Posts tagged: Semanal

Monday 19th of June 2023

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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.

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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

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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.

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Monday 22nd of May 2023

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Some sectors in the economy go through what are known as cycles. Periods of very high demand are followed by big cycles down in demand, in a cycle of boom and bust for the industry. These cycles of demand are driven by other factors, sometimes in the wider economy, sometimes driven by factors specific to that industry, like computer games consoles for example where cycles are driven by the age of consoles and the launch of new products. Many industries exhibit cyclical characteristics, from automotive manufacturing to advertising. It can be hard to avoid cycles as an investor.

If we are investing in an industry that exhibits cyclical characteristics, it is very important to understand the cycles in question and to try and ascertain where we are in that cycle.

Being at or close to the peak of the demand cycle can be a dangerous time to invest. Recent strong demand is often interpreted by the market, investors, even some management teams of companies, as indicative of the new base level of higher demand. This creates a false sense of confidence in the outlook for the business which, in reality, is on the precipice of a major cyclical downturn. Time and time again across multiple industries we see cyclical highs interpreted in an overly optimistic way.

This over optimism translates into high valuation multiples and higher share prices for the stocks in question. The peak of the demand cycle in a cyclical industry, misinterpreted as a new base level of demand for the future, combined with a gross underestimation of the likelihood of a cyclical downturn in demand, results in share prices of related companies that are too high. The risk of share price declines, as reality meets overly optimistic expectations, is high. This is a time to be avoiding investing in stocks exposed to such cycles.

The opposite is true for lows in a cycle. At cyclical lows, we often find that sentiment towards related companies is very pessimistic, often overly so. The path down to the cycle low was a tough one for investors, management teams, and researchers covering the sector, with share prices coming down heavily to reflect lower demand and weaker performance for related businesses. This also translates into lower expectations for demand and profit growth. The lows are interpreted as a new lower base level of overall demand for the industry, and the possibility of a cyclical move up in demand is underappreciated by the market. This results in share prices and valuations that are too low, the risk of a major surprise to the upside and major move up in share prices is high. This is a good time to be buying companies exposed to such cycles.

More often than not investors get these cycles the wrong way round. Time and again we see investors buying aggressively at the top of cycles and selling closer to lows. The optimal strategy when investing in cyclical industries is to do the opposite, sell at cyclical highs and buy at cyclical lows.

This begs the question, are there any cyclical sectors in the stock market today exhibiting cyclical high or cyclical lows?

We think there could be some sectors exhibiting the characteristics of cyclical lows and, as such, now could be an attractive entry point to buy into those sectors. One example is in the energy related capital goods sector. These are industrial companies that manufacture and service the heavy equipment used to produce and transmit electricity in the power grid. Last year was a very tough year for these companies, with high input cost inflation crushing profit margins and economic and political uncertainty delaying orders for new equipment. Share prices of related companies and valuations came down significantly. In some cases related companies traded on their lowest valuations in their trading history late last year. The market was valuing these companies as though the lows in profit margins and demand were the new normal.

The truth is far different, we may in fact be on the cusp of a major up-cycle in demand for energy related capital equipment. The world is in dire need of more energy supply, from renewables and other lower carbon sources to fight climate change, and to supply rising demand for energy in emerging markets.

This looks to us like a classic bottom of the cycle opportunity and we have already seen recent earnings reports from these companies surprise to the upside, with orders, revenues, and profit margins well ahead of estimates as cost inflation has eased and demand has improved, all resulting in strong moves up in share prices over the past 4-5 months.

In the coming weeks, we’ll be giving some more examples of sectors where we see cyclical highs or lows, where investors should be considering reducing or increasing exposure.

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 15th of May 2023

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Valuations, Valuations, Valuations (Let's Go!)

Dominions team recently had the pleasure of travelling to Latin America to meet with clients and partners they work with in the region. Their colleagues in Uruguay showed them the meaning of ‘asado’, while friends from Argentina, Brazil, Chile, Peru, Ecuador, and many other countries were as kind and hospitable as anyone could ask for.

During their presentations and conversations, one topic came up again and again. What is the investment outlook for the rest of 2023?

Last year was a tough year for investors with equity and bond markets declining significantly. High inflation and rising interest rates in 2022 have set us up this year for the prospect of a slowing economy and even a possible recession. Recent bank failures in the United States and Europe further adds to the uncertainty facing asset allocators and individual investors.

The current situation facing investors is highly uncertain and very challenging. What’s going to happen and how do we invest?

Dominions response to this question was as follows:

We cannot, in fact nobody can, accurately predict what the global economy is going to do in 3 months, 6 months, 1 year, etc. Trying to predict the future revenues of an individual company is highly complex and even with the best analysis your prediction is most likely to be wrong. Scale up this problem of unpredictability to the whole economy, and the project becomes pointless. The starting point for any and all investors, in our view, should be to not bother trying to predict the future of the macro-economy.

This is especially important in times of great uncertainty, as we find ourselves in today in financial markets. Taking strong views either way (either bullish or bearish) poses great risks to investors. Too aggressive / optimistic a position in your portfolio risks significant losses if the economy is weaker than expected. Too bearish / pessimistic a view risks missing out on strong positive returns from risk assets if the economy is stronger than expected.

Rather than focussing our attention as investors on factors we cannot control or predict (e.g., the macro economy), we think the correct strategy for investors today is to focus on factors you can understand and which are under your control.

The current market price of an asset relative to the cash income it produces is a very useful measure of its valuation. For example, imagine a business with a market value of $100 million, with 10 million shares listed on a stock exchange. This equates to a price per share (the stock price) of $10. This same company generated $20 million of free cash flow last year, equivalent to $2 per share of free cash flow. If we divide the market value of the company by the cash profits generated by the company last year, we get what is known as a ‘valuation multiple’. In this case, the free cash flow multiple is 5x. In other words, the company is currently trading on a valuation of 5x historic cash flows.

This methodology allows us to compare investment opportunities. Imagine now another company in the same industry as our previous example. Let’s say it generated $30 million of free cash flows last year, and trades on the stock market for a total company valuation of $360 million. The free cash flow multiple for this company would be 12x.

We can now compare the two investment opportunities based on valuation. One company trades on a 5x multiple, the other a 12x. As a prospective investor, you are paying much more for the second example than the first example, the first example is ‘cheaper’ and the second is more ‘expensive’. All else equal, you should buy the first stock trading on the lower valuation multiple.

There are dozens of different valuation multiples and other methodologies we can bring to the table when making investment decisions. The importance of doing this and focussing on investments trading on attractively low valuations is that you are reducing the downside risk to your portfolio. To go back to our example, two businesses trading in the same industry, one trading on 5x its cash flow generation, the other on 12x, all else equal in a recession the more expensive stock will fall much more in % terms than the cheaper stock.

This brings us back to the initial question. What is the outlook for 2023 and how should we invest?

We do not know what the economic outcome will be, but what we can do is invest in assets trading on attractive valuation multiples. The cheaper the better, if the asset is of a good quality. If we can build a portfolio of high quality assets trading on low valuation multiples, this sets up the strategy to: (i) be a recession beater and outperform in the event of a weaker economy, and (ii) perform very well if the economy is stronger than expected, because we still own risk assets and did not hide in cash or money market funds!

Dominions advice in this difficult time is: don’t panic, get the strategy right, and invest in strategies with a focus on offering quality at an attractive price.

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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Wednesday 10th of May 2023

Investment Strategies

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.

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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Tuesday 2nd of May 2023

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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.

Dominion Capital Strategies

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.

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 April 2023

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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.

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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Tuesday 17th of April 2023

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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.

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.

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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