Not everyone is cut out for contrarian investing.
Typically, purchasing shares in an index hugging ETF is a simpler option than formulating a distinctive investing strategy that capitalises by going against popular sentiment.
However, if you possess knowledge about market cycles, the performance of underlying businesses and stock valuations, you can make contrarian bets that have the potential for significant returns.
So where might a savvy contrarian be looking for opportunity now? Months of a volatile bear market have investors feeling leery -- especially tech and growth investors.
It’s not an exaggeration to say that tech stocks are unloved. The turnaround in fortunes has been spectacular, in many ways reminiscent of the early 2000’s.
It was impossible to predict in March 2020 how tech companies would fare as the COVID-19 pandemic shut down the global economy. Some tech companies saw immediate negative impacts. Alphabet (NASDAQ: GOOG) and Meta (NASDAQ: META), for example, experienced slowdowns in revenue growth as hard-hit industries such as travel,and hospitality pulled back on advertising.
Other tech companies flourished. Amazon (NASDAQ: AMZN) benefited from surging online sales as shoppers shied away from stores, and Netflix (NASDAQ: NFLX) enjoyed a boom in subscribers as locked down consumers had more time to watch TV. A potent combination of limited options for consumers to spend their money and unprecedented stimulus cash helped many tech companies report record revenue and profits.
But 2022 was the beginning of the end of the pandemic bonanza. Soaring inflation led to central banks around the world to rapidly increase interest rates, putting pressure on consumer spending. Shortages turned into gluts as supply chains improved and pandemic-level demand subsided.
Stock markets tumbled, entering bear market territory. Tech stocks were among the worst performers and most sold off.
With the Fed now in the spotlight for the inverse reasons and the financial system showing cracks (i.e. the Fed has broken something here), the market has now seen it fit to sell anything associated with duration, including treasuries.. The question every investor is asking: will quantitative tightening switch back to easing? Given the inevitability of a US recession an, will this give way to an interest rate hike pause or even cuts in the near future?
Even a pause will impact future valuations of growth stocks, so a contrarian must now consider whether current valuations make enough of an attractive proposition for investing in tech.
Predictions are a fraught business, especially when it comes to markets or their trajectory. After all, how many of us have really seen the most significant drivers in recent times. From the unprecedented pandemic era stimulus to the invasion of Ukraine which really was the precursor to the latest bout of inflation? But we can look to the past to grapple and reason through the noise. History after all in the words of Twain does ‘rhyme’. We begin with the elephant in the room, where to next for the Fed?
Maslow once said “if the only tool you have is a hammer, you tend to see every problem as a nail.” This seems to be particularly apt given the way central banks have operated in the past few years.
Initially, overstimulating during what was a tough and uncertain phase in the global economy (i.e. pandemic), then reversing course at a rapid and unprecedented rate in order to tackle inflation. These moves have been brash, with some arguing the Fed didn’t appreciatte risks of collateral damage or damage to the financial system.
While it is unlikely that we have the same level of systemic risks that resulted in the financial crisis of 07-08, we are undoubtedly in for a rather bumpy ride. Money supply is now in decline and the speed, as well as scale of rate rises, is the fastest in history (since at least the time of the creation of the Federal Reserve). All this has meant that markets that had been accustomed to a unipolar world of long duration and low inflation are finding themselves at a crossroads and with the prospect of unravelling the trade.
Cashflows are king for anything associated with growth. Oftentimes the selling has been indiscriminate to the fundamentals of the underlying businesses or the longer term value propositions which in many ways have not changed. Take for example, the growth-heavy Nasdaq down 31% from peak to trough to December 2022 while Cathy Woods ARKK (the poster child for pandemic era investing excess) comes to the stellar -80% over the same time frame.
But the story doesn’t stop there, the index tells a whole different story if one were to exclude the so-called megacaps (i.e. FAANGs & Tesla) which to this day remain the largest recipients of inflows given certain perversities associated with passive allocations. The S&P 500 having been incessantly negative since 2015 (see chart below).
The market seems to be following a rule of thumb almost based on effectively just doing the opposite trade that was taken the past 5 years (and doing so indiscriminately), essentially throwing out the baby with the bathwater.
One must remember that many of the secular thematics that were so prominent still remain in play. The transition towards renewables is still in play, in fact one offshoot of higher energy prices (at least till recent trading patterns) was that solar and other renewables utilities were net beneficiaries seeing their margins expand significantly through the entire period.
India’s uptake of EV’s over the past 3-years where the growth remains on track for the government's 30% target by 2030. Local manufacturers including TATA and Mahindra creating JV’s with BYD and Kia. China on the other hand continues its relentless growth with 37% of new vehicle sales being EV’s. Yet you wouldn’t think this to be the case just looking at the results of the Kensho Transportation Index which returned close to -27.8% for the 12-month period. And, if one were to take out the likes of Tesla (NASDAQ: TSLA) the returns would be even more abysmal.
