Weekly Market Commentary By H.E.R.O. (26 to 30 Oct 2020)
The Portfolio of Dividend-Yielding Global H.E.R.O. Innovators maintained her overall outperformance against major world indexes since her recent inception on 28 August 2020. During the week ended 30 October 2020, MSCI ACWI All World index plunged -5.2%, S&P 500 -5.6%, NASDAQ -5.5%, DAX -8.6%, Euro Stoxx -5.3%, Euro Stoxx Tech index -10.4%, Singapore STI index -4.3% (DBS -5.6%), Gold (physical spot in USD) -1.2%. Over the same corresponding period since her recent inception on 28 August 2020, MSCI ACWI All World index declined -5.7%, S&P 500 -6.8%, NASDAQ -6.7%, Stoxx -6.9%, Hang Seng index -5.3%, Shanghai Composite index -5.3%, and Gold (physical spot in USD) -4.4%.
The separate equity portfolios of H.E.R.O. Innovators of our clients generated around +44% in average returns since the H.E.R.O. research methodology was provided for and implemented in March 2020, vs MSCI ACWI All World index +23.9% and STI -4% over the same corresponding period.
- Key contributors during the week were led by: (1) Nordic Global Medtech Leader in Products and Solutions for People with Reduced Mobility and Age-Related Health Challenges (+7.7%); (2) Japan’s Largest B2B E-Commerce Platform in MRO (Maintenance, Repair & Operations) Items (+5.1%); (3) Global Leader in Testing Machines Required to Verify Chip Designs for the Extreme Ultraviolet (EUV) Lithography Method of Chipmaking of Advanced Chips (+2.2%); (4) Japan & Global #1 Online Medical Platform (“Facebook & LinkedIn for Doctors”) (+1.7%); (5) Japan’s #1 Shareholder Register Data Analytics & Consultancy Firm (+1.5%)
- The K-shaped recovery divergence, coupled with the worsening U.S.-China relationship, points towards the new world order in the post-pandemic future that marks the ascent of the quiet Nordic powerhouse region – comprising of Sweden, Denmark, Norway, Finland and Iceland with a combined GDP of over US$1.6 trillion, combined population of around 27.3 million people, and the highest regional GDP per capita in the world at over US$62,000 – where they are a Winter War kind of country: innovation happens when things are tough, not when they’re easy and comfortable.
Global stocks plunged to its worst week and worst month in six months since March 2020 on a sharp selloff in Big Tech stocks (Microsoft -6.4% despite reporting strong earnings that’s better than expected, NVIDIA -7.8%, Facebook -7.6%), weighed down by the combination of worries in U.S. political uncertainty, surge in virus cases globally resulting in Lockdown 2.0 in Europe (Germany, France, UK, Belgium, Austria), and weaker-than-expected Big Tech earnings outlook that overshadow earnings growth. In particular, the week’s selloff is highly unusual, going against the core tenets of conventional market flows, in which the combination of stocks, bonds and gold were down on the same day on Wednesday (see Table below on “Days with equities down at least 3.5% and Treasury yields up”). And this only happened twice in the market history since 1990 – on March 11, 2020 and March 18, 2020 - during the liquidity crisis where nearly all assets where liquidated as risk-parity and quant funds were hammered, pointing towards the limitations of traditional haven assets in gold and bonds.
Central banks were also reported by the World Gold Council to be net sellers of their gold holdings for the first time in ten years. Total bullion demand fell 19% year-on-year to the lowest since 2009 in Q3, largely due to continued weakness in jewelry buying as a result of record high prices and the lockdown-induced economic slowdown. Indian jewelry demand fell by half, while Chinese jewelry consumption was also down.
During the week on Friday, Regeneron announced that it has stopped enrolling seriously ill Covid-19 patients in a clinical trial of the antibody treatment that Trump has hailed as a “cure” for the disease. Shares in Regeneron fell as much as 3% after an independent data monitoring committee warned that the risks might outweigh the benefits for hospitalised patients on high levels of oxygen. The move comes after Eli Lilly, which is also developing a Covid-19 antibody treatment, stopped its trial in hospitalised patients earlier this week, when it found this group was unlikely to benefit. Both companies have submitted applications for an emergency use authorisation to the US FDA for treating patients with mild-to-moderate Covid-19 — a category that included Trump, who fell ill earlier this month.
With the U.S. presidential elections due early next week on 3 November, investors are looking at senate races as key to the election’s market impact. Democrats winning the presidency but losing the senate will result in Cyclicals having a particularly negative reaction. A Blue Wave sweep is also increasingly seen as negative for the markets in the longer-term despite a widely-anticipated unprecedented fiscal spending (“Fiscal is the New QE”), as the much higher taxes and increased regulation is expected to hurt corporate profits, and hence a Blue Wave is now seen by some investors as a buy-the-speculation-sell-the-news event for Cyclicals which might only enjoy a brief initial respite.
