July Week 4 - The Pavlovian Dip

Defending Economics;

The Pavlovian Dip;

And an overwhelming number of updates:

#BMY, #SDI, #IGG, #ULVR #FNX, #DUKE & #QTX

Public Service

An article from Anne Pettifor - author of The Case for the Green New Deal 

Quantitative Easing & Cold Turkey and

Bloomberg Odd Lots discussing

Complexity Economics

Before reading, the first one I'd issue the disclaimer first attributed to Henry Ford:

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

As far as Complexity Economics - perhaps I am a little unfair, but seemed like many different ways of saying Economics should use simulations (which they do as far as I know)

To be fair, there are some interesting ideas, but I feel I should make a passionate defense of the consistent attacks on the Gradus & Persona non Grata - Economics & Economists.

Here goes my attempt to challenge those far better than I.

I have no idea if what I am saying is correct to be honest - I just want to get a few things of my chest, probably because I am having to come to terms with the fact that everything I was taught was a lie by fools who didn't realise that decisions have consequences.

When I studied Economics, it had very little to do with money - it was about the allocation of resources and decisions thereon - trade offs.

No economist required optimal allocation - it just so happened that there was one mathematically (using simplifying assumptions) - policy makers were welcome to be as inefficient as they chose - as they demonstrated in the decades immediately prior to the Bond bull market.

As far as simplifying assumptions goes - all economists knew these were not real world assumptions - I am not sure why now people are surprised. Free Markets / Perfect Competition are Paradigms, not real world.

The OddLots podcast talked about no transport costs - I do not recall a single Professor during my BSc Economics suggesting that transport costs should be ignored when deciding where to locate a factory - If they had, I don't think they would have received their PhDs.

Whole branches of economics, for which Nobel prizes were won, were developed to address issues like information asymmetry.

Economic Agents are rational - I was taught this in the context of transience & satiety, not that we are walking calculators.

So if people like something, they prefer more of it. If people like A more than B and B more than C, they like A more than C - I would be hard pressed to find many examples where this is not the case. Diminishing marginal utility/returns is was a major part of the Economics I learned.

These rational agents maximise utility -  

Ordering a high calorie expensive whipped, caramel, frappe, latte blah blah blah woof woof woof over having a coffee at home -

makes perfect sense to this Homo Economicus, assuming blah blah blah woof woof woof has utility.

 

As for selfish capitalist pigs - well Command Economies were a different paradigm in economics. Recent history has demonstrated that being closer to free markets has resulted in better outcomes for more people than being closer to command economies. 

No economist would have said you have to move all your Steel production to China and let local communities rot, unless you felt cheap goods were more useful than rotting communities.

Of course being rational,  Homo Economicus doesn't differentiate between a developed market agent vs one from a developing/emerging market - think that is why we elect people to lead countries - Policy Makers if you will!

Economics is about the allocation of resources and different ways they can be allocated - it is pretty rich of policy makers to blame (albeit wholly predictable) Economics for the policy decisions they took.

It just so happens that money is utilised as a measure - so those "utiles" are expressed in currency terms - if one of the haters wants to come up with some reliable hedonic measure, I am sure a Homo Economicus who can do more than talk can oblige with the necessary Mathematics.

As for the Green New Deal / Magic Money Tree / The Deficit Myth

I haven't read The Deficit Myth - I am not a big fan of fiction, but I struggle to understand how these ideas can work in a world without capital controls - I am still waiting for a reply to my Twitter reply asking about this!

The idea that policy can be used to direct credit in a different way to that of the capitalist system is not new - I believe it is what people called the 50s-70s.

As for Economists told us there would be a big dose of everyone's favourite macroeconomic variable - 

Inflation is an increase in the general level of Prices - unless being adjusted to suit your own purposes - and doesn't bother most Homo Economici.

The worry is when inflation is a result of too much "Money".

If the money stays in the financial system, money chases assets and asset prices increase (property/shares) and is not a productive use - it reduces velocity in the real economy. 

On the other hand, if a company buys a machine to produce more widgets & 2 extra sales people to sell those widgets, who travel and buy more Sausage Rolls for themselves & donuts for their team - all of a sudden, Greggs is also making a little more money.

Due to various reasons (Policy Related), an ex post 100% repaid over 3 years at 3% from a small business wanting to buy equipment is not as good for the Bank as a 100% repaid loan from a Buy To Let mortgage with a 40% deposit.

Of course, if the money is outside the financial system CoVid Response being an instance (where they QE/Asset purchased/PTRO/TLTRO - anything but money printing) in both the real & financial system - and low and behold we have inflation in both parts.

Rather than leaving it to individuals / corporations, we could let policy makers decide how all this gets allocated - to new green boilers for instance.

