Kings Portfolio Newsletter Q3 2020 – No room for pessimists

Economy & Capital Markets

US equity markets moved to new all-time highs and the fastest ever recovery from a bear market as, Central Bank liquidity moved to assets whilst avoiding the huge economic capacity. In a well flagged move the US Federal Reserve Bank now target (excess) average inflation as a policy goal, that had led to sharp declines in the US dollar. In the previous ten years the Reserve Bank already failed the lower bar of MEETING its annual inflation target.

Politicians continue to target headline GDP that increase their power, a different policy goal than increasing their citizens income (or GDP/head and its statistical distribution). Further newborn US citizens are now responsible for $90,000 in government debt as the Treasury borrows from their future.

Productivity of the digital economy is being realised. In service sectors the acceptance of work from home allows, reduced property costs for employers and reduced travel fees and times for employees. For consumption sectors purchasing on-line boost distribution players and robots reduce the need for humans in production process’. However most human animals require social contact and experience that is not acceptable digitally even in the best virtual environments, this will maintain a proportion of the pre-pandemic order.

Performance

In the first three quarters of the year the Kings portfolio returned 6.04% (sharp 1.29) whist the S&P 500 returned 4.09% (0.33) and the ACWI 1.69% (0.21). Winning positions for the third quarter were longs: Freshpet (US fresh dog food) gaining 36%, Sunrise Communications (Swiss telecom subject to takeover) 32%, Penn National Gaming (US casinos) 30%, Avon Rubber (UK personal protection products) 28% and JD.com (Chinese online retail) 26%; and shorts: Husky Energy (Canadian oil and gas) falling 33%.

Development

Artificial Intelligent Deep Learning utilising hardware purchased two years ago is progressing ahead of schedule and providing very promising results.

Monopoly Money

Companies in nascent industries under the guise of lowering cost to the consumer are being allowed insurmountable economies of scale, by buying out their vertical and horizontal competitors. In the end, only these monopoly company owners and employees benefit from industry profits. New competitors now cannot enter to share the industry wealth on a more equitable bases. Whilst in general these monopoly companies have lowered the cost to consumers they have also reduced growth in consumer income compared to monopoly owners and employees.

Lower costs have helped reduce inflation. In Switzerland inflation is not necessary for a successful society and economy. But in an attempt to generate inflation central bank interest rates have been lowered; reducing income of the most venerable who cannot rebuild savings due to their age, if exposed to a downturn in asset prices. Further the availability of central bank credit is restricted to financial institutions, who have passed it on to in general to their large clients benefiting the owners and employees, at the expense of those deserving but not able to access credit.

Potential Solutions (subject to political fine tuning):

  1. The five largest companies in growing industries should not be able to purchase other companies that are in the top twenty companies of any industry.
  2. Central bank real interest rates should be set to a minimum of 2%, except whilst the stock market is less than 15% of it previous all-time high.
  3. Through today’s technology central banks, either directly or though proxy, provide the increased monetary base to all credit-worthy members of society.

Whist increasing interest rates punish marginal borrows it releases and lowers the price of resources for use in more productive methods.

Chart showing growing inequality in NY County, 2010-1018.

Kings Portfolio Newsletter Q2 2020 – “A game of inches”

Economy & Capital Markets

The US Federal Reserve expects to hold short term interest rates at 0.1% for the next three years. At present the ECB’s short term rate is 0%, the BoJ’s -0.1%, the SNB’s -0.75% and PBC’s 3.85%; punishing cautious savers, pensions and those who should not undertake risk, to benefit limited liability structures and those with capital buffers. Although smoothing the business cycles allows certainty in planning, it hinders the adoption of latest productive techniques by maintaining companies with sub-”normal profits”. Further the failure to apply anti-monopoly/trust law has created huge economies of scale for incumbents that crush new entrants. All of which leads to increasing inequality of income. Combined with the relaxation of temporary martial law measures, changing educational standards and susceptibility to social media, a spring of social unrest ensued.

Diminishing global fertility rates combined with communication and IT advances hold inflation in check while the further suppression of pricing pressure from adoption of AI awaits.

The UK left the EU in January 2020 but remains subject to EU law until the final agreement signalled for 31st December 2020 is negotiated. The UK’s persistent net deficit on goods and services trade with the EU reached £66bn in 2018 with additional net contributions to the EU budget of £7.8bn, over time we expect this to moderate. Inflation in the UK may rise as internal supply chains are developed and property price growth may slow from the reduction of immigration. Whilst in the EU we believe that GDP growth will further slow.

A US presidential election is scheduled for November 3rd with candidates appearing in 3 live broadcast debates from September 29th. As in the previous election, polls favour the Democrat candidate. Apart from style the policy differences are: the DNC’s preference for tax, regulation and global elitism whilst; Trump attempts a fair and equal playing field. Neither address better application of existing government/central bank programs for low wealth citizens and small enterprise. Negotiating the 2nd phase of China trade deal awaits the victor.

