January 2021
Dear Investors, Dear Friends,
Markets
After a year of almost no volatility in 2021, January 2022 brought a clear break in market behavior. Fears of a new surge in inflation have pushed up bond yields and pushed down most stocks (S&P 500 -9.22%, Nasdaq 100 -14.20%, Euro Stoxx 50 -3.76%, CAC 40 -2.62%).
This is reflected in the performance of most sectors, with most of them declining sharply, while those that theoretically benefit from the resurgence of inflation and rising interest rates (energy and banking in particular) have soared since the first trading day of the year.
In this context, Total Energies soared by +14.81% over the month and broke the EUR 50 per share barrier, which had not been reached since January 2020.
We mentioned at the end of last year that a downward trend had set in on some sets of stocks (notably the winners of the lockdown period), and that this decline was being disguised by the growth of indices that were near their historical highs. This did not stop in January, with the former favorite, Zoom Communications, for example, down another -25.61%.
But then, why the sudden burst of volatility? It is always difficult to identify a single reason, but after experiencing many such episodes, we can make a statement about the general context that accompanies these trends. First, periods of low volatility generally mean that investors share a relatively uniform view of the market and the economic situation over the next six to twelve months.
Conversely, periods of higher volatility, such as the one we are currently experiencing, generally reflect conflicting views about market trends and the future of the economy. These divergent views are then reflected in more extreme movements in stock prices, interest rates and even currencies. A perfect example might be the February/March 2020 episode.
As the global economy came to a complete halt, due to the unprecedented pandemic, volatility reached levels never seen before, not even during the financial crisis of 2008, when there was a systemic problem. This was rational, because while some could argue that economies would enter a deep depression that would last for years (at the time, no one knew if or when vaccines would be available), others thought that it would only be transitory and that governments would come to the rescue (which is what eventually happened).
To accommodate such different views, prices, inevitably, had to go through extreme fluctuations, to the point where, at one point, future oil prices were negative.
The belief that inflation may not be as transitory as hoped was reinforced in January. This led to sharp price adjustments in long- term bonds (the 30-year U.S. Treasury note had its worst weekly price decline on record), stocks and currencies. In the space of four weeks, we went from a consensus view that the U.S. Federal Reserve would raise interest rates only once in 2022 to a new, equally consensus view that it would raise rates at least four times, perhaps even five. At the same time, in early February, the European Central Bank also announced that rate hikes were not off the table for 2022.
Given this rapid change in perspective, it is not surprising that volatility has made a violent comeback at the beginning of the year. Although we do not invest with a specific macro orientation in mind, we still remain attentive to the macroeconomic situation and its potential effects in the short and medium term. However, we are very confident about the outlook for inflation recovery.
Firstly, because, as you know, and contrary to the majority of market participants, we are among those who believe that inflation was and still is transitory and should be partially channelled by the gradual return to normal supplies chains, which remain highly disrupted by the March 2020 global economic shutdown.
The other factor that reinforces this analysis is that China is currently experiencing the biggest real estate crash in its history. This is not well publicized, of course, because it is happening in China, which is governed by a single party where information is very controlled, but also because China is a financially closed economy (foreigners hold very few assets). The impact is therefore mainly felt within the country, even if it is enormous. Chinese citizens with assets concentrate, on average, 80% of their wealth in real estate, which means that if prices fall by 30% (which is a reasonable order of magnitude given the current situation), the negative effect on wealth will be extremely large. Given this crash, it also seems complicated to consider a sustained and lasting inflation, especially on basic materials.
Secondly, and more importantly, because our philosophy is, first and foremost, to identify companies that can weather these external events, whether sporadic or cyclical like inflation (and which are, in any case, unpredictable). For example, we believe that Visa and Mastercard are excellent hedges against inflation because they charge a commission on each transaction made through them. Mechanically, an increase in prices, due to inflation, will result in an increase in commissions.
We also consider that companies such as LVMH or Alphabet have sufficient pricing power to pass on the effects of inflation, and therefore ultimately to the consumer. Inflation, if it were to return, would therefore only be an additional adjustment variable that we would take into account in our selection criteria, but probably not a real threat to the economic health of the companies in our portfolio.
