hitting two-year highs.

Second, it acts as an effective loosening of financial conditions. Much like a central bank cutting interest rates has a lagged effect on boosting the economy via a lower cost of debt, a rising equity market has a similar effect of acting to make equity financing easier and cheaper for companies. Easier access to capital, whether sourced via debt or equity issuance, is stimulative to the economy.

In both cases, the above factors are inflationary. This is something investors and market participants should be mindful of in the coming months.

In the meantime, however, disinflation and bullish market sentiment are clearly the order of the day, and investors should consider tactical participation in this rally while it lasts.

At time of writing Netflix and Tesla had both announced their financial results and both stocks were trading down in the pre-market. In both cases, the results were actually pretty good, but relatively slight misses to expectations in revenues for Netflix and profit margins for Tesla, pushed share prices of both companies down in after-hours trading.

This tells us that the market rally may become more discriminatory as it goes on. Popular stocks trading on very high valuations (like Netflix and Tesla) may be prone to corrections in price on news-flow, even if that news is only slightly worse than expected.

Valuation remains king, in our view, and should remain the focus of investors navigating this market.

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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Monday 17th of July 2023

Listen to this financial market update by playing this audio...

The end of last year saw sentiment towards risk assets and in particular equities become very pessimistic. The bear market of 2022, which hit growth stocks hardest but also hit bond prices dramatically too, understandably led to broadly negative and pessimistic sentiment for market participants as we entered 2023.

The rises in interest rates by central banks around the world and continued high levels of inflation further led to economic forecasts predicting major slowdowns in the world’s largest economies.

Looking back, it is remarkable how strong equity prices have been through this period. The S&P 500 Index is up close to +17% so far in 2023, the MSCI World Index +15%. These would be strong moves for a 12-month period, so it is even more impressive to deliver this in just the first 6 months of the year.

For much of the first 6 months of 2023, the rally in equities has been led by a small number of stocks. Large cap technology stocks in the US have driven much of the performance for stock indices this year, with the news-flow around artificial intelligence (AI) and a starting point of below average valuations supporting a strong move up in share prices of these companies.

More recently, we have seen two things that make us think the rally in equities could continue through the remainder of the year.

First, we have seen a broadening in stock index performance. What does this mean?

The fact that much of the move up in stock indexes in the first half of 2023 was driven by a small number of stocks (Apple, Microsoft, Amazon, Nvidia, etc.) made that a ‘narrow’ market. When a rally broadens, we mean that more stocks in the stock market index are contributing to the overall index performance. This is typically a healthy sign for a market rally, as confidence from market participants spreads to other sectors and stocks in the index.

In the past two weeks, we have clearly seen a broadening in positive market index performance.

Second, the latest data from the United States show a major reduction in rates of inflation and evidence of disinflation coming into the system. Remember, higher interest rates and their associated negative impact on the economy are what have held back market sentiment and economic expectations. If inflation really is coming down quickly and surprises to the downside, this could be a major tailwind to the economy via: (i) lower prices which boosts demand, (ii) higher corporate profits which boosts share prices, (iii) the potential for interest rate rises to be paused and even (whisper it) reversed.

What is more, the hype around AI is no fairy tale. Large language models and generative AI are revolutionary and we see ChatGPT and other iterations of this technology as having the potential to transform entire industries and have a major positive impact on economic productivity.

Broadening in market performance, lower inflation, and a technological tailwind to the economy, could be the recipe for further upside surprises to equity prices this year.

Equity rallies of the past have been sustained by far less!

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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Monday 10th of July 2023

Listen to this financial market update by playing this audio...

As investors taking actions day-to-day, month-to-month, year-to-year, it is easy to get lost in the data, the news flow, and the emotions that come with making decisions of where to allocate capital.

We think it is important for investment success over the long-term to ask ourselves important questions which can ground us and help guide the investment decision making process.

The core question for all investors is quite simple, in our view: what are we actually trying to do?

We see the answer to this question as lying somewhere between perception and reality.
Perceptions of how the world works, how it is ordered, can sometimes diverge wildly from reality. There may be a widely held believe which when examined via robust data collection and analysis turns out to be incorrect. It is in this gap between perceptions and reality where opportunities and risks lie for investors.

