Ptf Update: Themes – Vietnam, India, and Brazil

Our Man began an update on the thematic positions but it quickly got rather wordy and overly complicated.  Fortunately he stumbled across the below AT Kearney chart, that helped him tie things together more simply.

 
Three of Our Man’s Thematic positions fit the same broad template; relatively young countries that are moving towards capitalism!   Vietnam, Brazil and India all have relatively large millennial cohort (in size and as a % of the population), currently aged 23-27, who are currently entering and driving the work force.

 

Source: AT Kearney

While this is interesting, when combined with an economic move from socialism towards capitalism and supplemented by an attractive long-term chart/technical set-up then OM is interested!  It will not always work, the moves towards capitalism are incremental and these are emerging markets so the absolutes (politics, economics, etc.) are largely in the darker shades of grey.  However, while the move from darkgray to silver is but a modest step away from darkness, the delta - or rate of change - for stock markets is meaningful.  Finally, OM suspects that the technological changes that we are seeing will speed up the process, when compared to historical examples.

Vietnam
One Sentence Thesis:  Young Confucian country following the mercantilist path of predecessors (Korea, Thailand, China, etc.) as it slowly opens to capitalism.
Vietnam is one of the clearest examples of the above traits.  It is following the mercantilist path previously trodden by Asian countries including Korea, Thailand and China, of focusing on securing foreign corporate investment to help develop into a manufacturing hub while slowly opening up to global trade.  While this began last decade, Samsung’s decision to build a second Vietnamese smartphone factory in 2014 helped accelerate the process.  Today Vietnamese subsidiaries are Samsung’s biggest production base responsible for 30% of its revenue, and Samsung represents over 25% of Vietnam’s GDP! 
 

To help solidify its attractiveness within manufacturing supply chains, and secure further foreign investment (such as for Google’s hardware), Vietnam has slowly been opening its markets to trade and moving from Communism to a China-like capitalism/communism hybrid.   Examples include the recent agreement with the EU on a trade deal and an aggressive schedule of privatizations.  Finally, Vietnam has been a beneficiary of the US trade war with China, which has provided further incentive for multinational firms to invest in the country.
 

However, like all things emerging markets this will be a slow and lumpy process. Vietnam is not China; it is size constrained (100mn people) and supply chains take a long time to be built.  Despite this, unless there is a significant change (such as in the trend to becoming a more open economy, or valuations get too crazy, or increased likelihood of a major economic downturn, etc.), Vietnam appears to be in that most virtuous part of circle where the benefits from becoming a manufacturing hub start to spill over into other sectors.  As such, expect it to be to be a 4% to 8% position in the portfolio for a looooooong time, and that the small incremental changes mean that OM will  talk about it far too little!
 

Brazil
One Sentence Thesis:  An economic and market collapse coupled with a massive political/business elite scandal opened the door for unlikely President and his key minister’s Chicago-school economics approach. 

Brazil was originally a dislocation investment and was once the largest investment in the portfolio!   Our Man won’t rehash the entire story for you but the cliff notes are; one of the country's longest and worst recessions, a stock market collapse (80% in USD terms) and a massive corruption scandal the enveloped the ‘elite’ business and political class, all of which culminated in the successful impeachment of President Rousseff.

 
While OM could have managed the dislocation investment better, the 2018 election and the appointment of Paulo Guedes – a Chicago-trained economist – as economic tsar helped confirm Brazil as a thematic investment.  Guedes’ economic plan is what you’d expect from a neoliberal economist – deregulation, privatization and pension reform.  Pension reform is the most important in Brazil; for the last 20-years various forms have been in the works as a necessary component to shoring up the government’s finances and none has succeeded.  However, Brazil’s lower house of National Congress approved a pension reform bill last month, which will now head through committee and the Senate with final approval of the legislation likely in October.

