Macro insights for specialist investors


What’s your citadel?

Last week I attended the MoneyWeek Investing Conference in London, called Protect and Prosper.  Insights were mostly macro-based and it’s targeted at private investors. As a specialist medtech investor, why did I go, and why is it relevant to this blog?

With a circulation of circa 50,000, MoneyWeek is the UK’s “best selling financial magazine” and contributors include professional investors and ex-City/ finance types. Once a year they put on an investors conference highlighting the thinking and ideas from their team (including some refreshingly contradictory views).

As I wrote in an earlier blog, its important for specialist investors to broaden their horizons, and at least consider what’s going on beyond their immediate sphere – even if it doesn’t have a direct impact. So, this was part of my regular time aside to consider broader views.

Pre-conference, I was uncertain about who I might meet amongst other attendees, but the calibre was high. In the breaks I met: a retired financial director who managed a $1 billion pension pot for his company; a serial entrepreneur who sold his last company, a fire safety equipment manufacturer, for $millions; a property manager and investor who’s recently focusing on multi-lets to boost his London rental yields; and an ex-IFA with a high ethical barrier and lifetime of investing experience. I was in good company.

Many areas were discussed in the presentations, including as one might expect for a finance magazine, views on the relative merits of gold in your portfolio (most agreed, as portfolio insurance), to residential property (sell what you don’t live in). All good and interesting.

But as a specialist investor, there were 3 insights that particularly hit home. These are every bit as relevant to my investing as healthcare reform and the 2.3% medical devices sales tax. In the order they came, here are the 3 insights:

1. Lower than low – bank interest rates

The opening speaker, Merryn Somerset Webb, as part of her introduction to the day, put up a chart. This was of bank interest rates since 1700 to 2011. The chart showed that bank interest rates are the LOWEST they have ever been since recorded history of bank interest rates.

You probably know this already. It’s been written about plenty in the press. In broad terms, I was aware interest rates were at an all time low (didn’t realise since 1700!). But too much repetition of a claimed critical thing seems to lead to fatigue. After a short while, Armageddon doesn’t arrive, and human nature being what it is, leads us to relegate such information so we can get on with our daily lives.

But as you also probably know, financial cycles can move slowly, very slowly. So much so that the new just becomes the status quo. And thus it seems with interest rates. Yet, if you have ANY belief at all in regression to the mean (I do), then this artificially low rate can’t continue. All you end up doing is backing up the underlying problem for someone else to deal with. In many ways this is like quantitive easing, instead of letting failing banks businesses fail.

Now, I’m not an economist or market analyst, and others write much more eloquently about the risks of such low interest rates. But I DO get it leads to bigger problems tomorrow.

2. All prediction is speculation

“Prediction is very difficult, especially if it’s about the future” – Neils Bohr

The second insight came from a guest speaker, Dylan Grice. Dylan is a global strategist at Societe Generale (and previously Dresdner Kleinwort’s director of proprietary trading). I figured this guy is still active at the investing coal-face, so he might know a thing or two.

Dylan opened his presentation with a picture of an ant climbing a blade of grass. The ant, seemingly possessed, climbs the blade of grass to the top, falls off, then does it again. It goes in a relentless cycle, up and down, up and down. Why? To get eaten by a cow. WHY? Because it’s infected with a parasite called the Lancet Liver Fluke – the fluke enters the ant’s brain and “takes-over” command, turning into an auto-pilot, grass climbing frenzy. Mind control, if you like.

Now, it’s clearly not in the ant’s interest to get eaten by a cow, let alone all the waisted energy expended climbing blades of grass. But it IS in the fluke’s interest – the parasite needs to enter a cow’s digestive system to complete its own reproductive cycle.

The point of all this was to draw an analogy to financial soothsayers or pundits. They tell you they can predict the future, and yours by the way is looking particularly rosy if you just invest in this or that. Usually “this or that” has some element of commission involved for the pundit – that’s how they make a living. So, it’s good for the pundit, but not so good for you or your financial future.