Sometimes this gap in perceptions can have major implications. Governments, financial markets, whole populations of people can respond to their distorted perceptions of reality which then have major real-world implications.
An excellent example of this is the public and media’s perception of terrorism. If we look at data of media coverage from mainstream sources like New York Times and The Guardian, and then take all of the published news articles covering issues related to human fatality and split these by topic, you find more than one-third (>33%) of articles published are on the topic of terrorism. More than 23% are focussed on homicide. That means that more than half of these media articles in the mainstream media are focused on terrorism and homicide alone as subjects.

This focus on subjects bleeds into public perceptions and, as a result, into government decision making. If the fear of terrorism is high, governments respond to this with changes to the law to ‘fight terrorism’. America even fought two major wars over the past two decades in the response to the perceived threat of terrorism.

But if we look at the data on causes of death in the United States, as a proxy for how worried people really should be about terrorism and homicide, we find something remarkable. Terrorism was responsible for less than 0.01% of deaths in the US, while homicide was 0.9% of deaths. So, in total, homicide and terrorism represent less than 1% of deaths in the US (and we can assume the Western developed world is close to being the same), while more than 50% of media coverage involving human fatalities was focussed on these subjects.

This is a dramatic divergence between perceptions (“terrorism and homicide are something we should worry about!”) and reality (“these issues are a tiny fraction of deaths and really not worth worrying about at all”). Gaps between perception and reality have real world consequences and are something everyone should be aware of.

These gaps of reality versus perception can occur in financial markets too. And the result is that prices of assets can sometimes reflect the distorted perceptions rather than reality. This creates risks and opportunities.

If perceptions are too optimistic and you own an asset, there is a high risk of prices falling if reality catches up and is priced in. On the flip side, if perceptions are overly negative, buying an asset can be a good investment idea as when (eventually) reality catches up with the price of the asset, the price should rise. Sometimes it can rise a lot!

We see this perception to reality gap in many of the sectors we focus our research on.

We have spoken in recent weeks about exactly this gap being a potential source of opportunity in the debate around artificial intelligence (AI). The market perceives that some businesses are going to suffer significant disruption from the introduction of AI, and the prices of those shares have fallen dramatically in some cases to reflect that perception. If that perception is wrong, if those companies end up doing just fine over the next several years, those share prices are likely to rise significantly as reality forces perceptions to shift again.

Big news stories and controversial subjects like AI can be rich picking grounds for investors! Tread carefully, but we think the dislocations thrown into markets by subjects like this, and many others, offer very interesting investment opportunities for the prudent investor.

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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You can see the videos of our weekly financial news report on our social media:

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Monday 1st of July 2023

It’s easy to forget, but less than 18 months ago Russia surprised the world with the full-scale invasion of a neighbouring, independent, democratic country. Ukraine then surprised the world by halting the Russian attack in its tracks and inflicting heavy losses on the invading forces.

Russia and Ukraine are both important exporters of major commodities and as a result of the conflict, the supply of these commodities was interrupted, resulting in major spikes in the prices of these goods.

When the supply of any good or service is disrupted, you would expect a spike in prices in the short-term. How long this rise in prices lasts depends on how critical the good or service is, in economics we call this the ‘price elasticity of demand’.

A good with a high price elasticity of demand likely is something that people can easily substitute, so if the price rises considerably, you will see switching out into other products and a major concurrent fall in demand. Imagine, for example, an event causes the global price of bananas to rise +300%. Assuming the price of other fruits remains unchanged, most consumers of fruit would likely stop buying bananas and simply buy something else, like apples or oranges. Bananas as a good have a high price elasticity of demand, in other words, if prices go up a lot, demand goes down a lot.

This process of demand collapsing in response to higher prices for a good with high price elasticities also works to bring prices down quickly. If demand for any good drops quickly, prices will fall as the market for that good will come back into equilibrium (where demand = supply) more quickly.

But not all goods have high price elasticities of demand, some have lower price elasticities. These are goods where it is not easy to substitute with another good, and where forgoing consumption all together is not easy. Forgoing the consumption of bananas is not that big a deal for most consumers, but what about forgoing electricity?

Many commodities used to produce electricity, like natural gas, coal, oil, these goods typically have lower price elasticities because in the short-term, you need to keep the lights on for a country like Germany, or the United States. If coal or gas prices spike +200% in the short-term, because of a major supply interruption like a war, then the buyers of those commodities must keep on buying, they cannot easily substitute. This further exacerbates the magnitude of the spike in prices, as demand does not decline as quickly, making the short-term supply interruption worse.

