Quotidian Investments Monthly Commentary – May 2020
I am obliged to Daniel Hannan (the writer and former MEP) for the literary image in a recent essay of his that lit the spark for the hypothesis of this opening paragraph alone:
The global economy can best be pictured as an inverted pyramid which relies upon a relatively small number of well-motivated, well-regulated and reliable countries each of which are similarly dependant on an equally modest number of consistently profitable and reliable companies. It follows that the vast majority of stock market-listed companies worldwide are not suitable for long-term profitable investment.
As we already know, the pre-coronavirus world as a whole was already facing a substantial fall in GDP and the subsequent closing down of economic activity in an attempt to suppress the spread of Covid-19 is highly likely to lead to even further and extreme economic pain. In many ways long-term corporate success (or failure) can thus be likened to the Darwinian concept of survival of the fittest.
We could all name a number of once-great companies that, through a toxic mix of arrogance and complacency, are no longer in existence. The sea change now effected on industry and commerce by this coronavirus pandemic together with the as yet immeasurable knock-on effects (strategic and financial) of Covid-19 adds another layer of complication to future business activity, stock-market valuations and, indeed, survival. Later in this report I will expand upon this theme as it relates to Quotidian’s investment strategy and process.
In the USA the first quarter reporting season is virtually complete and positive surprises still far outweigh the negatives. In terms of the best global markets the US still comfortably leads the way so far this year. Indeed, the Nasdaq is the only one of the world’s stockmarkets to be in positive territory year to date.
Digging a little deeper and with only a handful of results yet to be issued, a clear picture has emerged and shows that, in terms of Sales, 10 out of the 11 market sectors that comprise the US equity markets have delivered positive surprises (in other words their results have been above analysts’ expectations). The only errant sector has been Telecommunications which contains only 4 organisations. Obviously we have avoided that sector.
Turning now to Earnings, all 11 sectors have produced positive surprises ahead (and in some instances well ahead) of expectations. Question marks hang over the Financials and Consumer Services sectors and, again, Quotidian has had no interest in these sectors either.
A more reliable picture will emerge in the second quarter reporting season beginning from early July onwards. This, of course, will cover corporate performance during the ‘lockdown’ period and we await those results with keen interest. In the meantime we remain 90% invested and have cash in hand to deal with any potential buying opportunities and a finger on the pulse if a move to safety is deemed necessary.
In Europe, in mid-May the ECB announced a proposal to undertake a £2 trillion bond purchase programme as a means of providing financial support to the weaker EU countries and help them deal with the economic fallout of Covid-19. Although the term ‘bail-out’ was not used, this financial assistance is in direct conflict with the EU ‘rules’ which do not allow such state support. Indeed, Ryanair were fined last year for apparently being the beneficiaries of such state aid.
We are again treated to vivid proof that apparently rigid and immutable EU ‘rules’ can have their interpretation changed when the proverbial is about to hit the fan. However, the German Federal Constitutional Court (in a deliberately abrupt judgement designed to bring the EU’s attempt at unbridled largesse to heel) declared this programme to be ‘ultra vires’ of the ECB’s remit and therefore illegal and of no force in Germany.
In a rapid but vapid response, and in another vain attempt to convince (although perhaps this could be more appropriately shortened simply to con) a deeply cynical world that the European Union really does have a proper federal identity, the EU then wheeled out a stage managed and televised pantomime starring Angela Merkel (as Baron Hardup; the “deus ex machina”) and Emmanuel Macron (as the Dame: “unattractive, simple and slow-witted”). This charade only served to provide yet a further insight into the EU’s shameless use, abuse and manipulation of unelected but self-appointed ‘power’.
This double act presented a statement that Germany would underwrite a 135 billion Euro rescue package to help the hardest hit EU countries to rebuild their economies (in other words the same horse that had been rejected by the German Constitutional Court but wearing slightly different colours as camouflage).
It is interesting to note that Angela Merkel has long lost her mandate in the German parliament and Macron’s ‘En Marche’ party has also lost its majority in the French National Assembly and yet, despite that, both cling on by their fingernails to a mirage of power but with all the supportive authority of a wet paper bag. How strange that two lame ducks can combine in an attempt to force through a financial plan that has already been declared to be illegal and of no force in Germany (which just happens to be the largest and wealthiest State in the European Union).
In homage to Sun Tzu’s edict to “appear strong when you are weak” their aim was to present an illusion of unity and perpetuate the myth that the Euro is a real currency and a force to be reckoned with. But when one is presented with a threadbare and discredited script, even the best of actors will struggle to achieve a curtain call. The hole in the heart of the Euro has always been the complete lack of EU fiscal unity and communality of debt and so this comedy duo ran for one night only and to an empty house. Empty vessels do indeed make the most noise but, ultimately, they are doomed to sink without trace.
