Good afternoon,

ASX200 fell 50-odd points last week and is down this morning another 32 points. We are only down 1.3% from the 6 month high once you adjust for dividends (or 1.7% if you don’t).


The bears are coming out of the woods

As per my note last week, manufacturing PMI’s were out last week and were flat-ish and my base case is now a slowing in earnings growth driven by a fall in commodity prices. Share prices follow earnings so I can see the index falling back to c. 5800 in the back half of this year.

The long and the short of it is that the business cycle is turning from accelerating expansion to decelerating expansion.

How do I know this? Well, I don’t know anything for sure but history tells us that these periods are marked by PMI’s falling from highs, Industrial Production slowing, M&A activity increasing (anyone noticed…), an increase in cyclical stocks earnings misses, elevated valuations… the list goes on. But be a student of history; not the facts, but the patterns. If you want a brief run down, I suggest watching both the 30 minute videos below from two legends of the industry, Raoul Pal and Ray Dalio.

Don’t panic, it’s just another opportunity to generate returns for those properly positioned. Not sure how to play it? Why don’t you drop me an email (lukel@senecafs.com.au) and ask!

 
Raoul Pal on the business cycle
 
Ray Dalio on the business cycle

 


Setting Expectations

Quick reminder (and people who don’t work and live off the dividends are the obvious exception), it’s very important to reinvest both dividend and capital returns. For this reason, it’s near-pointless following ‘share prices’ and only relevant to look at TOTAL portfolio return.

The difference over 10 years is stark (chart below)
1.3% compounding return WITHOUT reinvestment.
10.8% WITH reinvestment. 

Does this mean you should sign up for every dividend reinvestment program you can? Of course not! Are you a simpleton who seeks only the simplest answers? No? Well then, look for the correct answer and make a better decision!

Take your dividends and if you don’t need them for groceries/holidays/dependents, rather than blindly buy more of the shares you already own, choose the companies that are going to deliver you the best returns or better serve your objectives in the forward period. 

By the same token, if you are investing for INCOME, don’t expect to keep up with the Accumulation Index every year. It makes no sense. Not only are you not reinvesting your dividends like the index, you are also not (generally speaking) investing in businesses that are investing in their business. How can profits go up if the company pays all the profits to you each year?

If CBA (just an example) is paying 75% of its profits out to you so that you can go on holidays, how do you expect CBA to grow its profits at a rate of change higher than inflation? And if profits aren’t growing, why do you think the share price will go up (remember, share prices follow profit expectations?!?!).

Anyway, the takeaway is, most investors are consistently disappointed with the share market because they consistently make the incorrect assumptions. These ‘rules of thumb’ or ‘logical fallacies’ result in expectations that are unsupported by facts, probabilities or adequate investigation.

You want a 6% dividend yield? Great. Your portfolio will under-perform the ASX200 accumulation index.
Want absolute returns? Good for you. Your portfolio will experience high capital losses at various times.
Want high relative returns? Fantastic. You have to have a longer investment time horizon than average.
Want it all? Become a client! Hahaha, just joking!
My point is you can have a great investment portfolio if you just define what “great” means to you and don’t change your definition every other week.


Become a client

Seneca has now been running 8 months (yay!) and now that we’ve moved the vast majority of my clients across from my previous place of work, I’m in a position to take on a few new clients.

I’ve probably got capacity of 5 new managed accounts depending on size/what’s involved so if you’ve been thinking about reaching out, now is the perfect time with end of financial year about to tick over.

We offer a bit of an incentive with pricing in year one to help ‘compensate’ for the extra admin involved in opening an account.

My role is to:

Help clients define/refine their objectives in an investment context
Design a high level strategy that will help them meet that objective
Execute that strategy through time (which requires adjusting the tactics employed for the given point in the cycle)
Our portfolios include audited tax reporting and fully transparent, daily performance numbers at a portfolio level. We provide advice on local and international shares, managed funds, ETF’s, private equity & venture capital opportunities, initial public offers (IPO’s) as well as exchange traded options and other derivative products.

If you’re interested, click the enquiry link below:

Click here to become a client

Spotify (SPOT)

For those clients who aren’t “up with the kids”, Spotify is a music streaming service. You pay a per month subscription fee for access to unlimited music. They have almost everything from classical to hip hop, from all around the globe, all genres. You can download the application in the Play Store or on iTunes.
The common thread for success among the best performing tech companies is not that they have a lot of users, or that they collect a lot of data. It’s that they use that data to seamlessly improve the customer experience.  

Want proof?

Google (GOOG +105% since 1 Jan 2015) gets better every time you search. The algorithm gets better at finding what you need more accurately.
Amazon (AMZN +410% since 1 Jan 2015) looks at what you buy and then shows you a personalised version of Amazon to optimise your experience.
Netflix (NFLX +580% since 1 Jan 2015)  knows what you watch, what you like, how long you watched it for and not only curates your interface, but those aggregated statistics drive program production.
Spotify (SPOT) is the KING of intuitive, automated, personalised user experience.
It’s uniquely social (you share with your friends what you are listening to, you can collaboratively manage playlists, follow what others are listening to etc.).

As a result, it’s amazing at finding you new music which you will love. The ‘Discover Weekly’ feature is just THE best way to hear what’s good, based on your taste. We’ve talked about ‘curation’ vs ‘information’ as an investment thesis a lot over the past few years in this note.

