Echoes of Neglect?: A Playbook For All Time

By
Douglas Isles
,
Investment Specialist, Platinum,
08 Jul 2013

It is often said that history does not repeat, but it does rhyme. Investment specialist, Douglas Isles, reflects on some of the key messages from Platinum’s quarterly reports written in the 1994-1999 period, many of which are remarkably pertinent today.

While reading through the Quarterly Reports written by Platinum's founder Kerr Neilson in the 1994-1999 period, it is remarkable to note how many of the comments appear as if written recently or perhaps, in the near future!  That five year period was strong for developed markets culminating in the technology boom, its bust and the challenges that followed.  There is no substitute for experience and a deep understanding of history.

One of the oft-quoted and most dangerous sayings in markets when confronted with an exciting concept is “this time it’s different”.  At Platinum, the approach of seeking neglected stocks, leads to eschewing fashion and hence these words can ring alarm bells with us.  It is also true that when analysts are presented with something that is new (albeit only to them), their enthusiasm can be at odds with the opportunity.

This exercise started as a curiosity to read through the reports of a time long past and to learn from Kerr’s experiences.  As I read further, the familiarity became stronger than the differences in many ways.  What then set-out to be one or two quotes cascaded into an avalanche of quotes.  However, it is the volume of similarity that in many ways becomes the most important point and I have grouped some of the quotes together under topics that resonate today.

To learn from these past events, requires one to contemplate the current environment and make the appropriate linkages.  While I have my own interpretation, the exercise is more valuable when one ponders your own view of the present and reconciles it with what has gone before.  My take may be different from yours but the idea is to make one challenge their existing beliefs.

Sharing these quotes aims to evoke the picture of a market that echoes; sometimes substituting a country, industry company name for another is necessary to make the echo clearer, while other times it is a straight parallel!.  Those who can hear the patterns of the past are best placed to capitalise on the future.  Appropriately weighting of the past and the present is the key.  Mark Twain noted that “History does not repeat itself, but it does rhyme”.

The echoes, in several cases, are particularly loud at the moment! 

The Price of Certainty

“We have no preference for so-called “blue chips”, for in many instances their valuations fully reflect their intrinsic qualities and there is no margin left from which we can benefit” (1994)

“In a year where the world’s very strong businesses saw their premium ratings move to spectacular new highs, our neglect/ value approach was unlikely to match the MSCI” (1995)

“During 1996, the US market was driven by stocks that we would tend to avoid…this narrowing of interest to companies which was already highly rated is reminiscent of the “Nifty Fifty” era.” (1996)

“Clearly those who follow a more conventional path of pursuing nearby earnings visibility, have done better than us over the last 18 months. We do not believe that this pattern will necessarily hold going forward” (1997)

“The stock market is creating its own folklore involving the open vistas of opportunity available to multi-nationals” (1997)

“Wall Street is providing little latitude for uncertainty” (1998)

“The clear risk we are running at present is that the US markets breaks to yet higher levels as investors chase “nifty” type stocks which then reach even more exultant valuations a la 1971-73” (1998)

“The problem… is the high valuations being given to the leading companies in each market [in South East Asia]” (1998)

“The true growth companies that will ride out the recession in Asia are no cheaper today than they were before the crisis. Regional funds with dedicated portfolios have treated these as a place of refuge” (1998)

“The weak are being pummelled while the strong applauded… The origins of this dichotomy lies, we believe, in the deflationary tendencies that are so evident” (1998)

“Turning to the “Western markets” we can observe a narrowing of leadership and a preference for companies with seemingly clear growth prospects. Here one identifies well-known brand type companies.” (1998)

“Investors preferring to pay high valuations for large, predictable earners in preference to their smaller, though equally steady growing, brethren” (1998)

“Given our philosophy to invest in under-priced, neglected stocks it is evident we find the oppressed more interesting than the lauded” (1998)

“It would be surprising if the dispersion in valuations between perceived good and bad does not narrow” (1998)

“It has not come as a surprise to see several high profile companies such as Gillette, Proctor & Gamble and Coke cautioning analysts about their current prospects” (1998)

“There are a large number of smaller companies which have sound growth prospects and balance sheets and yet which are being treated as pariahs in a world that favours large corporations” (1999)

“The gap between price-taking enterprises and those with price-making power had simply widened too far” (1999)

