The strangest film of quarantine so far

You need to start thinking about alternatives to the FAANG+ stocks.

The current narrative of eternal growth in cloud computing and digital advertising is blindly accepted by nearly everyone.

It seems like madness to suggest that Big Tech might go anywhere but up.

But we’ve been here before…

Source: Koyfin

This to me is the idea of cyclicality in action.

When a sector is exciting, money floods into it, investment is high, interest is high. And with each year and each new tech IPO, competition increases and profit margins are eroded.

After the tech boom, it took something in the region of FIFTEEN YEARS for investors to get back to where they were.

That’s pretty mental, given the hype of the sector, and the emergence of the FAANG+ stocks, don’t you think?

Trees don’t go to the sky, companies never grow forever, and in the immortal words of Qui-Gon Jinn, Jedi Knight from Star Wars: “there is always a bigger fish”.

And so, it may be time to think deeply about some long-term alternatives for the next cycle.

You know some of mine already: the energy transition, precious metals plays, and beaten-down value – wherever you can find it.

My next subject of investigation can be surmised from my Netflix history.

Last Thursday, my film-loving flatmate and I decided to browse outside the box for our latest film choice.

He suggested a Japanese epic called Harakiri, the trailer for which makes it look incredible.

Alas, it was weird.

Like a cup of tea using boiled milk with a dash of water. Familiar, but weird. Good and also bad. At the same time.

A great set-up in the first hour was followed by a long, retrospective flashback which made little sense and went on, and on…

In fact, it was slowly building up for a big finish. The long period when it felt like nothing was happening turned out to be laying quite a bit of groundwork, which then added a heap of colour to some of the closing scenes.

Now look at this chart of the Japanese stock index, the Nikkei 225, since 1990:

Source: Koyfin

See what I’m getting at? We had a rush of excitement, and then two lost decades – but while it may have felt like nothing was happening, in fact, a lot of groundwork has quietly been laid.

I imagine that Japanese investors in the late 80s felt as tech investors do today – invulnerable. It’s a story as old as time.

This goes back to Chris Cole’s wonderful quote from last week – defensive assets are “protection not for a rainy day, but for a rainy decade”.

Once a narrative is swallowed whole, investors struggle to imagine it doing anything more than stumbling. It’s impossible to imagine an entirely different and contradictory narrative driving an entire cycle of losses. But that’s what happened in Japan – and investors still haven’t clawed back their old gains.

The stronger and more widespread the narrative, the longer it takes to unwind. The higher the pedestal, etc. This is why you see frantic warnings about bubbles – because they can truly ruin you. Better safe than sorry tends to be my advice.

For example, governments and investors really care about the debt-to-GDP ratio (national debt/national GDP, expressed as a %). It’s important that it’s a ratio, because it means you can improve it by cutting the top/first half, or by boosting the second/bottom half.

I think it would be reasonable to expect that in the next cycle (seeing as the last decade was pretty tepid from a national economic growth perspective), governments will focus on infrastructure, ploughing money into public works, projects and services, trying to boost GDP rather than using austerity to trim down debt.

That would lead to a focus on real economy assets, commodities, and inflation and real prices go up. Inflation would also result in higher rates.

Such a narrative would lead to a crushing, grinding bear market in technology and internet stocks, as the focus zooms in on what you can eat, drink, see, touch, or build.

It seems crazy now, but after the tech bubble burst, China fuelled a commodities boom with its unprecedented economic growth, and houses were the epicentre of the next bubble – physical, brick and mortar assets, not digital advertising space.

Heresy? Not quite.

Madness? Think again.

Never before has any investment narrative ruled the roost forever.

Warren Buffett has now failed to beat the S&P 500 over the last 18 years – because he “doesn’t understand tech” and so stays away from it.

I saw some chap crowing about this on Twitter the other day: “Maybe he should’ve spent the last 18 years learning about tech!”

The thing is, one of these people is a gloat, and the other is the GOAT.

The Greatest of All Time.

The Leo Messi of investing.

Or if you’re Australian, somewhat bafflingly, the Nathan Lyon of investing.

I wasn’t conscious of it at the time, being an under-five, but I’m told that Buffett was likewise mocked in the late 1990s, as all things tech turned to gold.

But what Buffett avoids by avoiding the tech-manias is not just the way up, but the way down as well.

And an 18-year underperformance strikes me as a wonderful time to reinvestigate the core principles behind Buffett’s beloved Value Investing strategy.

Buy low, sell high is our constant mantra.

Which almost by definition rules out most Big Tech firms today.

I’m sorry, but it just does.

And not because you might get a 10% or 20% knock in the next year or two.

Because it might wipe out more than 80% of your wealth over the next decade.

Now that is risk. That’s devastation. And helping avoid that is pretty much what I feel I’m here for, and what we at Southbank Investment Research are here for.

I think that possibility is higher now than people think it is, and I think we can do better.

And Buffett agrees with me (or perhaps it’s the other way around!).

Don’t get me wrong – technology is still a great sector, but as others become more carefree and confident, you must become more careful and selective. This is crucial when you now look at the tech sector.

Or you can look elsewhere.

Buffett believes in buying things which are cheap when compared to the value of their businesses, as he calculates it.

Traditional measures include price-to-earnings, price-to-sales, price-to-earnings growth, return on equity, things like that.

On all these measures, corporate Japan looks vastly cheaper than the US.

The top five firms take up more of the S&P’s value now than they did at the peak of the tech bubble – by two times.

Source: Markets Insider

As a man who believes in psychology and cyclicality in investing, that’s a pretty powerful chart.

From a cinematic perspective, Japan is being revisited. Amongst other things, the recent Star Wars spin-off The Mandalorian (on Disney’s fantastic new Disney+ streaming service) includes buckets of references to old samurai movies, such as Baby Cart at the River Styx.

Japan was set to host the Olympics this summer.

And its corporate sector came into this spring’s corona crisis with more cash than any other developed market. That makes Japanese companies far more resilient to this year’s carnage than elsewhere, especially the US.

To quote the Financial Times:

Japan’s listed companies went into this crisis with the biggest cash reserves ever recorded. Collectively, they had slightly more than $6.5tn of cash equivalents on their balance sheets at the end of December 2019.

This amounts to more than 130% of the country’s GDP: more than three times the equivalent ratio in the US.

And unlike Japan’s broad base of cash, which spreads across almost every sector of the economy, America’s cash reserves are highly concentrated, with about one-third of it in the hands of the tech oligopolies.

What’s more, Japan’s historically conservative corporate boards are being encouraged and incentivised to become more shareholder friendly – with shareholder payouts increasing from 35% as a percentage of profit to 60%, since 2012.

Unemployment isn’t an issue either. In fact, it actually has too many jobs.

Based on earnings, sales and book valuations, Japan is wildly more attractive than the US. In order to buy low sell high, you have to be willing to buy low…

Coronavirus may also drive the global desire for automated manufacturing, something Japan is years on because of its ageing population issues.

I’ll go into more detail on Japan soon. It’s well worth all of our time.

It’s an old favourite too – my first ever investment was Sony, after all…

Hope you’re all keeping well.

All the best,

Kit Winder
Editor, UK Uncensored

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