EU political administration’s similarity to the CCP makes them natural allies.

Performance

The Kings portfolio returned 3% in the first half, with a low in the period of negative 6%. Including realised profits in i) longs: of 112% for Alibaba Health Information and 58% for ZTO Express Cayman, and ii) shorts: Banco Marco falling 56%, Micro Focus International falling 66% and Sasol falling 94%. In the same period the S&P finished the period down 4% falling 32% at its low. The MSCI ACWI, that better represents the universe of our potential positions, finished the period down 8% falling 33% at its low.

Family Office Bulletin – Investing – Earnings Estimates, COVID-19 & V-Shaped Recovery

12 minute introduction to understanding consensus earnings estimates. Their use in valuation models. How they represent a generalisation of the underlying economy. Why the stockmarket may not represent the consensus earnings view. Effect of COVID-19 (coronavirus) on earnings expectations. How they can provide a guide for managing operating business’.

Kings Portfolio Newsletter Q1 2020 – Now That’s What I Call A Quarter

Economy & Capital Markets
The S&P500 fell 35% and the U.S. Federal Reserve Bank cut effected funds rate from 1.59% to 0.25% in 24 trading days. This followed a reversal of Western Governments response to airborne COVID-19 (first globally reported on new years eve), initially failing to impose “cheap” measures pre-boarder, then enforcing delayed internal draconian ones. Government treasuries price rose then moderated, as the size of fiscal expansion further elevated borrowing levels on a diminishing or slowing income tax base. Although an opportunity to move to fiscal surplus and improve savings rates were missed during the previous decade, we maintain a lack of inflation accommodates both monetary and fiscal easing to combat the immediate slowdown in economic growth.


Multiple companies have identified potential vaccines for COVID-19 expected by year end and doctors are already sharing best “non-approved” remedies. Evidence from Japan and Korea support (as the secondary strategy) local authority social distancing orders to protect and bolster health service facilities and internally develop supply for testing, remedial and protective equipment. After which the spreadability can be embraced so non-vulnerable and non-infected citizens are released from quarantine back to normal activities. From mid-April individual economies can stagger start to accelerate through the end of the year. It is likely there will be no significant (5%) variance in 2020 from the death rate in 2019 (2.8m Americans in 2018).


Remodelling supply lines, to reduce exposure to China in favour of its low cost neighbours and home production, is anticipated to accelerate. International travel is expect to have health prescreening enforced similar to terrorism after 9/11, adding to cost and duration. Communication and broadcasting providers are likely beneficiaries. A large number of previously loss making business are not expected to reopen.


In the quarter OPEC and Russia could not agree production limits while Brent crude oil prices fell sixty percent.

As we expressed during the 2008 recession (http://sjc.capital/blog/index.php/2019/08/10/the-cohenplan/), economic disruption takes the form of an absence of liquidity and moral hazard brought about by the inability of commercial financial institutions to distribute funds made available to them by central banks. If central banks are unable to LEND directly to the general economy, governments should provide generous loan facilities underwritten by central banks and administered by the commercial banks, based on tax registration of LOW INCOME individuals and previously PROFITABLE business taxed entities. The moral hazard of bail-out and need for massive fiscal stimulus could then also be avoided. Once the liquidity crisis is over commercial banks should then be forced to adopt these loans.


Performance
Over the last 12 months our net exposure to equities fluctuated around the zero mark due to excessive valuations. As an investing portfolio the minimum holding period for any position is three months, therefore when western governments preparations for the epidemic proved to be “the Emperors New Clothes” we were unable to react, in response we have accelerated development of AI market sentiment tools. During the quarter we had overexposure to the transport sectors and underexposure to energy sectors that balanced out, with a marginal exposure to equities. The net performance of the strategy over the last three months was -3.5% providing a 39 month performance of +32% with 0.8 sharp ratio, compared to the S&P500 performance of -20%, +15% and 0.3 respectively.

Year 2019 in review

• Successes.
– Developed and implemented first deep-learning applications providing a massive improvement in analytical power by leveraging previous years hardware purchases
– Acceleration in pipeline of third party cutting edge quantitative research to implement
– Impressive performance from improved security selection criteria
– Further improved the fundamental and technical criteria for security selection
– Corrected and refined machine learning methods in asset allocation
– Further improved econometric criteria in asset allocation
– Developed new software to access better data sources
– Now accepting client defined portfolio universes (asset allocation, ESG, religious etc.)
– First venture capital investment
• Fails.
– Single digit net return for year (annualised double digit return over three years)
– Poor asset allocation due to not applying correct procedures for machine learning
– Natural language processing sentiment analysis not developed further