Market pundits are commenting that U.S. stocks are set to face a 20% slide if there is a contested election, which could see a risk-off and drive 10-year US Treasury (10Y UST) yield materially lower. The deadline for each state to certify its result and finalize electors is December 8th (35 days after the election) or six days before the Electoral College convenes on December 14th (first Monday after the second Wednesday in December). A rocky transfer of power or limbo until mid-December, or even until the January 20 inauguration would make for a worst-case scenario for markets.
If Trump leads on Election Day with a large backlog of absentee and mail-in ballots, stocks could see more volatility until more results come in. If the count is close, with ballots in question and state recounts, investors may respond as they did during 2000, when the S&P 500 sold off 5% before the Supreme Court called the election for George W. Bush on December 12. Declines will be sharper if either side refuses to accept the results, with the economy set for an “uncertainty shock” as confidence stumbles - with businesses delaying hiring and investments, while households turn to precautionary saving - and as doubts about fiscal stimulus mount. This means that as soon as Wednesday 4 November, once it emerges if the election will not have a clear winner, we could see heightened volatility.
Euro Stoxx Tech index crashed -10.4% during the week, as a Monday plunge in German software giant SAP led to a contagion in negative sentiments sweeping across nearly all Europe stocks. Shares of SAP, which accounts for more than 20% of the index, plunged as much as 21%, its worst day since January 1999 after the software company cut its 2020 outlook, saying that pandemic will hurt business through mid-2021, and that the profitability target will be scrapped entirely as the legacy expensive on-premise license-based company seeks to plough money into making up ground it has lost to cheaper cloud-based competitors. SAP went on to extend its losses during the week to 26.7% despite co-founder and chairman Hasso Plattner buying nearly $300 million in SAP stock.
Many of SAP’s cloud-based acquisitions made by former CEO Bill McDermott were only loosely integrated into the company’s existing suites, and many were marketed by separate sales teams, to the annoyance of many of SAP’s 440,000 customers. SAP’s new CEO Christian Klein’s decision to accelerate the shift to the cloud will cannibalize SAP's traditional licence revenue, which will fall to €1.04 billion in 2025 compared to €4.53 billion in 2019. The plunge in SAP has once again highlighted the pitfalls of looking only at financial numbers and supposedly “cheaper” valuations to assess the quality and relevance of the business model and its investment merits, especially when there’s complex accounting complications in the cloud transition. There are market chatters that the SAP results and guidance have longer-term implications for the global software industry, as management and board globally will now need to conduct sound risk analysis of whether or not the alternatives that are available from pure cloud software companies are cheaper and carry less operational risk.
Importantly, a key part of SAP’s weak outlook also reflects its selling model which is reliant on salespeople and consultants, who were paid multiple times the cost of the software to implement and maintain the flow of work, unlike the cloud software innovators who have adapted and thrived with a largely digital marketing and sales conversion model and speedier implementation effort that resulted in continued strong fundamental results growth especially during the depths of the lockdown in the pandemic. The SAP results is potentially a watershed event for tech and software companies as the market beast starts to further dissect and spit out the bones of loss-making imitators and overhyped companies, and longer-term investors will profit from accumulating into this opportunity when markets start to realize the rarity of the selected group of highly-profitable cloud software innovators who have reported – and will be continually delivering – strong and resilient fundamentals and earnings growth, even as Europe and the world experience another Lockdown 2.0. Notably, several Nordic tech and software companies with stronger-than-ever fundamentals rebounded on Friday as long-term investors responded to the overreaction in the sentiment-based correction in share prices over the week.
Some examples of winners in a volatile and noisy market that will remind investors that quality fundamentals will prevail and not to succumb to be emotionally jumpy include:
- QT Group, the Nordic global software code leader which is in the separate equity portfolio of our clients, is up +12.2% during the week. The company is the leading independent technology behind millions of devices and applications, enabling a single software code across all operating systems, platforms and screen types, from desktops and embedded systems to business-critical applications, in-vehicle systems, wearables and mobile devices connected to the Internet of Things. QT technology is used by approximately one million developers worldwide. On 29 Oct 2020, the company reported a strong set of 3Q2020 results, in which sales grew 30.6% yoy with operating margin of 26.5%, and it has upgraded its revenue forecast for the year which will increase by over 25% as compared to the previous estimate of 20%. CEO Juha Varelius commented: “The Group’s business development efforts will focus on desktop applications as well as embedded systems in the automotive industry, consumer electronics, medical devices, and industrial automation sectors. Product development efforts will also focus on the value-added features and tools needed in the creation of embedded systems. Products programmed with Qt can be used during free time, at work, at home and in vehicles. Qt is used, for example, as a platform for digital televisions, in automotive digital cockpits, in the user interfaces of medical devices and small household electronics.”