“The market has systematically migrated from one set of favourites to another with the last bastion of hope being the information technology sector. Two years ago we wrote about the over-valuation of the very highly rated consumer stocks such as Coke and Gillette and these indeed have subsequently been weak performers with their prices having gradually drifted down by over 35%” (1999)

Technology

“Our principal themes relate to changes taking place in the computer industry” (1994)

“Apple Computer has a terrific franchise built on the ease of use of its operating system and hardware” (1995)

“In its excitement for the high growth promised by specific segments of the information technology industry, it is common for the market to pay more than twice the multiple it ascribes to IBM” (1995)

“E-commerce is now on the cusp of more general usage and thus could invigorate the existing excitement in the trading of internet related shares” (1999)

“This gold-boom like mentality could build into an even greater frenzy” (1999)

“It is not necessary to change one’s investment style to participate in the IT euphoria, but rather to continue seeking those companies which will show inherent growth but which are not directly in the spotlight” (1999)

“Positive cash flows are rare but the potential of a cyberlinked world is all” (1999)

“Having looked at a wide range of offerings, we concluded that the most attractive way to pursue the inevitable growth of e-commerce is to search for those companies that are not directly in the spotlight and yet will play a significant role in facilitating its advance” (1999)

“Unlike some areas of the internet, the roadmap is fairly clear and Ericsson’s place in the market reasonably well defined” (1999)

“Cisco paid $6.9 billion for a two-year old start-up with virtually no sales, which has developed clever mathematical solutions in the field of routing” (1999)

Japan

“[Japanese companies] have come to realise that the days of very cheap funding are over and that they now need to pay more heed to shareholder needs” (1995)

“Japan has been the focus of most of our investment efforts with our holdings in that market doubling to around 20%. The emphasis has been on exporters which should see a strong recovery of their profits as a consequence of a more competitive yen. We are also finding some very interesting opportunities in companies that will benefit from the restructuring that is now taking place in the country” (1995)

“It is precisely this deterioration in general profitability in Japan that gives us confidence about that market’s attractive prospects” (1996)

“The Japanese stocks we hold were chosen precisely because they were either already internationally competitive or as domestic orientated companies had begun to emphasise profitability rather than market share alone” (1997)

“Such is its savings and wealth creation that it is the largest owner of US government debt” (1998)

“The Japanese companies we recently visited showed a keen awareness of the need for change” (1998)

“We have bought put options on Japanese government bonds (JGBs) on the basis that the support being rendered to the financial system is tantamount to the socialising of debt which inevitably must debase the real value of their currency” (1998)

“The lifetime employment “contract” is now proving to be one of the greatest impediments to the efficient working of the Japanese economy” (1999)

“The Japanese market has been the recent wild card. Happily many of our views are now more widely accepted. Barely a day goes by without an announcement of further restructuring and capacity closure” (1999)

“The relative problem of “under-consumption” by the Japanese shows up in its still immense trade surplus where exports are holding pace in value terms with strong imports” (1999)

Developed and Emerging Markets

“Rapid transfer of technology and vast discrepancies in salaries between the developed and developing world should result in the latter growing faster than the former, we do not necessarily prefer so-called emerging markets to traditional markets” (1994)

“The January 1995 mini-crash in emerging markets highlighted the risks of dependability and liquidity. Valuations following these declines are now more sensible but concern about liquidity and rising interest rates will retard higher valuations for a while yet” (1995)

“The rise of the new Asian middle class is one of the most dramatic social revolutions of our time” (1995)

“This movement of capital and know-how from Japan, and importantly also from other industrialised countries, added massive impetus to the development of Asia and created colossal capacity in the manufacture of traded goods… We believe that this laid the foundation stones of the low inflation that now prevails by mobilising resources that were previously untapped. Out of this massive transference of resources grew the impression that Asia had a future of certain and high growth. This encouraged further investment in the production of basic commodities – steel, cement and bulk chemicals. The net result of these developments has been an error of expectations and an improvement in terms of trade of several significant Western economies. The resulting flood of goods has made life pretty miserable for those competing against these imports.” (1997)

“The precipitous decline in many of the markets in the Pacific Rim reminds us how confidence can shear.” (1997)

“Quality listed companies in South East Asia and Latin America are now found trading on low trailing PEs, typically 7-12x” (1998)

