Ophir Asset Management

Big Apple indeed!

Apple has become the first company in history to reach a market capitalisation of USD $3 trillion. Last week the stock price reached $182.85, crossing that $3 trillion mark (see chart below).

To put that into perspective, the top 100 companies in Australia currently have a market capitalisation of approximately USD $1.5 trillion. This means Apple is now worth almost twice the ASX100!

Apple’s stock has returned 35% in 2021; 82% in 2020; and 89% in 2019.

The questions is, will this rally continue?

With recent events such as the Fed minutes delivering a gut punch to some high growth stocks, many investors might think there isn’t much further to run in 2022.

Where do you see Apple in the next 3-5 years?

Growth outperformed Value in 2021?

Investors fishing in the large cap part of the US stock market would say so with the S&P 500 Growth index returning 32.0% vs. its Value counterpart’s return of 24.9% for the calendar year.

However, in the small cap pool 2021 played out very differently…

The Russell 2000, which tracks the smallest 2000 out of the 3000 largest US traded stocks, trailed significantly returning 14.8% over the year.

But what was the return of its growth and value counterparts for 2021?

The Russell 2000 Value index returned an outstanding 28.2% while the Russell 2000 Growth index returned a measly 2.9% - the most US small cap value has won by since the tech wreck in 2000! See table below.

The primary reason behind this divergence was likely economic reopening and the risk of increasing interest rates – a justifiable position given the Fed recently announced its forecasts see three interest rate hikes in 2022.

Has the market priced in the impact of these interest rate hikes or will US small cap growth stocks continue to derate?

US Small Cap Growth outperformed Value by 30% in 2020 and circa 85% of that Growth outperformance was reversed in 2021 – so potentially there isn’t much further to go but only time will tell!

Valuations matter! And they matter right now.

In 2020 corporate earnings crumbled on initial lockdowns, but valuations exploded higher as monetary support and vaccine news came to the rescue – providing great returns overall for shares.

In 2021 global shares saw even better returns. But the opposite was the cause.

It was driven by massive earnings growth, as economies reopened.

This was despite valuations detracting from returns as price / earnings ratios shrank (de-rated).

Though many share markets are at or near all-time highs - there are parts that got smashed in 2021 with falling valuations completely overwhelming any earnings growth.

Which parts?

The most expensive parts.

Top chart shows this with things like the ARK Innovation ETF, expensive unprofitable tech stocks, Chinese internet stocks and SPACs all getting hammered.

This happened most recently in Nov/Dec when the market reacted to more aggressive tapering ahead by the Fed.

These expensive parts of the market saw some of the biggest winners in 2020 when the Fed first loosened monetary policy.

The lesson – don’t just follow yesterday’s winners. As Graham once wisely taught Buffett “Price is what you pay, value is what you get”.

One forecast for 2022 – valuations will matter a lot with a tapering and rate hiking Fed.

Omicron, higher inflation and interest rates with a more hawkish US Federal Reserve, huge disparities in market valuation metrics and the recent savage bear market in non-profitable tech companies…

…all the hot button issues for share markets now.

Some examples of more well-known names in the market to be hit hard recently of the high growth, low/no profit technology related businesses – with their share price falls from their 52 weeks highs in brackets, include: Draft Kings (-63.7%), Pinterest (-61.1%), Lyft (-45.1%), Robinhood (-78.7%), DocuSign (-52.3%) and Peloton (76.7%) – although it has got its own S*x and the City related issues.

We talk about all these issues and more in our latest Letter to Investors we just released.

If you’re interested in having a read or signing up to our latest insights, please click on the link in the comments section below.

The Grinch List.

No ones like a Christmas Grinch – let alone financial markets.

Bank of America just came out with their latest tail-risk list (aka “Grinch List”) from fund managers.

Rate hiking central banks are back as top of the pops (see first chart).

The US Fed has just delivered on its recent hawkish tilt today – bringing an end to QE early in March next year and forecasting three interest rate rises for 2022.

Forward looking markets seem to have already pencilled this in though – taking it in their stride with key US share market indices rising on the news today.

Globally, we might have seen a bottoming in central bank policy rates as almost all are hiking and virtually no one is cutting (second chart).

Key to watch out for will be whether central banks, particularly the Fed, go too far too fast.

Is there anything you think is missing from the Grinch List this Christmas?

Fear the Fed?

Or at least that’s what many share market investors may be thinking as rates lift off is looking more likely next year.

