Bottom up fundamental research and political analysis make strange bedfellows. As with many other issues, there is no “repositioning” for expected changes for a true bottom up stock selector. Political change does come often, however, and the backdrop is a component of the fundamentals that any decent company analysis will have incorporated. Given the current situation, the political future in some of the largest economies is a bit murkier than usual.
We at Ballina consider this current period to be an interesting time of political change. We know that two of the longest serving leaders of two prominent global economies – Chancellor Angel Merkel Germany and Prime Minister Shinzo Abe of Japan – are due to leave office within the next year. Another controversial leader, President Donald Trump of the U.S., faces an uphill climb to win re-election this November. It is very possible we have new leadership in three of the four largest economies in the world by this time next year. None of the three leaders will be very easily forgotten. All three also share the characteristic that they were relatively pro-business within their societies. What changes could we possibly see in these three countries, and more importantly, how do we factor that into analyzing portfolio companies at Ballina?
Political uncertainty is always present. What you really want to avoid from a company level is the “binary” situation. As it becomes more clear that policymakers are considering causing a company’s economics to decline full stop, for the fundamental investor this has become speculation. We’re no better at making a speculative bet than anyone else. We at Ballina will not incorporate positions with that kind of uncertainty in our portfolios. But not every political puzzle looks the same. The reality of change for most companies is almost never that brutal on a micro level. However, the market detests uncertainty. Therefore, it is often the case that the anticipation of possible change in leadership and the consequential change in policy, is the most difficult part of the whole process. I can recall identifying the opportunity in U.S. Managed Care stocks in 2007. The market understood that the Democrats had a major policy platform agenda for substantial health care reform. It did not matter for all of the months that passed in 2007 and 2008 that a logical argument to defend a high likelihood of a future where managed care company earnings would decline precipitously with a swipe of the pen did not exist. The stocks underperformed badly through the election. Of course, even with the passage of HCA, the best time to purchase these shares was basically election day 2008. Fortunately, this was an investment case we were able to make (se UNH share chart below).
Source: Factset
Coming back to present day, what could the end of the aforementioned end of the historically important leadership reign’s signify? Merkel has represented a predictable and safe pair of hands in Germany since 2005. She has played a meaningful role in keeping the EU together, given her constituent’s own desires to fracture at many junctures. Looking forward, with new leadership, the most likely change is a much more confrontational position from Germany towards China. For Japan, Abe brought long needed stability and leadership for Japan on the world stage. It is highly unlikely that Japan will anytime soon bring forth a leader that will engage overseas as confidently. Therefore, a likely change going forward is that Japan returns to a more fractious relationship with China, South Korea and possibly the U.S. Finally, for the U.S., it is our view that if President Trump is not able to win re-election, the most significant change will be on the tariff and trade front. Confronting China is popular around the world at the moment. But placing tariffs on the goods of U.S. allies such as Whiskey, Lumber and Steel products was a distinctly good idea for a tight circle around President Trump. On the flip side, private prisons are probably not going to fare as well under Democratic leadership.
Within the companies that we currently own, there are very few that are squarely in the cross hairs of the tariff war. We do own companies that own Forest Product assets in Canada. The tariffs enforced by the Trump administration have buckled the returns possible from these assets. U.S. homebuilders are desperate to have more sources of lumber. We don’t bank on these policies changing. But it would be a “nice to have”. We always prefer to invest in companies where the current earnings are depressed relative to what we view as “normalized”.
The most cruel political noise that some of our companies have had to deal with recently has not had to do with any one election or leader, but it has had to do with “Brexit”. It is so brutal because the period of “uncertainty” never seems to lift, and given what we said earlier, the waiting is the most painful part for investors. Inbound confidence and investment in the UK has undoubtedly suffered over the last few years (see chart below for FTSE 250 performance). Given the generationally important leaders such as Merkel and Abe that are stepping aside in the near future, one might think that the investment market is poised for uncertainty. This is somewhat true on a company by company level, and we at Ballina have to incorporate this into our company analysis. This is not true, however, for markets on an aggregate level. Investors understand that Central Banks are driving the securities markets. And there is no sign yet that political changeovers are going to impact the consensus among Central Bankers about the continued need for their market stimulus programs.
Source: Factset
Strategy Performance
International All-Cap Value returned 7% (gross basis) in August 2020 versus 4.43% for the benchmark. Year to date performance was -11.9% (gross) versus -3.21% for the benchmark.
Global Small Cap Value returned 5.58% (gross) in August 2020 versus 5.66% for the benchmark.[1] Year to date performance was -15.93% versus -4.29% for the benchmark.
Top Contributors and Detractors
International All-Cap Value’s top contributor in August was China Yuchai International. The Chinese manufacturer returned 22.8% in the month of August as the company had very strong Q2 results in its Chinese truck engine business. The leading detractor was Canfor Pulp Products, which declined 8.6%. Investors continue to worry about the length of the downturn facing the Canadian Forest Products given the leverage on the balance sheet.
Global Small Cap Value’s top contributor in August was China Yuchai International. The Chinese truck engine manufacturer returned 22.8% in August as the company had very positive results. The top detractor in the strategy was the telecommunication equipment company Adtran. The stock declined 9.97% as the stock consolidated after doubling in value since late March.
[1] Benchmark for Global Small Cap Value comprised of 50% weight iShares Russell 2000 Index (IWM) and 50% weight Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)