May 2019

May 1, 2019

The Advisory Panel met with the backdrop of markets that have risen 14% in the first 4 months of the year, and a clear return to “risk on”. Information technology once again tops the sector charts (up 25%) and the more “defensive” sectors of Utilities and Health Care are up 7% and 3%. Rising markets imply that investors are feeling relaxed, but should they be? We do not live in ordinary times. There are record levels of debt being held privately and on corporate balance sheets, we have yet to ween markets of quantitative easing fully, interest rates remain at un-realistically low levels, and there are more than $10 trillion of bonds trading at negative yields. What else is on the panel’s collective mind, and what (if any) opportunities does that present.

The ugly face of protectionism: there are increasing tensions between the US and China, and this has potential to be a “trade war” of a size that will not leave any global markets untouched. China has been exporting deflation globally for many years (as the rest of the world benefits from cheap Chinese labour, and seemingly limitless output). A surprising number of people are suggesting that “low inflation” is set to last forever, but should the US impose trade restrictions on China, this will almost certainly result in inflation, and put pressure on interest rates. Japan is the biggest direct competitor for a large number of Chinese exports and could, in the longer term, be a clear beneficiary. Relatively cheap equity markets make this a rich hunting ground for potential ideas. Asset heavy companies (long out of favour with the popularity of the asset light business model) are also likely to benefit from a return inflation as the replacement cost of those business increase with a return of inflation. These are investment ideas for those with a long time horizon though, as if the RMB depreciates in the short term, this trade gets tougher before any tariffs bite.

The rise and rise of the US: Since the bottom of markets in March 2009, the S&P 500 has delivered over 400% returns (416%) in sterling terms. The MSCI World excluding the US has delivered less than half of that amount (196%). The information technology sector has delivered a staggering 555%, whilst energy has delivered less than 100% (94%). These discrepancies in fortunes are remarkable, and inevitably lead value investors to look at those sectors that have underperformed (relatively) to seek havens from what feels like a universal re-rating. The Kennox portfolio already has a significant weighting in energy names. Remember that these are oil and gas companies (no longer just oil companies), that that the world will likely need more energy over the next 20 years and not less, and that we must rid ourselves of coal (which makes up 20% of the world’s energy supply currently) before we reduce our dependence on the other fossil fuels. Remember also that switching to what currently are more expensive alternative energy sources disproportionately hurts the poorest members of society, so is not the political “no-brainer” that it is often portrayed to be. The panel also thinks that the UK market (the weakest of the major regions) may well offer some opportunities. The FTSE 350 trades at around 14x PE (excluding those with negative earnings), compared to over 18x for the S&P500 and over 22x for the Nasdaq. Whilst Brexit is causing uncertainty, it is unlikely (again in the longer term) to quite so detrimental for all of the businesses as the discount implies.

Peter Hollis, Russell Napier, Angus Tulloch and the Kennox investment team.

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The Company is based in Scotland, UK with the above registered address (Registered Number: SC302037).

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