March saw a substantial rotation from growth stocks to value stocks as positive vaccine news flowed in the US and UK. The MSCI Growth Index recorded a return of 0.86% vs the value index at 4.8% ,which brings the YTD returns to 10.9% vs 0.3% for the growth index. Within this there were particular savage reactions in software and e-commerce stocks that had performed well last year. We felt this was a good buying opportunity for a number of our stocks where the outlook hasn’t changed.

Unfortunately the pandemic is likely to create further inequality between developed nations and emerging nations that don’t have the public health system to adequately contain the virus. We are seeing this in India which now has more than 100,000 cases a day (which is almost surely significantly understated due to low testing rates) vs the UK below 3,000. A massive turnaround since the start of this year when India banned all travellers from the UK entering India!

Many recovery stocks are now trading at levels much higher than where they were pre-Covid, however earnings estimates don’t share that same outlook as some of the demand may be slow to return; it took airlines around six years to recover capacity following the 9/11 terrorist attacks. There is also a lot of capacity that has been taken out of the airline sector. For example the market capitalisation of Ryanair, a low-cost carrier based in Ireland, is valued at €19 billion vs €17 billion pre-Covid, and EBITDA for FY22 is expected to be €1 billion vs pre-Covid of ~€2.5 billion.

I don’t like pontification on macro given the inherent difficulties in making correct forecasts, especially in the short-term. But this time I will break from habit and give some more longer-term thematic thoughts which will most likely be wrong!

It is difficult to know where interest rates are headed in the short-term, however in the long-term there are secular forces at play that could depress inflation and keep interest rates low, including ageing demographics and technological change. It is difficult to assess the pace of technological change and the impact this is having on productivity compared to the past. What we do know is many developed world economies are ageing, and the average propensity to consume is lower once you move past middle age.

We have seen in the past 25 years a structural decline in the velocity of the money. Velocity of money is a measurement of the rate at which money is exchanged in an economy. Therefore, to keep the economy at its desired 2-3% level of nominal growth requires an expanding monetary base to offset the diminishing propensity to spend.

The Covid-19 crisis caused an extreme fall in the velocity of money. More people were saving or investing because of the lockdowns, rather than spending, which is deflationary. To offset the economy falling into a deep recession, an exorbitant amount of monetary stimulus was undertaken. This has created asset bubbles, but not inflation, and heightened inequality between asset owners and non-asset owners. Wealthier people also spend a lower proportion of their wealth which further depresses the overall velocity of money. The fall in the velocity of money also aligns with a fall in the population growth rates in the US since 1992, as well as an increasingly ageing population.

Japan is an even more extreme example of this with the population number actually falling rather than just the growth rate falling, which has resulted in 10-year interest rates that are negative.

Unless there is a material change to population growth rates or increased spending per capita, which is difficult to envisage with an ageing population and inequality of wealth, there is unlikely to be sustained demand pull inflation. Therefore, it will be difficult to maintain a nominal growth similar to the past of 2-5%. To achieve even the lower end of these growth forecasts, the monetary base will need to keep expanding and interest rates will need to stay low. The supply of savings will outweigh the demand for investment therefore depressing interest rates.

Investors are concerned about inflation, but demand-pull inflation, which we have likely seen, is positive as it highlights an improving economy and stronger company earnings. However, if we see cost-push inflation from disrupted supply chains etc, then that is a more worrying situation for equities. Inflation increasing at the same time that economic growth may be stuttering could lead to a period of stagflation. Hopefully a period of cost-push inflation would only be temporary before supply chains revert to normal. However, there is a risk that the actions intended to lower inflation may exacerbate unemployment, leading to a worsening scenario.

Overall, I believe it will be difficult to produce the levels of nominal economic growth that we have been accustom to over the past 50 years and nominal GDP growth will trend towards the lower end of a 2-5% range, given the deteriorating demographics. In this environment, companies that can show above-trend growth will have an increasingly premium valuation, and this is why we continue to favour structural growth companies and view equities as the most favourable asset class.

Two other interesting snippets during the month were Buffett issuing bonds of $1.5B in JPY, taking advantage of the low rates on offer. The coupon was only 0.437% and he has used some of that cash to invest in a group of Japanese trading houses, including Mitsubishi, Itochu, Sumitomo Corp etc which he first invested in last year. These companies typically have earnings yield of ~10% which provides a large spread over his cost of financing the acquisitions. This also shows the valuation discrepancy between equities and bonds and is a shrewd move by Buffett to take on long-term non-recourse debt to invest in seemingly undervalued equities.

The other interesting point was Charlie Munger buying Alibaba for the Daily Journal Corporation which he runs. Alibaba is one of five stocks in Daily Journal’s portfolio and is its third-biggest position after Bank of America and Wells Fargo. The holding made up 19% of its total portfolio, which
contains only five stocks.

This is a rare foray into technology investments for Munger and also into China. However, it shows the mental agility of the 97-year-old but maybe, more importantly, how he is positive toward China. He has made comments in the past that China has “behaved very shrewdly” in managing its economy, which has performed better than the US. He was quoted as saying that the momentum will probably continue.

I am equally bullish on China as I believe they have taken the Lee Kuan Yew playbook from Singapore and are applying it on a large scale basis to reassert their dominance as the world’s foremost economic superpower, the position they held for most of the two millennia until the 19th century.

Once again, thank you for entrusting your capital with us.

Information is current as at 31 March 2021. Pie Funds Management Limited is the manager of the funds in the Pie Funds Management Scheme. Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Pie Funds Management Scheme investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a guarantee of future returns. Returns can be negative as well as positive and returns over different periods may vary.