We saw exactly this scenario play out last year. The global supply of commodities was interrupted by the war in Ukraine, prices increased but demand remained relatively unchanged, exacerbating the spike in prices.

This was made worse by the fact that many commodity markets were tight after years of low investment. What does this mean? A tight market is one where there is little spare or idle capacity available to respond to changes in prices. A loose market would be one where a rise in prices would unlock a whole bunch of new supply quickly, helping to alleviate the rise in prices. A tight market is the opposite, it is one where there is little prospect of new supplies in the short-term coming online to respond to higher prices. Many commodity markets have seen much lower investment in new supply capacity over the past 5+ years, in some cases some of the lowest levels of relative investment for decades. The tightness of many commodity markets last year combined with a major supply interruption (a big war) was the biggest contributory factor to the rapid spikes up in prices of some commodities.

Markets, the financial media, and market participants have short memories. Very few are currently talking about the prospect of more surprise commodity price spikes. But if we look at the causes of last year’s price rises, they are all still very much in play.

The war in Ukraine is intensifying with little prospect of easing up any time soon. Russia is also increasingly being incentivised to try and destabilise other regions where it has a presence (Africa, the Middle East) to put pressure on the West. The risk of further surprise interruptions to commodity supplies remains very high currently.

Meanwhile investment in new production capacity for most major commodities remains relatively low by historical standards, we are not seeing a rush from miners or energy producers to open new supplies, capital discipline remains conservative.

It is always difficult to predict the exact cause of an unexpected interruption to the supplies of any commodity. But what we do know is that the ingredients for further price spikes are very much there. Investors should be braced for these and even consider being positioned to benefit from them if they come.

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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:

To start taking professional financial advice and to learn more about investment opportunities...

Tuesday 27th of June 2023

Listen to this financial market update by playing this audio...

The recent and remarkable rise of generative artificial intelligence (AI) systems has captured the attention and imagination of the world. ChatGPT being the most discussed (although there are many other generative AI systems producing very impressive outcomes), there is already talk of a new technology revolution driven by AI systems.

Our investment team has trialled ChatGPT and it has become a useful tool in our work process. Many others we speak to across different industries are finding novel uses for generative AI to support workflows and improve productivity. We are believers in AI systems eventually heralding a new age of technological progress.

As with all new technologies with the potential to change the world, generative AI has also captured the attention of equity markets! Stocks deemed to be potential ‘winners’ from the AI revolution have seen dramatic increases in market valuations over just a few months.

The poster child of this recent short-term trend has been the chip designer Nvidia, which has seen its share price rise +192% in 2023, the company’s market value is now greater than $1 trillion. Other tech firms like Microsoft who are thought to have a lead in AI have seen significant share price rises too.

We think Nvidia, and Microsoft for that matter, are both fantastic businesses with great technology, and both are undoubtedly at the forefront of AI today. But both businesses also command high valuations too. This leaves little upside for investors who want to take a position in the evolving AI story.

Sometimes in markets as an active investor, when everyone is looking one way, it pays to look the other way. In fact, it’s always worth looking the other way, even if you don’t make any investments!
What do we mean by ‘looking the other way’? Well, the consensus in markets today on AI is that, as investors, we need to pick the ‘winners’, the companies who are going to see accelerated revenue growth and profits from the AI revolution.
But what about the perceived ‘losers’ from AI. Looking the other way in this context means, looking at the companies the market thinks are going to lose from AI. Maybe there are opportunities there?

It’s very early days with this new technology in generative AI. Past cycles of new technologies teach us that the expectations of how quickly a new technology will change the world are often overly optimistic early in the cycle. The internet really was going to change the world, the tech evangelists were right about that in the 1990s, but it still took decades for that to happen in practice. It’s also incredibly hard to predict how a new technology will be implemented, and who the winners or losers will be.

Meanwhile the market has already punished the share prices of many companies who are thought to be at risk from AI.

A good example of this is in outsourced customer care services, where large companies and governments outsource call centre and helpdesk services to companies who specialise in the provision of these services.

At a very basic level, it seems quite obvious that some call centre jobs are likely to be replaced with generative AI systems like ChatGPT. But it is also quite naïve in our view to assume that that it is necessarily bad for the companies in question.

