Divergent Signals

Dear investors and well-wishers,

Portfolio Update

The Fund returned -1.8% in May 2019, ahead of the S&P500 (-6.6%) and MSCI World (-6.1%).

This brought our net calendar year-to-date return to 21% net, vs the S&P500 at 11%, and MSCI World at 10%.

This was largely due to strong contributions from structural shorts, which partly made up for a pull-back in the rest of the portfolio.

Bluebird’s first treatment was approved in the EU, but timing was pushed back a few months. The $1.8 million price tag of the treatment prompted fears that end payers wouldn’t foot the bill. Data continues to support the likelihood that their next three treatments will also be approved, so we’re happy to continue to back the firm as it transitions from a biotech research platform to a revenue generating business.

There has been some fairly serious dispersion within market indices, as the S&P500 has benefited from rotation into defensives and sectors that benefit from lower rates as well as up from small caps. Small caps have significantly underperformed the headline indices.


The past two years in Australia are suggestive of what may come next in the US. If you guessed two years ago that housing would be down 10% across the nation, you might also assume equity market falls and perhaps recessionary conditions. In fact, many sectors of the stock market are hotter than ever.

Who would have thought housing would be down but the REIT sector would be up 25%?

Australian listed REITs since 2017 real estate market top 

While surprising, academically, the valuations of these businesses – especially those growing fast – should extend with lower discount rates. Practically, to companies growing at 40-100% (of which we have a number in our portfolio), it matters little whether the economy is growing at plus three percent or minus three percent.

For leveraged, cyclical industrials, who are obliged to spend large amounts of annual capex to maintain flat or low single digit revenue growth, a small change in GDP growth can make all the difference in the world.

It seems entirely possible that the recent Australian experience, where technology stocks reach new heights in the midst of slowing growth and growing uncertainty, continues overseas. So we are tempering our views and positions accordingly.

The recent Merrill Lynch Fund Manager Survey, which has an uncanny knack for picking positions that are about to lose money, shows investors are positioned extremely defensively. It’s highly unusual to see such negativity with market indices at or near all-time-highs. Such pessimism generally marks lows, not highs.

The problem with these kinds of surveys is that they always work apart from when they don’t. In this case, fund manager bearishness preceded falls in 2001/2008. So this indicator worked every time apart from two of the largest drawdowns of the past century. Not necessarily helpful.

There is still plenty of talk of yield curve inversion. This was first put forward as a recession indicator a while ago – and then predicted each of the next three recessions ‘out of sample’. Quite an achievement.

This is our favourite way visualization of yield curve inversions:

Tells quite a story, no? Meanwhile, some indicators suggest the world has flipped into a minor contraction:

JPMorgan Global PMIs are now negative

As many have noticed, the bond market (indicated in white below) and the equity market (yellow) are giving very different signals.

S&P500 (yellow) and the US 2 year yield (white)

In 2008/2009 the 2 year turned down decisively before the S&P500 peaked:

S&P500 (yellow) and the US 2 year yield (white)

In 2000/2001 the 2 year turned down a little before the S&P500 as well, though not quite as pointedly:

S&P500 (yellow) and the US 2 year yield (white)

It’s not clear how this resolves. We have high confidence in our portfolio companies, and are closely tracking their fundamental value creation. In many cases we’ve identified monthly or even weekly indicators of their underlying progress.

We don’t have answers as to what the market is doing next week. But we are invested in leading innovative companies with strong balance sheets, taking market share from incumbents, and have increased our short positions in structurally declining and capital intensive industries, such as physical retail, coal, and where appropriate, physical commodities.

We think this is the most prudent course forward irrespective of how (indeed if) the above anomalies resolve themselves.

Best wishes Michael

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