May 2020 – Mid Monthly Update
Know Your Alphabet?
Not a question about Google’s holding company but a prompt about certain letters – U, V, W not an updated German car company either. Those letters represent the preoccupation of the financial media with a letter that signifies the shape of the likely economic recovery from the current slump. For those fixated by some form of letter or symbol, they might want to look at the shape of the Nike logo the ‘swoosh’. The Oregon, USA-based sports apparel company chose the ‘swoosh’ which symbolizes the sound of speed, movement, power and motivation. Feel free to insert your own timescale for the horizontal axis that would sit beneath the ‘swoosh’. The point is, as we said in one of last month’s blogs – ‘It could be a Marathon, but it won’t be a sprint’, patience will likely be needed for economies to recover. By the way, Nike is the winged goddess of victory in Greek mythology. Victory against Covid-19 is something we all covet.
Smaller companies took a bashing in the illiquid, indiscriminate selling in mid-March and have recently begun their recovery. Illiquid markets will not favour them but, the liquidity injections from central banks should avoid a repeat of the market dislocations seen during the week beginning March 16th. Right now, and in recent times, larger capitalised companies have hogged the limelight – FANGS or similar acronyms have become a larger percentage of the US S&P 500 index (which actually has 505 constituents! Five stocks have two share classes). As at the end of April 2020, three companies – Microsoft (5.4%), Apple (5.0%) and Amazon (4.8%) represented 15.2% of the S&P 500 index.
‘There are decades when nothing happens and weeks when decades happen’ – Vladimir Lenin
Clearly March was one of those months containing weeks when decades of change happened as the coronavirus spread into Europe. However, in those decades when nothing appears to happen, things do change but don’t always get noticed until you look back. Back at the end of 1999, Microsoft was the largest company in the S&P 500 index, albeit a somewhat different animal than it is today but that’s what good companies do – evolve. The second largest company at that time was GE, a company whose travails we’ve commented on before and a company that has struggled to survive in recent times before the pandemic. A recent USD20 billion asset sale has helped reduce leverage but GE could become a fallen angel if it falls from its current BBB credit rating into junk/high yield.
In the 1990s, Amazon was an online book seller and later that decade, Steve Jobs was busy building Apple into a disruptor of IBM and other incumbents. IBM is still around today and is still in the game, not least because of its acquisition last year of Red Hat for USD34 billion. Red Hat, which started in 1993, is a leading provider of open source software solutions, cloud and innovative technologies. One final 1999 reference is the dominant US retailer then was JC Penney. Today, it isn’t worth much, has a mountain of debt and is on the brink of bankruptcy according to news reports.
The point is that today’s successful companies were small companies not too long ago. In the UK, think of Ocado, a company whose services are much in demand but started trading in 2002 before going public in July 2010. For many investors, a ten to twenty-year time frame seems too long but for investors building savings or pension pots in their thirties, is it? Working out who the survivors will be, who the disruptors will be and who might disrupt the disruptors, is important. The rewards for getting those decisions right are noteworthy and unlikely to be found in index investing. While it may seem inconceivable to think that Amazon won’t be a dominant player in the next decade or the one after that, who knows for sure? Consider a Canadian company called Shopify which started as an online retailer of snowboarding equipment in 2004 and is now a leading e-commerce platform but only became a public company after it floated in May 2015. It is now the largest company by market capitalisation on the Toronto Stock Exchange.
Yes, there are failures as well as successes but growth-oriented, technology-based companies, without being over-burdened with debt or too much private equity involvement, abound not just in North America but in the UK, Japan and elsewhere. Smaller companies are one of our investment themes and we can find good providers of investment returns without sticking to indices or income targeting.
Since our last mid-monthly in April, we have continued to sharpen the focus of both funds towards the winning themes surrounding the digital economy particularly cloud computing. While portfolio turnover is more elevated than its usual low-level, it is important to point out there is no market timing being taken on board. Cash levels on both funds remain at 10% to enable us to invest at lower prices should financial markets drop on over-optimism relating to the shape and timing of the economic recovery post this recession.