Dear Fellow Investors and Friends,
Welcome to another edition of my newsletter, where I share my efforts to understand markets and the world around me.
I do appreciate you taking the time to read this. Feedback is welcome; it’s great to start conversations.
Today is Thursday, June 12th, the 163rd day of the year. There are 202 days until the end of the year.
On this day, 59 years ago, Nelson Mandela was sentenced to life in prison for his anti-apartheid activities. This would be unimaginable today. Yet, he was convicted in terms of the laws at the time, which were morally indefensible. This poses an interesting question: What view do I hold today, which the future will prove wrong and utterly indefensible?
As for life, so goes investing.
Our worldview is built on what we have experienced over the past generation or two. But what if that experience proves to be absolutely useless in terms of dealing with what comes next? How can we build some robustness with respect to future unexpected outcomes into our portfolios?
Step one would be to imagine a very different world from the one we have become used to.
So, in the spirit of this letter, which represents my efforts to understand the world, here goes:
In the days of steam trains, operators would sometimes be under pressure to make essential deliveries on schedule. To do so, they would “run it hot” – lifting the temperature in the boiler by continuously feeding coal into the fire, increasing the pressure of the steam. This resulted in a much faster train until something broke down, as it inevitably does when machinery is run beyond nameplate capacity.
Overworking machinery often sacrifices quality, safety, and long-term viability for short-term gains.
There is an increasing likelihood that many governments worldwide are not only discussing but actually removing the shackles of austerity, fiscal prudence, and monetary conservatism in the interest of accelerating economic growth rates.
Running it hot, so to speak.
Government policies were generally pro-growth; however, over the past few decades, policy-making has begun to prioritise other goals, many contrary to economic growth.
The term “degrowth” was introduced in 1972 by philosopher André Gorz. It gained traction in the 2000s as concerns about climate change and resource scarcity intensified. The “degrowth movement” is a political, social, and economic ideology that challenges the traditional focus on economic growth as a measure of progress. It advocates reducing production and consumption to address ecological crises, enhance human well-being, and achieve sustainability within planetary boundaries. It relies heavily on Malthusian thought.
Conversely, Deutsch, in his book “A Conflict of Visions”, described his unconstrained vision for human beings. His view is that we are not fundamentally limited by inherent flaws or “human nature” but instead possess the capacity for overcoming resource constraints and thereby generating infinite progress through the application of knowledge. This perspective comes naturally to all of us. Unlike the view seemingly being forced upon us, that nature constrains human beings and subjects them to limitations they should adapt to, rather than seek to overcome.
Consequently, as I look around today, numerous unpopular governments are imposing restrictions on growth in the name of “sustainability”. Some have lost elections over the past year, and even fewer are likely to remain in power when their election cycles arrive.
Of course, politicians are nothing if not sensitive to the prevailing winds of popular opinion. Therefore, we are starting to see more and more countries break away from their self-imposed growth shackles.
In the interest of promoting growth, Trump aims to cut taxes, reduce regulations, increase oil production, weaken the dollar, and lower interest rates. He is not overly concerned if the fiscal situation comes to resemble that of Brazil. Growth is the objective.
Everything else is secondary: comparative advantage, historic alliances, and the dollar exchange rate.
Bring on the Big, Beautiful Bill, says Donald Trump.
He wants to run it hot.
But it’s not only Trump.
In South America, Bukele and Milei have swung hard “right”, away from the constrained, socialist, redistributive polices of their predecessors – policies which have destroyed their local economies. Today, Milei is having great success reviving the Argentinian economy with pro-growth, anti-big government policies.
What happens when Brazil, Chile, Colombia and Peru all swing the same way in the coming elections?
After squandering three decades of trying to make it worse, Japan is finally emerging from its funk. They are now clearly on a pro-growth path, regardless of what happens to the currency or the government’s fiscal situation. Then you have Europe, where they’ve spent a decade tilting at carbon windmills, hoping to improve the weather. As recent elections have shown, the average voter doesn’t care about the jihad against molecules; they care about growth. In multiple European countries, we’ve seen the so-called ‘far-right populists’ perform well in the elections, with the “socialist greens” going backwards.
Germany intends to abandon its debt brake to finance increased defence and infrastructure expenditures. This recently propelled the DAX index to new highs and caused benchmark 10-year bund yields to soar by 30 basis points, marking the largest single-day surge since the 1990 reunification. The current fiscal plans overshadow any previous attempts to stimulate the German economy.
