IT'S TOUGH! Insights on investor sentiment
- Toughest markets investors have “ever seen”
- Market architecture changes
- Investment themes
(1) Toughest market investors have “ever seen”… Investors with >20yr industry experience spoke about YTD being the toughest market environment ever seen. We’re in the longest bull market ever which on one hand is great but on the other hand is starting to make things confusing. Normal bull market rules aren’t working and inconsistencies make it even harder to invest now vs. even a downturn. Text book theories would have said to go long interest rates (banks) and cyclicality at the start of the year but that would've been painful. Trade wars and political uncertainty trigger investors to seek defensive yield but that trade is tougher. Traditional plays like telco and food retail are becoming less investible... I think Insurance will emerge as the hot new defensive sector.
(2) You hear more talk of market architecture changes…. The influence of algos is more prominent YTD than ever before. Perhaps it’s a function of lack of conviction, leaving fundamental money which lifts the influence of algorithms. People talk about higher leakage on trades than ever before which is increasingly painful in a declining margin world. Trend following algos have put some stocks in pure freefall. Of course the first leg down was fundamentally driven but it then goes further and further where valuations get ridiculous. Investors can’t remember the last time when share price reaction to news was so aggressive. Investors with a value tilt have had a tough few years but this year has exacerbated the pain.
(3) Investment themes….
- Insurance: Investors are still wary of cyclicality and companies exposed to discretionary capex. Predictable FCFy generation is in vogue and I see increasing interest in Insurance. It offers a reliable FCF stream enjoying a healthier mix of fee based vs. spread based businesses with growth fantasy of capturing more of the customers’ wallet and re-risking. Insurance also offers a route to play rising interest rates vs. banks who even with higher net interest margins, increasingly feel like utilities in a tough regulatory environment. Klaas Knot, President of the Dutch National Bank is putting pressure on Dutch banks to lower their double digit return on equity targets: “you can only realise a high ROE by taking significant risks”. Talk of high single digit ROE’s, makes me think of the regulated utilities which at least enjoy concession agreement visibility of >10years. It’s interesting to see the arbitrage between Basel IV and Solvency II (take e.g. NL where >50% of mortgage lending is now non bank). Unlike with banks, regulation on Insurance companies is still country specific and even there you see differences in company’s models. Hence if you do the homework, there are exciting opportunities. We see local examples in our coverage.
- Healthcare: We see more incomings regarding our European Life Sciences coverage. The valuation gap between European and US listed life sciences remains significant and industry players are increasingly looking to monetise this. Recently 2 European companies did a US IPO which resulted in share price increases of 30-40% only 3 months post their US listing. Our European Life sciences favorites list performed +68% in 2017 and +30% YTD. We renewed our favorites last week and the current list offers an average of >50% upside, containing bottom up stories which we believe are off the radar screens of investors.
- Idiosyncratic themes such as Self Storage are appreciated. UK listed self-storage companies have shown 15% earnings CAGR. It was once thought to be a tracker on housing transactions but transactions are -45% post Brexit yet earnings growth has been stellar. The market is only starting to appreciate the structural growth drivers here. The under-penetration of Continental Europe vs UK and US is startling (US offers c.6sq ft/capita of space, UK at c.0.6x and Europe at c.0.2x). It gets more interesting when you look country-specific. For example in Germany there are only 2.5 storage facilities out there per million population. In the UK that number is 22 and in Denmark it’s closer to 12. Alongside this, it’s an attractive business model as capex is typically 2-3% of revs vs. c.10% for Resi, hence you can see companies converting up to 90% of net income into FCF.
- Similarly, idiosyncratic stock specific stories are in high demand. One stock in our coverage pops up as a classic transition year story where over 2018, EBITDA will 2x, FCF will 3x and we should see a conversion of 150% of net income into FCF. The stock will likely re-appear on investor screens after having been un-investible, therefore unknown for so many years. Another example is a stock which has sold off 60% over the last 5 months. Of course there’s been cyclical headwind but it’s got to the point where almost 1/3 of the mkt cap is cash despite showing industry leading margins and benefiting from a significant moat around its business. At a double digit FCF yield, investors do start looking.
This article was originally posted on LinkedIn.