History suggests though investors should stress less.

Nine out of the last nine times in the year before the Fed has started a new interest rate hike cycle the market has risen (see chart).

And on average almost 20% higher!

A strong economy - that the Fed is responding to - and rising corporate earnings have outweighed any valuation compression.

Is this time different or should investors expect history to repeat?

Our money is on history repeating. The market is generally skewed in investors‘ favour.

We remain fully invested. At times like these when some investors are adding higher rates to their worry list we are reminded of that great quote by famed investor Peter Lynch:

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.

More transmissible but less deadly?

That seems to be the working hypothesis of markets about the Omicron variant to date with a significant amount of initial share market losses recently recouped.

There seems to be no doubt Omicron has taken a big genetic jump from previous variants as the excellent top chart from Nextstrain shows.

And whilst it’s still way too early to be definitive, the increase in cases at source in South Africa has not been accompanied by an increase in deaths (bottom chart).

Absent much company reporting at this time of year and markets will be fixated on this issue through Christmas.

Let’s hope there is some good holiday season news in store here for everyone – I think we’ve all earned it!

Want to turn a 21,833% return into a 4,670,630% return?

Just miss the worst 10 days on the share market each decade since 1930.

Oh, the siren song of market timing.

Who wouldn’t want to try and avoid the worst days right when the upside can be as HUGE as that described above!

If you could then Mr Musk or Mr Bezos might not be the wealthiest people in the world – depending on how long you’ve been doing it for - it could be YOU!

Well, the problem is, you can’t.

The very worst days for the share market, just like the best days, are scattered like needles in a haystack.

Tough to find when the probability of the market going up or down on a given day is about equivalent to a coin flip.

Think market valuations are a good predictor of when you are more likely to find ‘good’ or ‘bad’ needles?

Think again.

‘Expensive’ or ‘cheap’ markets are pretty awful predictors of market returns over the short term such as the next day, week, month or year.

Why sacrifice the haystack when if you get it wrong and miss out of the 10 best days per decade your 21,833% shrinks to 58%.

The very best days matter a lot for your returns.

The haystack is skewed in your favour.

Buy haystack.

Or even better – buy a bit better haystack with a quality active manager and stick with them.

Bulls on parade!

No matter where you look, share allocations in portfolios have shot to multi-decade highs and bond/debt allocations to multi-decade lows.

TINA – or “There Is No Alternative” is in full force for asset allocators courtesy of still ultra-low interest rates, helping to keep share markets near all-time highs.

Below are just two examples - with Australia’s big superannuation funds (top charts) and Bank of America private client allocations (bottom charts) showing how risk has been turned up to full volume.

Part of this is no doubt the response of asset allocators needing to hit absolute returns targets with shares being the least bad option on a street that is littered with expensive (low yielding) bonds.

While consumers opened their wallets on Black Friday just gone it was certainly a Friday filled with red for share markets globally as news of new COVID variant Omicron spread.

The question for share markets is will the bulls and TINA prevail again – buying the dip?

The United States – the supreme leader of world equity markets.

But it was not always this way.

Organised trading in securities first began in Amsterdam in 1602 and then London in 1698, with the U.S. a laggard – only starting in New York in 1792.

Even then, the United States used to be just 15% of world equity markets in 1900.

Incredibly now it’s around 60% overall and a massive 68% of developed markets.

This is a far cry from 1900 when the UK was the world’s largest share market comprising 24%, a time when Germany (13%) and France (11%) were similar in size to the United States.

Superior performance of the U.S. economy and returns from its share market – as well as a deluge of IPOs – has seen it rocket to the lead and it’s not even close.

Currently Japan has the second largest share of global equities at a little over 5%, less than a tenth the value of the United States.

In the last 10 years alone, the United States has turned on the jets and only strengthened its lead – MASSIVELY outstripping returns from other developed markets (top chart) and bonds (bottom chart) in a display we haven’t seen in generations!

Will they maintain their ascendancy?

Or are we seeing ‘peak US’ – with another upending of global share markets over the next century?

Let’s hope Nicolas Cage doesn’t make any more movies.

Or at least that’s what the below chart would have us believe.

Of course, the chart is a joke from Tyler Vigen’s great website “Spurious Correlations”.

But it raises the more serious question of buyer beware in investing when someone shows you a chart of two lines moving together and suggests you should buy or sell something on the back of it.

