Regarding… Vol 3 no 7 – Mr Market knows

Dear Fellow Investors and Friends,

Welcome to this 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.

Today is Thursday, February 27th, the 58th day of the year. There are 307 days until the end of the year.

On this day in 1884, Paul Kruger, president of the South African Republic, signed a treaty in London that disavowed British authority over the Transvaal. The question naturally arises: why did Transvaal want to separate from the Brits? Apart from the Afrikaners’ natural antipathy towards them, of course? Remember, this was before the Anglo-Boer War and its associated concentration camps.

Many would argue that it was the fiercely independent streak of the Afrikaners that motivated the separation. This seems plausible until you consider the following: Gerrit Bantjes made the first recorded discovery of gold on the Witwatersrand in June 1884, on the farm Vogelstruisfontein. This was followed by the Struben brothers’ discovery of the Confidence Reef in September 1884.

Is it merely a coincidence that independence and the discovery of gold occurred in the same year? I have my reservations. With this background, the story of the missing Kruger gold also gains more credibility. Perhaps we should get out to Machadodorp and explore the area…

History is a rich subject with many perspectives. The same story can be told in many different ways; just like in the market, absolute truth is often hard to find.

Ben Graham, the father of value investing, came up with the allegory of Mr. Market. He described Mr Market as your imaginary business partner prone to emotional excesses. Most days, he would be on an even keel, a pleasure to deal with, and you could get along with your work undisturbed. But sometimes, he would come to work in a wildly exuberant mood and offer you a ridiculous price for your share of the business. On other days, he would be in a foul, depressed state of mind and would be willing to sell his part of the business to you for a ridiculously low price.

It’s the same business, with different prices depending on his mood.

Ben Graham saw the stock market as his emotionally volatile business partner – there to be taken advantage of occasionally, but generally ignored.

Value investors derived the incorrect lesson from this story. They perceived the market as consistently being emotionally unstable. However, the truth is that the market is, for the most part, generally correct.

Why would value investors think this way?

Value investors had a wonderful time from 2000 to around 2012. On top of the world, their consensus was that they were pretty clever and understood the market well. As a result, their way of doing things was the right way, and all those stupid growth stock and index investors didn’t understand and were wrong – all of the time.

And guess who the value bros eventually encountered whilst travelling down this road called hubris? Why, hello, Mr FAANG, what magnificent teeth you have!

Today, the FAANGs have morphed into the Magnificent 7, creating tremendous wealth for growth and index investors. Meanwhile, value investors have been doubling down on buying the shares of buggy whip purveyors.

I’ve taken much longer than I should have to learn this lesson. Still, it’s been hardcoded now:  instead of seeing something and immediately saying, “The market is wrong,” I begin with the assumption that the market is right and I’m the one who is missing something. This forces me to develop a list of potential reasons I might be missing or overlooking and exhaust those explanations before I can build my confidence that the market is, indeed, wrong.

Which isn’t very often.

It’s helpful to think about the conditions under which the market may be “wrong”. Or, more appropriately, slow to adjust. Here are a few:

• Strong emotions – rationality disappears when the fight or flee instinct kicks in.
• Broad consensus – when everyone agrees, whatever they agree is probably baked into the price.
• Liquidity constraints – when an asset is not liquid, it can easily be pushed higher or lower.
• Fraud – when a crook runs a business, it will be mispriced.

Importantly, these things happen much less often than one would think.

Compounding the problem, they can take a long time to resolve. Steinhoff was a fraudulent business for a long time before the roof came crashing down. As Keynes said, “The market can stay irrational longer than you can stay solvent.”

There are two takeaways here:

1. The market is hard to beat. Make sure that’s the game you want to play.
2. Make sure you know why you think you can beat it – being smarter than everyone else is not the correct answer.

A stock with a ticker DNUT has to be great, right? Ozempic, Wegoway and all their cousins have created a bit of a headwind for the company that sells the most delicious doughnuts.

Here’s the chart:

New 5-year lows are not bullish. The company reported a loss and preferred to blame a cybersecurity incident and the weather for weak sales. GLP-1 agonists were not mentioned. Like the Kruger millions, they are entirely missing.

My take: If you sell doughnuts and are not aware of or choose to ignore the effects of appetite suppressants, you deserve a share price 75% lower than four years ago when you listed via an IPO. Investors with a risk appetite would be better off eating some of their doughnuts, rather than buying the stock.