Even better, this expansionary fiscal policy shift could persist, as Germany has relatively low debt levels, with a debt-to-GDP ratio of just 63%, roughly half that of the US.
Europeans are not the only ones determined to do “whatever it takes.” In China, the Communist Party’s “special action plan” to bolster consumption is also expected to fall into that category. A recent gathering of policymakers reaffirmed a commitment to encouraging consumer confidence and spending in China. According to Gavekal, the fiscal stimulus in 2025 will be larger than the pandemic-driven stimulus of 2020.
Investment conclusions:
If everyone starts to run it hot, the economic environment will be characterised by
- Higher inflation
- Less globalisation, more localisation
- Higher frictional costs of doing business and shifting capital around
This will have the effect of:
- Pushing up bond yields
- Inflating commodity prices, especially gold prices
- Lighting a fire under equities
In short, you want to own real assets that give you a claim on a growing stream of cash flows. What you want to avoid are nominal – or contractual – assets. Or assets that impose significant costs between you and the cash flows – costs that will be subject to significant inflationary pressures. See Cash Machines (part 1) and Cash Machines (part 2).
Could we be on the brink of the mother of all (equity) bull markets?
Markets
1. Sabvest Capital
Investment holding companies on the JSE don’t have a great reputation. Disregarding minorities, making poor capital allocation decisions, murky valuation practices and charging high fees seem to be par for the course.
Of course, there are always exceptions, and Sabvest is one of them. Managed by Christopher Seabrooke, Sabvest has posted exceptional returns over a long period. This is how its NAV has grown over time (courtesy of Blue Gem research):
Over the years, its NAV per share has grown by over 20% p.a. due to good capital allocation.
NAV per share is currently around R130, and the share price is just over R100, a new all-time high:
Sabvest owns a diversified portfolio of predominantly private businesses. Despite its fantastic track record, it continues to trade at a significant discount to NAV, for reasons that are not apparent.
- Seabrooke has always treated minorities well, despite owning a controlling voting bloc
- Capital allocation has been exemplary, illustrated by the chart above
- It has exited investments at valuations at or above their carrying value, illustrating conservative valuation practices
- Management fees amount to just over 1% p.a. at present, which is not unreasonable, especially given the value creation
My take: Sabvest Capital is a great investment hiding in plain sight. It is up 58% over the last year and has compounded by 30% p.a. over the past five years. Very, very few funds have a track record that can hold a candle to Mr. Seabrooke and Sabvest. It is also the biggest holding of the MWI Value fund.
2. KAP Ltd
KAP is an industrial company with subsidiaries operating across various industries in South Africa. It’s also a poster child of the hollowing out, which is taking place locally, as the local economy becomes less and less attractive for capital-intensive businesses. The reasons for this are legion, but include:
- A poorly educated workforce
- An anti-business regulatory environment
- Broad-Based Black Economic Empowerment (BBBEE) – effectively a massive (additional) tax on capital providers
- An inept government, corrupt to the core
The share price of KAP illustrates these problems vividly:
It is currently trading at less than 40% of its level 10 years ago, barely above Covid levels.
In South Africa, there are four investment options:
- Invest in offshore companies listed on the JSE
- Invest in capital-light, service-oriented businesses
- Invest in businesses with excellent management
- Invest in massively undervalued local industrial companies
We have some world-class offshore businesses (Richemont, Naspers). We have world-class, capital-light local businesses (WeBuyCars, STADIO). We have some businesses with really great management (Capitec, Discovery). We have a host of (mainly small-cap) undervalued industrial companies (Adcorp, Telkom, Tharisa).
My take: Although the JSE is a small market, we are spoilt for choice. Investing here is simple, but not easy: all we need to do is avoid companies exposed to the hollowing out of the economy, or where the valuation doesn’t pay you for the risk of owning them.
3. Brown-Forman
If you think shareholders of KAP have had a rough ride, spare a thought for the shareholders of this erstwhile (U.S.) market favourite, Brown-Forman:
What does it do? Looking at that share price chart, would you be surprised if I told you it manufactures, markets, and sells various alcoholic beverages (mainly spirits)?
Selling alcohol to the public used to be a dependable, sexy business. Not any more.
