Stuck in a Moment, and you can't get out of it
December 2021 Newsletter
2020 was such a unique year in the post World War history, that it would be strange to say that any other year can be described as similar to it. However, I would suggest that from an economic and financial markets perspective, 2021 is as close to “2020 adjacent” as one can come. From the most positive viewpoint, 2021 had vaccines and other medical means to address the COVID-19 pandemic. Here in the United States, 2021 had many signs of normalcy return. For financial markets, we had another strong year, albeit some of the unhealthy speculative fervor that immersed the markets in Q1 retreated as the year progressed. However, COVID-19 was the story of 2020, and the virus is still very much in control of the global economy as we enter 2022.
For example, Inflation was the key word for 2021. But the shocking mid to high single digit inflation figures that have been reported for the US and Europe for late 2021 are not this distinct factor that shares no connection to 2020. Supply Chain interruption and excess stimulus, what we currently understand to be the drivers of much of this inflation, they were directly a result of COVID-19. Part of what drove inflation was increased energy prices. As you can see below, this energy inflation helped Commodities to a 39% return in 2021. Investors repositioning for hard assets to protect against inflation pushed U.S. REIT’s to the top position in the asset classes below.
We at Ballina did not actually write about inflation during 2021. If we had, we would have sided with the “Transitory” camp. This over-used term has been fortunately retired for the moment. One might think that being incorrect about the biggest market driver of 2021 would have led to a tough year for Ballina strategies. As bottom-up fundamental investors, we actually didn’t change anything about our portfolios in the middle of 2021 as the Inflation debate raged. As it turned out, both of our strategies had very successful years in 2021. More than not, the companies that we believed in and supported, they delivered in 2021 with good earnings and catalysts. For example, Investec PLC, a UK/South African bank that was one of our largest positions, had their March 2022 profit estimates increased by roughly 36% during calendar 2021. Turns out that good news and cheap valuations do not make good bedfellows for very long. Quite a few of our 2020/21 winners, including Investec, have now left the portfolio. If you look below at our top picks for 2021 (made one year ago), you can see that three (the UK/Ireland contingent) were big outperformers in 2021. We also had two significant underperformers, albeit both were stocks that we managed to trade for gains during the year. We still own all of these stocks except for Bank of Ireland.
As we turn to 2022, we at Ballina continue to be struck by the relative attractiveness of opportunities outside the U.S., specifically the closer you get to China. If we exclude style factors, and stick to geography, Emerging Markets have been the big underperformer in equity markets. We can never be sure when this will turn, but we believe that we are more than adequately being compensated for the risk. See our top picks below. A few common characteristics stand out: 1) Very cheap valuations – companies are returning to mid cycle and in some cases late cycle earnings. We’d like to see lower multiples on the companies just returning to mid-cycle, and this is what we have below with several companies below 10X earnings, and below 1x book. 2) The amount of leverage is appropriate or if a bit elevated, it is due to Property interests, 3) While we do not target Dividend Yields, the yields on this list are high as companies return to generous payouts with the economy returning to strength. All but one of the Dividend Yields below are above the yields for U.S. High Yield Bonds, 4) While we do not target a geography, all of the companies happen to make the bulk of their money in the Chinese market, or in an economy highly linked with the Chinese economy (Australia). We believe that the Chinese economy is recovering strongly, and if you are able to avoid the companies policymakers are targeting in the “Common Prosperity” drive, which are mostly high flying growth companies that we would have no interest in, then we see little reason for the significant underperformance of stocks driven by Chinese sentiment to continue indefinitely, and 5) Four of the five stocks listed below are trading below their long-term valuation multiples. See the 2nd and 3rd charts below. We have written within the last year about how you have to pay more for U.S. listed companies than you have for the same businesses in the past. It is much easier to find discounted companies versus history in overseas markets, and especially in Asia.
Source: MRB Partners
Source: MRB Partners
The strength of the U.S. equity market continues to be strongest signal in the global asset marketplace, and one that allocators cannot ignore. We’re struck by the lack of awareness of the relative openness of the Global economy outside of the U.S. On a scale of 1-100 (with 100 being completely closed), the German and Chinese economies are roughly at 80. See Stringency Map above. The United States is at 56. The market seems to be aware that these lockdowns overseas may have ramifications for U.S. goods inflation, but in our view is paying less attention to overseas earnings. Yes, the explosive earnings growth in the U.S., especially from Technology, has been impressive. Overseas earnings have yet to really hit their stride with the relative stringency of the lockdowns. Given the attractive bottom-up value we are finding in Asian stocks at the moment, the earnings recovery appears to be something that is out of focus for most. If you’re positive on the world being able to move further away from the grips of COVID-19, Asian equities should draw your interest.
Happy New Year to everyone. May the next year be prosperous and healthy.
International All-Cap Value returned 2.78% (gross basis) in December 2021 versus 3.58% for the benchmark. Year to date performance was 19.74% (gross) versus 8.99% for the benchmark.
Global Small Cap Value returned 5.38% (gross) in December 2021 versus 2.99% for the benchmark. Year to date performance was 19.99% versus 13.92% for the benchmark.
Top Contributors and Detractors
International All-Cap Value’s top contributor in December was Banca IFIS. The Italian Financial returned 15.9% as Banca IFIS continued to deliver against expectations, at the same time as investors became very positive on European Financials outlook for 2022 in the final month of the year. This was partly a recovery from weakness in the final weeks of November as the market became concerned about the Omicron variant. The strategy’s top detractor in December was LSR Group, which declined 19%. The Russian property company was very weak as Russia increasingly moved toward hostilities with Ukraine, and investors anticipated more sanctions to come as a consequence.
Global Small Cap Value’s top contributor in December was Pressance. The stock returned 20.1% in December, as investors became increasingly comfortable that the Japanese housebuilder has passed the weakest conditions of the domestic housing environment. The top detractor in the strategy for December was Gungho Online Entertainment. The Japanese video game company declined 15.5% as investors took some profits after a very strong finish to the month of November. The Japanese equity market is still caught in a wave of skepticism from global investors.
 Canfor Pulp Products returned 11.77% for International All-Cap Value Strategy, and -17.5% for the Global Small Cap Value strategy. HollySys Automation Technologies returned 3.3% for the Global Small Cap Value Strategy.  Reference: ICE BofA U.S. High Yield 5.06% 1/17/22  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)