Good afternoon,

ASX200 down 50bps for the week (still basing at Monday last week) with the 20 leaders (-0.30%) outperforming mid (-1.33%) and small caps (-1%).  Utility sector the strongest performer with AGL +2% (down 13% over last 12 months) and IFN +3.5% (down 40% over last 12 months).

A new bear market?

“Trend is your friend” and the short term trend has reversed.  Since lows in January 2016, caused by fears around global growth/stagflation & a lack of Chinese monetary stimulus (at the time), we’ve seen global markets increase in value.  This growth has been driven by accelerating rates of growth & confidence around the world, favorable monetary policy settings (read: low interest rates) and more recently (breaking us out of the 2017 sideways trend), Trump’s tax cuts in the US.

However, Trump optimism has turned to pessimism as the risk of a “trade war” has come to the forefront of investors minds.

Trade war is a pretty emotive phrase and I’d like to remind investors what it means.  The US government is planning to unveil a list of foreign imports that the US government will impose a tariff/tax on.  This makes goods and services (G&S) produced overseas more expensive in the US, relative to goods and services produced by US citizens, in effect, encouraging locals to buy from each other, rather than foreigners.

This all sounds pretty reasonable.  More demand for local G&S, more jobs in the US, more tax revenue for the government, everyone wins right?  Well, not quite. 

For those who didn’t wag grade 11 economics, you would have learnt that ‘trade’ can in fact increase GDP for nations who choose to participate in it.  And whilst I won’t go into the have’s vs have not’s / wealth effect / inequality argument today, basic economics says that if China make microchips really well and America makes education really well, they should both stick to what they are good at and swap, rather than both try and do something they don’t have a competitive advantage in doing, as this creates the most output, for the lowest cost and increases the wealth of both nations.

Trump is essentially threatening to prevent this ‘swap’ by making it expensive.  So the logic is no trade, less output at a greater impost to customers, less consumption, lower wages and subsequently, investors are worried about revenue/earnings growth slowing in that scenario.

The problem with all this chat is that it’s only chat at this stage.  I’m becoming more accustomed to Trump saying all kinds of things every week and, like the boy who cried wolf, paying less and less attention.  I think it’s naive for local investors and strategists to play the “I know what Trump is going to do next, so position your portfolio like I say” game.  Trump doesn’t even know what he’s going to do next in my humble opinion, neither do our local politicians.

I’ll stick to trying to buy quality businesses at fair prices.  I probably won’t get the lowest price in the short term in the same way I won’t sell for the highest price over the medium term, though I’ll always have confidence in the work I’ve done and this work allows us the opportunity to not panic sell because prices are going against us for a week, a month or even a year.  By the same token, this work allows us to hold assets despite strong performance when the temptation to ‘cut and run’ begins to weigh on shareholders minds.  If your only measure of value is price, chances are you’ll be losing.  (…and yes smarty pants, I know ‘price momentum’ is a real factor… but it is also the most volatile predictor of future returns – we can do this topic another time.)

Short-sellers target Blue Sky Alternatives (BLA)

As many of you know, I’ve been a fan of BLA for many years.  They’ve been great to us as a business and I really like the people that work there.  The founding CEO Mark Sowerby is someone who I admire for a host of reasons and as an outsider looking in, I reckon the culture at BLA is one of youth, pretty high standards and a sense of responsibility to investors and shareholders alike.

Last week, Glaucus Research released a scathing ‘research note’ on BLA questioning BLA’s fee-calculation methods, claiming exaggerated asset valuations and therefore, the overall value of the business (which at highs was over $1bn).  You can read the whole 64 pages by clicking here (though you’ll have to confirm that you are NOT an Australian Resident to view the report).

As you’d expect, I’ve read this report cover to cover and this is certainly a piece of biased writing intended to scare shareholders into selling, which Glaucus (as a short seller) intend to (and have) profited from.  This does not mean some of their claims do not require a ‘please explain’ from Blue Sky.

The company is yet to release a statement and I’m going to reserve my overall judgement until then.  What I do know is that these kind of accusations strike at the core of the BLA business model, a business model that inherently relies upon fees being levied on assets that are (generally) not priced or valued in the public domain.  Unfortunately, when a business is trading on c.30x forecast earnings and accusations like this are made, regardless of their validity, investors generally are not willing to pay the same price for that company until confidence is restored.  A process which, as you know, may take many years.

