March 2018: Peak Data

Dear investors,

The fund returned -3.0% net of fees and costs in March. The ASX 200 contracted -3.8%, and the S&P 500 dropped -2.7%.

For the March end quarter, we returned +14% net, while the ASX 200 lost 5%, and the S&P 500 lost 1%. This represents AUD outperformance vs the ASX 200 of 19%.

Part of this was a general pull-back across the portfolio, but this was magnified by our decision to invest the hedging profits from earlier in the year in US tech stocks days before the Facebook / Cambridge Analytica scandal hit.

We were also wrong-footed on oil, as rising tensions in the Middle East and pipeline issues in the US outweighed the rising US shale rig count. Speculative positioning in crude remains at record highs. Trading in commodities has contributed ~2% to the fund’s performance since June 16 inception.

Peak data

We’ve been of the view since late Jan that global economic data has peaked for this cycle.

We believe the key variable is employment. As you can see, it trends clearly, with none of the zigging or zagging that bedevils the stock market:

This isn’t a long-term chart illusion.

When people return to work, they spend more the following month, leading to further economic activity, and employment gains. This is the cycle. It’s self-reinforcing, as is the reverse.

When people are fired, they cut back on spending, resulting in further economic weakness, and more people being fired, and so on. There’s always a set of people who are unsuitable for work, hence the tendency for these charts to bottom out at ~4%.

Understanding unemployment is a solid first step when determining where we are in the cycle.

Interestingly, any stability seems short-lived: unemployment is generally rising or falling, as though the only stable state is one of motion.

The next two variables we look at, inflation and rates, derive directly from this chart. Employment is still rising, so businesses are hiring. But in doing so, they are currently having to pay up. Inflationary pressures are rising.

And with them, rates, on which all asset prices are valued. The bond market peaks market below were often terrible times to purchase stocks.

If this line of thought is correct, and we are approaching a change in cycle, then we may have seen the mid-term top, and would expect a contraction later in the year, though by the time that showed up in the data, we would likely be at or close to an equity market bottom.

There is a very clear link between valuations and subsequent equity market returns. As you can see in the chart below from Hussman Strategic Advisors, higher multiples are strongly associated with lower returns, as you’d expect from a bottom-up approach.

And while sentiment has certainly soured, allocations are still at extremes:

On a forward looking basis, the view is more nuanced, as forward earnings are at least partly influenced by lower tax rates. This chart also shows the steady rise of Earnings Per Share (EPS) – which over the long term dominates changes in valuation. Even when we are most bearish, we maintain our allocation to cheap, high quality equities. It’s all too easy to get lost in macro speculation on where multiples are heading, and forget that, over the long term, it’s the steady upwards grind of earnings that counts.


It’s looking quite likely that in the near future Trump is charged by Mueller, and probably a State Prosecutor as well. Nixon resigned when his position became untenable. We can expect no such relief from Trump, who seems to show little care for the norms of political and social life to which the rest of us voluntarily bind ourselves.

The bullish reasons for the ‘Trump Trade’ have already largely disappeared. Even the Goldman Sachs and Exxon executives have left, replaced by trade war agonists.

Valuations, rates, sentiment, the political climate – all now suggest caution. We are implementing this view through two-way bets, which, while expensive, are a handy tool. This puts us in line with an old market adage to buy protection when the cost is high. (More conventional advice suggests to buy low and sell high).

We are aiming to be positively correlated when markets are rising, and negatively correlated when markets crash.


This month we used the pull-back to add to positions in US tech stocks – as well as our Nasdaq hedges. After strong runs in many of our stocks, we also reduced each of our equities to below 6%, with one exception. This was partly a rebalancing, but also to make way for new stocks in the portfolio. We added positions in the Shaver Shop and Lundin Petroleum.

Lundin Petroleum is in the cusp of a dramatic expansion of production, which will drop 2020 EV/EBIT to ~4.6x. As with Cooper, we are investing now to get ahead of the upgraded profile. The cost of development should be comfortably covered by operating cash flow, and the position balances our short crude position. If energy rallies hard from here, energy equities may well rally harder.

The position we kept above 6% was Fiat, at ~7%. Fiat is trading at a 2020 valuation of 0.8x EV/EBITDA, after accounting for the planned spin-off of its auto parts business, Magneti Morelli. Fiat is also assessing options to sell the luxury brands Alpha Romeo and Maserati.

With a refreshed line-up, and excellent performance from the core brand Jeep, Fiat is as compelling, perhaps more so, than when we first bought it.

We also increased our weighting to the US dollar, banking on further rate rises, and also the potential for a sharp reversal if the ‘risk-off’ scenario envisaged above takes place.


On April 9, Avexis, our favorite biotech plays, was bid for by Novartis at US$8.7 billion. We had purchased at a market capitalization of US$3.9 in November last year. This won’t show in March results.

Shortly after, Goldman Sachs released a comprehensive report on gene therapies, and we were pleased to note that two of their highlighted picks were already on our portfolio. There is clearly plenty of opportunity for clear thinking in biotech.

We will be reinvesting the proceeds back into the sector. Of our four biotechs, 2 have been bought out at substantial premiums, and the other, bluebird bio, which we wrote about a year ago, has advanced 2.5x – and Goldman has pegged it’s value at nearly twice the current price. The fourth, Bellicum, we exited at a loss. This has been over a period where the biotech index itself has been flat or falling.

Genetic technology is in the first stages of a true revolution, with long promised cures finally starting to reach patients. We will continue to invest heavily in the most promising companies.

To balance this risk, we’ll also short companies that are based on faulty scientific logic, and/or recycled failed drug candidates. Institutions are loathe to completely cancel a drug programme, as there’s always a way to cut the data to suggest that a different set of trial parameters might lead to success. When programs are cancelled, there’s often enough someone willing to buy the drug and IPO a new company around it.

There’s something of a mathematical tailwind when shorting biotech companies. If 10 companies are searching for a particular cure, at best, only one will offer a cure and win the market. And if a terrible disease is cured and we lose 1-2% on a hedge here, I think we would all agree that’s still a win.

We’ll limit this kind of activity to areas of high conviction, such as Alzheimer’s. There are a few good reasons to think that the current consensus around the cause of Alzheimer’s is wrong, and a disastrous causation/correlation error has been made. We’ll short companies based on dodgy logic with a clear conscience, and keep an eye out for any novel approaches that show particularly interesting data.

Warm regards Michael If you were forwarded this article and found it interesting, please subscribe for more.

ps to follow up on previous letter’s comment on the similarity between credit spreads vs VIX courtesy of Topdown Charts:

Note: we also have put spreads on the S&P 500, Nasdaq 100 hedges, amongst other macro positions and hedges.

These numbers are prepared in good faith. They should not be relied upon for investment decisions. Past performance does not indicate the likelihood of future performance. If you require more detailed information on our positions and risk profile, please let us know.


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The information and opinions contained in this document are subject to updating and verification and may be subject to amendment. No representation, warranty, or undertaking, express or limited, is given as to the accuracy or completeness of the information or opinions contained in this document by Frazis Capital Partners or its directors. No liability is accepted by such persons for the accuracy or completeness of any information or opinions. As such, no reliance may be placed for any purpose on the information and opinions contained in this document.

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