The art of prediction has a long and illustrious history across many walks of life. In investing, its akin to chasing the next hot tip. Think about it. If someone really had an insight on a particular situation where he or she could profit from it materially, would they want to share it with you? At the very least they might position themselves first before sharing the tip. Commission based advisors rarely do this.

In my own investing, I focus on medtech stocks using a value based approach – described in Medtech Value Investor’s Magic Number. I look at several factors – high ROE, low valuation (through PE or EV/EBITDA), low debt to equity, and a long history of steady upwards earnings trend. I even look at 1 yr forward earnings to make sure the trend is in the right direction (a fall in EPS is an automatic disqualification).

But what I NEVER do is predict. I have no view on the future, other than it might be here tomorrow. I look for a big enough margin of safety, so if the underlying business continues to perform as it has for several years, I should do OK. If it dies, any one situation will not kill my portfolio.

So, read widely, even listen widely. But ultimately, believe in your own counsel – an investor lives or dies by the sword of his or her own decisions.

3. Capital preservation

The final insight came from Simon Caufield. Somewhat sensationally (I thought, at first), he titled his talk: “The coming 70% crash in stocks.”

What attracted me to Simon’s talk was his background. He had previously founded and built up a company devising pricing and profitability management for financial services companies (existing readers already know how I feel about entrepreneurs – you guys are cool). Then in 2007, before the Lehman crisis hit, he sold up and took ownership of his entire pension pot into his own hands. One who eats his own pudding.

Simon got into quite a bit of technical detail, beyond the scope of this post. But an overview – he focused first on the level of countries’ debts, and that private sector debt considerably surpassed even public sector debt. The UK here is particularly unhealthy. Then, he showed through a series of charts and datasets, that throughout history, increasing earnings and increasing asset prices were in general driven by higher levels of debt. And conversely, when debt levels contracted, so did earnings and asset prices.

The charts constructed showed a function of debt correlated with various other measures – house prices, company profits and share prices. Though, to make the test tougher, they weren’t correlated with just debt levels, nor even change in debt levels (the lag could make it easier to explain away the effects with other factors). Instead, he focused on “debt acceleration” – how much faster is debt going up or down? A much tougher test.

According to his charts, the best time to buy is when debt levels go from low and are turning up. The worst time to buy (or the time to sell) is when debt levels have peaked and turning down. The last debt bubble burst 5 yrs ago, in 2007, and is still very much in debt-deflating mode.

Using the same approach, he suggested fair value for the S&P 500 was around 900-950 – around a 30% drop from the current level of 1315. But markets, when they correct, don’t just revert to the mean. They usually over-correct on the up AND down side. This means a correction from current levels could be much more severe. Even 70% – who knows?

Without giving away his specific recommendations, his underlying message was clear: PRESERVE CAPITAL, and WAIT – for potentially the best buying opportunity of our lifetimes.

Does this affect medtech? Particularly, given that I focus on well-established companies with long earnings histories, defendable barriers to entries and strong balance sheets? YES. It still matters. What I learned in 2008 is that even prices of quality assets fall when the market tanks. Everything gets hit. Often, investors have to sell prime liquid assets at undervalued prices, just to meet margin calls on other holdings (I don’t use leverage, but many investors do).

And of course, when things get that bad, most folks get sick of stocks, and just want to “get the heck out.” That’s the time to buy big – when there’s (investing) blood on the streets.

In summary then, some really valuable insights and food for thought that affects this specialist investor. Will I still buy stocks – of course, yes. But perhaps I’m already heading the way of the post? My (v. modest) portfolio is currently around 40% invested and 60% in cash. Not because I had great insights already. But largely, my current “default setting” is already wary, and my margin of safety is steep. Only limited situations qualify. Time to wait.

Posted by Raman Minhas.

Images: lonley planet, MoneyWeek

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One thought on “Macro insights for specialist investors

  1. Pingback: Millionaire Teacher: Index investing for medtech specialists | Medtech Value Investor

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