Take another example of cyber which ironically played an especially prominent role in the Russian invasion of Ukraine and made headlines with the China spy balloon, the Global Kensho Cyber Security Index returning a stellar -18.7%. Many of the underlying companies should be net beneficiaries from policy intervention (these are 38 of the largest companies in the space located in Canada, Israel and the US). With the Biden administration seeking an additional US$24 Billion in FY2024 alone and DoD making increased requests for additional funding, we see significant catalysts for the space in the coming years.
Let'sget back to basics, a price of a security is composed of two things:
- expectations of the future; and
- current fundamentals.
In many ways the best time to invest in growth stories including the likes of Apple or Amazon was following the tech-wreck of ‘00 & 01’ but why should this be the case in the first place? The usual rationalisation is that the names became steeply undervalued, but that's not the entirety of the story, for they were undervalued with the benefit of hindsight i.e. expectation of growth.
Ask yourself the question, could you have really mapped out Apple's fortunes from close to bankruptcy in the mid-90’s and the launch of runaway products such as the iPod which made the company?
Or Amazon’s evolution from essentially a bookseller to the behemoth today?
Clearly, this is more art than science but there were some indicators. Looking at the present and trying to extrapolate the future from it can be a funny business. If you could see the story play out, there is really no reason to have a portfolio in the first place, the most rational thing to do is to buy Apple or Amazon and be done with it. Given that we cannot, the best thing is to have a well diversified portfolio.
Let's look at the steps one could’ve taken. Starting with the knowns. The internet was a game changer, the rise of e-commerce was a given, telecommunications was undergoing rapid change this could be extrapolated purely from fundamentals of the sector. So with that, we know the space in which to look.
We then move on to the businesses that operate in the space. Here we have a little less certainty, which ones are going to be the winners and which the losers? At the time one would’ve assumed that Nokia would dominate the phone market or E-bay or any number of e-commerce sites would’ve been up for grabs. The easiest way then is to create some more clarity. From a purely fundamental perspective (this is where metrics such as cashflows and margins come into the equation), we would thus buy the known quantities but with an exception, the small allocations to the less known. Thus an allocation to the growth in e-commerce could easily have led one to buy the likes of Amazon with some allocation to say eBay.
As one develops more certainty one can then look to increase the gradual weighting. Even an equal weighting here would’ve still 100x the money. Similarly, an equal weighting to Nokia and Apple would’ve still done similarly in spite of the former's decline. So there is the second step.
Consider this a framework:
Step 1 - sell-offs or rapid declines should be seen as blessings in disguise for they often have the advantage of having the secular growth stories underlying them to be intact (only expectations or sentiment has changed).
Step 2 - is to look at the whole ecosystem with an allocation to the known quantities but with the caveat of diversifying into unknown or potential black swans (to take the words of Taleb). From there we move on to the next and perhaps the most emotionally challenging step.
Step 3- hold onto the winners as the certainty increases.
In our view, portfolios should be increasingly concentrated as one moves through phases (i.e. adding to winners). This will happen naturally when particular investments have outsized returns. Consider the impact of having had just 1% of your portfolio was in Amazon in 2001: the share price has grown over 10,000% since then and would likely take up a major large portion of your book.
The fact of the matter is this, finding an Amazon is extremely hard. Placing contrarian investments in times like these is tough - if it wasn’t, the herd would be doing it. Amazon is a great story, but if you had bought Microsoft (NASDAQ: MSFT) in 2001 it would’ve taken you close to 14 years to be in the money.
The future is uncertain: sentiment could turn for the worse as a recession in the US becomes clear. Where there is certainty is that bear markets do not last forever. s the saying goes, markets are voting machines in the short run but weighing machines in the long run.
Sentiment will be transitory (though we are probably turned off by that particular word). Duration will be in the vogue at some point, but we cannot predict when nor for how long. What we can confidently say is that when sentiment gets worse in a short period of time, take a contrarian stand has repeatedly shown winning results in markets over a longer time horizon.
At the moment, we remain sceptical that the government will completely abandon the idea of a "government put." Despite concerns about moral hazard, we don't believe that policymakers are willing to risk a hard recession or financial instability, especially in the lead-up to an election cycle. Furthermore, the trends that emerged during the COVID-19 pandemic, such as the energy transition, cyber security, and policy intervention, are unlikely to reverse anytime soon.
However, we must acknowledge that inflation poses a significant risk to long-term investments. It may persist longer than expected, but we're confident that with a few heuristic adjustments, we can navigate this challenge as we did during the Clinton era.
We can only conclude that the risk-reward is slowly getting more attractive by the day. To quote one of our favourite super investors, Bill Miller:
“Sometimes growth is cheap and value expensive. . . The question is not growth or value, but where is the best value ... “