 
The success of pension reform should be a good first step – investment has remained weak in Brazil, with international businesses viewing pension reform as a litmus test of the economic team’s ability to pass its agenda.  OM’s expectation is that successful passage of pension reform will prove a strong first step in restoring the market’s confidence in the economy and the political stability in Brazil.  While Brazil is unlikely to be held for as long as Vietnam, and OM is more sensitive to the medium-term charts/technical picture, it is still likely a multi-year holding in that same 4-8% NAV range.
 
 

India
One Sentence Thesis: Modi’s re-election with another large majority likely means continued steps towards his version of national capitalism and reduced bureaucracy.
Back in 2014, when Narendra Modi swept to power to become Prime Minister of India it was a time when many believed in hope and change for India.  This partially reflected a Modi campaign, and his reputation as Chief Minister of Gujarat, that was focused on economics and cutting bureaucracy.  It also took advantage of a decade of Congress party rule that collapsed under disappointing economic conditions and a multitude of corruption allegations. 

Like all things emerging markets, it wasn’t so simple.  While PM Modi has made strides to reduce bureaucracy, he has also introduced his version of state or national capitalism and in so doing failed to live up to some of the high expectations the market held for him.  However, 2019 saw PM Modi re-elected in a landslide and OM is quite aware that it is often in the second term that the largest economic changes can be made (from US/UK history, think Reagan’s second term or Thatcher post-1983 election victory).  There have already been suggestions of wide-reaching changes to the civil service and we are likely to see further expansions of Modi’s national capitalism.  While much of Modi’s platform and approach is far from perfect, as noted previously investing in emerging markets is often about incremental progress.   Our Man increased the India position in early 2019, as it became clear that Modi was going to comfortably win re-election, and it is in the midst of its 4-8% range.


Disclosure: OM is (obviously) long all of the themes mentioned above.

OM’s Philosophy: How Today’s Portfolio Fits

As a follow-up to OM’s last piece on his investment philosophy and strategy, this one looks at how the current portfolio fits within that framework.

Dislocations – 35.4% NAV, as of end of June 2018 
OM seeks to take advantage of dislocations – areas of the market where performance has been abysmal and investors have lost hope.  In addition to cheap valuations and fundamentals that are turning around, these investments require a narrative to help encourage investors to reexamine the opportunity.

Brazil (20.3% NAV) 
The longer-version of the thesis can be found here.  The shorter version is that Brazilian equities lost 80% (in USD-terms) between 2011 and 2016, and investor sentiment reached a nadir in early 2016 as the Carwash Scandal enveloped Brazil’s elite culminating in the successful impeachment of President Rousseff.  With sentiment at a trough, there were positive signs; new President Temer was viewed as competent and a short-term fix, and the length-and-depth of the recession meant that politicians were open to reform (especially pension) and companies had spent 5-years cutting costs to survive (i.e. created operating leverage to any pick-up in demand).  This was supplemented by the macro environment picking up (Brazil exited recession in 2017) and stock prices rising.

However, the big current question is whether the narrative peaked in December 2017, when Brazilian stocks continued to rise even as the planned pension reforms were shelved.  If so, this position should be vastly smaller especially considering the uncertainty of the upcoming election.

Uranium (9.5% NAV) 
Uranium remains the most frustrating position in the portfolio, which is a sign that it should probably be a smaller one.  Nothing has changed in the thesis;
- The primary demand is nuclear power plants which are slowly coming back online (post Fukushima) and being built (mainly in China and India).  These plants have long-term contracts (2-10yrs) and the majority of existing contracts come due in the 2018-2020 time frame.
- The supply-side is now rational.  A multi-year price war saw suppliers seek to build/retain market share, but the continued falling price meant there was no investment and most mines currently operate at a loss.  Two suppliers (Cameco and Kazakhstan) now control over 50% of the market, and have both been disciplined and aggressive in shutting down capacity.  Our Man hoped that these public demonstrations of supply-side discipline, especially the major cuts coming into 2018, would help start to drive the narrative and price but despite strong rallies on the shut-downs, there’s been little price follow-through.