The business faces multiple headwinds, including tariff risks, a challenging macro environment, and a weak spirits market with an oversupply of American whiskey. But on their most recent call, the CEO gave an additional reason for their weak sales: “One reason is that they are using more cannabis.”
I wrote about “Zebra-Striping” earlier this year in Regarding…Vol3 No2. It seems to be a real thing!
My take: Buffett became a successful investor by buying predictable businesses. He never bought an alcohol business. It seems he was right on this one, too.
4. Lululemon
The share price of this purveyor of overpriced athleisure kit for the work-from-home crowd fell 20% last week, after announcing poor earnings:
I called its share price formation the “downward dog pose” almost a year ago in Regarding…Vol2 No29, and it seems to be holding the pose very well. Given poor earnings, increased competition and increasingly less work-from-home, poor earnings reports probably shouldn’t surprise.
My take: Like the luxury goods businesses, Lululemon might have pushed too hard on the pricing lever. This has created an umbrella for a host of competitors to enter the marketcompetitors like Athleta and Vuori in the USA, Burnt Studios in South Africa and many others. However, current ratings don’t expect much, so although the outlook might still be tough, share price returns might be better.
Let’s see, it’s an interesting situation now.
5. Nintendo
Nintendo is a Japanese gaming company famous for Super Mario, The Legend of Zelda, and Pokémon. It was founded over 100 years ago in 1889 and is one of my favourite businesses in the world.
Last week, it launched a new gaming platform, the Switch 2, which proved popular. Long queues of dedicated fans ensured the new console sold out as in-store sales commenced. This is despite a price tag of nearly £450, roughly 50% more than the previous model.
The share price is also quite a bit higher as a result:
Nintendo is also one of my “Forever Stocks”, a concept I am busy incorporating into the MWI Worldwide Flexible fund (aka The Cockroach). I have not bought Nintendo yet, as, despite its quality – or maybe because of it – it’s quite pricey. The stock’s current forward price-to-earnings multiple of 37 times is already well up from a five-year average of 20 and is more than double the industry median of 15.
My take: In my experience, good companies don’t always make good investments. Good investments depend on the price you pay for them when you buy them. Right now, I think the price of Nintendo leaves a lot of room for disappointment. But I have no doubt there will come a time. Patience is all that is required.
In The Media
1. Waxahatchee
I’m in London for the week, along with many South Africans who seem to have some business here. Not me. I’m here for the Test Cricket World Champs between South Africa and Australia at Lord’s. Never having watched cricket at Lords before, it’s pretty special.
Notwithstanding our poor batting performance.
Fortunately, I managed to get tickets to Waxahatchee’s show last night, which made everything a lot better. For those who don’t know, Waxahatchee is a band fronted by Katie Crutchfield. Katie’s style is Americana – a blend of genres, folk, country and something else. It’s more storytelling than the run-of-the-mill verse-chorus-verse-bridge chorus.
After watching the show, I thought Katie reminded me of a female version of Neil Young. She’s an introvert – she gets on stage and sings her songs, letting the stories speak for themselves. No outfit changes, no bombastic choruses, no indulgent guitar solos. Definitely no “sing-alongs”.
Just stories from the heart, sung honestly.
Pure joy.
Here’s a Spotify playlist of a similar set to the one she played tonight.
2. Sam Harris – A Philosophy for Life
I’m a big fan of Sam. He’s not everyone’s cup of tea – atheism, for some reason, seems to rub a lot of people the wrong way. After all, out of all the gods there are to believe in, atheism is just believing in one less god than everyone else. I also think Harris has a touch of TDS (Trump Derangement Syndrome).
But he is, on balance, one of the most sensible and rational public speakers I have ever encountered. I suppose that’s because he consistently disregards the first rule of persuasion, which says you should appeal to incentive and not reason. Harris always – without fail – appeals to reason.
I like that.
So here he is speaking about a “philosophy for life”. He makes what could be a boring, didactic topic fascinating. I guess the fact he is preaching to the converted – i.e. me – makes it more compelling.
Anyway, give this podcast a listen. It might be useful, especially when you are watching the Proteas play against Australia.
That’s it for this week; I’m off to the cricket where, once again, the Proteas are in danger of doing what they do best – not winning a final.
But it’s still a joy to be at Lord’s, watching cricket.
Please remember to be careful out there.
Piet Viljoen
RECM