Assuming the claims are found to be completely invalid and incorrect, I suspect BLA will trade (in the near term) on PE’s similar to other listed fund managers, perhaps 17x earnings.  I think earnings might be slightly impacted next year with investor trust being eroded, so I’d be downgrading earnings by c.10-15% to take into account potential outflow, reduced inflow of funds and a bit of a fudge factor/margin of safety. That brings me to c.53 cents per share of earnings or an forecast valuation of $9.00 per share.  $10.40 last trade, stock is still in trading halt/suspension.

Would I be a buyer?  Maybe. Seller? Maybe. It will depend on the response, the conference call and the big IF in bold at the start of the previous paragraph.  

This is a really good example of how most non-professional investors (and even some ‘professionals’) don’t actually understand the companies they own for themselves or on behalf of clients. Remember, the global financial markets are a zero sum game.  If you make money, someone else loses money.   Remember that it’s directly adversarial and for every share you own, there is someone who thinks you are a moron and is happy to sell you as many shares as you want to buy.  You need to ask yourself, are you happy playing poker against the world’s best players? If you’re sitting at home, managing your own share portfolio, you better answer ‘yes’ (and your partner better agree with you!) or get some help really quickly.  

Picking up pennies off the floor

The pin-striped folks over at Morgan Stanley put out a nice chart last week showing the valuation dispersion between low growth and high growth companies.  It shows companies with high growth are very expensive when compared to low growth companies right now. The spread between the two is near 15 year highs.  MS reckons this extreme spread throws up some opportunities in the lower growth, cheaper valuation end of the market (despite the recent strong performance of the high valuation/expensive/momentum stocks.)  MS like BPT, LLC, SGR, QBE and BSL.

But because we aren’t broker-research following sheep here at Seneca, we (as always) will do our own work.  I’ve banged together a bunch of companies trading under 16x earnings, at a discount to their average 5 year PE ratio, with a market cap of over $300m and a little sneaky secret quality filter I like, here’s the list ranked from lowest PE to highest, happy hunting.

Fire sale on Technology Stocks

Let me get one thing straight, the President of the United States, Donald Trump, is “tweeting” (TWTR, +17% YTD) threats at Amazon (AMZN, +17% YTD) and Facebook (FB, -12% YTD) after winning the election a year ago with a campaign based on social media marketing… and people are selling technology stocks (NASDAQ down 2.74% this quarter)?  Seriously.

Look.  For the last 5 years you’ve probably wished you’d owned all these companies.  I’d suggest you take a good hard look at some of these world class names and stack them up against your crappy holding in Telstra (TLS, -14% YTD, which by the way, I did a bit of ‘math’ on this morning and I reckon the dividend will be sub 16.5c I reckon TLS is a $2.75-$3.00 business based on FCF and dividends.) or punting whether the iron ore price will go up next month.  Here’s a list of business worth investigating.  If you’re a client, feel free to ask me the best way to go about doing this in your Seneca private wealth account.

Is Facebook cheap on 21x earnings with 18% EPSg and ROA% at 19.5%… I don’t think you need to be a rocket scientist to figure that out.

Is Adobe a world leading, very high quality business which you can buy on a PE similar to Domino’s Pizza, but with better growth… yep.

Does anyone realise how big ‘gaming’ as a category is going to be in 2022?  Probably not.  But EA, TTWO and ATVI will be leading the pack with all the talent and all the technology.

Anyone notice how there isn’t a single listed company on the ASX that has an ROA above 14%, EPSg of above 24% and trades on a PE under 15x.  Apple does.


Big moves of the last week

A quick scan through the biggest movers in both directions last week. Had to cut the losers off at -7% as there was too many companies in the list.  Lots of high flyers with accompanying valuations down the bottom of the list, WiseTech (WTC) really stands out as a company that was lorded by investors before being unceremoniously dumped.  Lithium/Graphite/Milk stocks all make the list with double digit losses as did Afterpay (APT) which has short interest now well over 7% of the stock – lookout!  Santos (STO) making moves with a new takeover offer from Harbour Energy at $6.50.

Have a good week,
LL

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