“False Causality” or “Spurious Correlations” are a big deal in investing and many a fortune has been lost because of it.

As Mark Twain once said, ‘there are three kinds of lies: lies, damned lies, and statistics”.

Exhibit A: the correlation between the S&P500 and the annual production of butter in Bangladesh was 87% over the ‘80s and early ‘90s!

How to overcome it?

Without a controlled experiment - like in medical research – it’s not easy!

A few helpful tips though are:

1. Look for long term data with big sample sizes
2. Control for outside factors
3. Ask does it have an intuitive explanation?
4. Investigate if the relationship holds overall and for sub periods
5. If you’re into statistics – do some hypothesis testing

None of these is fool proof – but it’s a start.

Now that we’ve debunked any causation below…

…rather than no movies, let’s hope Nicolas Cage makes more Raising Arizonas than more Ghost Riders.

Diversify that.

Top 5 companies in the S&P500 make up a quarter of its value – the highest since 1969 (top chart).

That’s a pretty stunning change since the top 5 made up barely 10% just 5 years ago.

Are we on the verge of a new era where the big will keep getting bigger?

Maybe…but history is not on its side.

And not from the level of disruption coming from small caps where it’s never been easier to scale a small business globally.

To date though US Big Tech has kept its moats wide and strong.

It is throwing up relative valuation opportunities to diversify though with US small cap valuations at two-decade lows versus large caps (bottom chart).

Who wins this battle royale over the next 5 years? The very big and entrenched…or the small and nimble up and comers?

More alpha, less beta.

Never before in the history of modern financial markets have both US shares and bonds been simultaniously as expensive (see chart).

The “Golden” 1920s and 1950s got close, but no cigar.

The expensiveness of US shares is mostly large caps though, with the Shiller PE of the S&P500 at 38x versus the Russell 2000 (US small caps) at a much more normal, though still elevated 25x.

If low interest rates have pumped up US large cap valuations, and rates can’t go any lower, it suggests US large cap market returns (beta) might have more soggy days ahead.

And at almost 60% of the global sharemarket, to a degree, as go US shares, so go global shares.

You can’t help but see how market outperformance (alpha) – where it can be found – is going to be more valuable in the years ahead.

How confident are you in yours?

Downtowns are still a ghost town.

As one of the first developed economies to start “living with COVID” – many have looked to the US to what “return to the office” might look like.

And the picture is still bleak if you’re a business that thrives on city offices coming back to life.

Most office building foot traffic is still down 60-80% from pre-pandemic levels.

Silicon Valley has been one of the most impacted, down -82.6%, as tech workers can more easily do their work from anywhere and are escaping the high living costs and commute times.

In aggregate office foot traffic has been slowly increasing in the US over the last year and a half but at a glacial pace.

The jury remains out what downtown and CBD life will look like in a post pandemic world.

The answer holds huge ramifications for the supporting ecosystem of businesses.

Where do you think this story ends?

Final nail in the coffin for income investing?

The real (after inflation) dividend yield of the US share market has hit generational lows.

Historically, the default state for real dividend yields on US shares has been negative, with only short positive periods.

This may be one of the reasons why investors in the US have been forced to focus on total returns – that is – dividend plus capital returns.

In Australia, due to the tax treatment of dividends, dividend payments have been high and hence real dividend yields have tended to be positive.

This has bred a generation of local investors designing portfolios around dividend returns – that don’t optimise total returns – taking on excess risk & generally winding up the poorer for it.

At Ophir, we invest in small caps that tend not to pay out meaningful dividends as they are re-investing for growth.

And so they should – if these companies started de-prioritising growth and paying out large dividends, we would probably sell out.

Whilst our funds have very low dividend yields, total returns in each fund have been greater than 20%+ p.a. after fees since inception.

Perhaps if there’s a silver lining to inflation persisting at higher levels for a little longer, it’s that more investors might raise their gaze back to what’s truly important – total returns.

Well, that was fast.

And no, we’re not talking about how top end Tesla’s can do 0-100 km/h in under 2 seconds – although that is stupefyingly fast.

We’re talking about how fast Tesla has cracked the US$1trillion dollar club – which it literally just did.

It’s now rocketed the company to being worth more than the next 10 largest global automakers combined – and its CEO Elon Musk to the world’s richest person.

And it's not even close – with Musk now personally almost US$100bil richer than second placed Amazon founder Jeff Bezos (US$287bil v US$196B).

