Global Equity Strategies: October 2021 Monthly Commentary

Global equity returns were unusually strong in October rising over 4.5% in US$ terms and essentially flat in A$ as the Australian $ strengthened. The strategies underperformed significantly as growth styles outperformed value, and our overweight to Japan detracted as the Japanese market fell.

The USA rose 7% driven by decent corporate results, and a continued postponement of the tapering of central bank intervention. Inflation is rising quite clearly, even using today’s somewhat massaged construct, and with wage rates also rising, the chances are high that inflation expectations become embedded. In the short term this is a tailwind for equities given that they are a claim on nominal growth and a better inflation hedge than bonds. In the long term it is a problem for asset market stability, but a problem unacknowledged as yet by policymakers.

The USA continues to provide contradictory messages in the domestic and international arenas. President Biden recently indicated that the United States would defend Taiwan if that became necessary which is somewhat at odds with the official line that respects the “One China” policy. Taiwan’s President Tsai Ing-wen confirmed that there are a small number of US forces located in Taiwan to help with training of Taiwanese soldiers, an admission that annoyed Beijing with a call for the United States to immediately cease military and other official interactions with Taiwan. This will raise tensions and provides a source of volatility to a complacent equity market. The deal to export US LNG to China was announced while at COP26 the need to reduce fossil fuels further was announced by the US delegation. The infrastructure bill remains mired in Congress with some Democrats now removing their support for the ‘social’ spending aspect. Popularity ratings continue to fall.

Essentially investors are becoming confused about US monetary, economic, and foreign policy.

Japan was the weakest market in our portfolio with the index declining by 3.7% ahead of the general election called by recently appointed Prime Minister Kishida. There were fears that the ruling LDP would lose their majority in parliament; however, this fear proved unfounded as results announced on 1st November indicated a clear single party majority for the LDP. Prime Minister Kishida now has a mandate to push ahead with the additional budget spending that was promised during the campaign. This will include increased military spending to counter a more assertive China. The market responded positively to the election result. The election could be seen as the beginning of a change of generations within the LDP, having seen several senior lawmakers losing their long-held seats while younger lawmakers including Taro Kono and Shinjiro Koizumi achieved emphatic victories. The equity market should enjoy better returns now that this major period of uncertainty is out of the way.

We sold ABB in Switzerland after moderate results but a clear indication that next year was going to be tough as the European economies continue to struggle. We purchased Cheniere a US LNG provider and ONEOK a pipeline company supplying to the US export terminals in Texas. The US is now an exporter of LNG, a clean energy source. Such businesses are stable and thus attractive investments if a sell-off in the exuberantly priced equities is forthcoming.

Results were strong for Norfolk Southern, Seagate Technologies, KLA and Simon Property Group and all rose 10% or more.

We see irrational exuberance in many pockets of the market; and rapid and punishing share price falls on adverse news. Tesla rose 10% or many billions of dollars in value on a ‘deal’ announced by Hertz that they were buying Tesla cars for their rental fleet. It transpired there was no signed deal. In any event the sale of cars to the rental companies was long considered to be poor quality business for the auto manufacturers because they were at low margins and the quick resale of these cars hurt the second-hand prices of all models. More confusing to us is that if demand is so strong for high margin retail sales, why would Tesla countenance this move into the rental market? The company is now capitalised at about $2m per vehicle produced and is worth more than the next 9 auto companies combined even though it may produce c. 700,000 vehicles next year in a global market of over 75 million. It is on a P/E of over 300 x

SNAP fell 20% plus when it blamed a shift in Apple policies for a dramatic and ‘unexpected’ reduction in ad. revenues, and Zillow fell almost 40% in 3 trading sessions as its punt on flipping houses proved both difficult and costly.

We obviously ‘don’t get it’ but were told the same in 2001 and in 2008.

The words of Scott McNealy CEO of Sun Microsystems in April 2002, come to mind. “At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard, with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

There are currently 28 companies in the S&P on over 10x revenues.

We consequently remain overweight to dividend paying stocks, Japanese companies, and value generally. Recent performance has been disappointing relative even to a value benchmark but we have got through this before and the long term is what matters.

Delft Partners, November 2021