Imagine, for example, a large government department who outsources visa application call centre and helpdesk services to a large expert company in the field. That same department is not going to go to OpenAI (creators of ChatGPT) and request the entire call centre service is moved over to ChatGPT. OpenAI wouldn’t want them to do that either.

The obvious outcome from this user case example is that the existing service provider integrates ChatGPT into their existing service offering, with humans and AI working together to provide a better and more effective service to the end client.

The end client is happy, since it gets a more efficient service that works. OpenAI is happy because its AI system is being used. And the service provider is happy because it is now offering a better product to existing clients.

If anything, AI may be a tailwind to these call centre outsourcer companies. They might end up being AI ‘winners’, rather than ‘losers’. But their share prices have declined because the market (incorrectly, we would argue) is assuming AI must be bad for call centre services.
This kind of short-sighted, poorly researched thinking in markets creates opportunities for the thoughtful investor! And there may be many more opportunities where the market is assuming businesses will lose out from AI.

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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Monday 19th of June 2023

Listen to this financial market update by playing this audio...

Equity markets have had a strong first-half of 2023, with strong moves up in many of the major stock indexes around the world. This has been led by very solid moves up in US stocks, with much of this increase in equity value driven by a relatively small number of US technology stocks.

The launch and widespread adoption of ChatGPT and other large language models has further added fuel to the fire of the market rally, with expectations of the implications of artificial intelligence feeding into the stock prices of the suppliers of related technologies. Chip designers like Nvidia, and business process implementation companies who use AI like Palantir, have seen very strong moves up in share price in recent months.

Meanwhile, however, the economic outlook for the global economy remains as confusing as ever. Despite one of the fastest moves up in central bank interest rates in history in the US and Europe, we continue to see relatively robust economic data, especially from the US. Housing markets have seen some slowing and dips in prices, but nothing dramatic just yet. Consumer spending growth rates have slowed but remain positive. And we continue to see labour market data surprise to the upside, most recently in the UK.

So, while equity markets have been buoyant in the first 6 months of 2023, with the latest hype around AI providing further support, we think that the economy will increasingly come back into focus for global financial markets and guide the direction in the second half of 2023.

A steep rise in interest rates will always have an impact on the macro economy. The question is, how much of an effect?

Going from close to zero interest rates up to closer to 5% is a big move, especially when it happens in the space of 12-18 months as we have seen in the US. This begs the question, how big an impact will we see on the US, and as such, the global economy from this rise in rates and subsequent decline in liquidity?

Whatever the case may be, there will be some slowing in growth rates in the economy from higher rates. The worst outcome would be what is widely being called a ‘hard landing’. This would be a dramatic decline in economic output and confidence. The last economic ‘hard landing’ was the 2008-2009 recession. The best outcome would be ‘no landing’ at all, where we see some slowing in the economy but we do not see anything that looks like a recession. The third option is somewhere in between, what is being called a ‘soft landing’. This would look like a mild recession, something along the lines of the recession seen in 2001.

Which do we think is most likely?

This is probably one of the hardest macro-economic environments to predict in our careers. And many other commentators and investors agree. The supply chain and demand pattern disruption caused by the pandemic has shifted business cycles in many industries in unpredictable ways. Inflation, caused by a war in Europe and over-stimulation of Western economies by governments and central banks has further complicated the situation, pushing central banks to raise rates dramatically to attempt to tame inflation. This leaves us in a position where the outlook is highly uncertain for the global economy.

It is helpful to think about what needs to happen for either of the extreme outcomes to occur. Starting with a ‘hard landing’, we think this is probably less likely than a soft landing because to get a hard landing in the economy, we typically need to see a major credit or financial crisis. If we look back at two of the biggest hard landings in history (1929-1933, 2007-2009), in both cases there were systemic risks to the global system caused by the failure of large banks and financial institutions. Although there have been some worrying recent parallels with the failure of several regional US banks and Credit Suisse this year, we do not see the risk of systemic bank failures as being particularly high. Banks are much better capitalised today vs. 2008 and it is rare (if ever) that a crisis repeats a second time. If there is going to be a major crisis that pushes us into a hard landing, it won’t be bank failures or a major credit crisis in our view.