- Nordic Global Medtech Leader in Products and Solutions for People with Reduced Mobility and Age-Related Health Challenges, which is up +7.7% during the week. On 28 Oct 2020, the company reported a strong set of 3Q2020 results, in which sales grew 5.8% yoy and operating profit jumped 67% yoy. The company had also announced on 8 Oct 2020 the acquisition of a US-based company that is developing solutions for biometric diagnosis, which include an innovative portable SEM skin tissue assessment scanner that biometric sensor technology to measure sub-epidermal moisture (SEM), which allows early detection of pressure injury risk and thereby reduce patient suffering and healthcare costs. Pressure injuries represent a common and significant economic challenge for healthcare systems worldwide, costing healthcare more than US$24.8 billion each year in the US alone. Current detection methods of pressure injuries rely on subjective visual judgement; however the clinical guidelines issued in 2019 suggest increased focus on the SEM technology, a more objective and reliable evaluation that can help detect pressure injuries days before they are visible to the human eye. With this acquisition, the company significantly strengthens its offering in the fast growing wound care segment, and fuels the company’s transition towards becoming a mobility outcome partner to healthcare. CEO Mr. L commented: “The challenges associated with Covid-19 remain, including the extensive need for rehabilitation of patients who required prolonged intensive care – a process that is both staff intense and costly, and where we play a key role. We continue to see a product mix dominated by acute needs related to the pandemic with high demand in medical beds, therapeutic mattresses and rental. The recent acquisition of a US-based company that is developing solutions for biometric diagnosis, which include an innovative portable SEM skin tissue assessment scanner that biometric sensor technology to measure sub-epidermal moisture (SEM), which allows early detection of pressure injury risk and thereby reduce patient suffering and healthcare costs, strengthens our offering in the fast growing wound care market – an area with significant growth potential over the next few years. Outcome-based solutions will become increasingly important in the future as healthcare systems and elderly care remains under pressure.
- Japan’s Largest B2B E-Commerce Platform in MRO (Maintenance, Repair & Operations) Items, which is up +5.1% during the week. On 27 Oct 2020, the company reported a strong set of 3Q2020 results, in which sales grew 17.4% yoy and operating profit jumped 36.3% yoy, with operating margin improving from 11% to 12.8%. The company commented that it had added 1.08 million new customers during 9M2020 and the number of registered members at the end of 3Q was around 5.19 million accounts. Its Korean subsidiary had also successfully expanded its customer base. Earlier on 24 September 2020, the company had announced the acquisition of the e commerce business of an Indian company (IndustryBuying.com) which will become its consolidated subsidiary, and that it aims to efficiently expand its business in India, where the market is growing (crude steel production and automobile industry size are world-class).
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.
Interesting Readings to be a Better Investor & Person
Tim Ferris Podcast: Seth Godin on The Game of Life, The Value of Hacks, and Overcoming Anxiety (#476)
Seth Godin (@ThisIsSethsBlog) is the author of 19 international bestsellers translated into more than 35 languages, including Tribes, Purple Cow, Linchpin, The Dip, and This Is Marketing. He writes daily at Seths.blog, which is one of the most popular blogs in the world. He’s also the founder of the altMBA and The Akimbo Workshops, online seminars that have transformed the work of thousands of people. He writes about the post-industrial revolution, the way ideas spread, marketing, quitting, leadership, and most of all, changing everything. His newest book is The Practice: Shipping Creative Work. In this episode, we explore many topics, including:
- The value of hacks
- The magic of Hamilton
- What learning to juggle and cultivating creativity have in common
- The myth of quality
- What Seth means by “Don’t steal the revelation.”
- Focusing on generosity instead of anxiety
- Choosing the ruleset of your own game of life
- How Joni Mitchell eschewed the safety of the sinecure
- What you would do if you knew you would fail?
