Navigating the narrow global equity market

0:00Welcome to the Denker Capital Podcast, where our highly experienced team of in-depth thinkers and other experts share their insights on a range of investment-related topics. In this podcast, we have conversations about developments in South African and global markets and what these may mean for investors. We analyze specific stocks and sectors and explore general themes relating to the fundamental principles that underpin sound investment decisions in an ever-changing world.

0:34It's June 2023, and today, Yacouba's worst days and Nigel Barnes will be discussing the performance of global markets for the year to date. They'll explore the impact of tech stocks and the AI frenzy and factors that have contributed to the performance of the Denker Global Equity Fund and the Denker Sky Global Equity Feeder Fund year to date. They'll also delve into our investment approach and some stock ideas and shed some light on the challenges and opportunities that lie ahead. Hello, everyone, and welcome, Yacouba. Nice to see you. Thanks for joining me. I never say

1:09this as well. Welcome, Kaylin, my wonderful producer, who is as normal standing here with the mic and giving us, you know, directions and bits and pieces. But anyway, Yacouba. Good morning, Nigel. Morning. Let's talk global. Global markets 2023. How have things been going? Nigel, 2023 has started off quite well for global markets, although it's been a very narrow market. Been a few big winners and not all stocks have participated in a rally that we've seen so far

1:45this year. Just unpack that a little bit in terms of the narrowness of the market for me. So the top 10 stocks in the US has basically driven all the positive performance for the year. So if you exclude the top 10 stocks, the market has been pretty much flat. Okay. Okay. And those top 10, I believe it's the main large tech companies. It's predominantly the tech stocks. So it would be Microsoft, NVIDIA, Google, Amazon, the likes.

2:18Okay. And I'll take those off the table, pretty much flat markets. Yes, that's right. Okay. I mean, that must throw up some challenges for you, but let's get to that a little bit later. Just to remind the listeners, Miyakobos, which funds do you run or do you manage for Denka Capital? Just to remind us of those, it's the Denka Global Equity Fund and the Denka Global Feeder Fund. So you've got a dollar-based fund and a RAN-based fund. That's right, yes.

2:49And performance so far this year? So the Denka Global Equity Fund has given us 7.8% so far this year in dollars. Okay. That's the A class. Okay. Yes. And then the Denka Sky Global Equity Feeder Fund has given 26% in RANs and that would be the A1 class. Okay. Excellent. 26% in RANs. So based on the new 45% limits allowable for offshore investing, then that would be the fund that people would focus upon.

3:22So that's great. I mean, one of the few global equity feeder funds out there in the market. Okay. Fantastic. Why, in terms of your approach, why those numbers? What have you been doing? Maybe give us a couple of specific stock ideas, things you've been buying, things you've been avoiding. Maybe start with your approach. Nigel, in terms of our approach, our listeners will be aware we follow their fundamental approach to investing.

3:52We make sure that we invest in companies that over time can grow share of their wealth by earning returns on invested capital that exceeds their weighted average cost of capital. And in where the management teams have a track record of good capital allocation and are aligned with us as investors. So, and in third, the third pillar of our approach is valuation. So, we make sure that we remain very disciplined on valuation.

4:22So, last year, this time, I think we also had a bit of a talk and we spoke about some of these semiconductor stocks where they've been sold down due to the market's concern about a recession. Sure. And that was an area of the market where we saw some value, where we just felt that these are very decent companies with a very strong long-term outlook, but where the market has become too pessimistic in the short term about possible recession.

4:54Sure. So, both semiconductor stocks have done quite well for us so far this year. Obviously, the AI frenzy has contributed to that, and we would be very cautious about the whole AI frenzy at the moment, but there are stocks that are very decent companies with good products, good business models that will benefit in the long term from the global need for semiconductor chips. So, yeah, that would be one area that has done well for us and our approach has worked well.

5:28Why would you be cautious about the AI development and frenzy as you use it? Just give us your feedback. Nigel, the difficulty with the technology sector and technology companies is just the rate of disruption. And you can see it now again with Microsoft coming with OpenAI and the risk that poses to Alphabet and Google's business model and their whole search business model. Two years ago, you would have thought that Google's moat is almost impenetrable.

6:04And here comes a new technology that just disrupts it. And so, the same applies for today's winner. So, apparently, the market is saying in the video it's going to be a big winner. The stock is up almost 160% this year. It trades at a PE multiple of 45 times. So, it's extremely optimistic. And, yes, I'm sure the company will do well and the new chip that they have is very well positioned for AI.