We also think the ‘no landing’ scenario is somewhat unlikely, simply because of the very high levels of debt in the global financial system and the rapid rise in interest rates. We find it hard to believe that the global economy can completely get away with no significant slowing in growth rates given these factors.

Which leaves us with ‘soft landing’. We think this, therefore, is probably the most likely outcome. A recession at some point in 2023-2024, but in the absence of a major credit crisis, a shallow recession that looks more like 2001-2002. This also chimes with the equity market we have seen over the past two years, where tech stocks rallied to unsustainable valuations before seeing major declines last year.

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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Monday 12th of June 2023

The energy transition is the biggest structural trend underway in the global economy today. Climate change and the requirement to re-tool the entire global energy system touches every human, every company, every country. It is a true global trend. To some degree, every business on the planet and as such, every investment, is in some way exposed to the global energy transition.

And the scale of the challenge and investment opportunity is vast. Still today more than 77% of global energy is sourced from burning fossil fuels, the emissions from which contribute to the greenhouse effect which warms the world’s climate. The road to full de-carbonisation of the global economy is likely to be long, expensive, and complicated.

Unfortunately, there is today a wide gulf between much of the political rhetoric and news coverage on climate change vs. the reality of what is really happening on the ground. After two decades of heavy, government subsidised build outs of renewable energy (wind and solar), the average person on the street is likely to think that the % of global energy we source from fossil fuels must have fallen. Some progress at least must have been made, especially given the incredibly optimistic assumptions we have all heard about the low costs of solar and wind.

Sadly, the reality is very different. Since the year 2000, after 23 years of heavy and increasing investments into renewable energy, the % of world energy that is sourced from burning fossil fuels has actually gone up slightly, it has not come down at all!
The mix of renewables has risen, and that is good, up from close to 0% in 2000 to 4% today. But in the meantime, other aspects of the global energy mix have changed enough (much higher demand, higher gas demand, lower nuclear supply) such that all of the progress made in renewables build out does not show when we look at the total energy demand picture.

What is more, fundamental aspects of energy technologies seem to be ignored, or missed due to ignorance, by mainstream media outlets reporting on the subject of energy policy, and worse, from the politicians in many countries making decisions on energy policy. For example, it’s all well and good building wind and solar farms, but these need to be located where the wind or solar resources are optimal, often far away from existing electricity grid infrastructure. This means they need to connect to the electricity grid, often over long distances, which is technically challenging, expensive, and takes a lot of time. This means today there is a growing number of completed renewables projects waiting months, even more than a year in many cases, to be connected to electricity grids. These delays in connection are even resulting in delays in the commissioning of new projects.

Fossil fuels like coal do not face this problem. You can locate a new plant anywhere, and often they are located close to existing infrastructure so that connection is relatively easy. These plants do not take very long to commission and build either, and they do not face the limitations of intermittency faced by renewable sources of energy.

A major part of the problem facing the global energy system today is an under-investment in energy supplies, which increases the potential for future short-term energy shortages. Taking, for example, $20 billion of capital that would have been spent on fossil fuel generation and instead spending it on solar or wind farms, is not a 1-1 switch in energy production. The same investment in renewables gets you much less useful electricity supply, the capital intensity per MWh of energy produced is much higher for renewables (this is a function of the significant difference in energy densities of the fuels). And what’s more, even if we were to adjust up the investment in renewables to match the capacities, intermittency of supplies from renewables means the load factors (% of capacity that produces energy) are much lower. So, while total spending on the global energy system may have been going up, the switch away from investing in fossil fuels and into investing in renewables has meant that, relative to total energy demand today and in the future, we are not spending (in total) enough on total energy supplies.

This raises the probability of short-term energy shortages. Any unforeseen event or interruption of supply can create shortages that are much worse because of the lack of flexibility in the global supply chain for energy to meet the unanticipated demands of the crisis in question.

The outcome is that, even if it means switching investment in the short-term back into buying fossil fuels like coal at very elevated prices, that is exactly what governments will do to keep the lights on in their economies. This is what happened in 2022, where we saw record prices for coal and record profit levels for coal companies. This is not what you would expect if the narrative around ‘coal being a thing of the past’ was correct. Far from it, if climate and energy policies around the world continue to be as disjointed and detached from reality as they have been in recent years, coal and other fossil fuel companies could be set to see rising, not falling, realisation that their assets are strategic in nature and deserve valuations that reflect that strategic value.