Last time the UK Govt had a clever idea, they used subsidies to encourage us to buy the diesel Currus non grata (in stead of investing in electric charging infrastructure), but hindsight is an incredible capital allocator!

And if everything in Economics is wrong - So What - It is a Science (that doesn't lend itself to the scientific method). Science learns, adapts and improves with new information, why not Economics.

I have news for scientists from more scientific disciplines:

Medics thought smoking was good for you, until they didn't;

Physicists thought that the Atom was the smallest thing in the world, until they split it & a heap of stuff came out;

Dieticians told us to eat Carbs & Low fat for a healthy diet until Carbs became Cibus non grata;

Epidemiologists told us so much over the last 18 months or so - jury is still out I think (notwithstanding that it too does not lend itself to the scientific method).

Portfolio Review

Quite the recovery on the market this week after Monday, which did feel a bit more than just noise.

It was a busy week for the updates, but similar to the previous week the moves were not necessarily on the ones that reported results.

I would suggest the moves are as reflective of liquidity / small cap risk appetite/ summer hoo haa as much as anything else.

Lessons:

To borrow from miserlyinvestor (How do you do it??) Never Sell GAW!

To be honest, it is a lesson I learned the hard way - which is why I reduced!

Cursory Market/Macro Observations

Well markets fell on Monday & the world was worried about Inflation, Economic Growth, Delta Variant - It was like OMIKRON!

Then - Buy the Pavlovian Dip.

It is dangerous to read too much into FinTwit (given you see what you want to see & then twitter jacks it up on steroids), but I felt that there was some salivation on Monday, that after a down week & follow through on Monday, at last we can put money to work.

Alternatively, all those concerns sighted on Monday, much like everybody's favourite macro variable, are transitory. 

The bond market did seem to do some odd things (and has been the case for a while) and I wish I knew what it was - but bonds rallying (flat over week incidentally), Gold outperforming industrial metals and in the month to date, Utilities & Staples outperforming Financial, Energy & Materials -

I am inclined to think Risk Off phase, but institutions are better prepared this time - I am invariably inclined to think Risk Off.

In other macro/strategy issues I am dealing with, my client is giving me FOMO headaches - I thought 6.5% YTD while being 35-40% cash wasn't terrible, but what do I know. 

My wife's portfolio is funds, a lot of passive, some other stuff and a high % in cash at the moment.

The cash is in part expression of my macro view/market timing and new contributions. 

I was reading the Ruffer report this week - I dare say my macro concerns are pretty well expressed in that letter and they are able to express those views in various ways, whereas I am limited in the instruments I can use.

Also, I trust their judgement over my own.

Should this cash be placed in a vehicle such as this (others of this ilk), held in cash / go index / "safe" fund managers, bearing in mind that the vast majority of these funds will be locked for at least 10 years unless things go a little beyond wrong.

As far as the client issues, I think my wife has a higher risk/loss tolerance than I do and I am not sure how to reconcile that difference.

Transactions

Add FNX 

• Added on what I felt was a reasonably positive trading update, certainly not one that reconciled with the recent share price weakness.
• Given the metrics on this business, I wanted it to be a larger position that it was and based on the full year results & Annual Report, I may add further.
• As for the update;
• Revenue & profit comfortably in line with mgt expectations, TPV up 10% to £233.4m (PY 211.7m), GP up 13% to £11.3m (PY 10m)
• ADJ EBITDA (excludes SBP, IPO) grew by 14% to 8.8m (7.7m PY), strong underlying cashflows & pay dividend in line with policy
• No. Customers up 13% to over 100 active customers (£500 in GP in LTM), 100% retention & 99% repeat revenue, which suggests customers spend more.
• Some impressive statistics in the Charity space - 81% of the number of public donations & 57% of Comic Relief - suggests customers like using SMS feature
• First overseas operator connections established in Austria & one more European territory expected
• Payments, messaging & managed services all grown & robust pipeline of prospects in new year.
• Significant growth across media, gaming & charities & working on product development.
• Confident for 22 and beyond - repeat revenue, current prospects & international (solid foundations, meaningful contribution to growth)
• Given the quality and capital light characteristics of this business, this is great - but there does have a little bit of a too good to be true feel about this - all this growth/expansion with such little CapEx/OpEx increases?
• HOLD - Read the results properly before any further action

Portfolio Risers > 5%

BMY up 11.10%

• A very well received update and I thought it was rather spectacular in the context of the forecasts.
• If it was not for my rule of not doing anything on the day of the announcement, I would have added, in what I understand is called a shakedown.
• In fact, I would have added even earlier if stockopedia didn't put me off by showing me I have a big allocation to consumer cyclicals already!!
• Revenue growth 4 months to 30 June at 28%, continuing momentum on PY. 13m increase from 49.5m to 63.1m - 1.3m from acquisitions
• Digital Resources growth of 41% - summer benefitting Outdoor cooking & some coastal book
• Expect to be in line with market expectations - 193m Revenue & PBT 19m
• Interesting that forecast revenues are 5% increase, they have delivered 28% in T1 & third of forecast when company has 2nd half weighting
• HOLD, could be Add