Glencore, a holding in the MWI Value fund, is one of the best-managed mining houses around. But it struggles to gain institutional acceptance. This could be due to the market’s perception of Marc Rich, its founder, who was involved in several controversies, including being indicted in the United States for tax evasion and making oil deals with Iran during the 1979 hostage crisis.

Having said that, if you go far enough back in the history of most mining businesses, you are bound to find some scary skeletons in the cupboard. This negative perception was probably reinforced when some institutions started virtue signalling around coal. Glencore stuck to its value-orientated gun, even buying Teck’s coal assets for $7bn.

Recently, Glencore’s share price has been tanking:

Glencore has a strong position in copper, which many regard as the future, and coal, where consumption continues to grow (see the article on the energy transition below). Their trading business is also a consistent performer.

My take: Some say the world will embark on a re-industrialisation process; if so, Glencore is a stock you want to own.

Insurance companies are doing well all over the world. Both underwriting outcomes and investment returns are good. But Momentum has been flying under the radar for quite a while – Sanlam (for good reasons) and Old Mutual (for less good reasons) have hogged the headlines.

Momentum is a well-managed insurer that does business without attracting any headlines. Some would say that’s exactly what an insurer should do. If so, Momentum is doing a good job, which is being rewarded in the share price:

Not bad for a stodgy South African Insurance business.

My take: The South African market has many companies like these – good businesses managed by good people who quietly go about their business and create value for shareholders. The Momentum Group is one of those, and the MWI Value Fund is a happy shareholder.

Speaking of insurance, here’s another insurance company excelling beyond expectations. Okay, I lie – it’s actually an investment holding company, but it does get a large proportion of its earnings from insurance activities:

This has helped BH over the past year, as its earnings have benefited from a positive underwriting cycle. Operating earnings were up by almost 25%, helping the share price hit a new all-time high after the release of its annual results over the weekend:

Berkshire has faced considerable criticism over the last few years for its poor investment performance, particularly regarding its most recent acquisitions: BHE (the energy business), Precision Cast Parts, and BNSF (the railroad business). The NAV per share has compounded at 11.7% per annum over the past 10 years, compared to the S&P 500’s gain of 13%. Thus, the criticism that Buffett has slowed down is likely valid. However, when you’re 90, I suppose you’ve earned some downtime.

But it’s not like he has bombed out…

Given BH’s size, that performance is not to be sneezed at. It is also sitting on a record amount of cash – $318 bn, to be precise – so he is well positioned to take advantage of future opportunities.

I always find it interesting to look at things that don’t get done, not only those that do. There is much information in absence, so to speak. The two things I noticed from BH’s report are that they haven’t been buying back shares recently and that they haven’t been selling any more Apple.

My take: BH is one of the “10 stocks forever” in the MWI Worldwide Flexible Fund (aka “the cockroach”), primarily due to the culture that has been ingrained in the business, which will persist long after Mr. Buffett, as well as the quality of the businesses it owns.

Alibaba has long been the poster child for Chinese stocks. Initially, it introduced the world to China’s technological prowess. Subsequently, it became the focal point of Xi Jinping’s crackdown on the tech sector when the founder, Jack Ma, effectively “disappeared.”

More recently, it has been the one stock held out to show how cheap Chinese stocks are. How cheap? Here’s a chart by local research firm Avior, which shows that Alibaba’s sum of the parts is more than two times its current share price:

To me, it looks like the share price has bottomed:

My take: Alibaba is one of the “must-own” Chinese stocks. That’s if you want to own Chinese stocks, which I think is a sensible course of action.

We’ve been hit by bad news lately – a failed budget, talk of US sanctions, a bankrupt (morally and financially!) government, and anti-free market and anti-growth legislation. It’s not surprising that the general mood has turned sour.

It’s hard to see through the gloom right now, but two facts are key to understanding the investment environment:

1. Our interest rates are high. You get paid for the risk of having money in the country. Over the long term, you are better off owning Rands and earning local interest rates than owning Dollars and earning US interest rates.
2. Our equity market is cheap. This is the P/E of SA stocks (excluding Naspers, Richemont, et al.):

(The chart is from an article published on BizNews)

Just like with interest-bearing investments, in equities, you get paid for the risk of being in SA. At these sorts of prices, if things turn out better than expected, you make a lot of money; if they don’t, you won’t lose much.