All this whilst Tesla is only ranked 196 globally by revenue while every other company in the below list is in the top 25.

Incredibly it cracked the US$1tril market cap club on Monday this week when it rose US$118bil in a single day – more than the market cap of every other single automaker in the world except Toyota, Volkswagen and BYD (China).

AMAZING!

Not bad for a company that sells only about 1.2% of the circa 75 million cars sold globally this year.

Has there been a bigger bet on future growth of a large cap company?

Are investors too wrapped up in an enigmatic leader that some see as walking on water, or will Tesla truly come to dominate the world car market?

Retail gets rational in 2021?

On a daily basis the share market is basically a coin flip.

About 50% of the time it goes up and about 50% of the time it goes down.

Typically, retail investors are procyclical – that is they put more into equity funds after the market has gone up and take more money out (or put less in) after it has gone down – generally to their very serious detriment!

As behavioural finance giant Danny Kahneman has said:

“The average investor’s return is significantly lower than market indices due primarily to (this type of) market timing”.

A different kind of market timing has been going on in 2021 though – buy the dip.

Flows into share funds have increased on days when the S&P500 has gone down (see chart).

At Ophir, we are not big on market timing – it is painfully difficult if not impossible to get consistently and accurately correct.

Our investment team just continue to re-invest their personal money into our equity funds regularly over time, irrespective of daily market moves.

But if you are going to ‘sin a little’ on market timing, it looks like this year retail investors might have been listening to Buffett’s classic advice:

“Whether socks or stocks, I like buying quality merchandise when it is marked down”.

The question is – how long will buy the dip last?

Why does being great at school not necessarily make you a good investor?

The human side.

If all there was to the game was a sky-high IQ, you’d expect many of the wealthiest investors in the world to have a PhD after their name… but that’s not true.

Hopefully recent books like “Thinking, Fast and Slow” has disabused us of the idea that we’re the paragons of reason we once thought.

Our mental faculties & neural mechanisms were formed back in a time and a world that looked very different to the one we live in now.

The world we occupy has rapidly changed since the first Industrial Revolution that started two and a half centuries ago – a mere blip on the evolutionary scale – and our brains haven’t caught up – perhaps they never will.

But like all people with a problem, the first step is admitting it. And we’re learning more about our ‘problems’ and how they impact our investing with the progress of behavioural finance over recent times.

In this month’s Ophir Investment Strategy note we unpack four of the most destructive cognitive biases that might be sabotaging your investing & how you can combat them. Click on the link in the comments to have a read.

Perhaps Jason Zweig said it best “Investing isn’t about beating others at their game. It’s about controlling yourself at your own game”.

We have a very special guest for our upcoming Ophir investor webcast.

We consider her as one of the best & most connected US Economists out there, with direct lines into some of the world’s most important policy makers.

She is the person we pick up the phone to when trying to understand the impact the Federal Reserve’s actions could have on equity markets, and gives us a ringside seat to where the global economy is heading – putting conviction into our portfolio positions.

Her name is Dr. Julia Coronado. She is the founder of Macropolicy Perspectives and previously worked for nearly a decade at the Federal Reserve in Washington, briefing the Board and contributing to their forecasts.

With the Fed about to exit the biggest stimulus program in our lifetimes, we thought it timely to sit down with Julia (via Zoom) and ask her some tough questions.

On the webcast we will also talk through:

- a couple of stocks we have recently added to the Australian and global portfolios;
- performance of the Ophir Funds during the September quarter; and
- some recent big picture observations & how they are shaping the way we are positioning our portfolios.

We hope you can join our webinar at 2pm (AEDT), Wednesday 20th October.

You can register for the webinar via the link in the comments section below.

I’m sittin’ on the dock of the bay,
Watchin’ the tide roll away,
I’m just sittin’ on the dock of the bay
Wastin’ time

Otis Redding’s classic was the first posthumous no.1 chart topper in the US, hitting the top spot in 1968.

Almost two decades later in 1987, Michael Bolton would release what many would consider, including Ophir, its most famous cover version.

Though clearly far from their minds, both could have easily been singing about goods trying to enter the United States at present by sea – given the record backlog of ships (see chart).

Companies we have been talking to have been complaining about not being able to book revenue for the September quarter as they can’t get goods off ships in the LA-Long Beach ports at present.

Restocking for the holidays boosting cargo volumes, labour shortages and COVID-19 safety protocols are all conspiring to the build-up of an armada in the two neighbouring ports that handle 40% of all seafreight containers into the land of the free.

