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The last 12 months could be categorised as a period of significant swings in sentiment, which has created opportunities, but also leads to less attractive risk/reward when sentiment is too positive. 2019 was a good year for markets, but as the year progressed, I became more concerned. US-China trade tensions underpinned market rhetoric and there was a lot of positive sentiment towards a deal made. This happened in January 2020 and at this point, the portfolio was at the lower end of the stock count range and at our maximum cash position. I did not believe the phase one trade deal was the full stop to trade tensions and market valuations looked too expensive. That said, there were some opportunities and positions in Hong Kong were added at the height of the protests there as valuations hit recent lows and saw good companies with international businesses caught up in indiscriminate selling. However, we ended January 2020 concerned that valuations were pricing in no room for error, and portfolio positioning reflected this.
No one could have predicted the COVID-19 outbreak that followed, but the volatility that followed meant there was a point in March where I was a buyer in the market and was deploying cash in to new ideas. However, the subsequent rebound in Asian markets has been the sharpest in history and suggests the market is pricing in a in V shape recovery, perfect execution by businesses and no second wave - all of this concerns me.
Therefore, I am cautious in my outlook. I think the recovery is going to take a longer than many anticipate. While factories in China are back online, the virus has spread so far that we’re now facing a global demand shortfall. New orders are not going to absorb the inventory that was already sitting in factories before the shutdown. Government stimulus packages do not create new consumption - they are just a replacement for consumption that’s been lost due to the virus shutdown. In addition, the stimulus we have seen is for the real economy, so unlikely to filter through to markets quickly.
I think we’ll have to go through a period of inventory destocking before things start to normalise again and that means the market is still too optimistic in pricing in a sharp V-shaped recovery.
That said, there are opportunities. Companies exposed to the travel sector have been hit across the board. The market took a pretty bleak view of earnings and balance sheet risk. Even though some have now bounced off their lows, if you take a two to three-year view, I think there is still money to be made. I have added Galaxy Entertainment, a Macau casino operator with rock solid balance sheet and Trip.com an online Chinese travel agent, whose business will be impaired in 2020, but benefits from the long-term trend of Chinese people traveling and have already seen domestic travel bookings returning to normal.
I continue to avoid the big online names in the region like Alibaba and Tencent. It simply comes down to valuations. I thought they were overpriced before and they didn’t fall far enough to become interesting. The market still isn’t reflecting the lower margins and returns that I think these stocks will make in the future. Competitors can emerge very quickly - just look at the growth of ByteDance (TikTok) in a very short period of time. I’m also not sure how quickly or how well they can respond to device changes as we move away from smartphones to wearable tech or whatever comes next. They are essentially conglomerates but are not being priced at the discount you would normally see on such a business.
However, within the technology space I have added a new position in SK Hynix. Its stock price fell significantly amid the market sell-off, but structurally I think memory demand will be strong as we continue our shift towards AI, high powered computing and automation. Although not part of the thesis, working from home should provide some support as this puts pressure on servers and data centres.