Then there is the Rand. File this under “the dog that didn’t bark in the night” – despite all the bad news of this year, the Rand has strengthened from 18,80 to 18,40 to the US dollar:

Here is a chart my colleague Josh Viljoen (no relation) put together at MWI. It shows the performance of the Chinese “Terrific 10” vs the US “Magnificent 7” since the start of 2024:

The terrific 10 (Tencent, Alibaba, Meituan, etc.) have started outperforming the Mag 7 (Apple, Alphabet, Amazon, Nvidia, etc.).

Even if you believe that China is uninvestable and that US exceptionalism is a permanent feature of markets, it is important to be aware of developments in China. The sheer size of the Chinese market, coupled with the constraints imposed by sanctions on specific technologies, has enabled them to develop low-cost and competitive products with those available in the West. See DeepSeek, BYD, etc. etc.

My take: Even if you don’t invest in China, you need to be aware of their companies’ potential to act as global disruptors. Just like US tech companies have been disrupting the status quo for the past 20 years. That’s the nature of tech; there’s always a new disruptor.

This article from the magazine Foreign Affairs presents the most balanced and comprehensive discussion of the energy transition I have encountered in quite some time. It is astonishing that mainstream media rarely features anything of this nature, but I suppose their backers have their own agenda.

Here are some choice quotes:

• “Past transitions, such as the shift from wood to coal, were motivated by improved functionality and lower costs, incentives that are not yet present across much of the entire energy system.”
• “A global economy in transition depends on another transition – a shift from “big oil” to “big shovels.” That means much more mining and processing, driven by major new investments and resulting in much-expanded industrial activity. The energy transition is not just about energy; it is about rewiring and reengineering the entire global economy.”
• “The trilemma of energy security, affordability, and sustainability looks very different in Africa, Latin America, and developing Asia than it does in the United States and Europe. As Malaysia’s prime minister, Anwar Ibrahim, put it, “The need for transition” must be balanced against the “need to survive, to ensure that our present policies eliminating poverty in providing education, health and basic infrastructure are not frustrated because of the dictates of others that do not place adequate consideration on what we have to face.”

My take: Life is energy. Life is also one big trade-off. Logically, then, energy is a trade-off. You can have “green” energy, or you can have growth. Most countries will choose growth. Fossil fuels are not a thing of the past.

My journey through life via music continues, and I recently finished reviewing 1989.

That year, I completed my compulsory national service and returned to work. I got a job on the bond trading desk of the SARB. It was an exhilarating time in the bond market. In the final days of Apartheid, the government’s deficit was spiralling out of control (sound familiar?), and our role on the bond desk was to sell enough bonds to cover the deficit. In practice, this meant we would sell to anyone willing to buy.

Occasionally, we would attempt to make a market, but in reality, we were simply consistent sellers.

During this process, I met some wonderful people and learned a great deal about how markets function. Unfortunately, some of those lessons came at the expense of the South African taxpayer. I know for a fact that some traders at investment banks and stockbrokers did very well from my naivety.

But I had fun, learnt a lot, and the deficit got funded. Aren’t those the important things?

Some truly great music was also released during the year. Highlights for me included Lou Reed’s album, New York, and The Cure’s album, Disintegration. Song of the year? That was Neil Young’s Rockin’ in the Free World.

How are these for powerful lyrics?

“We got a thousand points of light
For the homeless man
We got a kinder, gentler,
Machine gun hand.”

And who can ever forget that first Nirvana album, Bleach – it changed the music world!

Here are:

The top 20 songs of 1989 (counted down from nr 20 to nr 1, as usual)

The top 10 albums of 1989 (because we all need to listen to the whole album)

A long list of the top songs (hopefully, you find something in here you like)

Last week, I quoted some lyrics from a song by Laurie Anderson in my introduction to the letter. Oscar Foulkes, my Epic partner and good friend, subsequently sent me this link to her amazing performance of “Waiting for the Barbarians.”

It just goes to show that there’s still life after 70.

By the way, one of her songs, Baby Doll, is also among my top 20 songs of 1989.

Roberta Flack died this week. I can’t say that I loved her whole body of work – I’m not a big soul and R&B fan, but her song, The First Time Ever I Saw Your Face, brings back such great memories. I was 10 years old, living in New Orleans when the song was a hit. It feels like, along with her song, Brand New Key by Melanie and American Pie by Don McLean were the only songs playing on the radio.

Here’s Roberta singing what, for me, was her best song.

What a joy!

That’s it for this week.

Be careful out there. And stop reading the newspaper.

Piet Viljoen
RECM