Fast money in a crowded space

Volatility and wild swings in company share prices were a feature of the August 2018 reporting period. For example, Bellamy’s shares immediately fell 8% on the result only to rally and end the day 6% higher. According to Charlie Aitken, it’s a symptom of large amounts of short-term money sloshing around in a very small market.

In this thematic discussion Matthew Kidman speaks with Ben Mcgarry from Totus Capital and Charlie Aitken from AIM Funds to get their unique perspectives on what’s really going on under the bonnet of the local sharemarket. While investors may have largely celebrated the latest set of results we learn that not all is what it seems when you dig a little deeper. 

“There’s big funds meeting in crowded places in thinly traded stocks and the results can be spectacular in the short term. I think that provides an opportunity over the next couple of months as eventually sanity prevails and earnings and cashflow becomes the gravitational pull for share prices.”

- Ben McGarry, Totus Capital 

Edited transcript

Matthew Kidman: Welcome to Buy, Hold, Sell. My name's Matthew Kidman, and today, we're going to discuss earning season. We've just been through full-year results, well, they'll finish tomorrow. It's been, well, it's been okay. Been some beats, been a lot of misses, and a lot of movement in share prices, which has shocked everyone.  

To discuss the earning season, I have Charlie Aitken, from AIM Funds, and Ben McGarry, from Totus Capital. Welcome gentlemen.  

Ben, I'll start with you. Any kind of macro themes that came out, certain sectors doing well, certain sectors underperforming? 

Ben McGarry: I could think of one theme that was interesting this reporting season, it was the increased use of aggressive accounting to hit market numbers or maintain growth rates. Companies are using things like excessive capitalisation of software investment, running it through the balance sheet rather than the profit and loss, using things like acquisition accounting to release provisions to boost profits, even things like factoring payables. All of that tells us that these companies are having to run faster to meet market expectations.  

Matthew Kidman: Not a good sign. I can't remember the last time a company said what their net profit was.... it's always underlying or EBITDA. Charlie, something you found that was a little bit more inspiring tell us? 

Charlie Aitken: A lot of abnormals and things like that. No, I thought it was a pretty ho-hum reporting season. I think that cost escalation in resources was something I thought was interesting. I thought that the margins have peaked, probably, in the resource sector. 

I think that companies have not been spending enough on capex in the resource sector, so I think perhaps the margins have peaked in resources. Cash flow may have peaked in resources, I thought that was interesting. Most of those stocks are very well held now, and they didn't really beat expectations. I thought that was interesting, but really for me the price movement for small changes in consensus earnings was unbelievable. I've never seen anything like that, and I think that the price reaction, both up and down the results was probably more stunning than the actual results. 

Matthew Kidman: Well it's quite interesting, that's ... some companies that just met whatever unexpected ... up 20, 30 percent. Some days you wanted Valium. Some days you wanted uppers. Is it ... is the market changing and is the volatility around earning season? 

Charlie Aitken: Something's changing, I mean if you had basically been short the most well held stocks and long the biggest shorts you would have had a fantastic reporting season. So for me it was more about positioning, I suppose that's what you learn than necessarily the results. Expectation and positioning, so ... but it's new to Australia, I think some of this price action reminds me of what happens in America on a quarterly basis.  

Matthew Kidman: A lot of second and third derivative type investors.  

Charlie Aitken: Yeah, but then also some of those moves can fade within a day or two. So we've even seen stocks open down six percent finish up eight percent on the day. Fifteen percent intra-day movements. Which to me is a lot of money. A lot of fast money playing in a small space and I think that's what changed.  

Matthew Kidman: Yeah maybe we've got to just sit through the turbulence early on. Okay let's go forward. Let's get through the turbulence and let's think, well what has the reporting season told you about how you're positioning your portfolio on the long and the short side. Has it changed, or is the same? 

Ben McGarry: One of the key things for us is that we were pretty cautious heading in to a reporting season. Particularly around stocks exposed to a housing slow down. We might be in a bit early there, I think the results that were reported generally weren't as bad as feared. I think it's potentially the next six months that is the issue with bank funding, cost going up, credit growth slowing. The gradual increase in investment from overseas players like Amazon and Aldi. So we were probably a little early there. And things weren't quite as bad as we had thought it may be this reporting. 

Matthew Kidman: What about those mid-caps with big multiples that everyone had talked about for a long time? They came off, but low and behold guess what, the multiples are getting bigger. So what do you do with those stocks?  

Ben McGarry: I think, exactly what Charlie said, they're extreme moves in the short term driven by positioning. I think we've got a lot of long short money, large funds are getting bigger. Particularly growth funds, a lot of funds like L1, VGI have raised a lot of money. So there's big funds meeting in crowded places in thinly traded stocks and the results can be spectacular in the short term, but I think that provides an opportunity over the next couple of months, because eventually sanity prevails and earnings and cash flow become the gravitational pull for share prices.  

Matthew Kidman: Okay Charlie let's get to your portfolio. You just told us resources may have peaked. Costs rising, not spectacular compared to expectations on the earnings. Do you start shifting your portfolio around? Does it go back to the other part of the bar bell where banks are their knees? Where are you at? 

Charlie Aitken: Banks are absolutely no interest to me. I agree with Ben, I think that the reporting season confirmed the last six months earnings. The next months earnings could be quite different. I think we can absolutely see there's a housing slow down starting. The cost of money is going up, the availability of credit is going down. All the factors that drive lower house prices lower consumption, are starting to hit Australia.  

You've also got political uncertainty which came after the reporting season and in to the new financial year. So look, for me I think some of the multiples on some of these sort of Fintech type exposures in Australia are ludicrous. Absolutely ludicrous. I think the market's got a short memory. And I think a lot of the short money in Australia is not sticky short money. People say they are structural shorters, but the shorts in Australia are very weak handed. Present company excluded. But it seems that we don't have the tolerance for pain in shorting that the rest of the world does. And I think, I agree with Ben. I think there's some situations in Australia that you might have been wrong on the six months that we've just reported. But in 12 months from now you might be very right. 

Matthew Kidman: Okay, let's keep going on down the bad part Ben. Going back to your first statement about what earnings look like and pieces moving, the deck chairs moving around the titanic. Has that got you worried about anything in particular? Have you found some stocks that you think in the long run I am going to be right on this because they haven't fessed up their real earnings? 

Ben McGarry: Well back on a couple of those most really expensive stocks, earnings stocks like Domino's and Wisetech missed earnings on almost every metric you can think of and rallied hard. We think that's got to be short term and there's eventually some catch up that will come in those share process. They are the ones that were really surprising when we think of the opportunities over the next few months. 

Matthew Kidman: So it might have been a bit of a ho hum season, but as usual investors found a way to thrill themselves.