Why Hamish Douglass could finally get the crash he banked on

To say Hamish Douglass has been in the news recently is an understatement. The past few months have seen him confirm a split from his wife, the abrupt departure of Magellan's CEO Brett Cairns for personal reasons, a steep decline in his firm's share price and the loss of a $23 billion institutional mandate. 

But then things have been tough for a while.

Despite delivering a 3.1% return for the month of December, Magellan's flagship Global Fund has still underperformed its benchmark over three months, one year, three years, five years, seven years and 10 years. As of December, the fund has only outperformed the MSCI World Net Total Return Index (AUD) since its inception (July 2007), delivering investors a return of 12% per annum, or an outperformance of 3.8%. 

This period of underperformance comes after the fund's chief investment office infamously doubled down on cash during the COVID crash, took a big bet on China, and later, reacted bearishly towards positive vaccine news. 

But now, with inflation and interest rates on the rise (and with Livewire readers feeling more bearish than ever) could Magellan's mega-cap tech, defensive positioning help it stage a turnaround (or resist the "material market correction" that Douglass has been warning of for months)?

In his recent global strategy update for January, Douglass sat down (virtually, of course) with Matthew Webb, Magellan's head of strategy (asset management) to discuss the Omicron variant, inflation, two new portfolio additions (both leveraged to travel and the global reopening), and recent market volatility. 

In this wire, I'll take you through some of the key takeaways from Douglass' update - including why he is selling down his position in Facebook (now Meta), and - in perhaps the beginning of the weakness he has foreshadowed over the past 18 months - why the 30% drawdown in many unprofitable tech names is just the beginning.

Omicron to affect growth in Q1, could heighten inflation risk

While Douglass isn't "overly concerned" about the Omicron variant, he does believe that it will affect global growth in the first quarter of 2022. It comes as Australia records its deadliest day of the pandemic, with the nation reporting 74 deaths overnight.

"I really think the next two or three weeks may not look pretty, but it should actually pass pretty quickly as well," he said. 

The real concern is the impact of the rapidly spreading Omicron variant on supply chains, as workers around the world are "taken out" by COVID, Douglass said, which could ultimately heighten inflation risk. 

"China has a zero COVID policy and therefore whenever they're getting any infection from Omicron, they're locking down entire cities," he explained. 

"If you lock down cities and those cities happen to be important for the global supply chain, we could have further supply chain disruptions as the world gets over Omicron... Further problems in the supply chain, if they were lasting, heighten inflation risk."

This could result in a "rude shock for markets", Douglass adds, particularly if central banks are forced to tighten monetary policy in a bid to stamp out inflation. 

"We'd put a 30% probability on that scenario. Omicron may be modestly increasing that probability at the moment. So we still remain, not alarmed, but cautious on the inflation scenario," he said. 

"The market feels like 1999" 

Despite an approximately 30% retraction in many non-profitable tech names since November, Douglass also warned that the "bubble is yet to burst". 

"Don't forget, these stocks have been up very, very strongly before that retraction," he said. 

"Potentially it's more of a canary in the coal mine. They're just warning us that things that aren't supported by earnings can have massive air pockets if there's a change in sentiment. And we're in a pretty crazy environment at the moment in certain assets." 

For example, there's trillions of dollars in cryptocurrencies and non-profitable tech areas, Douglass said, as well as a "massively" crowded trade within the "economic recovery" story. 

"These (assets) have reacted with a very modest move in sentiment regarding interest rates. There's been nothing dramatic that's happened. You've seen a 30% price fall," he said. 

"If we have a large move in sentiment... if we got an inflationary environment, (and) we had to materially increase interest rates, we could easily see, even from these levels, a 50% plus drop in share prices of some very well known companies around the world. 

The market feels like 1999 in many respects. We've got many companies without any earnings with very high valuations at the moment. And we all not know what happened in 1999."

This could have wider implications for markets, Douglass added, as there are trillions of dollars at stake here. 

