Tesla, Bitcoin, AirBnb. Pick your speculative favorite. In a year where leisure and hospitality were crushed by a pandemic, speculative investing proved to be one of the most active hobbies. If anyone was taking a taxi these days, they would surely be told of the latest great investment by one of their drivers.
While performance has benefitted from the speculative fervor, we at Ballina Capital are concerned. We are specifically concerned about the returns available on publicly traded equities for the long term. Aggregate benchmark valuations are at very extraordinary levels. The FY2 P/E on the S&P 500 is just under 20x. This is a level that has only been exceeded this year[1]. Central bank activity and market signaling have been so powerful in relation to the commitment to low interest rates, that investors have had little choice but to use the discounting mechanism to pull forward virtually all future valuation upside for developed market growth companies to today (see asset returns for 2018-2020 below).
How can we at Ballina use this information? As bottom up, fundamentally driven investors, the best way that we can incorporate long term market skepticism is in our portfolio construction. We can err towards healthier weights for our more “ballast” like equities, and watch carefully over the weights of our more risky names. We remind ourselves that elevated valuations are not a timing signal. Equity markets can and often will get even more expensive. With Central Banks as the driver, part of the reason that the markets have become so bullish is that the monetary policymakers are so firmly committed to one “doveish” direction. There is not an economic forecast that comes within a galaxy of a scenario where central banks get hawkish within the next two years.
In our April letter, we wrote about the work we were doing, and the stocks we were buying in healthy quantities. The table below lists the names we highlighted. As you can see, three of the five stocks have done very well. One company, Waddell & Reed, agreed to be acquired. The two laggard stocks have appreciated, but less than the impressive market. While the rally did eventually find it’s way to value stocks, such as the names below, one can see in the Price to Book multiples that this valuation expansion hasn’t been overdone. (Four of the five still trade below book value). We still very much like the two laggards below, Yangzijiang Shipbuilding and Unipres.
Now, for the stocks we want to mention for the coming year. As we often highlight, we are looking to invest in companies that can withstand a difficult downturn. 2020 brought the downturn. A few things to notice: 1) All five of the stocks mentioned were in Ballina portfolios before March 2020. They’re not brand new. 2) We continue to like strong balance sheets. Three of the four applicable companies carry net cash on the balance sheet at the current time. This is despite the fact that, 3) earnings estimates have been devastated for this group. For example, Vistry Group PLC, a UK Housebuilder, is expected to achieve FY 2020 Sales that are 27% lower than the same expectations were at the start of March 2020. Four of the five companies suspended their dividends, and have yet to formally reinstate them. 4) Despite the rally, we are still favoring smaller International companies. Four of the five companies below are less than $3bn in market capitalization. The one U.S. listed stock, HollySys Automation Technologies, is based in Singapore with a high dependence on the Chinese market. 5) We like Banks, especially European Banks. We never expected to be big fans of European banks, in fact we favor them about as much as my children do cauliflower and brussels sprouts. But the Pandemic firesale was way too harsh. Bank of Ireland continues to be a favorite position for us. 6) All of these companies have significant earnings upside. None of the companies benefited from the homebound economy. 7) Except for Canfor Pulp Products, all would require a significant rally before their Sales or Book value multiples would approach five-year averages. They are basically far from being described as anything but cheap. 8) Three of the companies are quite dependent on the UK economy. We wish we did not have to mention Brexit anymore, but the discount on UK dependent companies has been too significant for us to ignore. The locally dependent FTSE 250 Index returned -6% in the last year, well below other developed international benchmarks.
Many market pundits believe that Emerging markets, Small Cap and Value will be the preferred investments for equity investors in 2021. These were chosen simply for being the asset segments that were late to the rally. This would, of course, be good news for Ballina portfolios. However, if 2020 has reinforced one thought, it is that we most assuredly should not be confident of exactly what will come next, especially if most everyone is calling for it. Value investing continues to be a bit of a roller coaster, except it is a ride with the relatively enjoyable part occupying a small portion of the journey. What November demonstrated, in spades, is that conviction and patience can indeed be rewarded. We at Ballina are prepared for all parts of the journey.
Happy New Year to everyone. May the next year be prosperous and healthy.
Strategy Performance
International All-Cap Value returned 8.28% (gross basis) in December 2020 versus 5.84% for the benchmark. Year to date performance was 12.27% (gross) versus 10.66% for the benchmark.
Global Small Cap Value returned 8.19% (gross) in December 2020 versus 7.78% for the benchmark.[2] Year to date performance was 5.17% versus 15.94% for the benchmark.
Top Contributors and Detractors
International All-Cap Value’s top contributor in December 2020 was Dongyue Group. The Chinese chemical company returned 52% as it benefited from more robust economic figures in China, especially a strengthening recovery in the industrial economy. The top detractor of the strategy was China Oriental Group. The stock declined 11.6% as investors fretted about capital allocation going forward, given the Chinese steel company’s strong balance sheet and desire for acquisitions.
Global Small Cap Value’s top contributor in December 2020 was Dongyue Group. The Chinese chemical company returned 52% as it benefited from more robust economic figures in China, especially a strengthening recovery in the industrial economy. The top detractor in the strategy was Signet Jewelers. The jewelry retailer declined 12% in December as investors took profits on a stock that had climbed almost 6x since the low point in April 2020.