Tough sledding

It’s been a pretty brutal first three weeks of the year for asset markets. Markets have seen a strong risk-off phase, with high growth stocks and crypto being slammed. Even big, well established growth stocks like Amazon, Google, Facebook have been hit hard.

Netflix was crunched by over 20% after some weak results (https://abcnews.go.com/Entertainment/wireStory/netflix-stock-plunges-subscriber-growth-worries-deepen-82382917). I’ve never been as big a fan of Netflix as it has less of a competitive moat. That’s why I prefer the likes of Google and Meta (previously Facebook). The valuations on those two stocks are pretty reasonable too, in my opinion.

More broadly, markets have been riled by supply chain disruptions and inflation concerns and the prospect of monetary tightening by the Fed (in America) and more broadly across the world. Losses are not insignificant for markets, for instance the tech-heavy Nasdaq is around 14,400, having been around 16,500 a couple of months ago – more than a 10% correction.

Generally speaking, corrections are the best time to pick up stocks. While I’m currently cash poor, I’d be looking to pay quality stocks that have suffered amid the broader sell-off, which has been relatively widespread.

The carnage has been even worse in crypto, which is a high risk space. 2021 was great for crypto and me personally, but now I’m off to a shocker for 2022. Bitcoin is back to around A$50k, having hit over $90k in late 2021. And it has fared better than many other cryptos.

Without firm yardsticks to price crypto (e.g. price to earnings for shares), it is highly speculative. For that reason, most recommend a relatively small portion of networth in crypto. Put simply, don’t put in more than you could survive losing if it all went to zero. Perhaps some will learn a hard lesson that crypto isn’t free money and a way to accelerate a housing deposit or wealth in general. Like dessert around a meal, it shouldn’t take the place of a healthy meal, but rather be an addition.

Tough sledding in January…

House price gains slow

At the 5 capital city aggregate level in Australia, house prices gains continued to slow in December, with a gain of 0.63%. Melbourne (-0.06%) actually recorded a fall, while Sydney showed weaker gains (0.27%). Other capitals remained on fire, particularly Adelaide (2.56%) and Brisbane including the Gold Coast (2.87%). Canberra (0.92%) and Hobart (1.03%) slowed a bit after some pretty manic gains over the last year.

Much of these machinations have to do with relative affordability and internal migration flows. It’s well known Victoria is seeing significant people outflows at the moment, which likely contributed to the weakness in house prices in December. Queensland is a major beneficiary, and the property market has been on fire there.

As we look ahead in 2022, the outlook is less positive for property. The prospect of tighter financial conditions (and higher interest rates) has caused jitters in financial markets and will flow through to the property market. Moreover, the rate of increase was not sustainable at close to 30% annual gains in some cities. The easy money has likely been made on this property cycle and recent entrants will find it much harder going I predict.

2021 share portfolio recap

It’s that time of year, 31 December.

My personal share portfolio increased by an estimated 21.2%, outperforming the ASX200 (11.5%) and Dow Jones (18.9%). It was another good year for markets with an average of US/ASX index gains of 15.2%. I had eight stocks increase by more than A$1000, 13 positions in noman’s land (between -$1,000 and $1,000) and two losers (more than $1,000 loss – one of them mentioned on my previous post – Beyond Meat).

My portfolio came home with a wet sail in Q4 2021 thanks to my largest holding, Nickel Mines (NIC.ASX), having a strong finish to the year. NIC was a high conviction play I entered into in 2020, I even got my Dad in at 57c (although he sold some of his shares for a modest profit without telling me, not happy).

Again an important point about diversification. Even now, having trimmed some profits recently at $1.39, NIC accounts for more than a quarter of my portfolio (18 stocks, meaning a theoretical mean share of 5.6%). Had I not gone heavily in, I would not have made the returns I have so far. Bet heavily when the odds are in your favour. I didn’t go all in, but my strong return in 2021 owes much to a 29.4% increase in NIC (plus 4c dividend paid out). NIC wasn’t my biggest percentage winner, but my biggest $ winner due to the larger size of the position.