"This could be a very dangerous year if you're holding the wrong assets," he said. 

"I think unprofitable technology companies could be a place of real risk. I even think places like cryptocurrencies could be a place of real risk. And I do think economically sensitive companies that have done very well could become very crowded trades in a very short period of time." 

With this in mind, Douglass recommends investors take caution over the coming 12 months. 

Google is a winner, but Facebook has seen Meta days

During the global strategy update, Douglass also revealed that he had maintained the fund's position in Google (Alphabet) but had "meaningfully" trimmed its position in Facebook (now Meta Platforms), despite being bullish on both companies in the near term. 

"The digital advertising industry is experiencing enormous tailwinds, and Alphabet and Facebook are two of the best mousetraps that have ever been invented in business," he said.

Alphabet remains undervalued, Douglass said. Meantime, its economic moat continues to expand and margins are expanding as it continues to grow. 

"It has five incredible growth businesses," he said. 

"First of all, the Google Search business, which may be close to the best business in the world, it's been growing a 24% per annum over the last two years... YouTube is a fabulous business, and it's growing at almost 40% a year at the moment of an average over the last two years. Through its Android business, it's got its Play Store business, and it's been growing at nearly 30% a year over the last two years. And it's Google Cloud business, which is one of the hyperscale cloud platforms in the world... has been doing over 45% a year." 

Meantime, revenues at Meta Platforms are likely to decelerate over the medium term for three key reasons, he said. These include: 

1.  Younger users are more inclined to use TikTok and Snap, instead of Facebook. 
2. The metaverse is an opportunity but also a threat to Facebook, and Douglass isn't entirely convinced that Meta Platforms is going to be the winner in VR and AR (these technologies complement Google instead, he argued.)
3. Operating costs are set to rise 33% next year, while capital expenditure could rise 65%. This would total about US$169 billion dollars, up US$40 billion from the previous year. 

"So we could get to a point in the medium term, where you get a big shift where revenues start coming down at faster rates... but costs keep going up," Douglass said. 

Two new positions: Safran (EPA: SAF) and Amadeus (BME: AMS)

Douglass also revealed that he had recently purchased positions in two travel-related companies, Safran and Amadeus, amid the recent uncertainty for the global recovery. 

"The place to look for investments at any point in time is where there's uncertainty," he said. 

"And clearly in the travel industry, because of what's going on with the virus, there's still obvious uncertainty in the short term about when travel will recover."

Douglass believes there is likely to be a strong travel-related recovery post-COVID, which could particularly benefit Safran as one of the world's leading manufacturers of jet engines for narrow-bodied aircraft. 

"The vast majority (around 65%) of new planes are narrow-bodied planes that have been developed for the commercial airline industry," he said. 

"Safran's developed a new engine called the LEAP engine and it actually has a 72% market share of all new narrow-bodied aircraft in the world from Airbus A320 and the Boeing 737 Max, which is going to deliver a large number of new narrow-bodied edge aircraft over the next five-plus years and this underwrites the earnings of Safran for the next decade."

As soon as these planes start flying again, Safran should get a nice earnings kickback as the maintenance cycle resumes, he added. 

Meantime, Amadeus is an IT firm that provides software for the airline and hotel industry, Douglass explained. 

"When you scan your card or they have to put your bags on a plane, a lot of the IT that tracks all this is done by Amadeus," he said. 

"This is again leveraged to airline bookings and actual passengers boarded. And in the last quarter that they reported, we still have airline bookings and passenger boarders down 40- 50% from 2019 levels." 

Thus, as we see the reopening of travel around the world, we are likely to see "very strong growth in earnings from Amadeus", Douglass said. 

"It's structurally a very attractive industry, so we wouldn't be surprised if we put more money to work in this space," he said. 

"If there's a bit of volatility, we may do something. But we're very strict on what we'll pay. We like buying things when people are uncertain when we're pretty certain on the medium-term outlook."

If you would like to view the complete update click here.

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