Chinese stocks have continued to sell off over the past few weeks and last week Europe and the US even joined in the fun. The news flow have become increasingly negative and worries around: 1) Fed tapering, 2) Covid resurgence, 3) Chinese reforms have painted a bleak picture of the future. Some of the fears I had earlier in the year are coming to pass but like always, it's the bus you don't see which hits you. And like always I was early to exit the party and early to arrive at the new one - the trimming to 60% equity exposure by early 2021 followed by an increasing allocation from May after BABA's valuation became tempting.
Our portfolio have performed poorly in this environment with the heavy exposure to Chinese equities (50% ex and >60% inc Chinese oil & gas stocks) and >30% oil & gas related exposures. Fortunately we had no direct exposure to Chinese education, games, liquor or healthcare sectors. Unfortunately everything has been selling down. Even E&P and Refining stocks have been victim to virus fears despite showing strong recovery in profitability, optimistic forward estimates and rational supply side actions. Additionally our previous Cash+ idea: PSTH, suddenly found itself the target of a ridiculous lawsuit - that it operated as an illegal investment company because it kept cash in money market funds and short term Treasuries. Until this lawsuit is ended, PSTH will find it hard to engage in any merger discussions (uncertainty risk to targets) or return capital (Ackman wants to return PSTH monies with SPARC warrants attached). Despite being the fairest SPAC structure and revolutionising the PE capital raising process, these villains went after PSTH instead of the pumpster dumpsters like Chamath. Late last week PSTH traded a few % points below $20/share - the cash one can expect to receive if the SPAC was closed or if one opted out of any proposed merger transaction. In a normal environment I would hold onto PSTH for the SPARC warrants (rationale: https://www.investin1.com/post/spac-vs-sparc-the-ackman-difference) but the lawsuit has thrown a wrench in the works and the discounts on other ideas is too large. We will recycle PSTH capital at a loss and potentially look at acquiring SPARC warrants when they eventually list.
Despite the red ink on the performance numbers, I am excited by the return potential of my portfolio today. The low end of the valuations for my holdings are well >50% and/or offering high single digit dividends. The fear in the air is palatable and the Market seems willing to sell at any price. Everyone claims they will buy when there is blood on the Street but if that was the case there would never be any blood. As a bottom up, fundamental, contrarian stock picker the current risk/reward payoff is a screaming prime rare steak and I'll rather take my bites early than fight for scraps later.
One of these underpriced stocks is CNOOC which reported its 1H21 results last week of RMB33bn NPAT from an average oil price realised of US$62/bbl (my estimate for sustainable oil price is $50-$60/bbl see: https://www.investin1.com/post/away-from-the-crowds). So at the current MCap of RMB290bn (with RMB30bn net cash), one is paying <5x "normal" PE and getting a 7-8% dividend yield (30% payout) for one of the lowest cost producers in the world. This is a company that made RMB30bn NPAT in 2020 on just $40/bbl oil! CNOOC has been one of the few E&P players which over the past decade has grown their reserves at mid single digits each year (costing ~$5/BoE Proved Reserves) whilst still increasing production at low to mid single digits every year! It is a quality company at a cheap price in the low risk part in this industry's cycle. The risk of absolute loss seems limited while the upside is substantial.
Am I worried about the Markets? Always. But my fear isn't in the beaten up E&P and Chinese stocks. I think eventually those fears will prove to be transitory. The bigger risk that has haunted me for the past year is yet to pass and that's the popping of the liquidity bubble/low interest rates and the contagion effects that follow. This risk is summed up nicely by the 13Fs in 2021 of the excellent Michael Burry (Scion Asset Management) who has increasingly added to his large leveraged bets against interest rates, duration and liquidity fueled asset bubbles. While the timing is uncertain, I agree that the ultimate direction is inevitable. A fantastic interview with Larry Summers and Ray Dalio (link below) is further food for thought. One question to consider: what happens if there is not sufficient demand for US Treasuries when the Fed cuts back its buying?
This seemingly puts my current portfolio positioning of 110% long equities (and 10% short) at odds with this view. The way I see it, I have at least 30-50% of dry powder (20% portfolio liquidation of 'safe assets' and the remainder from gearing) which can be deployed in a severe market correction. Also the assets I hold are already at depressed valuations for reasons unrelated to interest rates. If inflation takes flight and the market panics on US monetary actions (or lack thereof), who's to say where capital flows go? There are worse places to be than in businesses priced at mid single digits to teens cash earnings multiples growing with an expanding domestic demand driven economy and where monetary and fiscal policies have ample room still to maneuver. Markets are singular in their focus and short on memory. Today's bogeyman become tomorrow's friend and vice versa. Don't believe me? Just ask the US.
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