Greece (5.6% NAV) 
Greece suffered through the Great Depression (and more) and everyone’s still annoyed/frustrated with them, with investors having been burned more than once.  However, Greece exited its third (and final?) adjustment program a couple of weeks ago and the IMF/EU came to a French-brokered understanding re. its future debt path earlier in the year.  While there is much reform that still needs to happen, it’s also too easy for outsiders to discount what’s already been done (e.g. reforms making it easier to fire workers, new laws to work out NPLs, etc.).

OM has limited the position size since while all the ingredients are in place there is no compelling narrative to force people to look at Greece again.  As such, OM is waiting to see (i) Greece come to market with another debt issue, and especially (ii) elections.  OM suspects that the latter will prove a strong driver of the narrative, especially if Kyriakos Mtzitokis’ New Democracy look like winning.  They represent a much more palatable partner to investors/the EU/the ‘media’/etc. than current Greek PM Alex Tsipras and his Syriza party.

Thematic – 28.8% NAV, as of June-end 2018 
This represents OM’s exposure to long-term secular themes.  The themes likely won’t change much over time though the underlying components and position sizes may do.

The 3^rd/4^th Industrial Revolutions (14.2% NAV) 
The Digital Revolution (3^rd Industrial Revolution) was the shift from mechanical/analogue technology to digital electronics; at the simplest level think sending mail to email.  It began with the invention of the transistor (1947) which led the advent of digital computers, and it continues through today cellphones and the Internet.  The Fourth Industrial Revolution is building upon and extending the Digital Revolution, and seems likely to transform society in the coming years/decades.  So far, it has been characterized by breakthroughs in fields such as robotics, artificial intelligence, machine learning, autonomous vehicles, genome science, and cryptography.  Most will have at least heard of some/most of these fields, but they are all still emerging and their impacts and relative importance isn’t yet known.

Our Man has long-held various technology and biotech names in the old Equities book; while the companies have their own attractive traits, these “Industrial Revolutions” are the overarching theme that binds them together.  OM suspects that by classing all the positions that are predominantly driven by this theme together, it will help from a sizing and risk management perspective.

If you’d like to read a simple primer on the 4^th Industrial revolution, here’s a good one from World Economic Forum.

Argentina (8.0% NAV) 
Argentina started in the dislocation book; Kirchnerism from 03-15 resulted in a poorly managed and distorted economy, with no access to global capital markets.  However, political change was imminent; President Cristina Fernandez de Kirchner couldn’t run in the 2015 elections, and any of the 3 candidates would be more market friendly.  She was replaced at the end of 2015 by President Macri, the most market friendly of the candidates.  President Macri began an impressive liberalization of the economy including removal of currency controls, inflation targeting independent central bank, settling with the bond hold-outs allowing Argentina to access capital markets, etc.  

The thematic bet is long-term that Macri-ism succeeds and Argentina becomes a ‘normal’ country and market economy, with single digit inflation and normalized interest rates.  This allows the development of a broader credit market (both corporate and personal) and businesses have greater ability to plan/invest for the future.  Think of the US in the early 1980s, following Volker’s raising rates to tame inflation, as a good but vastly simpler historical rhyme.

India (4.9% NAV) 
The long-term bull case for India is widely known, and OM doesn’t have much special insight.  The thematic case starts with the 2^nd largest country in the world, which also has great demographics and is (relatively) technologically advanced.  These natural advantages are supplemented by some self-help.  While there is much to criticize the Modi government over, it has made some structural shifts (taxation changes, bankruptcy code and financial reform, etc.) and the push to digitize the economy, highlighted by the introduction of Aadhar (a unique individual ID number based on biometric information), is potentially world-leading.

Vietnam (3.1% NAV) 
The cliff notes for the Vietnam is that it looks like China/Thailand 15-25 years ago and is treading down the same path.  The longer form can be found here; expect Vietnam to be in the portfolio for a long time though the position size will vary depending on the pace of reforms, the strength of the economy and the proximity and likelihood of any MSCI upgrade (to Emerging Market status, from Frontier).


