The Weekly - The next big thing

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20/05/2019
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Assessing existing quoted businesses for potential investment usually revolves around either value strategies or growth strategies. The former often relates to businesses fallen on hard times or out of favour where there could be unlocked recovery potential, whilst the latter is more of a momentum play surrounding growth businesses of today which are favoured by many. Needless to say, the valuation attaching to these two opportunities differs markedly. Potentially the risk is similar, although intuitively value investing could be perceived as higher risk than growth investing, with a currently successful business model feeling more comfortable. However, this can be illusory.
 

There is also another type of investing which is the holy grail of trying to anticipate the next big thing. The flotation of Uber last week or the latest round of financing for Tesla are cases in point where the potential value is based on investors’ belief in those particular businesses possessing a product which will change all of our lives. A charismatic leader can often be involved, full of self-belief and predictive certainty as he or she tries to persuade you to invest.

Twenty years ago in May 1999, those with grey hair will remember the predictions of the internet revolution and the stratospheric valuations of dotcom businesses at the time. The last profitless flotation at the time that promised to revolutionise discount retail was lastminute.com - an ironic title, and where are they today? Actually, they are still going but competing in a crowded marketplace with the likes of Booking.com, Kayak, Trivago, Groupon and many others where the low economic barriers to entry have competed away any first mover advantage they may have initially had. 

The same can be said of Purplebricks, which was trading at 104p in December 2016 and was also priced at 104p last Friday but visited 500p in the interim as investors took the view that it was successfully revolutionising the estate agency business. Unfortunately, lots of secondary mover businesses have also set up, competing away the super-normal profits in the UK whilst Purplebricks were spending all that first mover profit on loss making overseas expansion. The CEO has gone and investors are now regretting not selling when they had enjoyed a five-fold share price increase. The wonders of hindsight!

Amongst the largest companies of today are Apple, Microsoft, Google and Amazon and we all know why. To illustrate their penetration into everyday life, I have used the first three of these in the preparation of this article. Then there is the social media revolution involving Facebook and the like, with ‘youtubing’ now being an advertising career based upon followers rather than subscribers, making millionaires out of teenagers. Additionally, we have witnessed the move into domestic TV-on-demand and box-set binging that we are all able to do instead of making do with scheduled terrestrial TV.  All of these are examples of technology-enabled consumer evolution and all have delivered investment opportunities and disturbed the incumbent status quo.

Last week, we wrote about Uber and our incredulity with regard to the valuation and the fact that the prospectus stated that the business may never make a profit. Despite this, the flotation succeeded and the likes of PayPal took a $500m stake (although the share price has been volatile as Trump has been spooking the market over his Chinese trade negotiations). The key here is not what Uber achieves today, it is what it could become in the future with self-driving cars and a captive passenger who can be sold to whilst travelling. Investors, and PayPal, are obviously prepared to gamble on that future.

The same can be said of battery technology. The company that creates a rechargeable battery powerful enough that mobile phones only need charging once a week, or enables electric cars to travel for as long as petrol fuelled cars, will be the largest company in the world. The same goes for artificial intelligence applications. Many of us will experience the frustration of poor service from call-centres and being passed around a large organisation where no-one appears to be able to or want to help. In time, artificial intelligence will provide this, but as we have just seen tragically with Boeing, allowing the machine too much control can be catastrophic.

We wish we had the answers as those who do will be the billionaires of the future. Observing all the security paranoia over Huawei at the moment, just imagine if China became the source of these inventions and not the US? In fact, electric car sales in China were twice that of the US to December 2018 (Source: Google not Baidu, the Chinese equivalent) but that is probably influenced by the availability of US oil reserves, population density and the US desire for gas-guzzling pick-ups. So, as Android enabled phones stop supplying US applications as part of the Huawei/trade negotiations, will China really care that much if they have their own alternative with equivalent functionality?

The US is feeling that its global dominance is under threat, having had it all its own way for so long. This is no bad thing and they should be the last to complain about being such advocates of free market competition and capitalism. However, that is probably only okay whilst they are the dominant player. We recall China quietly landing on the dark side of the moon in January, just after Trump had announced his planned space force for near space US domination. Observe how US western allies, including the UK, are being careful not to aggressively join the anti-Huawei US assault nor support the US aggression towards Iran. These are all potential allies of China (and Russia) and smaller nations need to be careful how they play their cards.

