It was apt that last month started on April the 1st, April Fool’s Day, because that’s how the market seems to have performed throughout the month.

Heading into the month, we had just gone through that tumultuous period where Covid first erupted and the markets really swooned, and if you were to bet on it, going into April you would have thought that markets were going to be very weak. As it turned out, April was extremely strong with the S&P 500 posting its strongest month since 1987 which was certainly quite surprising.

In markets like this, as always, it’s important to be diversified and not take single bets that could make or break a portfolio. We’re looking to hold:

  • highly cash flow generative businesses
  • that are growing
  • have fortress-like balance sheets
  • and have very strong management teams.

There are a couple of reasons why companies like this would outperform.

  1. In down markets you do not want debt, and so that obviously helps;
  2. People are willing to pay for growth, so having growth companies makes a difference.

However, if you pay too much the growth is all capitalized in the price, so focusing on valuation is also very important. Being diversified across these types of businesses has proven to work for the long term.

Now to the future.

We’re very concerned with the way markets have reacted, and a lot of our stocks are already reaching prices where we have decided it’s time to sell some of them. The market seems to be betting on a V-shaped recovery, which means that after dropping precipitously (as in the left line of the ‘V’), economies are going to rebound very quickly. We think on the basis of probabilities, that’s very unlikely to be the case. We think this market’s taking the elevator down, and we’re going to have to take the stairs back up.

There’s a lot of damage in the broader economy and what we are seeing in economic data just does not correspond with what’s happening to the markets.

We’ve got worldwide unemployment that is certainly heading to record rates. In fact, the unemployment numbers don’t tell the whole story because governments are paying companies (effectively) not to fire people.

When you offer small businesses loans, and say you don’t have to repay the loans if you don’t let go of your staff, of course small businesses hold on to their staff.

They’ve got to hold on to them till the second half of this year and then, despite the fact that we are seeing eye-watering unemployment numbers, numbers that are going above 10% in the US, and are going to be all-time records, we still think there could be worse to come.

We’ve seen GDP drop by over 4% in the US, that’s just the start of things to come. Most economic experts are predicting GDP will decline by over 30% in the second quarter. These are just astronomical numbers we have not seen certainly in most people’s lifetime. These are numbers that are often worse than the Great Depression, so they matter. To think that the economy can rebound very quickly from that is very naive in our opinion.

Now the market knows a lot of this, and the market’s effectively saying “yes, we get it, the second quarter is going to be bad, but we expect the recovery to happen in the third quarter, and we think that’s been priced into the stocks.”

That begs the question, what happens if there isn’t a recovery in the third quarter?

What happens if that’s the quarter when these companies that couldn’t let go of staff previously, now do so? What happens if that’s the quarter where credit card companies, and mortgage lending companies, who have allowed their borrower’s some forbearance not to repay, decide that comes to an end? What happens if there’s a second wave in the virus?

These are all realistic possibilities investors have to keep in mind, and we’ve certainly got them in mind.

We do NOT want to be doom and gloom, because the world will get through this, and there are some fantastic businesses out there that we really do want to own, but we will only buy them at the right price, and we’re waiting for them.

At the moment, we’re about 88% invested. We like being invested. We are paid to be invested. However, we are letting go of some of the more expensive stocks that have rebounded violently since the turnaround started towards the end of March, and we’re now looking towards the third phase of this virus where the markets likely drop again, and we will be there to scoop up the investments to try and make continued gains for our investors.

We hope May is similar to April in the significance of the symbolism of its first day. We all know April Fool’s Day. May Day is an ancient festival of Spring in many European cultures where people go out and celebrate, and we hope that there is a responsible pullback in the amount of time people have to stay locked up in their homes, and there can also be time to celebrate.

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Michael Giles

Cheers Steven Your piece persuaded me to visit the Pengana Group website. Many of the macro risks that exist today most certainly existed a few months ago. This includes factors such as ongoing trade tensions and broader geopolitical risks now amplified by the pandemic. The strategy I often come back to in more volatile times is the genuine focus on quality and value. Conviction in one’s thesis and valuation can be tested when the broader market crashes then soars. However, a strong understanding of the given business, its prospects, and true value range, provide reinforcement in difficult times. Well done to Pengana for continuing to renew your put options in the face of a rising market that was obviously overvalued. I see the firm made tenfold gains on this 'insurance' strategy. Do Pengana also 'short sell' stocks it feels are way overpriced? Mike.