Inconceivable investor behaviours in a strange market

Pengana Capital

Pengana Capital Group

Over the past few months, we have seen some inconceivable things from markets and economies around the globe; from talk of negative interest rates to wild valuations, and even an attempted share sale from a bankrupt company. 

Yes, Hertz recently got the green light to raise cash by selling shares worth as much as a billion dollars even with the company saying to the court that they will warn buyers that the stock could become worthless. It really amounts to a donation by equity investors to creditors. What is this telling us about the environment of risk-taking at the moment?

Sure, it’s a function of a free market and the company has been transparent, but I’m concerned that investors are prepared to get involved. It’s akin to taking a case of beer to an AA meeting. Yes, you should be able to drink if you want to drink, but maybe it’s not a good place to do it. Buying Hertz shares is not necessarily something you should be doing, and it’s largely retail investors who are attracted to these kinds of stocks, because it’s easy to participate in the share market and we’ve recently been in a bull market, a certain hubris ensues; a sense that you can excel in any market conditions. I’m concerned that many retail investors are not really familiar with this type of risk.

There’s an inconceivable volume of risk-taking at the moment, and I've found the situation absolutely flabbergasting.

On top of that, you look at US eTruck start-up Nikola which has seen its share price more than double to the same market cap as Ford, despite the fact that it has not sold a single car. Tesla has twice the market cap of GM, Ford and Fiat combined. And Apple's market cap is now approximately the same as the entire Australian market. Mind-boggling.

A lot of it is related to near-record-low interest rates. For example, this environment saw the largest pension fund in the US announce they will take on gearing to achieve their target return of 7%. This sort of thing hasn’t happened before. Everyone's been forced up the risk curve.

Alongside corporations doing strange things, you have a whole lot of people who have a fear of missing out, and it's creating some inconceivable changes in markets that don't align with what's happening in the underlying economy.

We are in a state of severe uncertainty and I worry where this leaves investors. Conservatism has never been more important in investing.

In this market, it is imperative that investors should be taking a conservative position with a focus on companies that:

  • are generating free cash flows;
  • are growing;
  • have strong balance sheets;
  • have a reason for being; and
  • are diversified

In Pengana’s International Equities team, we believe you should always be invested in the market, and not try to pick the market. If you didn’t stay invested in this market, you missed out on the 40 percent rally since mid-March.

And it seems as though, in the current age of risk, people have forgotten the importance of diversification. There's a massive herd mentality towards the FAANG stocks, which are wonderful stocks, but they're also exceptionally expensive and crowded.

What you really need is to do is marry valuation and growth together and if you don't do that you really are taking on too much risk in single bets that can make or break you. Put simply, it’s time to dial up your conservatism in the market.

So the kinds of things that I think people should be looking at now are more solid types of businesses. We hold stocks in US health insurers which are still growing, are cheap, and have a reason for being. Indian telcos are another. That’s certainly not a crowded trade. Things like discount retailers. Think Dollar Tree. Why? There’s a bifurcation in the world between the rich and the poor and, at the end of the day, people need to eat, and those people use discount retailers. To give you a sense of how wide that gap has become, the Fed recently disclosed that the richest 10pc of people in the US own 90pc of the equities.

Companies that benefit from bankruptcies are another good investment, such as Houlihan Lokey; a leading global investment bank that is one of the biggest companies involved in debt restructuring. It’s an established company, well-managed, cash-generative and not crowded because it doesn’t have a dot-com at the end of it.

There are lots of opportunities out there. 

You have to venture a bit wider than what others typically would but I would argue that taking big risky positions is not always a smart thing to do. We’re avoiding FANG stocks, momentum stocks, and banks.

We also believe there are long term opportunities within emerging markets. Emerging markets are forecasted to grow over 6 percent over the long term while developed markets growth forecasts are approximately 1 or 2 percent. While emerging markets look appealing, one must be very careful in the short term, and you will need to have a long-term investment horizon.

It is important to acknowledge that emerging markets are simply not as well prepared for Covid. They are arguably more affected by the shutdown of an economy, where people live day by day in very tight quarters in key economies like Brazil, India, Nigeria, Russia.

When the world economy slows, the effect on emerging markets is compounded. So, emerging markets look vulnerable in the short term, but if investors have the fortitude to hold for the long term, they are likely to be rewarded.

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Deputy Portfolio Manager, Pengana International Equities (ASX: PIA)
Pengana Capital Group
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