It could make for a messy September quarter reporting season in the US.

Let’s hope it's resolved before Santa comes to town or we might see fewer toys under the tree this Christmas in the U.S of A.

Pullbacks happen.

If you were feeling the pangs of nervousness last week when the US sharemarket finally registered its first 5%+ pullback for the year – you should get used to it.

Pullbacks of that magnitude happen. All. The. Time.

In fact the average pullback of the S&P500 in a calendar year is 14.2%.

So investors have had it good in 2021.

As Buffett has said:

“Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market”.

Where did he get that 50% from?

Well as seen in the top chart, pullbacks near that magnitude have happened about every 10-25 years – the horizon for many equity investors.

But it’s because of the risk of those pullbacks, along with the exposure to businesses that are finding faster and better ways of producing things we want and need….

….that they have consistently been the main game in town for long term investors (see bottom chart).

At Ophir, we love pullbacks. We’re highly confident the market will head higher over the long term.

Pullbacks provide some of the best buying opportunities to help set our portfolio returns up for the future.

COVID-19 for the vaccinated now becoming more like the flu?

Perhaps at least insofar as hospitalisations are concerned.

Below is one of the more positive charts we’ve seen recently that we just had to share.

Recent COVID-19 hospitalisation rates for the vaccinated are now the same or less than for those with the flu from recent data compiled by McKinsey for the US, the UK and France (see US chart below).

Providing vaccine effectiveness holds up, this augurs well for a more optimistic future and far better health outcomes than were pictured just a year ago.

And one where businesses and the global economy can finally get back to firing on all cylinders.

Don’t fear the Fed.

With the US Federal Reserve helping to underpin equity markets with massive monetary stimulus since COVID-19 hit last year – many investors are worried what will happen when they soon start taking the punchbowl away from the party.

Previous tightening cycles where interest rates are hiked suggest they shouldn’t though.

US equities have tended to increase when interest rates have started increasing (see chart).

This is particularly true in the early stages of tightening - like the first two years.

Why?

The Fed is responding with interest rate hikes BECAUSE economic data such as GDP, unemployment, wages and inflation is sufficiently strong that lower interest rates are not warranted anymore…

…AND this improved economic environment tends to be good for companies and their earnings – particularly in the early stages when interest rates are still lower than 'normal’.

Will this cycle be like those of the past?

Recently Clancy Yeates from the Sydney Morning Herald got in touch with our Co-Founder and Senior Portfolio Manager, Andrew Mitchell, for a general chat.

As a very early investor in Afterpay, the conversation quickly turned to Andrew’s view on its proposed $39 billion acquisition by Square.

Andrew told Clancy that while he thinks it is a full price, Ophir still holds most of their stock. The key reason being we are not ruling out a rival bid.

On Monday this week we found out Square was indeed hurried along to bid for Afterpay because a mystery suitor was also in the wings. The smart money is saying that suitor was PayPal. However, we would not rule out companies like Apple, SoftBank, Visa and MasterCard or even Facebook having interest.

Ultimately we think Buy Now Pay Later will be an option provided by each of the major payments providers. When arguably the number one player is up for grabs there will undoubtably be FOMO by payment rivals both offensively and defensively.

We are not ruling out another bid or even more.

Like every good thriller, will there be more twists in this chapter of Afterpay’s story?

We have attached a link to the online version of the article in the comments below.

August was a very important month for Ophir for more reasons than one.

First it marks us moving into our 10th year since starting. From humble beginnings we could never have imagined we would have raised well over $1 billion and more importantly generated over 25% p.a. after all fees for our investors in our original fund over the journey. We have to pinch ourselves sometimes!

Secondly August is the most important month for Aussie investors because most stocks report their full year profit numbers in the month. August is the report card for the stocks in your portfolio so you want stocks that deliver better than expected grades. It sets the tone for trading in a stock for the following 6 months.

Ophir is pleased that after a flat few months we had one of the strongest months ever in our Australian High Conviction Fund. In total it generated 11.1% after all fees during August beating the market by 6.7%. Although it’s only one month I’m incredibly proud of the whole team sticking together during the flat months preceding and delivering when it counts the most.

We have attached the Ophir High Conviction Fund (trades on the ASX under ticker ASX:OPH) below. If you would like to read the August monthly newsletter please click on the link in the comments section.