Now, let's be clear: January was not a smooth ride for our portfolios, as the major rising sectors (basic materials, energy and financials) are excluded from our investment universe. After a great 2021 vintage, it is perhaps not a surprise to be going through a period of underperformance, which we anticipated in our last quarterly letter. While it is impossible to say how long this might last, it seems to us that the main thing is behind us, as the majority of companies impacted by the correction are approaching historically low valuation levels. We have already used the analogy of the Tour de France, which remains very appropriate: to win the Tour, you don't have to win all the stages, you have to be the most consistent!
Also, and to answer the questions of some of you concerning the excellent performance of certain sectors, it seems important to us to recall that these are mainly the sectors that had suffered the most in 2020 and generally rebounded less in 2021. For example, to return to one of the flagship positions in the energy sector, Total Energie, which posted an excellent month of January; the latter is finally only returning to its January 2020 level! So we are obviously not changing our approach and our long-term vision to trade our positions in good companies that continue to grow year after year in order to invest in oil companies simply because they are in the spotlight and benefiting from the price recovery, for the moment..
In this early-year context, the FFM European Selection fund fell by -13.44% over the month and the FFM American Growth fund by -13.50%.
Our portfolio holdings
As with our previous editions, we would like to take this opportunity to provide an update on some of the companies we hold in our portfolios.
PayPal
After each quarterly result, we listen to (or read) the management's speech. Often, the discussion with analysts offers more explanation than the raw numbers released just before. In 90% of the cases, the discussion allows us to reassure ourselves about the situation, in case of a bad surprise. This was not really the case during this quarterly call, where the management announced a sudden change of strategy from a goal of increasing the number of users to a new goal of increasing the revenue per user (in short, the goal of reaching 750 million users by 2025 was dropped). We were already surprised when a possible takeover of Pinterest (a social network) was mentioned at the end of last year, before being denied. Similarly, the impact of the end of the exclusivity agreement with eBay (which PayPal parted ways with a few years ago) was supposed to have been digested and yet executives are now explaining that it will have a material impact again this year.
As you can see, this was not necessarily the message we were expecting. That said, PayPal is probably also getting back to normal, after having benefited greatly from the pandemic. The improvement in the pandemic situation meant that this fourth quarter was going to be complicated for this type of company anyway. On the other hand, the number of users increased by 13% year over year and payment volume increased by 23% over the same period, in line with the objectives of the company's executives. Today, PayPal has a network of 390 million consumers and 34 million merchants and the company is no longer a simple payment button, but rather offers complete solutions for the entire purchase payment process (seller and buyer protection, marketing solutions, electronic invoices, etc.).
In this context, and the damage being done, we have decided to keep PayPal shares and to reassess the situation when the next results come in. Impatience is a very bad advisor in these situations and PayPal has rarely been this cheap, which should provide a solid base for the share price.
Facebook (Meta)
Here, the story is a bit different because, while the results were totally in line with expectations, it was the management's forecasts that were more conservative compared to analysts' expectations. Indeed, in order to counteract the advances of TikTok, a platform of Chinese origin competitor, Meta decided to focus on its Reels offer (similar to TikTok's content, short videos) at the expense of its Feed and Stories offers. The problem is that, for now, Reels is much less monetizable than Feed or Stories, which will impact the company's revenue. Such a change is not new for Facebook/Meta, which already had to negotiate the transition from desktop to mobile and, precisely, from Feed to Stories ( in the same time doing a cannibalization of its rival Snapchat's offer) and we think that this delicate transition will be successfully negotiated by Meta again.
It is interesting to note that the executives have put a lot of emphasis on the fierce competition from TikTok, which has had the gift of scaring investors. We think that this competition is real but that Meta insisted particularly because the company is accused, in the United States, of a dominant position on its market and must regularly go under the knife of Congress and the various government agencies in charge of competition. But how can you be accused of a dominant position if there is strong competition? We believe that the message was as much dedicated to the people in charge of the various investigations as to the financial analysts. In this context, and given the management's track record, we believe that this weakness will be temporary.
Netflix
Clearly, Netflix's Q4 2021 earnings announcement, proved to be very complicated, at least from a stock price perspective. After reading the results in detail, we didn't find the numbers as bad as the rest of the market and we note, with interest, that a large hedge fund used this weakness to take a significant position in the company, which actually allowed the stock to recoup some of the losses.
Soitec
Soitec's underperformance was totally unexpected and came about when the company's executive committee wrote an open letter to the board opposing the appointment of the new CEO. This rare public fight hit the shares hard but did not impact the company's operational performance, which remained unchanged.
With best wishes,
Fisconsult Fund Management
For more information, please email contact@fisconsult-sinews.com