|The H.E.R.O. Investment Framework
The H.E.R.O. framework, methodology and strategy are powering equity portfolio asset for our clients. The Portfolio of Dividend-Yielding Global H.E.R.O. Innovators is the only equities strategy in the market that focuses on both dividend yield and innovation-driven capital gains to enhance total shareholders’ returns. It is also the only dividend-yielding equities strategy in the market that is entirely not dependent on and with zero exposure to: (1) cyclicals (concentrated in economically-sensitive and rate-sensitive sectors such as financials, property & construction, energy & materials) that may not be resilient in economic downturns, and (2) cheap-gets-cheaper yield- and value traps. It also applies the proprietary forward-looking fact-based accounting fraud detection system that was pioneered and taught at the Singapore Management University, ranked top five in the world accounting rankings, and presented to the top management team of Singapore’s top financial regulator Monetary Authority of Singapore (MAS), to mitigate downside risks which escape detection by typical western-based forensic tools.I. Strategic Focus on Quiet Innovators & The H.E.R.O. Investment Framework
Our investment strategies distinguish from those of all other tech- and innovation-themed funds with its singular focus on quiet innovators, which present structurally mispriced opportunities and avoid overcrowded misopportunities that stem from the human tendencies to equate flashy popularity with excellence, and have an active ratio of over 95% (vs the MSCI World Index). The portfolio companies are exceptional innovators and focused market leaders in their respective fields with unique, scalable, recurring-revenue and high-profitability business models delivering innovative products and services indispensable to our well-being in daily life and run by high-integrity, honorable and far-sighted entrepreneurs with a higher Purpose in solving high-value problems for their customers and society whom we call H.E.R.O. – Honorable. Exponential. Resilient. Organization.
H.E.R.O. is operationalized into a systematic 4-step investment process and investment framework powered by sustainability & ESG principles to identify the winners, to distinguish between the true innovators and the swarming imitators, between the devoted missionaries forging a greater Purpose and the mercenaries.
We use the framework and positive criteria of the United Nations Sustainable Development Goals (SDGs) to integrate environmental, social, and governance (ESG) considerations into the research and investment process in selecting companies that generate sales in products and services that contribute to the achievement of the UN SDGs. The central focus of our impact investing is on innovators who contribute to the UN SDG Goal 9: Industry, Innovation, and Infrastructure — “Build resilient infrastructure, promote inclusive and sustainable industrialization, and foster innovation”.
H.E.R.O. is unique in eliminating the downside risks from accounting tunneling fraud and misgovernance through unusual related-party transactions, consolidation accounting craftiness (opportunistic shifting of expenses and debt into unconsolidated entities), and hidden balance sheet liabilities at the wider pyramidal business group level etc., which escape detection by western-based forensic tools through a proprietary forward-looking fact-based accounting fraud detection system developed by KB, and taught at the Singapore Management University, ranked top five in the world accounting rankings, and presented to the top management team of Singapore’s top financial regulator Monetary Authority of Singapore (MAS). For instance, prevalent across Asian companies, previously Big-4 audited “cash” in the balance sheet are often misclassified “cash equivalents” disguised from improper short-term related party loans employed by the insiders to expropriate or tunnel out cash from the company after initially propping up financial numbers artificially to create false positive signals to lure in funds.
|II. Be Stronger, Wiser & Kinder By Participating in the Quiet Innovators' Quest to Purpose
“Innovators” are companies that generate sales in technologically enabled new products and services that potentially transforms the way the world works. We seek to identify companies capitalizing on innovation in offering faster, cheaper, more productive, more cost effective, more compelling products and services, or that are enabling the further development of an innovation theme in the markets in which they operate.Not only do the H.E.R.O. innovators generate high profitability at the inflection point of their exponential growth trajectory, more importantly, they are governed by a greater purpose in their pursuit to contribute to the welfare of people and guided by an inner compass in choosing and focusing on what they are willing to struggle for and what pains they are willing to endure, in continuing to do their quiet inner innovation work, persevering day in and day out.
|II. Quiet Innovators Thrive in Stormy Times
Prepare and position a winning portfolio for a post-pandemic world with innovators who thrive in stormy times and transform crises and trauma into opportunities for the future. The coronavirus crisis has helped accelerate innovation and enhanced the leadership of innovators. Market positions are not redistributed during sunny and calm times, but during times of crisis. The pandemic crisis has changed the behavior of both consumers and businesses. Companies offering faster, cheaper, more productive, more cost effective, more compelling and innovative products and services are gaining significant share.Market leadership and resilient winners in stormy market environment and in the post-pandemic future will be much less about the overcrowded popular trades in mega-cap tech and loss-making tech/biotech, as defined by FAANGT-STAMP (U.S.: Facebook, Apple, Amazon, Netflix, Google, Tesla; Asia/China: SEA, Tencent, Alibaba, Meituan-Dianping, Pinduoduo), who also do not pay any dividends (with the exception of Apple and Tencent), and will be led more by highly-profitable quiet innovators, including dividend-yielding cloud Software-as-a-Service (SaaS) companies.
Notably, of the 90+ cloud software companies listed in the U.S., nearly all (>95%) do not pay any dividends, with many still looped in a negative free cashflow position, while the 20 global SaaS portfolio companies in the Portfolio of Dividend-Yielding Global H.E.R.O. Innovators are unique in being exceptional market leaders in their respective field with ample internal cashflow generative capacity to reinvest for higher-margin growth and still consistently produce rising dividend yield to reward shareholders.