All in all, I’m happy with my portfolio performance this year, building on a good 2020 as well. Looking forward, the themes of supply chains, inflation and CV-19 restrictions are featuring heavily in my thinking. I want to invest in stocks that are not at the mercy of global supply chains, have limited pricing power (ability to pass on higher costs) or could get destroyed if CV-19 restrictions feature heavily in 2022 (think casinos, cruise lines, airlines etc). There’s a high degree of uncertainty out there, meaning some diversification is likely to be beneficial, while we focus on investing in quality businesses at the right prices. A simple formula.

Speak in 2022.

The importance of market research

Earlier this year I had a reasonable sized position in Beyond Meat. Despite that, I’d never actually tried the product, a ‘fake’ burger – a burger without meat, but a similar texture and taste – supposedly. Well, I was out with a couple of mates at a pub in March and saw they had it on the menu. I thought it would be worthwhile testing the product.

Sure enough I did. Initially I wasn’t too wowed either way, it kind of tasted like a traditional beef burger, but something was off. Even without knowing it was a meatless burger I could’ve sensed it wasn’t a beef burger. As I like to say, a substitute is never as good as the real thing.

Things got worse later on what I started getting an upset stomach, something other people have reported when trying their Beyond burgers. All this for a burger that was still not cheap! I also knew many vegan/vegetarian types are not attracted by the fake meat spin. Understandably, if you think sleeping with prostitutes is unethical, would you go out and get a blow-up doll? How big is the target market for meatless meat?

In any case I was prompted to trim my position. I sold a parcel of shares at US$137 and bought into a stock which has moved modestly higher since. Meanwhile, BYND has had a terrible year, currently trading just north of US$67. That sale saved me US$70 a share (more when you consider the share I bought is up by 7%).

As a result, that A$20 burger and unsettled stomach was well worth it. This takes listening to your gut to another level. It also influenced me dumping most my remaining shares quite recently after a bad quarter of sales.

More generally, getting to know the goods/services of companies you invest in is a great idea wherever possible. If you like the end product, more than likely other people will too. And the same in reverse. Who knows, Beyond might get its act together, but I’m happy I cut my position when I did.

Population growth bottoms out

The Australian Bureau of Statistics released population data for the June 2021 quarter. Population increased by 34,000 people to be 46,000 higher than in June 2020. After a negative quarter of population growth in September 2020, the pulse has been steadily improving. This has been driven by a narrowing of negative net overseas migration (NOM). NOM was -2,300 people in the quarter having been -42,700 people in September 2020.

Plans for return to more normal travel appear to have been jeopardised by the new dastardly strain of COVID-19, omicron. A feeling of de ja vu as we enter into 2022…

In net internal migration stakes, Victoria and New South Wales continue to see large exoduses. Victoria unsurprisingly takes the crown in this respect with -18,300 people over the past year. Those remaining residents will be left with a Budget that has been smashed over the past year. The operating deficit is expected to have blown out by around $8 billion to $19.5 billion in 2021-22. Ouch. Expect property rates, taxes and charges to rise strongly in future years as the Government tries to pare back the damage.

To be fair, Victoria isn’t alone in this respect, with lockdowns, business closures and higher government spending causing budget blowouts in other states and territories as well. But particularly strident in its policies, Victoria is the opposite of America’s Texas or Florida.

Housing slows in November

CoreLogic results for November showed that house price gains continued to soften in November after record gains, increasing by 1.1% at the 5 capital city aggregate level. The largest markets of Sydney (0.90%) and Melbourne (0.59%) pulled down growth, while smaller, more affordable markets on the east coast continued to run hard, Brisbane (incl Gold Coast) surged 2.83% for the month, followed by Adelaide 2.48%.

The investor segment of the market has been strong, while owner occupier activity has started to ease – likely reflecting waning fiscal stimulus and perhaps some would be owner occupiers tapping out as prices have spiralled higher. It’s become extremely difficult for first home buyers to enter the detached housing market without parental assistance. Many cities are now roughly $1 million for a house, requiring a $200,000 deposit plus closing costs (difficult without parental help – or some next level savings habits, white rice diet anyone?).

