Chester High Conviction Fund January 2020 Market Commentary
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Chester High Conviction Fund January 2020 Market Commentary 1 month (%) 3 months (%) 6 months (%) 1 year (%) p.a Since Inception pa % Since Incept Accum % Chester HCF (after MER) 0.14 4.91 9.75 20.38 11.88 35.00 S&P/ASX 300 Accumulation Index -2.03 0.75 3.28 23.77 9.44 27.26 Value added (after MER) 2.16 4.16 6.45 -3.39 2.44 7.74 *The inception date of the Chester High Conviction Fund was April 26th, 2017, the NAV at December 31st, 2019 was 1.3017 “Good times teach only bad lessons: that investing is easy, that you know its secrets, and that you needn’t worry about risk. The most valuable lessons are learned in tough times..” Howard Marks, Oaktree Capital “OK Boomer”. Perhaps the phrase that captures the essence of 2019? Millennials and Gen Z children have been using this phrase for the past 12-18 months as a derogatory term to dismiss the advice and wisdom of Baby Boomers. Of course, Baby Boomers and their offspring (Gen X children) are the first to lament the ideals and work ethic of the younger generation. Millennials see the Baby Boomers as having outdated, judgmental and condescending attitudes towards the youth of today. Which, of course, they do. “OK Boomer” is then used as a dismissive retort by Gen Z’s to any unsolicited advice given by a Boomer. You can imagine our surprise then when lecturing our 12 year old daughter at the dinner table recently she decided it was time to dish out an “OK Boomer”. To which we recoiled in horror, as we are merely Gen Xers. But maybe (at the risk of offending pretty much every client), maybe the Millennials have a point? Baby Boomers as a generation have enjoyed an unprecedented era of no inflation and debt accumulation like no generation ever before it. Those with assets have gotten richer, those without assets have gotten poorer in a relative sense. The global stock market (MSCI World) has increased 150% over the past decade, Australian house prices are up almost 80% in Melbourne and Sydney while debt accumulation has also doubled (across the 4 major central banks), refer to chart 1 below. The rise in inequality we find to be the most challenging aspect of what we do. The capitalist in us cheers the rising asset prices, while the socialist in us worries profoundly about the ability for our children’s generation to enjoy the same lifestyle and opportunities we have been afforded. Capitalism is going to face some very tough choices over the coming decade. The US election in November will effectively be a referendum on which way the country heads into the next decade. For every crisis in the past 10 years post the GFC, central banks have resorted to the same playbook, which is to print more money. Certainly the strong returns experienced in 2019, were solely due to the increase in all major central bank balance sheets and a very sharp reversal of a hawkish stance by Jerome Powell in January 2019. In fact to calm the overnight lending markets in New York, the Federal Reserve added USD112bn to its balance sheet in December 2019 alone, a mere 3 months after it stopped taking USD50bn a month out of the financial system. Which leaves us with a dilemma. As long as central banks are determine to smooth volatility and continue to inject such large sums of money into the system, we expect asset prices (equities) to keep rising. With interest rates so low, there remains limited alternatives and equities still remain attractively priced relative to fixed interest (or cash). With inflation nowhere to be seen, currently a tight labor market causing wage inflation appears the only obstacle. Herb Stein once observed, “if something cannot go on forever, it will stop”. We cannot foresee when this central bank liquidity will stop, or even what level of debt accumulation is needed before withdrawing from these academic experiments. It has created an enormous tailwind for low interest rates (bond yields falling) and with that, spectacular returns for long duration assets (property, healthcare, infrastructure, technology etc). But we are very mindful of the fact that if something cannot go on forever, it will stop. Our preferred investment thesis is to be more contrarian in nature than trend following, so our natural inclination is to seek stocks or sectors that have not enjoyed the same level of passive flows as other sectors that have become overwhelmingly expensive. Thus to us, glancing at chart 1 below we can observe the strong returns in financial assets (equity markets) while real assets (oil, copper, corn and wheat) have experienced a forgotten decade. The contrarian in us suggests that better times are ahead for real assets, and hence look to allocate a portion of our capital towards these sectors. We also highlight the HSCEI (Chinese stocks listed in Hong Kong) as returning only 26% across the decade. There is certainly value there. We believe that the US dollar will be influential in this thought process over the coming years. Chart 1 Asset Class 2009 2019 % change Asset Class 2009 2019 % change S&P500 Total Return Index 1837.5 6553.6 257% US cash rate 0.25 1.75 Nasdaq Total Return Index 2378.3 10539.0 343% US 10 yr 3.7856 1.9175 ASX300 Accum Index 33915.0 71658.0 111% US Unemployment rate 9.90% 3.50% HSCEI Total Return Index 17907.7 22511.0 26% HSI Total Return Index 44382.3 81652.6 84% US Federal Reserve Balance Sheet 2.23 4.17 87% FTSE 3590.8 7838.0 118% US Public Debt USD Tn 12.3 23.2 89% MSCI World Index 2796.0 6909.7 147% US Budget Deficit Tn -1.4 -0.984 Global Central Bank Debt (US, JPN, EURO, CHINA) US Tn 9.4 19.4 106% AUD 0.898 0.702 -22% Aust cash rate 3.75 0.75 GBP 1.617 1.326 -18% Aust 10yr 5.703 1.309 RMB 6.820 6.963 2% Australian Unemployment rate 5.53 5.23 Gold USD/oz 1097.0 1517.2 38% Oil USD/bbl 79.4 61.1 -23% Iron Ore USD/t 105.3 91.5 -13% Copper USD/lb 334.7 279.7 -16% Wheat USD/bushel 544.8 554.5 2% Corn USD/bushel 417.0 390.0 -6% Source: Chester Asset Management Chester High Conviction Fund January 2020 Market Commentary Back to the Millennials. Perhaps we have been too harsh on the Baby Boomers. Millennials have had it easy for their entire iPhone fueled life. In fact perhaps they have been the biggest beneficiary of this low interest rate environment. Given the cost of capital is so low, the funds being thrown at venture capital and “disruptive technologies” has never been more prominent. But if we are Millennials, we order our Uber Eats on our iPhone, after working all day in our WeWork serviced office. At night we’ll watch all our friends on TikTok, while our helicopter Gen X parents follow us on Life360. On the weekend we’ll stream Netflix on our iPad and catch an Uber to our Airbnb holiday house. A wonderful lifestyle, built with amazing companies, funded by investors (excluding Apple). Including Tesla, all these companies (ex Apple) would not exist unless interest rates were so low and equity and debt investors were so tolerant of losses. Uber will still lose USD8.6bn in 2019, the others are still loss making apart from Netflix, which is only recently profitable after pouring huge capital into its market leading content. Service inflation will really take hold once these companies actually need to turn a profit for their investors (Uber can’t sustain prices 20-25% below taxis). We know Millennials are digital and tech savvy, mobile, and seek instant gratification. They will as a rule favor investments in sustainable businesses, clean energy, health and experiences. But will they still support these companies if prices are rising 15-20% pa as required to actually justify the business case? The contrarian in us also believes that no Millennial has ever needed to or owns any hard assets, but they probably own a lot of tech companies trading on 8-10x sales (that is tongue firmly in cheek!). Stock markets used to enjoy a level of correlation with the underlying economic fundamentals, but as we have witnessed over the past decade, the more central banks intervene in asset prices, the level of actual price discovery (or freedom) becomes more challenging. We have witnessed a deterioration in the economic backdrop across both Australia and the US over the past 6 months, with new car sales to us, a leading indicator of underlying consumer confidence. Hence the disconnect between underlying economic fundamentals and stock prices which continue higher. If Australia cuts interest rates again in February (a 50/50 probability), the spread between the cash rate (currently 0.75%) and the dividend yield on the ASX300 (currently 4.4%) would widen, only making the stock market more attractive on a relative basis. The reason the RBA would cut interest rates again is because new car sales, job ads, business confidence and advertising remains soft as we start 2020, not to mention the economic and social impact of the bushfires. The impact of which, like all Australians, we have found both confronting and profoundly moving. Maybe both the RBA (Australia) and the Fed (US) can engineer a housing led recovery in the respective economies, then we can look forward to better economic prospects in 2020.