REAT up 9.28%

• Absolutely no idea, recovering from previous falls.
• One explanation could be this tweet 
• I wasn't aware he had reduced, so maybe the weakness was a function of some that tweet.
• GlassHalfFull - don't know him, think real name is Gordon - comes across a very nice chap on the twitter exchanges/Mello and he does have some pretty spectacular returns.
• Quite frankly, if that is the reason, great an investor as he is, I wish he didn't have such impact on movements (on shares I hold).
• Perhaps, I am taking BOTB too personally but lets just say if I had the power to move a company's share price in my favour, it would be tempting to use it (just for the dopamine!).
• No Action
• General consideration re crowding in this / some watchlist as some are owned by finfluencers - maybe need to consider FinTwit/PIWorld/SCVR as similar to the Simon Thompson effect.
• Especially in the small / micro / illiquid space!

Portfolio Fallers > 5%

IGP down 8.89%, IHC down 8.8%

• IHC seems to have been sustained lower, which I find strange in the context of their most recent update, and am tempted to add, although it is not what I would call cheap.
• IGP, pulling back after a strong run and hideously illiquid - did a pointless RCS - probably a good thing.
• No idea, but probably a continuation of the risk off that I talk about and they are very illiquid.

Updates & Results

Fonix & Bloomsbury provided trading updates this week, both positive as I discuss above.

There were a number of results/updates from my portfolio, as well as a number of other companies which interest me - actually it was all a bit overwhelming!

ULVR 

• I think any number of websites can summarise the results and explain this company better than I can, but the market did not like these results, and I understand this was because of lower margin guidance.
• Reading the reports, as long as the inflation is transitory, it shouldn't be a problem.
• In all this talk about inflation / macro data, I don't think I have mentioned that Producer Prices seem to be going up faster than consumer prices - that is not good for margins.
• Older people than I often talk about inflation and how it is is scary and what it can do to asset prices/savings.
• I think an ultra defensive company taking a 6% hit was a bit of a taste to a bold young buck like myself as to the damage inflation can do.
• The next day, young bucks like myself probably engaged their Pavlovian dip buying.
• I really should read the Berkshire Letters from the 70s period & the partnership letters from earlier - I am sure I emailed something to myself a while back.
• Common sense suggests to me, Consumer Staples is not the worse hiding place during inflation, especially given I find the reports of a £100bn company easier to understand than the report of a £100mn mining company.
• Wonder if my common sense is misplaced confidence in what has for me been a Goldilocks inflation environment?
• Hold.

QTX 

• CEO/Founder leaving, remains Non-Executive. Outside appointment
• New CEO - Good CV - seems a pretty humble start & worked his way up and did well - Andrew Waters talks about having followed for 20 yrs/excelled at every stage
• Lets see how it goes - always a change but encouraged that Andrew retains a sizeable stake and Chairmanship - and more comfortable with reasons for the share sale.
• Warm & genuine congratulations to Andrew Walters - very well deserved and wish you all the very best Sir.
• HOLD

DUKE

• New Royalty partner - buy & build ICT services provider - acquisition financing
• 13.5% royalty, 30 year term - turnover linked subject to collar - follow on financing opportunities
• Intek is only 5 years old, but seems in good space. 
• If taking duration risk (fancy talk for interest rate sensitivity), think this is better way than regular bonds!
• HOLD

SDI

• Revenue up 43% to 35.1m from £24.5m - 19% organic - 2 acquisitions Monmouth & Uniform Engineering
• Adj & Rep Op Profit up 67 & 69% - 7.7 & 5.9m (4.6m & 3.5m)
• Net Debt (after post year end Monmouth earnout) - 1m - good cash generation 11m (Op Cash flow- 3m WC benefit)
• Not paying dividend, look to 1-2 acquistions in current year and can fund existing businesses - Graticules Optics & Monmouth are CapEx areas
• GM maintained, volatility in the businesses - COGS are inreasing but Op Ex below PY - will pass on price rises
• Atik & MPB covid beneficiary - camera order & flow monitoring, of which Atik order has repeated for current year - not expecting thereafter (although there was nothing there to suggest that it can't repeat)
• Further growth in 21/22 including from one off orders - in line with expectations - look to future with confidence. 
• They guided revenues/profits lower in call - will cover from acquisitions
• The results were really strong and seems like the buy and build is coming together - I think demographics support a Buy & Build / acquisition led model so am more comfortable, especially when it is core of strategy.
• I would be interested to know if Monmouth could have purchased Uniform Engineering to secure supply without SDI's support - there being some genuine value add for the acquiree.
• Call was a bit strange - on the whole positive - astute & cautious management team was my impression.
• There were some questions around capital allocation / cash conversion in the call, where answers were wooly, but when describing what they do, it seemed sensible.
• Maybe it is a case of management take it very seriously but hard to express in the context of mapping various businesses into two divisions.
• Given the commentary, I would be disappointed if further shares were issued (unless as part of acquisition bonus)
• HOLD - Valuation up with events and need to see how much one off