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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Lunes 5 de Junio del 2023

There is a scene in the American crime drama The Wire where police officer Cedric Daniels (played beautifully by the late Lance Reddick) is discussing a complex situation he finds himself in at work, work for Daniels being the dysfunctional and corrupt Baltimore Police Department. Daniels finds himself left with no good options, only options which all seem to lead to more problems and risk for him, whichever decision he makes, an honest cop working for a thoroughly dishonest institution. Over dinner, his wife simply tells him: “the game is rigged, but you can’t lose if you don’t play.”

As an aside before we dig into the relevance of this scene for investors, we would highly recommend watching The Wire because it is a true masterpiece of television drama and includes career high performances from Lance Reddick, Michael Kenneth Williams, Idris Elba, Dominic West, and many other fantastic actors.

Getting back to markets, we think that the advice officer Daniels receives from his wife over dinner is excellent advice for investors trying to invest in major structural trends in the global economy today. We as investors are faced with seismic changes in markets and the industries we invest in via bond and equity markets. New technologies, demographic changes, climate change, these and many other sources of change often result in the old order changing, sometimes very rapidly.

A good example of this is in a sector like electric vehicles. New technologies and growing manufacturing scale are facilitating a generation of electric cars that work just as well if not better than combustion engine vehicles and at similar cost. The transition to a global fleet of cars that are fully electric is well underway. What’s more, new battery technologies are emerging which could further revolutionise the de-carbonisation of vehicles and accelerate this transition. The risks and opportunities are big, but the choices available to investors are daunting.

Which auto companies do you choose to invest in today as the potential winners of tomorrow? Will Tesla maintain its market share 5 years, or 10 years into the future. What about VW, or BMW, maybe Toyota will surprise everyone, perhaps Hyundai, or China’s Geely will emerge as victors in the global competition for domination in electric vehicles. And the same is true for emerging battery technologies. Solid state batteries could genuinely be on the cusp of changing the world, edging out other technologies. Or perhaps incremental improvements in lithium-ion batteries will suffice and this technology will continue to dominate.

The risks of getting this wrong are high, you may end up with an investment which performs very poorly, invested in the wrong manufacturer or technology. Much like the dilemma facing officer Daniels in The Wire, there seem to be no good choices but a lot of potentially bad ones.

But to echo officer Daniel’s wife, you can’t lose if you don’t play. Our advice to investors is: do not play the game in the first place. Be smart and rise above the game of picking winners in highly competitive and uncertain industries. By avoiding participation at all, we guarantee that at the very least, we will not be holding risky investments that underperform because we got the call wrong, because we never made the call in the first place. We didn’t play.

We can also take this one step further. While avoiding the risky game with low probability of success, we can play a different game with much higher chances of success. Pick the winning car company or battery technology in electric vehicles? Low chance of success in your choice, high risk, avoid playing that game. But what about the suppliers of critical materials and components needed in all electric cars, no matter the manufacturer or battery technology? This is a game we can have much more confidence in playing!

Whether it’s BMW, or VW, Chevrolet, or Ford manufacturing an electric vehicle, they will all need to use batteries and wiring which is intensive in its use of copper. Copper is a material unique in its characteristics that makes it perfect (and very hard to substitute) in electric vehicles. It is an enabling material, without which electric vehicles simply would not be a viable technology today.

We also know with a high degree of certainty that over the medium- to long-term, demand for electric vehicles is going to grow a lot. The transition is well underway and will continue. When we plug these future demand numbers into a model of future copper demand, we see demand far exceeding global supplies, which means we can expect prices for the material to rise. This sounds like a good set-up for the suppliers of copper, which is much more supply restricted compared to automotive manufacturing, copper being an increasingly scarce and hard to mine resource.

This and many other areas of potential ‘supply bottle necks’ supporting a major structural trend are where we like to go hunting as investors. We avoid ‘playing the game’ in any trend, whether it be AI, electric cars, or many other sectors, where debate rages about who out of many competitors will ‘come out on top’ in the end. Better we think to avoid playing that game, and instead play another game, a game where you find the suppliers of the materials, products, and services that all of the competitors will need to use. We gain exposure to the trend, without taking the risk of picking a loser!

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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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Lunes 31 de Mayo del 2023

Listen to this financial market update by playing this audio...