The outlook for interest rates has become more negative from the perspective of house price gains. Our neighbours (NZ) across the ditch have seen their Central Bank raise interest rates, which signals the punchbowl may be taken away here soon – even though Phil Lowe has indicated rates will not rise to 2024. I found that to be a strange statement to make as it’s basically ceding the Reserve Bank’s mandate over the next couple of years – who knows what could happen to economic conditions in the interim?

On the positive side, supply chain issues and high building costs are supporting house prices. The potential for immigration to return en masse is also another factor many will be looking at in their bull thesis.

Until next time.

How bad was CBA’s September quarter?

Commonwealth Bank (CBA), recently had its shares fall sharply after it announced its 1Q22 trading update. This may have come as a surprise for our largest residential lender amid a continued property boom. After hitting record highs over $110, shares are now trading below $98. A handy discount.

CBA has been performing well out of the CV-19 panic and recently completed a $6b off-market share buyback. What gives?

Cash net profit after tax (NPAT) was around $2.2 billion, 20% higher than 1Q21 (largely meaningless given CV-19 related volatility) and 9% lower than 2H21 quarter average (a more meaningful comparison point). Yes, profits fell quite significantly compared to the first half of calendar 2021.

Lending continued to grow at higher than system multiple (1.2 for home lending and 1.5 for business lending), indicating CBA continues to execute relative to peers. Its CET1 ratio of 12.5% remains healthy (this is a measure of capitalisation).

The big hit to CBA came from net interest rate margin compression (NIM). CBA attributed this to home loan price competition and switching to lower margin fixed rate loans, as well as the continued effect of a low interest rate environment.

Operating performance (operating income less expenses) remained solid, flat on H2 2021 ($6,427m). This certainly wasn’t a disastrous report. However, given the strong share price performance, clearly the market wanted more. I recently posted on how I took some profits on CBA over $105. If it were to fall under $90, I’d definitely be interested in adding again to my position. I think positioning into crypto was a good move for CBA so I’ll be watching closely for more weakness.

Property market rolls on in October

According to CoreLogic, the property market had another strong month in October, increasing by 1.4% at the five capital city index level. This was a continued moderation in growth, yet still very strong at circa 20% annualised growth.

The strongest performers were Brisbane (including Gold Coast) at 2.54%, Hobart and Adelaide (both 2.0%) and Canberra (1.9%). Peth was the weakest performer (-0.1%), followed by Darwin (0.4%) and Melbourne (1.0%). Annual growth rates remain remarkable, with many cities increasing by over 20% over the last year.

Historically speaking price increases of these rapidity have often been followed by corrections (as happened in the GFC and again around 2011 after the GFC-related stimulus was pared back). Interest-rate stimulus is now waning and banks are moving to push up fixed rate offerings. This is likely to cool down the market over time, as many property owners will be currently locked in and only feel the effects when they go to refinance their loan in one, two, three years (or whatever the case may be). But the prospect of higher interest rates is likely to side against continued gains at 20%+ per annum.

In addition, house prices have run very hard relative to wage growth. While there have been a lot of headlines around employees receiving healthier payrises (and it’s true), at a macro level wages growth remains pretty weak. Over the year ending June, the wage price index (WPI) rose by a pretty weak 1.7%. However, annual growth in private sector wages has looked to have bottomed out at 1.2% in the September 2020 quarter and had increased to 1.9% growth to June 2021. The next quarter’s release will be out shortly which will be interesting. I’m expecting to see continued growth in wage gains. Anecdotally some professions are throwing money to obtain talent (e.g. lawyers, consultants, accountants/auditors) while blue collar tradies are in high demand as well.

The prospect of interest rate rises is likely to temper the market. Another uncertainty is over overseas migration as travel starts to begin again. If net overseas migration picks up to pre-CV-19 levels (or exceeds it), that will likely boost the housing market, all else equal. Overall, it’s a complex picture, but price gains look likely to continue to moderate.

Let’s talk China

China has thrown commodity markets a curve ball in the second half of 2021.

Prior, red hot demand for commodities from the world’s largest consumer saw iron ore surge to all-time highs well over US$200/ton. Other industrial commodities (nickel, copper, aluminum etc) were similarly robust. Post CV-19 stimulus and a view to massive renewable investment (net zero shift) had many – myself included – leaning to a stronger for longer commodity narrative.

