Markets are at an inflexion point

If you’d never heard of Dean Fergie or Cyan Investment Management before, you’d be forgiven for thinking he was a dyed-in-the-wool value investor after reading this interview. But long time Livewire readers would recognise Dean as the first person to publish about Afterpay on Livewire, a stock they held until October last year when it grew too big for their small cap mandate.

Afterpay was no wild aberration either; Dean has often backed high-growth small caps with both his money and his mouth. So when Dean says that conditions in the market are changing, and old trends may not hold, know that this is not just a line he’s repeated before.

Following the announcement of Pfizer’s surprisingly effective COVID vaccine, I spoke with Dean to get his take on the importance of this news for investors. He explains why last week’s events (and I don’t mean the US elections) are more important for equities than a vaccine, and he shares his number one stock to benefit from a reopening economy.

With Australia having possibly eliminated or at least heavily suppressed the virus, and of course, with the overnight announcement of the successful vaccine trial, do you think investors should expect a rapid global recovery from here, and what are the implications for equity investors?

I don't think it's that simple that there'll be a rapid economic recovery. I think there's been so much damage to the economy that it's just not going to bounce back like magic. There's been systemic changes in industry, a lot of job losses. The economy has largely been propped up by government spending recently. I think the optimism that it's suddenly all going to be bright skies and clear seas is optimistic and probably a little bit naive is my view. The broader implication for equity markets is clearly that a vaccine is more positive than no vaccine, but it's still quite a way off.

Recently, the more important thing for equity markets has been the cutting of the RBA official rate to (another) record low of 0.1%. I think that is more significant to the stock market than a vaccine.

The initial announcement saw ‘value stocks’ and small caps rally while tech stocks and lockdown-exposed stocks got slammed pretty hard, which has obviously been a significant reversal of what we've seen or particularly recently. Do you think we're at an inflexion point for these trends?

Yeah. I'd probably fully agree with that. I think it is an inflexion point. When you have extreme momentum, a lot of sentiment driving stocks to what would previously be considered completely unrealistic valuations, you need a catalyst or tipping point in order for that momentum to be stopped and reversed. I think that's what we've had with the vaccine.

Markets have been assuming everyone's going to continue to spend online, get deliveries to home, all those sorts of things. But now they're thinking, well, hang on, we might actually be going back to a new normal.

What's the new normal? Well, it's probably not paying six times sales for Kogan (KGN) or Temple and Webster (TPW).

We need to get back to a new normal. I think people are realising that. Maybe we're going back to a more normal environment where investors want to look for traditional value stocks that have things like earnings and cashflow and dividends, which a lot of these COVID-tailwind stocks weren't really offering investors.

This is probably a bit off topic, but you've seen a few of the short sellers saying, “we're not going to continue to play in this market until people start looking at things like fundamentals and accounting,” which appear to have been largely ignored by a lot of the market, given how some stocks have been powering along.

Do you expect this change in trends will be shorter term or longer term in nature?

It all depends on how this plays out with the vaccine, whether we go back to being a new normal. I think what we've seen is a real disconnect between what's happening in Australia and what's happening overseas. Europe's going into their second wave, America getting record cases. Whereas Australia looks like, especially with Victoria, it's kind of beaten it. Things look fine here, but overseas, they still look pretty uncertain. So the implications for travel, trade, those kinds of things still are a concern and should be for investors.

With stocks that are directly exposed to COVID, such as Flight Centre and Sydney Airport, for example, a lot of them have already recovered significantly from their lows earlier this year. Do you think that this news is already priced in?

Yeah. That's the problem with the investment markets is they tend to be forward-looking. The fact that the market hasn’t priced those travel stocks down to zero implies that there will be a recovery at some time in the future. We've seen a little bit of bump up today, but I think they've also largely been factoring the fact that we will get back to a new normal, certainly if not next year, in 2022.

I'd say the good news is largely factored in. If investors are thinking in the next couple of days, “I'm going to pile in to travel stocks.” I think you’re too late.

What would be your number one stock to own today to benefit from a re-opening economy?

I think you need to look at a few things. You need to look at stocks that will have a bit of a rebound in their operations. But they must have reasonable valuation metrics, have not already recovered – like we've talked about in the travel stocks.

In our portfolio, I think the business that's probably going to perform best is Vita Group (VTG). They run about 120 Telstra stores, a lot of which have been closed or really limited in what they can sell. They're also rolling out a series of cosmetic clinics, which have also been badly affected by COVID. The company has a lot of cash on its balance sheet, and pays a reasonable dividend yield. I think from an operational perspective, and also from a financial perspective, it's got some real positives that could be advantageous over the coming months if we go into a more normal, post-COVID investment environment.

Is there anything else you wanted to add? Any key messages for investors to keep in mind as we look to open up again?

The only thing I'd say is that, I do this for a living and I've found this year to be incredibly challenging to ascertain the direction of stocks, investor sentiment, momentum, et cetera. I think diversification is the name of the game. You don't want to be all in on tech stocks. You don't want to be all in on value stocks. You don't want to be one hundred percent in cash, a hundred percent equities. You really got to have a balanced portfolio because everything's uncertain. 

Markets are very, very fast moving and so to take a big bet one way or another, I think is a little bit foolish.

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