Idiosyncratic – 18.2% NAV, as of June-end 2018 
The idiosyncratic book is made up of two things; a small number of attractive individual stocks and some Funds.  These Funds take advantage of some structural inefficiency be it through active stock picking/time horizon or using a combination of (valuation) factors to systematically allocate capital. 

Texas Pacific Land Trust (TPL, 6.7% NAV) – if there could be a poster-child for the type of individual stock in the idiosyncratic book, it would be TPL.  It’s attractively priced, not covered by any Wall Street analysts (of note), not in any ETFs, and its business (oil royalties, land leases, and water rights) has no real peers to benchmark it against.  Throw in the uniqueness of its structure – it was created in 1988 as a result of the Texas Pacific Railway co going into receivership, and all it does is manage/sell land and use the proceeds to buy back shares – and nobody really knows or cares about it.   

Fannie Mae (FNMA, 0.3% NAV) – Either the government should not be sweeping all of FNMA’s profits to the Treasury and it’s worth multiples of the current price, or they should and it’s worth almost nothing.  For a resolution, it requires political decisions to be made on a topic nobody wants to make-them on (government’s role in the mortgage market) and with no immediate need for a decision.  Think of it as a glorified option with lots of unknowns and very attractive risk/reward payoff.  Also, it has no time decay but also no strike date…it could be here forever and worth the same, or worth multiples next quarter/year.

As previously noted, the Funds (11.3% NAV) are within the idiosyncratic book.
- GVAL and CAPE are both based on applications of Shiller’s PE Ratio (aka Cyclically Adjusted Price Earnings, CAPE).  GVAL applies it to International stocks (finding the cheapest stocks in the cheapest countries), and CAPE applies it to US sectors.  To Our Man’s mind Shiller’s PE Ratio/CAPE is a tool that is poorly applied in finance with too many trying to use it as a timing mechanism or reason for a short-term decision, whereas it’s real value is as a very long-term measure of relative value.  The intent of both ETFs is to buy things that are cheap on a relative basis (compared to other countries/sectors) and Our Man’s wager is that over the long-term this will prove to be more profitable than the market.
- CWS:  Our Man has read the Crossing Wall Street blog for most of the last decade, and this ETF is based off that blog.  CWS publishes an annual “Buy List” of ~25 stocks at the start of each year, which are equally weighted and then no changes can be made during the year.  Each year only 5 stocks from the Buy List have been replaced, with the others carried forward (with any additions) onto the new Buy List.  This longer-term focus (typically, 4-5 years on the Buy List) leads to a bias towards quality and value and if the process can remain disciplined this can lead to out-performance over time.


Technical - 32.9% NAV, as of June-end 2018 
The Technical book was added back in 2014, to help compensate for OM’s natural skepticism by formulaically take long positions (in the levered ETFs for the S&P 500, Dow Jones and Nasdaq 100) to capture long-term trends in these markets.  The position-sizing of these positions is also rules-based, and more information on the genesis and rules for the Technical book can be found here.


Hedges/Shorts 
None currently.

Portfolio Update: Argentina, Greece and India

Argentina 9.7% (International Book)

Argentina has been a long-held thesis in the portfolio, it is approaching its 3^rd anniversary, with the initial thesis being that the 2015 elections would bring significant change.  The crucial fact was that President Cristina Fernandez de Krichner couldn’t run in the election, after being term-limited and failing to secure the necessary votes for a constitutional amendment.  Under Cristina, Argentina had largely been isolated from the world markets with capital controls and a pegged currency that traded at a significantly different level in the black market (the ‘blue rate’).  The country was also involved in a long-running argument with bond hold-outs that ended with Argentina losing in court and being shut out of the global debt markets.  The result was an economy with significant imbalances (government subsidies/interventions), a large government deficit, runaway inflation, and exceptionally high interest rates. However, this also meant that Argentina was a country with very limited government debt - a benefit of not being able to borrow internationally!