6:35But, you know, Denker, we just believe, you know, if you pay that type of valuation for a company, you better be very sure that that graph does come through and that there's no disappointment. And we saw that in 2022 with a lot of these growth tech stocks pulling back 30% to 40%. And that could easily happen again. I think it's very important to remember that we're also still in a period of quantitative tightening

7:06and liquidity is getting taken out of the system. And that means that you can see extreme volatility in the coming months or years as the Fed progresses on this quantitative tightening path. You just don't know how things are going to play out. So, we have to be very cautious about paying 45 times for any company. Sure, sure. Okay. Moving away from tech, what other areas have you been positive about and have contributed positively to the portfolio?

7:42Yeah, Nigel, I agree. Maybe it's a good idea to step away from tech because that's been the big driving force this year so far. But if we just take a bit of a longer-term view of the last 12 months,

7:55interesting companies for us that have done well is HEA Healthcare, which is the largest private hospital group in the U.S. We've dominant positions in Texas and Florida. We've obviously benefited from a nice demographic tailwind with people semigrating to Florida and Texas. Sure. And obviously, people getting older and needing more healthcare. A very well-run business, very reasonable valuation, ticks all the boxes for us.

8:27Okay. That's been up, I think, about 27% over the last 12 months. Okay. Then Ferguson, PLC is a very interesting company. It was listed in the U.K. for many years and only recently moved its listing to the U.S., where they've actually got most of their business. It's a plumbing supplies business, distributor, plumbing, heating and ventilation, aircon equipment.

8:57A very well-run distribution company benefiting from infrastructure investment in the U.S. OMS getting older, needing new plumbing. That company is up, or that stock price is up 24% over the last year. And then Boeing, interesting one, up almost 56% over the last year. Everybody knows the Boeing story. One where you have to be very patient due to the turmoil that's been through,

9:29first of the 737 MAX and then COVID. Yeah. And they seem to be coming through all the crises. The 787 MAX is up and flying again. Yeah. Global travel is recovering quite rapidly. We're almost at pre-COVID levels. The East is not quite there yet, but the U.S. has recovered. And there's a massive demand for airplanes. Okay.

9:59So their order book is looking good? The order book is looking very good. The biggest challenge for them is just the supply chain and getting the supply chain up and running again and being able to manufacture enough plans to fulfill the demand. Okay. They've also got a challenge on the balance sheet side. So as they are delivering stock that's sitting on their inventory, we expect the cash flow to improve, and that should lead to a big improvement in the balance sheet.

10:32Okay. Great. All right. Thanks for that. And that's consistent with your approach of very much a sort of bottom-up thinking. You know, just finishing off, Ekovis, in terms of the rest of this year, you know, what do you expect? Anything, you know, keeping you awake at night? How do you feel about, you know, if we see a pause in the Fed raising rates? What are the impacts going to be? Any thoughts? Yeah. Nigel, what's keeping me up at night is quantitative tight.

11:02We alluded to it previously in the conversation. It's just that we've never been through a period like this. We've never seen a Fed with a $9 trillion balance sheet. We're trying to wind that down to $8 trillion. It means there's almost $100 billion of U.S. treasuries that they are allowing to roll off every month. It's a massive withdrawal of liquidity from the system. So I just think there's a lot of unintended consequences that can come from that.

11:35And so for me, from a risk management point of view, I think it's important for us to look at companies where the balance sheets are strong. We just mentioned Boeing. That's one of the examples where the balance sheet is stretched and we have to have a very strong view on which direction things are going. But generally, the portfolio is invested in companies where the balance sheets are very strong, where we should be able to withstand a liquidity crunch. This environment obviously also comes with a lot of opportunities. One of them would be the regional banking sector in the U.S.

12:08We've seen a big sell-off so far this year. And luckily, we can leverage off a world-class financial team for our financial stocks. So we think there are opportunities in the regional banking sector. I think the baby has been thrown out of the bathwater. And there are strong regional banks that are totally mispriced at the moment. And, yeah, I think that would be, for me, the main risk is liquidity and just to be aware of what that could do to your companies and also the portfolio overall.

12:47Yeah. Okay. Because thank you. It's been great to catch up. Everything driven by tech this year and the AI comments and, as you say, use the word frenzy, probably a good term in the market. But some great performance, especially from the feeder fund up 26% this year, the A1 class in rands, which hopefully will appeal to a few listeners. And, yeah, nice portfolio. How many stocks in the portfolio at the moment? Around 55. Okay, so concentrated portfolio, 55 companies, strong balance sheets, able to sustain, you know, any sort of liquidity crunch that might come.

13:26And then, you know, you're rifle shooting some opportunities there in areas like regional banking, et cetera. So, Jukobis, thank you for your time. Nice to see you. And, yeah, keep it going. We'll chat later in the year. Thank you, Nigel. Look forward to it. Cheers for now. Thank you. Cheers.

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