Weekly Market Commentary By H.E.R.O. (28 to 31 Dec 2020)
Goodbye virus-ridden 2020, Hello hopeful 2021. As we cross into the new year, the virus is still raging, with new infections near peaks in the U.S. and much of Europe, where millions of people are living under strict lockdowns. Yet, global stocks added around US$15 trillion in market cap in 2020, pushing above US$100 trillion for the first time ever. Noteworthy is that the U.S. Dollar Index has slumped 13% after spiking to its highest level in three years at the height of the coronavirus crisis. Real yields crashed to record lows in 2020, plunging from a small positive to -110bps; the collapse in yields results in around US$18 trillion of global negative yielding debt.
The cold reality of the staggering market rally - in the midst of a catastrophic pandemic that has infected over 84 million people and killed more than 1.8 million people, halted business and travel, wreaked havoc on the economy, and upended the life and livelihood of millions of people – is difficult to comprehend for many investors. Many more are wondering what 2021 holds for the temper of the capricious market beast – and the surprises and challenges ahead. Having missed out much of the market rally, some remained adamant that the markets are more fragile and unstable than ever and are ever poised for a steep crash, with their blue-and-green faces bursting to shout out the pent-up “I told you so”; while others argue that the opposite is true, that the markets are more resilient than ever and will continue to break new cathartic highs. Noteworthy is that U.S. investors borrowed a record US$722.1 billion against their investment portfolios through November, according to FINRA, topping the previous high of US$668.9 billion from May 2018. The milestone is an ominous one for the stock market—margin debt records tend to precede bouts of volatility, as seen in 2000 and 2008.
The situation remains confusing in the frontline of the ongoing health pandemic crisis. WHO chief scientist Soumya Swaminathan warned during the last week of 2020 that there is “no evidence to be confident shots prevent transmission" and that people who receive the vaccine should continue wearing masks and following all social distancing and travel guidelines. U.S. begins the new year with over 20 million virus cases, including reports of the new virus variant that is more infectious and affects the young, which may alter the course of the pandemic. 32 more countries have found the more contagious virus variant first seen in Britain. Meanwhile, there continues to be unfortunate news worldwide of vaccinated people who have died shortly after receiving the first dose, suffered serious allergic reactions, or are reinfected. In California’s Tehama county, it was reported that over half of frontline workers at one hospital unwilling to take it, and between 20% and 50% of workers at other facilities who feel the same, according to the Los Angeles Times. All these add to “vaccine hesitancy” and the new problems on how best to distribute the unused doses and to convince those who refused to be vaccinated. The vaccination rollouts may run into problems, or take too long, or new mutations may mean that the virus stays with us as enough of a lurking danger to make people behave cautiously in their social and economic lives. Even if the pandemic is defeated, the psychological scarring from the unprecedented events of the past year may make people permanently more cautious.
Meanwhile in Asia, deleted words in the statements by President Xi’s economic policy speaks volume about the true economic health of the country, according to the analysis of Nikkei's Katsuji Nakazawa who highlighted a key phrase which was glaringly absent from a statement of Xi's released upon this year's Central Economic Work Conference, which ran Dec. 16 through 18. And China is once again battling a surge in virus cases ahead of the Lunar New Year in Feb 2021, with reports of the new virus variant surfacing in Beijing and Shanghai.
China on Thursday ordered banks to cap loans to homeowners and property developers, the latest effort by the government to rein in a real estate bubble that has erupted in cities. The biggest banks, such as ICBC and CCB, will face a new cap of 32.5% of all outstanding loans that can be lent as home mortgages. Medium-sized banks, such as China Merchants Bank, now have a 20% cap, while the smallest village and town banks will only be allowed to lend out 7.5%, according to a joint statement from the People's Bank of China and the China Banking and Insurance Regulatory Commission. Loans to real estate companies will be limited to 40% for the top tier and 12.5% for the lowest, according to a five-tier ranking.
There's certainly no "Round Two" trade talks anywhere in sight amid a ratcheting Trump trade war and sanctions. American companies will have to pay higher taxes on the more than US$360 billion in products they import from China, including textiles, industrial components and other assorted products, as the tariff exclusions that had shielded many businesses from President Trump’s trade war expired at midnight on Thursday. NYSE has begun delisting China’s three largest state-run telecom groups to comply with a Trump administration executive order barring US investors from holding stakes in companies suspected of having ties to the Chinese military. The move by the US’s largest exchange follows similar restrictions from index providers and will restrict the Chinese companies’ access to capital from American investors. Notably, the pushback on Xi’s vision for China has spread beyond U.S.: Countries that once avoided upsetting Beijing are moving closer to Washington’s harder and largely bipartisan stance—to curb Chinese access to customers, technology and sensitive infrastructure.