Given the glut of gloomy forecasts (Economics is known as the dismal science for a good reason) in respect of profitable corporate activity (or lack of it) following the global ‘lockdown’, the current positive stock-market action may, on the face of it, seem to be counter-intuitive but it is supported by extraordinary levels of state-sponsored stimulus in terms of both extremely low interest rates and exceedingly high monetary easing. Certainly the US markets have rebounded very quickly from the depths of the February/March downturn but it may well be that the vast and comprehensive financial rescue packages introduced by central banks around the world will be enough to perform the same salvage miracle as was achieved following the great depression of 2007-2011.
In these circumstances it is vitally important to make hay and maximize available profits in what might otherwise appear to be illogical markets in order to build a meaningful cushion of financial safety to counteract the potential of any negative impact from a typical stock-market correction in the future.
Central banks the world over have unleashed a tsunami of financial stimulus into the worldwide financial system and this will certainly inflate asset values in the short-term. That may well be enough to keep the global economy above water for the time being but, in our view, it will lead to painful problems with inflation further down the line.
Simply in order to test the efficacy of our investment processes in that scenario we were prompted to measure the Quotidian Fund’s investment performance against all the other funds in our sector. I can confirm (with a degree of humility rather than boastfulness) that the result of this experiment showed that from a global peer group of 34,917 similar investment funds the Quotidian Fund is currently in the top 450 in the world. The only reason for highlighting this point is that it encourages us to believe that our decision-making systems remain robust and fit for purpose. We are not supporters of the Cult of Personality that has afflicted investment management and its methods since the City became Americanised. Indeed, we are very happy to avoid that marketing gimmick. As a deliberately and determinedly boutique organisation our aim continues to be to provide first class investment performance and high quality personal service to a self-limited number of successful, intelligent and like-minded clients. We have no ambition to become a huge and impersonal investment house and, in doing so, lose touch with our clients or our fundamental business principles.
Some commentators have expressed concern that stockmarkets (and the Nasdaq in particular) have recovered too quickly from their recent precipitous falls but we disagree with that view. Since 1985 there have been 44 occasions when the Nasdaq has fallen by more than 10% in a relatively short period of time (the most recent being from 19th February to 23rd March this year). This latest downturn has been the ninth time that such a markdown has exceeded 25% and the sixth time it has exceeded 35%.
Equity markets have always bounced back and it has usually taken no more than 56 trading days (circa three months) for that recovery to have taken place. The point is that the extreme volatility we saw again between 19th February and 23rd March is not an isolated incident and our proprietary program of technical analysis allowed us to be out of the market and free of exposure to risk from 7th February through to 20th March.
We hasten to add that our technical process is reliable but not entirely infallible and in the normal course of events it gives us trustworthy decision-making signals. However, if there is a ‘flash crash’ (a double-digit fall in just one or two days…..and we have seen three of those in the last 10 years) then the signal can arrive a few days too late and so we simply have to keep our patience, hold our nerve and successfully manage our way out of the negative situation and back into profit.
The whole point of subjecting you to this turgid piece of history is to emphasize that it has been proven time and again that stock-market corrections (down 10%+) or slumps (down 20%+) have never been terminal and, whilst they can be unpleasant, they should not induce one to be fearful or panic-stricken.
As for the financial future post-Covid, it is not going to be easy or straightforward but it will be a successful recovery. In order to avoid the long-term negative interest returns on offer from Building Societies or watch one’s wealth being inflated away in so-called ‘safe’ negative-yield gilts and bank deposit accounts (and thus losing their value in real terms) one’s investments, savings and pension schemes will need to identify positive returns in other asset classes. Over the past one hundred years or so history clearly shows that the most reliable asset class to successfully meet this challenge is equities.
Despite the economic effects of Covid, we are sanguine for the future of profitable equity investment but not blind to the huge economic problems now facing the world economy. Our optimism is based on solid historical evidence together with a belief in the human spirit to respond well to adversity. Necessity being the mother of invention, old and flawed business models will be reviewed and revised, successful new businesses will be established which will take up the slack; unemployment will fall; there will be a Thatcherire surge in self-employment; a new wave of entrepreneurs will emerge; consumer spending will recover and kick-start demand for goods and services to thus complete a virtuous economic circle. In Darwinian terms: only those who fail to adapt, modify, invent and evolve will fall by the wayside.
This brings us rather neatly back to where we began. A small number of well-motivated, well-managed, reliable and consistently profitable companies (combined with fortitude and patience) is all that it takes to produce first class investment returns and beat inflation. Our portfolio is not selected on emotion and does not follow fads, fashions or short-term bubbles. It pays simply to have robust, reliable, tried and trusted investment processes which cut out extraneous, fear-based media noise and thus allows us to make unemotional decisions with confidence, factual corroboration and good timing.