Last week we introduced the concept of investing in cyclical industries and why we think it is important for investors to think about this subject. To recap:

Some sectors in the economy operate in cycles. These cycles of demand are driven by factors in the wider economy and sometimes by factors specific to that industry. These cycles create periods of high demand and profits, followed by lower demand and profits.

Many industries in the economy are exposed to cycles in some form, more so than others. This means that most (if not all) investor portfolios will have some significant exposure to business cycles.

As such, understanding how these cycles work and, most importantly, the risks and opportunities they offer, are very important for investors. To cut a long story short, investors should avoid exposure to cycles near their peak, when expectations and valuations are high, and should favour higher exposure to cycles close to their lows, when expectations are washed out and valuations lower.

In practice most investors get this the wrong way around, investing close to cycle highs and exiting close to lows. This is a big part of the reason why we see big swings up and down in stock markets, it is the underlying cycles in big industries driving these dramatic price changes.

The question we posed last week was: are there any cyclical sectors in the stock market today exhibiting cyclical high or cyclical lows?

Last week we introduced our first example of a sector we see opportunities in, namely energy related capital goods.

This week we want to introduce another sector we think is exhibiting the characteristics of being at or close to cycle lows. Remember: a cyclical sector close to its cycle lows typically has been through a prolonged period of volatility, poor stock price returns, weakening demand and low profits, and as a result sentiment towards the industry is rock bottom. Investing at that moment is a counter-consensus strategy, consensus being at a place where it still thinks the outlook remains as dire as the recent past has been.

Some (but not all) areas of the semiconductor industry today are, we believe, exhibiting characteristics of being at or close to cycle lows.

The semiconductor industry is the supply chain of companies and technologies who facilitate the fabrication of the computer chips which power the PCs, smartphones, servers, and other devices which utilise computing in the modern economy. The industry spans high-end design firms who design the chips, the suppliers of software used to design and test chips, the companies (fabricators) who manufacture the chips at scale, and the suppliers of the equipment used by fabricators to manufacture chips.

The COVID-19 pandemic and widespread use of lockdowns around the world resulted in a major increase in demand for electronic goods. Government subsidies in many countries and work from home requirements accelerated the upgrade cycle of PCs, laptops, smartphones, and other electronic devices which are heavy users of semiconductors. This led to a boom in demand for semiconductors and very strong growth in demand across the semiconductor industry in 2020 and 2021. This is a classic up-cycle in a cyclical industry.

Last year (2022) saw a major reversal in this trend, and as such, a major decline in many of the associated share prices of companies in the industry. Expectations and associated valuations in the semiconductor industry were, at the end of 2021, elevated as a result of the very strong demand in 2020 and 2021. This was a poor time to be investing in the sector, the top of the cycle.

As demand came off last year and profits across the industry have declined, driven by much lower demand than expected for PCs, laptops, and smartphones, the performance of the companies and their share prices has been weak too. In early 2023, we have seen classic signs of the bottom of the cycle. Management teams of the companies in the sector sound pessimistic, expectations are low, the news articles you read on the industry are very negative, and there is little appetite to invest.

However, these cycles never stay at their lows in critical industries like semiconductors. Eventually demand for laptops, PCs, and smartphones will pick up as upgrade cycles kick back into gear. What is more, new technologies and features, like 5G and foldable phones, can accelerate these up-cycles. We may be closer than many think to a new up cycle driven by these washed out end markets.

In addition, we now have the kicker to future demand of the rising adoption of artificial intelligence (AI) powered features, led by large language models like ChatGPT. These processes are intensive in their requirements for computing power, and more computing power = a lot more semiconductors. In server and data centre demand (a large and high growth sector that uses a lot of semiconductors), we may also see much sharper increases in demand for computer chips to supply the computing power needed to meet rising demand for AI-enabled functions online.

This is the combination we search for as investors. The weak sentiment, low demand expectations, and low stock valuations associated with the bottom of the cycle, combined with an underappreciated up-cycle in demand that could be just around the corner. A very interesting opportunity indeed, and one we are taking advantage of now.

We would like to thank Dominion Capital Strategies for writing this content and sharing it with us.

Sources: Bloomberg, Yahoo Finance, Marketwatch, MSCI.

Copyright © 2023 Dominion Capital Strategies, All rights reserved.

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:

To start taking professional financial advice and to learn more about investment opportunities...