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Weekly Market Report
Tuesday 28 June 2022
Weak Yen offers an investment opportunity.
Investing in times of inflation.
Global and local indicators.
By Carel La Cock
Inflation in Japan hit 2.5% in April, a level of price increases last seen in 2014 when the government raised the sales tax by 3%. Japan has had a decades-long battle with deflation and news of prices quickening at a rate exceeding the Bank of Japan’s (BoJ) inflation target of 2% was met with cheers from many corners of the economy. The BoJ has kept its ultra-loose monetary policy in place, just as the rest of the Group of Seven (G7) countries embark on aggressive monetary tightening. The result is that an interest rate divergence between Japan and other G7 countries has put the Japanese Yen under pressure. The currency has depreciated by over 20% against the US dollar in the last year marking a 24-year low point and some analysts predict that the Yen could go lower still.
There have been mixed emotions about the depreciating Yen. Conventional wisdom says that a depreciating Yen would benefit exporters, making their products more competitive in the global market. Japan is a major exporter of heavy machinery and vehicles, and the weaker Yen has been a boon for these industries. Prime minister, Fumio Kishida, has made economic security one of the pillars of his economic policy. A weaker Yen will help incentivising the return of production to Japan and reduce its reliance on China. It is hoped that increasing local production would boost the job market and the virtuous cycle that supports stronger economic growth.
However, the counter argument is that the higher prices paid for raw materials imported by manufacturers would offset the gain from higher export sales. On top of that, Japan’s main importer of heavy machinery, China, is going through a slump. Re-shoring production will also exacerbate an already tight labour market that boasts unemployment at a mere 2.5%. There simply are not enough workers. Lastly, a weaker Yen will also cool consumer spending as the cost of living rises due to the soaring cost of food, logistics and energy. The Japanese nation are astute savers and there have been periods in the past where the high savings rates were to the detriment of economic growth.
While the BoJ has not condemned the level of the Yen against the US dollar, it has expressed concern about the rate of decline and in a recent press conference the governor of the BoJ, Haruhiko Kuroda refrained from previous remarks that the weaker Yen was broadly positive for the economy. The coming elections in the upper house will see politicians strike a more sympathetic tone towards the consumer, but it remains to be seen if there is anything to be done about a weaker Yen.
While the Yen remains weak, it poses an opportunity for savvy investors. The chief executive of Nomura, Kentaro Okuda, recently predicted that the weak Yen will kick-off a wave of mergers and acquisitions by foreign buyers. A relative strong dollar and low valuations for Japanese assets have prompted large Asia-focused funds to pivot away from China and focus its gaze an a more liquid and accessible Japan. Warren Buffett invested about $6bn in Japan during the summer of 2020 and has made some handsome returns. In the first six months of investment, Berkshire Hathaway booked gains of $1.4bn. Capital Economics, forecasts that the rotation from growth to value stocks will continue for the foreseeable future and mature Japanese industries are well placed to benefit from these capital flows.
In a recent note to investors, Matt Brett, principal manager of the Baillie Gifford Japan Trust, highlighted by way of example the incredible quality of Japanese companies in which they are invested. The Baillie Gifford Fund, which many of our clients have held for several years, have a stake in Bridgestone, the world’s leading car tyre manufacturer in terms of market share. It is a mature industry, but one that offers incredible value. While the motor industry is going through a period of disruption with new electric vehicle manufacturers such as Tesla and Rivian breaking the mould, the one constant that remains is that cars still need tyres to stay on the road. In fact, it becomes even more important to keep traction as electric engines have increased acceleration and torque. Matt Brett argues that Bridgestone is better placed than most tyre manufacturers to keep up with innovation and new products that will evolve as the car industry takes a new turn. Through the Baillie Gifford Japan Trust, our clients have access to many excellent Japanese companies. At a discount to net asset value of nearly 6.5% it offers an incredible opportunity to invest in quality Japanese mid and small cap firms. Speak to one of our highly qualified investment consultants on how you can invest in quality Japanese firms.
By Gielie Fourie
INTRODUCTION: “Inflation is the most regressive tax of all, yet it is advocated by those who proclaim to be progressive” – Elon Musk. In economics inflation is a progressive increase in the general level of prices. Inflation erodes the purchasing power of money. While high inflation is generally considered harmful, some economists believe that a small amount of inflation can help drive economic growth. The US Federal Reserve targets a 2% inflation rate. Investors should invest in assets that grow at a higher rate than inflation. For example, current inflation in South Africa is 6.5% per year – your investment should grow at 6.5% plus at least 5% to protect you from getting poorer.
SOCIAL SCIENCE RESEARCH NETWORK (SSRN): A 2021 research paper by research house SSRN, “The Best Strategies for Inflationary Times”, looked at historical returns of different US equity sectors when the country’s headline inflation figure moved above 5% over the past 95 years. Its findings revealed that across all sectors only energy stocks showed positive annualised real returns. Energy-linked companies that focus on the exploration and production of oil, gas, and renewable energy sources were the optimal stocks to hedge against inflation, according to the report. The reason these companies benefit from inflationary spikes is that rising commodity prices, including the cost of energy, is what often drives inflation.
SCHRODERS: Research by UK asset managers, Schroders, found that during high periods of inflation, two of the best assets to hold were energy and Real Estate Investment Trusts (REITS). Energy, they found, beat inflation 71% of the time and could offer returns of 9% a year, higher than current levels of inflation, while REITs beat inflation 64% of the time.
WELLS FARGO: Wells Fargo, a US bank, looked at 15 major asset classes and calculated which ones did the best and worst during inflationary periods since 2000. The findings are instructive. It boils down to this: Inflation is bullish for oil. If you want to know what to own during inflation, know one word: Oil. Wells Fargo found the price of oil to jump more than 40% during inflationary periods since 2000. It surely tops the 10% inflation-period gain of U.S. large stocks like the S&P 500. Oil’s inflation-times rise is also more than any other major asset class the bank looked at. Oil’s gain during inflationary periods is also roughly three-times higher than the average 12% rise of all 15 assets Wells Fargo studied. Remarkably, investors have already sniffed this out. The United States Oil Fund (USO), a major ETF that tracks the price of oil, is up 89% in the past 12 months so far. That is a larger jump, too, than any other ETFs tracking the asset classes Wells Fargo analysed. Wells Fargo research shows that the three best asset classes to hold during times of high inflation are Oil, Emerging Market Stocks and Gold. The three worst asset classes to hold are US Large Cap Stocks, Value Stocks and lastly, High Yield Income Stocks.
BANKS: Banks could be another type of stock to buy during times of high inflation, as an unexpected spike in prices introduces the possibility of an interest rate hike by central banks. In 2022, the policy tightening cycle has already started, with central banks around the world, including the BoE, the Fed, and the Swiss National Bank, responding to inflationary pressures by raising interest rates and tapering bond buying programmes. That is good news for banks and lenders, as higher interest rates mean borrowing is more expensive, resulting in higher profits from lending margins. In theory, banks should benefit from an inflationary environment.
BOTTOM LINE: It is noteworthy that Warren Buffett invested in Chevron, Occidental Petroleum and Citigroup this year – two oil companies and one bank. Investing during inflation can be risky. Analysts’ views can be wrong and should not be used as substitutes for your own research. Remember that past performance does not guarantee future returns. This is not investment advice. If you are concerned about investing in these times of high inflation and high interest rates, contact one of our highly qualified consultants.
The Bottom Line: Innovation and the Magic of Compounding
By Carel La Cock
The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.
Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.
After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.
Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.
As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.
Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.
Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.
Spend some time with our team to find out which one of our portfolios is best for you.