Yield

“The big driver for equity markets in the last six months has been the continuing fall in the yield of government bonds in all major industrialised countries” (1995)

“The striking feature of the developed markets in the first half of 1996 has been the divergence between equities and bonds. At a time when bonds have delivered zero to negative returns, shares have typically appreciated by  7-10%” (1996)

“Short term interest rates have already begun to rise in the US and with the price of capital being increasingly homogenised internationally, there is the risk of higher cost of capital in the US impinging on the valuation of markets in general” (1997)

“The search for yield is greatly benefiting Latin America” (1997)

“The problem now facing investors is that their cash deposits are earning seemingly meagre returns at a time when they observe others capitalising on the rising valuation of long duration assets (especially equities)” (1997)

“Facing the same hunger for yield witnessed in the States, Italy surged” (1998)

“The hunger for returns in the face of low nominal yields continues and is focussed increasingly on those few remaining market segments that can produce exciting revenue growth, namely info tech stocks in general, and internet stocks in particular” (1999)

“Equity markets will respond with alacrity to an environment of positive earnings surprises and the absence of attractive alternative investments, notably, cash or bonds” (1999)

Liquidity

“Observers point to the “eternal spring” of mutual fund flows as the main driving force behind this surge” (1996)

“The spectacular earnings gains of the nineties, which have captured the imagination of investors, should be viewed in terms of a longer history. These gains were off a low base and have been fuelled by a weak dollar and a significant decline in finance costs” (1996)

“Though we continue to have difficulty finding companies that make attractive investment sense, the underlying environment is positive for financial assets. Even in countries that have bad records and who have seen large depreciation in their currencies in the last four years, are experiencing unusual price stability. Liquidity remains plentiful as European central banks stay highly accommodative…the Japanese continue to price money at close to zero interest cost” (1996)

“The benefits of cheap money are coming through and growth is apparent on the broadening front” (1997)

“The lack of price pressure caused by abundant capacity should continue to encourage Central Banks in most of Continental Europe and Japan to maintain easy money conditions…..Even as growth synchronises, cost pressures in the laggards (Japan and Mainland Europe) will be held in abeyance by virtue of still under-utilised resources” (1997)

“In this environment, valuations of stocks will play second fiddle to the tidal wave of money that is seeking higher returns” (1997)

“Flows suggest most foreign investment managers have capitulated on the US……With the US market carrying a weight of nearly half in “the official investment universe”; the MSCI, make it hard to argue that this is a neglected market” (1998)

“Looking forward the US market looks totally unstoppable on the tidal wave of liquidity which is seemingly also now driving Western Europe” (1998)

“Repeated interest rate cuts by central banks have unleashed liquidity that acts as a lubricant to the market” (1999)

Country and Company comments

“The attraction to foreign investors is [India’s] vast population, a familiar legal system and the fact that the language of business is English. Some saw it as the ‘next China”….Infrastructure is the one great weakness, though this is being addressed through various financial inducements” (1995)

“We have great respect for the remarkable change in the American business and political environment but point to the record level of profitability evident among listed companies” (1995)

“Having been one of the hottest markets in Asia in the late eighties, Korea is now one of the most neglected with PE ratings approximately half those of the rest of Asia” (1996)

“North Korea is reported to be on its last legs, characterised by power and food shortages” (1996)

[a leading European engineering company] “now finds its recently reduced prices being undercut, by Asian producers, by around 30%. To secure its long term position it is entering the lion’s den and setting up joint ventures with Chinese “partners”” (1996)

“There is much hype of a corporate renaissance in the US” (1996)

“The case from Samsung primarily rests with the realisation that this is a truly global company that has demonstrated technical excellence in a broad range of products and is competitive with the big players in Japan and Europe” (1997)

[Hong Kong] is continuing to benefit from the relatively low cost of money (related to its fixed exchange rate to the US dollar) which together with a booming hinterland, is creating unrealistic expectations in its property market” (1997)

“Indonesia is receiving more favourable commentary” (1997)

“At the macro level, Asia has just demonstrated errors of expectations with a super investment cycle” (1997)

“In the case of China, almost overnight a group of countries with a population total of some 350 million people have taken a “wage cut” varying between 20-50% due to currency devaluations. For a country in the midst of economic transformation, as it attempts to raise the efficiency of State owned enterprises and remove an overhang of surplus capacity, this is an unhelpful development” (1997)

