Weekly Market Commentary By H.E.R.O. (8 to 12 Feb 2021)
Markets rose to new highs in a choppy U.S. session even as 10-year Treasury yields steepened further this week to 120 bps after Fed’s Powell pledge of a 'patiently accommodative' policy to boost the pandemic-ridden US labour market. Gold fell after Powell moved to damp down inflation expectations by saying that any rise in prices would be transient and unlikely to affect monetary policy while the labour market remained “very far” from being strong. Global capital markets remained driven by flows and investor positioning, rather than by the underlying fundamentals of businesses, with the possible exception of the Nordic market. Ever-rising share prices in especially the US and Greater China and Hong Kong markets that have no basis in fundamentals have birthed yet another meme, “Stonks!”, which is feeding frenzied retail speculation. Notably, amidst the deluge of Q4 reports, BofA found "perverse" reaction to earnings beats: “Perverse reactions remain a big theme this earnings season. Companies that beat on both sales and EPS underperformed the S&P 500 by 50bps the following day, the worst reaction in history, albeit improving from the -1.6ppt through the prior week.”
Yet, this intoxicating bizarro market phenomenon seems “logical” – imagine if you were told that the casino is closing soon in say an hour’s time, and you observe that nearly everyone inside are winning money - what would be the most logical thing to do? Naturally, the “logical” investor would place his or her bets on the game that has the highest possible lottery-like payout, for example, 1-to-100 returns. The problem is that no one really knows when the casino is closing its door. Is it a week later, a month, a year, or even longer? Staying “defensive” is no panacea, and most likely be even hurtful, as the traditional havens and defensive stocks in consumer staples (e.g. Nestle and P&G), regulated utilities, conventional Big Pharma, and high payout-ratio-high-dividend yielding stocks are cut by both the vaccine-led recovery hope and the steepening yield curve.
As euphoric traders piled into the trendy Cyclicals, Value Traps, speculative penny stocks, and loss-making electric vehicle and green energy stocks, we believe that there is a high probability of downside risk in chasing and catching them at exactly the wrong time after their sharp run-up from being blinded by the fiscal stimulus hopes and vaccine euphoria — the light at the end of the tunnel — and things can turn very nasty suddenly, as markets tend to underestimate how long that tunnel is, and how dangerous that tunnel is. This situation is very vulnerable for cyclicals to degenerate or revert back into its true ugly colors as cheap-gets-cheaper Value Traps once the vaccine euphoria fades or something negative happen on the mass vaccination roll-out or the vaccine does not prevent people from carrying and spreading the virus to others or new mutated virus strains erupt to render the vaccines ineffective.
Once the vaccines actually start being administered at scale and the pandemic recedes, a lot of investors are going to wake up to the fact that the global economy is still dogged by a host of thorny problems that both predate and have been exacerbated by the virus. The current unsustainable market euphoria over Cyclicals, Value Traps, Zombies (companies who cannot cover their interest expense with cash from operations) and Vampires (junk-rated corporations with negative EBITDA) has created opportunities for long-term investors in the inexorable rise of a selected group of fundamentals-based structural growth innovators who have remained resiliently positive throughout the most extreme ever market rotational change since November 2020, setting the roadmap this year and beyond in a post-pandemic future. These winners solve high-value real-world problems to generate visible and vigorous quality earnings growth before and during the pandemic, as well as are poised to enjoy continued healthy demand and staying power in a post-pandemic future when the world recovers painfully and slowly to transition from the Pandemic Health Crisis to the next crisis – the PTSD Post-Pandemic Growth Crisis.
Our portfolio companies have shown resilience and scalability during this tumultuous environment and the management continue to make key strategy decision to expand their market leadership in their respective fields. The quiet HE.R.O. innovators have invested wisely in innovations that sharpen their exponential competitive edge for long-term value creation, strengthened their market position in the value chain that supercharged their cashflow dynamics, developed new channels, new markets and new customer base for revenue growth while improving their profitability at a time when most businesses are struggling, and nurtured their human capital and corporate culture to foster innovation and ESG sustainability.
While the short-term day-to-day price movement can be volatile, what continues to be crystal clear is that the quiet structural growth H.E.R.O. innovators remain the most visible and vibrant pathway in a foggy, volatile, whipsawing, uncertain market to deliver sustained outperformance with their healthy fundamentals results.