This influences investment as most equity portions of portfolios are significantly exposed to western businesses. If the future technological revolution is going to come from the east, and the west may subsequently be in decline, then we need to take action. However, access to Chinese equities for overseas investors is highly restricted, being Chinese citizen only ‘A’ shares, foreign currency ‘B’ shares or Hong Kong listed ‘H’ shares which are freely available to foreign investors. The best route is to buy a fund as these are allowed access in certain circumstances but investors should be wary, as commercial law and state interference is not as we know it in the west, hence all the Huawei interest.

Clearly, the US is using any means at its disposal to protect its global monopoly on technological evolution and has been accused by China of being a bully in the latest trade negotiations where intellectual property theft is a perceived stumbling block. We are all familiar with the importance and demand from the east for our universities and fee-paying schools – this will be all part of the centrally controlled future strategy of the People’s Republic of China. Regardless of your views on the political system, western democracy is hardly covering itself in glory at the moment. Meanwhile, under the bonnet, there is a technological war going on which will define the winners and wealth of the future.  As investors, we need to keep a very close eye on this as the US plays hard ball with China. History has seen the rise and fall of many seemingly invincible empires and that significantly influences investor returns.

 

Sterling slumps as cross-party Brexit talks fail

Sterlings recent struggles continued last week as Brexit discussions between the Conservatives and the Labour broke down. Weeks of talks between the two parties have failed to yield any positive results despite the next parliamentary vote taking place in just two weeks’ time. Jeremy Corbyn has said that he will vote down the deal once again which means that a Tory leadership contest (where Boris Johnson is clear favourite with the bookmakers) or a general election now look increasingly likely. Sterling finished the week -2.3% lower against the Dollar at $1.273 and -1.6% down against the Euro at €1.141.

The FTSE100 took full advantage of the weakness in sterling with the domestic main market rising by +2.0% whilst the more domestic focussed FTSE250 closed the week +0.7% higher. In the US, the S&P500 dropped by -0.8% after China imposed retaliatory tariffs on $60.0bn of US imports whilst in Japan, the Nikkei fell by -0.4% following a downgraded assessment of the economy by the Cabinet Office. On the Continent, European bourses rebounded from the previous weeks’ lows with the German DAX30 and French CAC40 concluding the week +1.5% and +2.1% higher respectively.

In the commodity markets, oil markets continued to edge higher on rising tensions in the Middle East. A number of incidents have taken place along the Strait of Hormuz in recent weeks including an attack on two Saudi oil tankers. Brent Crude rose by +2.3% to $72.21 a barrel and is up more than +30.0% year-to-date. Gold declined on the strengthening dollar with the precious metal dropping by -0.8% to $1,277 an ounce.

Given the uptick in global uncertainty last week, it was unsurprising to bond yields pull back last week. Domestically, the 10-year gilt yield declined by 9 basis points (bps) to 1.04% as no-deal Brexit fears mounted. Meanwhile, the US treasury equivalent fell 6bps to 2.39%.

 

The week ahead

Bank of England Governor Mark Carney and several of his MPC colleagues testify before Parliament tomorrow with the main focus of the discussions being around the UK’s economic outlook. In terms of domestic data, CPI inflation (Wednesday) and retail sales (Friday) are the main numbers to keep an eye on this week.

In the US, the Federal Reserve releases the minutes from its most recent policy meeting whilst Chairman Jerome Powell presents at the annual Financial Markets Conferences in Florida. Notable data includes existing and new home sales and durable goods orders covering April. Flash PMI readings are the standout data from the Eurozone with the EU Parliamentary elections likely to dominate the newswires throughout the week.

The most significant release from Japan this week has already arrived with Q1’18 GDP growth left unchanged at the previously calculated +0.5% (quarterly). Chinese activity is limited on this occasion.

 

Past performance is not a guide to future performance.

Data sources - Datastream and Forex Factory - Accessed 20.05.2019

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