The Greatest Challenge for Investors

April 25, 2020

The current market is certainly challenging the resolve of many investors.  This week we have been deploying capital slowly and cautiously as we see mispriced opportunities.  I mentioned that in the early 50 cent levels I had been topping up my GC1 holdings, with the shares still trading at a discount to NTA, they have firmed to 63.5 cents at the last closing price.  That's a 27% return in a few weeks on a company that while I am biased, it was oversold and outstandingly cheap.  It's still cheap if you use the last reported NTA figures we published.

 

The chart below from Bell Potter shows that while there are cheaper LIC's our share price since December is in the lower half while we have been outperforming the market.

 

 

 

Short term mispricing is what creates opportunities.  The current spot oil price is an example.  Longer-term oil prices will recover.  This doesn't mean going out and buying energy companies, because the shift in demand may have the impact of forcing marginal producers out of business which is positive for the oil price recovering longer term. It's just a matter of who will survive and who won't.  A barrel of oil earlier in the week was cheaper in real terms than it was in 1870 as the chart below shows.

 

Whatever happened to "Peak Oil".
 

 

 

So investors face the challenge of what's just fundamentally cheap and what has had a business altering change that means it won't get back to where it was before?  There will be downgrades in the short-term but if you think of yourself as a business owner, you need to ask yourself the question when will the business get back to normal?  We looked at Virgin very early on in the Coronavirus onset and worked out that the interest cover was so low that there was a serious risk that even a marginal shift in travel patterns could cause them to default on their debt.  The worrying thing about that was that it took the rating agencies weeks to determine the same thing and they are paid to do that to protect the note and bondholders. 

 

The Consumer won't lead a Recovery

 

There are 330 million people in the US, not all of those people work, the number of working pre coronavirus was 155 million.  If the US unemployment rate moves to 15% that's 23 million people out of work, nearly the same as the entire Australian population.  While some of those jobs will come back, not all will.  That unemployment figure doesn't account for those who have taken reduced pay, reduced hours, unpaid leave etc.  That will inevitably make the personal financial budgets significantly tighter which will impact discretionary spending.  Additionally, consumers who have been drawing down savings or living on credit will need to slow down the discretionary spend until they have recovered.

 

In the US 47,000 retail stores have closed.  All their casual workers have no income,  the owners, corporates or individuals are now burning cash on rent and fixed overhead.
 

 

 

Australia has done a great job of containing the spread of the virus and while the same metrics of consumer spending, reduced savings and a permanent loss of some jobs will impact our economy, we are in a far better situation than the US.  We will have a clearer idea about businesses' profitability when we get to reporting season and companies start to gain some clarity on the outlook for their respective industry.

 

So happy investing and stay safe.

 

Michael

 

 

 

 

 

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