[This Japanese company’s] “ products are targeted at leisure related markets which would seem to be growing at rates well in excess of GDP attributable to rising wealth levels and the opening of new markets” (1997)

“Europe is at an earlier stage of economic recovery and transformation” (1998)

“The real dangers of [European Monetary Union] lies in the impostion of a fixed exchange relationship between members ahead of political and fiscal integration…The one-size-fits-all approach in a continent with disparate sensitivity to interest rates, varying fiscal regimes and labour mobility impaired by language and cultural barriers, will create severe pressures early in the next century” (1998)

“Moving on to Kuala Lumpur, we witnessed the same excess with the recently completed twin Petronas Towers, the tallest building in the world (offering 2.4 million square feet of office space) epitomising the boom mentality. The excitement and optimism was at an extreme with capacity being added principally with an eye on capital appreciation rather than recurrent income” (1998)

[In Hong Kong] “tourism has crumbled, hotel occupancy dropped, and the retail scene imploded with most clothing retailers experiencing declines in sales of anywhere between 10-30%” (1998)

“On the subject of China, the emergence of Zhu Rongji as the new Prime Minister is of great significance” (1998)

“The most illuminating observation of market behaviour in the last three months is the way the seemingly dysfunctional markets of Italy and France have performed. Just prior to year end, criticism of the inflexibility of these markets reached a crescendo only to find that within three months they have outperformed most comers” (1998)

“It is hardly an exaggeration to say that the hopes of the world are being carried on the backs of the American “mall shuffler”. The problem with this is that the American consumer has already being doing more than his fair share to support the troubled world’s hunt for outlets for its products” (1998)

“Our principal holding is the Samsung group which has been particularly rewarding. As the standard bearer of excellence in that country and as an emerging micro-electronics powerhouse, the shares have been aggressively purchased as investors’ confidence has returned…They are still not expensive” (1999)

“In Europe and Asia the same picture emerges of oversupply. This will keep the lid on prices for the while.” (1999)

“Asia has surprised professional forecasters with its resilience (in the face of a bankrupt banking system)” (1999)

“Without wishing to be churlish, we feel obliged to highlight the role that debt has played in bolstering activity in the strongest economy of all : the US” (1999)

Currency

“Signs of a major turning point in the US$ have emerged.” (1995)

“With the Yen weakening it will allow companies to recover competitiveness and hence profitability” (1995)

“The Korean market is suffering from the deterioration in competitiveness of its exports in the face of a weakening yen” (1996)

“The supply of yen being created to stabilise the financial system in Japan and the imminent prospect of the formation of the EMU on the one hand, keeps liquidity flooding, but equally it should pressure the US dollar further upwards. This is not helpful for the foreign earnings translations or exports of US companies” (1998)

Portfolio Management

“It is quite clear that misreading [the US] market, was the most expensive decision of the year” (1996)

“Several of our established holdings are now being recognised by the markets and are starting to appreciate” (1997)

“The weight of our funds are in Europe and North East Asia and “everyone knows” that these economies have huge problems so why on earth are we putting clients hard earned wealth in apparent basket cases. Though we run the risk of stating the obvious, we are trying to buy low and sell high” (1997)

Miscellaneous

“Travel, media and other influences are encouraging people to try something different: we are intrigued by the resurgence of cigars and the opening of cigar bars, and the general retro tendency a la Harley Davidson” (1997)

“The problems involved in the “bail out” of Long Term Capital Management highlight the extent of the leverage within the system” (1998)

“The danger lies in the prospect that market participants now over-compensate for their previous cavalier attitude to risk” (1998)

“As consumption and loan growth are increasingly predicated on asset prices, some of which are inflating at alarming rates, it is evident the system is becoming inherently less stable” (1999)

“This is fuelling the “urge to merge” as many companies face the hard edge of deflation / globalisation and seek the benefits they hope to extract from economies of scale and greater reach” (1999)

“When examining developments at an industry level, it is clear that globalisation continues apace” (1999)

 

DISCLAIMER: The above information is commentary only (i.e. our general thoughts). It is not intended to be, nor should it be construed as, investment advice. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances. The above material may not be reproduced, in whole or in part, without the prior written consent of Platinum Investment Management Limited.

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