If Trump is thinking of running on the same slogan as two years ago, he will need to add something – “Make America Great Again – it should be easier from a lower base…” While it would be unfair to blame the President for the entirety of the ‘Trump dump’, the sniping at the Fed, the incompetence of the foreign policy (what policy?) and the totally unnecessary trade wars are material factors. Yet the main drivers of the recent turbulence in markets have been in place since last year.
A strongish US economy that has allowed the Fed to (nearly) normalise interest rates, an unwinding of Central Banks’ QE, a strong Dollar, an economic upturn of nearly record length and a self-inflicted slowdown in the Chinese economy to rein in debt have all been known for some time and were always likely to crimp returns in 2018. Throw in the regulatory travails of big tech, a mature consumer electronics market (aka the smartphone), an excess inventory induced down-cycle for tech hardware more generally and a sharp sell-off in commodity prices and it’s a recipe for losing money across the board. In hindsight the aberrant market behaviour was the strong first half of the year and the latter part of 2017, rather than the weaker second half. The correction has been unusually broad-based, with nearly every asset class negatively affected. The main exception of late has been gold, and even here returns have been muted as the economic impulse has been primarily deflationary. Asian equities and our portfolio have not been spared. The strategy is oriented to cash rich and cheap stocks, with a sprinkling of names that should be entirely uncorrelated to the economic cycle. We were not expecting that 2018 would be a banner year. Sadly, it has made little difference in the last few months. Cheap stocks have become very cheap, 5% yields a quarter ago are now 6 or 7%… and nobody seems to care. Depressing as this is for any active and value-oriented manager (or any other sort of investor recently), we have been here many times before and when sentiment turns more positive, returns from these names can be stellar…and at least in the meantime you are being paid a decent income with no balance sheet stress to lose sleep over.
The income attraction of Asia is now a significant factor for more patient and/or risk averse capital. The only other equity market which can compete in yield terms with our universe is the UK, and here the yield is as much a function of over-distribution (particularly oil, pharma and utilities) as opposed to sustainable real value – a function of the somewhat rabid demands from institutional investors that are income-starved in their bond portfolios. Australia is the best destination for yield, with the banks and big miners providing 5-6% yields, fully franked, so grossing up to around 8% for domestic investors. However, most of the industrials yield over 3%, and some are near double digits (CSR for example). In Hong Kong a 4% yield is almost par for the course, and significantly higher, is easy to find without resorting to companies with strained balance sheets or unsustainable payout ratios. Even markets such as Singapore and Korea, which absent Singapore Telecom and Singapore Press have not historically been popular with income funds, can now provide 3-4% yields, with Korean payout ratios still stingy by international standards (typically 10-20%) but supported by strong balance sheets and significant pressure from investors and government to raise these to an international norm. Taiwanese payouts tend to fluctuate with the profit cycle rather more than most markets, but even here and despite adjusting for a cyclical downturn in the electronics industry, yields of over 5% are easy to find. We would hope that these features start to influence investor behaviour in 2019 more than they have in the last three months.
Australia may be usually referred to as the ‘Lucky Country’, but the epithet may better be attached of late to India, at least in stock market terms. The de-monetisation debacle that singularly failed to eradicate dirty money, the introduction of a GST which has so far been a significant fiscal failure, an assault on the independence of one of the few central banks previously free of overt political interference and a resurgent Congress which threatens the re-election of the market-favoured BJP….none of these has had any lasting effect on the most expensive market in the region, in part because the collapse in the oil price has compensated for the increasing list of negative macro factors. We still struggle with the valuations of the market, and view the risks, particularly political ones, as being under-estimated by the market. We remain unenthused and uninvested.
We received an unwelcome Christmas present from the FDA on the 27th asking Starpharma for more clinical data on their novel treatment for Bacterial Vaginosis (BV). This compound (Vivagel) has already been approved in Europe and Australasia and will produce first revenues in 6 months or so. US earnings will now be delayed a year. While this is disappointing, the investment case for Starpharma rests on its dendrimer-based platform technology for drug delivery, which is potentially applicable to improving hundreds of drugs by enhancing solubility and/or enabling better targeting of the diseased organs, thus improving efficacy and reducing side effects, which are a crucial limitation for many oncological treatments. Progress in these areas has been substantial this year, and revenues from these types of drugs have the potential to swamp Vivagel revenues in a few years. These drugs account for 95% of our valuation of the company. The FDA has absolutely no problem with the safety profile of the dendrimer, and this is clearly crucial for all commercial applications. There is NO read through on any query over Vivagel’s efficacy to the effectiveness of any other drug using the dendrimer platform. We had trimmed the position substantially prior to this setback as the stock had performed well…it is now likely that we will buy the shares back