The hope remains to be this: As we continue to live in a pandemic-fighting world, innovators will aim tech solutions at our personal and professional lives. Society as a whole was becoming more technology-oriented, even before the pandemic. The end of the coronavirus pandemic won’t be a panacea to companies in already struggling sectors such as oil. In a note to clients during the week, ARK’s Catherine Woods commented that technological innovations are creating not only “exponential growth opportunities” but also “black holes” in global economies and financial markets. She warned that whole swaths of industries — energy, industrials, consumer discretionary, communications services, health care, and financial services, which compose more than half the S&P 500 – are at risk of being black holes, and ended with the message: “So, investors beware. Innovation is evolving at such a rapid pace that traditional equity and fixed income benchmarks are being populated increasingly by so-called value traps, stocks and bonds that are ‘cheap’ for a reason. Staying on the right side of change will determine success and failure not only in investment portfolios but also in careers, companies, and countries.”
As euphoric traders piled into the trendy Cyclicals and 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 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 over the past four to six consecutive weeks, setting the roadmap going into the next 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.
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.
We will continue to avoid the overcrowded and popular frenzy-gripped frothy emerging markets, such as China, Korea and India, that are driven and dominated by retail traders, as they are far more vulnerable to destabilizing selloffs, systematic corporate misgovernance and accounting fraud blow-ups and black swan risks. The Nordics has the lowest macroeconomic and corporate governance risk as a region and also the strongest in terms of resiliency in coping with the vaccine rollout transition and rebounding well in a PTSD Growth Crisis situation, far ahead of any country/region. Most importantly, the Nordic is less vulnerable to destabilizing fund flow sell-off, and market microstructure wise, the investor shareholding base in the Nordic companies is largely longer-term institutional investors and pension funds, unlike the volatile short-term speculative retail-driven trader flow in many other countries, including the U.S. where the longer-term forex risk has increased. Also, the Nordic is quite distinct from the Eurozone (EU) where fiscal and monetary coordination/disunity are always a problem, so it's regarded as an oasis on its own even though it is technically in Europe but is not part of the EU's problems.
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.
Interesting Readings to be a Better Investor & Person
A Blessing for the New Year [Source: Reboot's Allison Schultz]
May you grow still enough to hear the small noises earth makes in preparing for the long sleep of winter, so that you yourself may grow calm and grounded deep within.
May you grow still enough to hear the trickling of water seeping into the ground, so that your soul may be softened and healed, and guided in its flow.
May you grow still enough to hear the splintering of starlight in the winter sky and the roar at earth's fiery core.
May you grow still enough to hear the stir of a single snowflake in the air, so that your inner silence may turn into hushed expectation.
- Brother David Steindl-Rast
Podcast #671: Begin the New Year by Reflecting on These 3 Life-Changing Questions
As one year ends and another begins, it’s natural to reflect on both the past and the future — who we were, who we are, and who we want to become. My guest today offers three questions that can help make that self-reflection truly fruitful, insightful, and possibly even life-changing. His name is Gregg Krech, he’s executive director of the ToDo Institute, which promotes principles of psychology based on Eastern traditions, and the author of Naikan: Gratitude, Grace, and the Japanese Art of Self-Reflection. Gregg and I begin our conversation with what Naikan is, and how this structured method of self-reflection can hold up a mirror to your life, helping you gain greater self-awareness, and see reality, and the way people perceive you, more clearly. Gregg then walks us through Naikan’s three rich, incisive questions and how to use them to help you discover how you really show up and operate in the world. We end our conversation with how to incorporate these reflections into your daily routine, and even make it a special ritual with which to ring in the new year.
- What is naikan? What’s its history?
- How naikan fits into the idea of morita (action oriented) therapy
- The value of self-reflection
- Why we often miss how much other people are doing for us
- Moving from a complaint-based life to one of gratitude
- The power of asking yourself what you’ve received in the last year
- How to work reflection into your daily routine
- Why it’s important to look at what you’ve given to others
- The hardest question of all: what are the difficulties I’ve caused?
- Turning naikan into a regular ritual
|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
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.