IGG

• Another excellent set of results but one that I have more misgivings about, especially in the narrative.
• I am not a big fan of having to read in between the lines - much prefer management to say it how it is, as opposed to figure things out - if companies need appendices to go with what are already pretty long statements, it is not a good sign.
• Revenue up 31% to 850m - £650m last year - included April to June 2020
• 3.1bn in client funds - Active clients up 31% to 313000 (239,600), 135,000 clients onboarded (up35%) - retention in line with historic 
• TOO EARLY TO REACH THAT CONCLUSION I THINK
• PBT 450m vs 300m PY - Op Leverage is good - Profit Margin at 55% (vs 45% PY) - not dissimilar to those generated by HL / AJB
• Lower engagement (RPU/Profit per user) next year, but on a higher base.
• Benefits of acquistion - enhanced presence in largest markets, TT improve IG education and stuff, IG improve SEO - TT international expansion
• Growth guidance upgraded from 3 - 7%, however definition of what they are planning to grow also updated, includes Japan, EM & Prime!
• Significant opportunities, includes TastyTrade - 25-30% growth, TT at higher end of this range.
• Not sure these businesses are that predictable - Perhaps they would have learned by delivering Signifcant Opps 2 years early - but whatever
• Reading the results versus valuation & dividend, I thought - Very cheap, but why are they not increasing the dividend given the increased capital - at least by way of special (or even buyback considering cheapness)
• I learned that:
• Reviewing capital planning framework - peak margin requirement - they did get close to the limits!!!
• may need to conserve due to TT, not to mention I expect they were getting close on higher margin requirements - have reduced risk, although at what customer anger
• An interesting tidbit from the results that we may want to take note off:
• Retail - Revenue per client up 29%, Professional, Revenue per client up 2%
• My View:
• I don't like this obfuscation and figuring out where the numbers are and how they combine. 
• I agree that US needs its own focus as opposed to being another region
• Either that, or the TT acquisition is causing quite the shake up in senior management politics & fiefdoms
• Genuinely torn 
• If they can get to anywhere near those targets in 3 years, it is back the truck given 40% Op Margin & 20%+ returns
• Even without that it would be cheap (on 2018 results, even though much bigger business - less so on 2019 post ESMA impacts) & one of the few ways I can express a long volatility view.
• The reporting is annoying - if you are going to change measures and upgrade guidance, how about you include the information on how they are performing pre and post change in definition - so shareholders can see that the great big important UK business is not flatlining / going into reverse!
• I was expecting a good set of results and expected to add on the back of these results, but less so now
• I wouldn't call it deliberate obfuscation but I'd expect more clarity from such a large company, especially in the space it operates.
• I can't say that this was clear reporting and the changes result in quite unnecessary questions.
• HOLD

And Finally

There were some wild swings in the Bond Market on Tuesday & stock markets were "volatile" (fancy talk for down) on Monday.

Fortunately, the media was too distracted by Jeff Bezos going into space to trouble us with it

I understand some took offence to his comment about Amazon staff & customers helping fund this - I think it was quite gracious. 

I think he played at least a small part in becoming a bizzilionaire. 

And I don't know about others, but I can think of people I know that (unknowingly suggest) that their successes are down to them and their failures down to circumstances.

Now being a cynic, I think it would be easier to make the dessert bloom than move heavy industry to space, but I understand, the Sahara does not have any oil and Salt is far less sought after than it was in ancient times.

Either way, and I appreciate not many of us are Jeff Bezos (or Richard Branson for that matter), but here is a guy who went from:

"I sell books from my garage" to 

"I sell whatever I want from wherever I want, even Space!"

People are awesome - courageous & capable - look at all the scientific discoveries that people have been wrong about with such confidence (risking radio active poisoning in the process)!

I look forward to us fixing the world, getting it wrong, screwing it up & then fixing it again - because that happens to be how we roll.

Lets see how we screw up space before we make it better. 

I look forward to hearing about the next Jeff Bezos and await his company delivering my item before I realised it existed, let alone that I needed it - Amazon Yesterday!

I think the world gets better from here and we are starting from a pretty fantastic place. 

Adieu