(Basic premise is “information” is not worth anything as you can find out the answer to any problem on Google. It’s “curating” information that’s valuable. Passing on highly relevant information to the right person and the right time.)

Spotify has all the hallmarks of a multi hundred billion or perhaps even, trillion dollar, business (current market cap c.$26bn). For those bad at mathematics, a trillion dollars is 38x current value.

It’s global and by 2020 will have over 100m paid users (MS estimates).
It’s algorithm improves with usage, more input, better results.
It’s intuitive – it learns what you like and tailors its offering.
It’s perceived as doing good, likeable, and able to attract the best and brightest.

Spotify also has huge opportunities in all streaming, not just audio, but video as well. I think in time, Spotify could become a significant competitor to Netflix and Amazon, particularly in music video category. 

This space is competitive. YouTube (Google) already try and own music video (however it’s largely seen as a value leak for record labels and artists) and the likes of Apple Music have some (though small relative to Spotify) market share in audio. Then there’s Jay-Z’s TIDAL which has its niche as well as Pandora. None of these companies have been able to exploit the intersection of music streaming, social and data as well as Spotify.

Last trade USD $156.60 after listing at $150 at the start of April. EARLY DAYS!


Online Gaming / ESports Thematic

I had one of our readers ask me how to best get exposure to E Sports which we discussed a couple of weeks back.

I came across the US listed  GAMR ETF, which is designed to track an index of video game exposed companies. This could be worth a look for those interested in the thematic. Click the link for the fact sheet.
http://www.etfmgfunds.com/fact-sheet/ETFMG-GAMR-FactSheet.pdf

Chart below is total returns for last 2 years, indexed at 100. Up 88%. Last trade USD $52.19.


Local Market

Looking at the local market we had 4 potential/actual takeovers play out last week. FOUR IN ONE WEEK!

Sealink Travel (SLK) – We’ve liked SLK for a while and has been a sneaky tip from me from a few months back (see notes from  8 Jan 2018 and  11 Dec 2017 here). Good business, well managed and in the right business. Execution risk on strategy but not short on will or opportunity.
BWX (BWX) – management buyout. Sukin is a ripping brand and product and I like everything about it except management haven’t been able to handle guiding market expectations so probably a smart move.
iSelect (ISU) – Compare The Market have gone substantial, suspect hostile takeover here. Opportunistic. Probably necessary as its a small margin game with a few too many players. Not sure how it will work out for CTM, but makes sense.
Ooh Media (OML) & APN Outdoor(APO) battling it out for Adshel (not listed). That outdoor media space is pretty interesting, we’ve been long OML for a year or so now and it’s been good to us. Getting a bit rich maybe at $5.50, but again, it’s at the right dance party and is wearing the right clothes. Chances are it’s going home with someone!
Elsewhere Aristocrat (ALL) keeps just making more and more money. Surprise surprise it’s a dominant player in the market where VIDEO GAMES intersect with MOBILE and cross pollinate with GAMBLING. Fairly sure that’s pretty much a license to print money.   You’ll see ALL got some love back in our 11 December note. In fact, 4 of those 5 stocks mentioned have outperformed the ASX200 since that date, an equal weighted portfolio would be up 32% (inc. Ramsay, down 11%)

Energy stocks took a bit of a bashing this morning, with oil falling 3% overnight. Elsewhere profit taking in GWA Group (GWA) and Altium (ALU) saw those good businesses give up a bit of their recent gains.

What’s of interest?

With my views on the overall market you have to speak in more relative terms than absolute. In fact, this is the perfect time to review your portfolio as high quality companies perform better (historically speaking) than low quality businesses in bear markets and often get caught in the carnage. A few names that I’m looking at domestically are Ansell (ANN), Computershare (CPU), the staples sector (WOW, WES, CGC, TWE) and the labs business ALS (ALQ) as well as traditional defensive stocks (infrastructure, REITs etc.).

A bit more offensively, I still like lots of the stuff we talked about in December.

  • Integral Diagnostics (IDX) I expect to get taken out as some point.
  • Amcor (AMC) is cheap if you’re patient and not too bearish on changes to diet being a headwind for packaging (if you eat more healthy, fresh food, you need less packaging.)
  • I think Boral (BLD) has a price which it would interest me.
  • Reece (REH) and Reliance (RWC) are no brainers, as is ARB Corp (ARB)
  • Challenger (CGF)  hasn’t been this cheap for a while, though probably exposed to markets a bit more than people realise.
  • Soft markets will give you a chance in stuff like Janus (JHG) or Magellan (MFG).
  • Soft oil prices in Woodside (WPL) or WorleyParsons (WOR) but you need to understand the requisite risk and buy with the correct margin of safety from a valuations standpoint.
  • Down the smaller end of the market, you guys know what I like. Zip Co (ZIP), The Data Exchange Network (DXN), Gage Roads (GRB). Why punters are always after “new” ideas is difficult to understand for someone like me. Don’t you just want to make money?
  • When I’m speculating on exploration plays or micro-cap mining, there’s a handful of people that I support and invest with. My very high risk, very speculative punt is Hawkstone Mining (HWK).  It’s a US lithium explorer.  Very, very early days. 

Have a good week,
LL

The information contained in this email is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser.