Weekly Market Commentary By H.E.R.O. (12 to 16 April 2021)
Treasury yields slide during the week despite a parade of positive economic data in which U.S. retail sales rose nearly 10% in March, the second largest increase on record, to the chagrin of speculative traders in the reflation/reopening trade of the Cyclicals. With yields retreating, gold rose 1.9%, heading for its best week since December, though it’s still down 6.4% in 2021. The market narrative has now shifted to “peak economic momentum”, pricing in a more “normalized” growth environment ahead. That’s different from prior expectations for a supercharged economic boom that some feared would spark runaway inflation that would dent demand for long-term bonds and threaten corporate profits. Speculative excesses in the market were curbed after SEC dropped an accounting boom on SPACs, threatening filings for new SPACs that may not go forward until the accounting issue is addressed, and there is the possibility that SPACs that are already public and that have struck mergers with targets may have to restate their financial results.
The earnings season kicks off in earnest next week, and there were generally some disappointments, relative to the explosion in earnings optimism, from Cyclical companies that reported during this week, casting further doubts that the overexuberant reflation/reopening trade could be priced in. Notably, on the other hand, the structural growth companies have made strong progress in their fundamentals. For instance, Vitec Software, one of the RISING portfolio stocks, rose 12.9% during the week after it reported strong and healthy results and outlook, proving once again that quality earnings growth based on a resilient business model remains the guiding North Star in choppy markets and stormy weather with plenty of distracting speculative Siren-like noise. Following the rise in portfolio stocks, the smallcap as % of AUM is now 27.4%.
Meanwhile in Asia, the potential bankruptcy of giant China Huarong Asset, the largest of the country’s four largest bad-asset managers, has continued to weigh on China markets and sparked contagion fears, with CSI 300 index down 1.4% during the week. Beijing also ordered 34 internet corporations on Tuesday to rectify their anti-competitive practices within the next month, signaling that Beijing’s scrutiny of its most powerful firms hasn’t ended with the conclusion of a probe into Alibaba.
The portfolio stocks remain well-anchored to very strong and powerful fundamentals with clear and visible growth prospects and positive corporate development progress and robust end markets, and are very likely to rebound resiliently from the speculative sentiment-led rotation and frenzied positioning once the 1Q2020 earnings reports start from mid-April onwards, and it’s a great opportunity to accumulate existing stocks and potential new companies.
As euphoric traders piled into the trendy Cyclicals, Value Traps, 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.