The opportunity was that all 3 candidates, including the one favored by President Kirchner, were all likely to be substantial improvements.  As luck would have it, President Macri, the eventual winner, was viewed as the most market-friendly candidate (and no ally of President Kirchner).   Any doubts were dispelled in the first 100 days with an array of actions including floating the currency, removing capital controls, granting independence to the central bank (with a mandate to reduce inflation), announcing substantial reforms/ cuts to subsidies, settling with the old bond holdouts, and subsequently raising debt in the international capital markets. 

Unsurprisingly, markets rejoiced…including Our Man’s Argentinean basket of stocks, which are up 140%+.    OM expressed the Argentina theme through a small basket (5-6) of stocks as the ETF (ARGT) was a poor reflection of the opportunity (commodity heavy + largest position is focused outside Argentina).   The basket has steadily been pared back to OM's 2 favorite names, Pampa Energie (a beneficiary of electricity subsidies being cut) and Adecoagro (an agricultural company).

The recent strong win by President Macri’s party in congressional elections only increases the chances of reforms, and the possibility that Macri will run again.  With a low-level of government debt and wide-open credit markets, Argentina will continue to have the opportunity to reform at a reasonable pace.  Add to that a newly independent central bank that has been willing to raise rates to conquer inflation.  There are positive signs as inflation has started to fall and this is widely projected to continue.   

To Our Man this rather rhymes of a certain 1980’s US President who reformed an economy and saw the Federal Reserve defeat inflation.  That started a multi-decade boom for numerous asset classes in the US. So don't expect Our Man to exit Argentina any time soon (even if he can’t invest in Argentinean PE, which is likely the best asset class)!!  

Greece 2.7% (International Book)

Our Man’s previous Greece exposure was exceptionally disappointing – too early and over-sized – but like a moth to a flame, he has returned.  Yes, OM can see you shaking your heads sadly – so, why now?

The French.

Yup, I kid you not.  The Frogs have gone and done it!  It being, breaking the impasse between the Eurogroup (*cough* Germans) and the IMF over a longer-term plan on Greek debt sustainability - “The Eurogroup formally agreed to a longer-term French plan to link the scale of Greek bond repayments to the country’s economic growth…”

So, now we’re finally near the end of the tunnel and by golly there’s light!  The light is Greece exiting the bailouts in mid-2018, with the banks looking like they are in decent shape to pass the final stress tests, and the market being prepared for new Greek debt.  And the tunnel?  After a 45% fall in GDP – the same decline as the US saw during the Great Depression - finally some stability and growth and a small government surplus.   And so, OM is back and hoping that the clearer catalysts (stress tests, exiting the bailout, issuing debt in the market and perhaps even elections) will stop the portfolio from seeing a second Greek tragedy. 

India 3.3% (International Book)

Our Man has a small position in India.  Though the % of NAV is larger than Greece, it is a much safer investment.  It has neither the substantial risk nor the same massive potential short-medium term upside as the Greek position.   

The long-term bull case for India is very widely known, and OM doesn’t have any special insight bar noting that the speed and prolonged nature of these changes is often under-appreciated.  The long-term bull case starts with the 2^nd largest country in the world, which also (unlike the largest) has great demographics (working age population is not expected to peak for at least the next 10yrs).    

This is supplemented by some self-help.  The Modhi government has been busy (not always in a good way) and has made some structural shifts (taxation changes, bankruptcy code reform, financial reforms, etc) that will have long-term benefits.  However, the most interesting to OM is the push to digitize the economy, highlighted by the introduction of Aadhar (a unique individual ID number based on biometric information).  Unfortunately, most of the potential applications (loans, credit history, transaction confirmations, to name the obvious ones….) of this are “in the future” and many will initially be captured in the private markets (and OM is not a VC).  Thus, until OM has a clearer idea of how to directly benefit, expect India to be a small but consistent part of the portfolio.

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take the above that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.