Then came the slowdown. Chinese authorities wanted to lean against excesses in the steel sector. The direction was to cap steel production at 2020 levels. After a record first half of the year, this meant production had to be reigned in in H2 of the year. And it has. In turn, that has meant less demand for inputs such as iron ore and coking coal. Iron ore supply had started to pick up as well (as expected with sky high prices), so more supply has hit faltering demand, leading to a decimation of prices (circa 60% decline).

Authorities have also seemed to have strengthened their resolve to reign in overdevelopment in the property sector. Evergrande is the most notable example, but there are other highly indebted developers running into genuine strife. Many of us are shocked as we’d been used to authorities running to their aid, thinking that they are too big to fail. However, the risk tolerance has seemed to have increased. There could be some pain ahead if weight is put on a transition away from debt-heavy, commodity-intensive growth to more consumer-led growth. All of this is terrible news for big commodity producers like Australia.

Economic growth has slowed in China to roughly 5% in the September quarter, which in China terms, is weak (the previous quarter was around 8% annualised growth). A faltering property sector, combined with energy shortages (related to coal and a push for cleaner energy) has hit growth hard. So far, authorities have been content to take the hit. The question is how long will they allow things to cool down. It’s all well and good to say clean and sustainable economy, but the reality is a major chunk of China’s economy is based on building, and the upstream and downstream industries. Fixed asset investment comprises around 40% of economic activity. Hitting the brakes will inevitably hurt at some point.

The question is when authorities will flinch. Until they do, it’s going to be a painful time for our commodity producers (BHP, RIO, FMG etc). I’ve regretted being overweight commodities this year (particularly iron ore) and it’s killed my returns relative to market. A few big dividend cheques have not outweighed the capital losses. Now overweight, and unsure of the situation in China, I’m reluctant to keep averaging down. Discretion valour something something.

Until next time.

Portfolio management

A challenge of managing your own share portfolio is knowing when to sell holdings.

We have all had the bad experiences of selling a share to watch it skyrocket it after. I can think of multiple examples, we’re talking going up five times plus since selling. My most recent face plant in this respect was selling Tesla in the first half of 2020, figuring amid the CV-19 recession who would be lashing out on expensive EVs. Well Tesla stock is up about eight times since I sold. Ouch.

That’s part of the game. I’ve also sold stocks that have practically gone to zero after I sold them, a major relief. Knowing when to sell is hard. A common approach is not to sell out fully, for example if a stock doubles, sell half of it (covering your initial investment) and let the rest ride. I wish I’d stuck to that with Tesla. Hindsight is 2020. The downside of that is you can end up with a lot of stocks in your portfolio and over time start to approximate the market, thus removing the potential for outperformance. It’s a delicate balancing act.

When looking at your portfolio, you should be confident that your shares will go up over the next 12 months. Otherwise, there’s no real point being in the stock. Likewise, if the best outcome you can see is being roughly stable (maybe with a few % dividend), again you’d be better of redeploying your capital. A thing to keep in mind with selling positions to rebuy is the transaction costs (brokerage on the sell and the new buy) and the taxation implications (if a share is positive, you generally want to hold for 12 months to get the 50% capital gains tax discount in Australia).

Today I freed up some capital from CBA, selling for $105.12. That’s a handsome price, and I did well out of the stock, buying under $60 in 2020 and at $82 in February of this year. Even from February that’s a 28% increase plus dividend (CBA paid out a $2 dividend quite recently). Why sell? I don’t see the same upside from $105. If all goes well, maybe in 12 months we could be at $120. If the property market turns, we could well head back under $100. It’s no longer a strong buy, it’s a hold in my eyes. And there’s other opportunities out there I want to get my teeth into. Opportunities where I could see 50% share price gains in a year as quite possible. So I freed up some capital. I didn’t sell all. CBA is banking royalty in Australia and has a track record of rewarding shareholders. I think it has a place in a portfolio. But from this price, I’m more hoping for gains than expecting, which is a good sign to think about downsizing the position.

And just in case you think I’m full of it with my buy:

With the freed up capital, I’ve got my eye on a few US stocks which I’m currently researching. Until next time.