The Moneyball Newsletter – December 2021

Knowing what you don’t know

The future is getting particularly unpredictable with the lingering virus, the economy and the Fed. How many more coronavirus variants would we expect to be dealing with and which of them are going to result in lockdowns that will dampen the economy? Will the government continue to reopen in spite of all these and how bad things can be if the pandemic continues to spread? In order to counter the rise of inflation, should the Fed take measures that scale back in stimulating the economy? Should they be rising interest rates so as to curb spending and tackle inflation? But by doing so might it be an overreaction to slow down inflation and risk the recovery of the labor market? These are the issues that are clouding the stock market currently and causing analysis paralysis for most investors.

Let us address some of these concerns. We do not know how long the virus is here to stay. But what we do know is that regardless of that, there are some companies that are more Covid-resilient than others and even when variants are somewhat not of a big concern some time in the future, they will also continue to do well. Some of these companies may include Microsoft, Salesforce and Adobe. Whether we continue to work from home more or go back to the office, these companies will still receive their streams of recurring revenue. We have seen for ourselves when things look much bleak in March 2020, these technology/SaaS stocks were among those that recovered the fastest at a time where there was no news of vaccines. The same situation is going to hold true even as we move on to the Delta, Omicron or any other future variants.

So the next question is, are rate hikes bad for stocks historically? History says that it tends not to. Over the last 3 decades, the Fed has raised interest four times and on average, S&P 500 moves 4.5% higher after 6 months and 7.7% higher after 12 months after the rate hikes. There could of course be a combination of factors at play but rising rates alone do not seem to hurt stocks. This would probably be especially true for companies that enjoy pricing power for their products. These are companies that enjoy economic moat such as the likes of Google and Apple where customers have either high switching costs, brand loyalty or do not have any next best alternative. These companies could very well pass on a larger portion of their rising costs to the end consumer while enjoying the same if not higher margins. As the production costs of iPhone increase, you can be sure that so does the price of the shares of Apple that sells the iPhone which its fans are willing to pay for. Inflation is in fact our friend if we learn to own the right type of assets.

Because of the multivariate problems that investors have difficulty in forecasting the future, most would have chosen to stay on the sidelines in this period of uncertainty. Most investors would not be able to grapple with all these uncertainties and to process them in a meaningful manner that is better than the rest. To make outsized gains, you must be able to see something that the majority of the investors overlook. 

Recall that in our Moneyball Investing methodology, we learn to pick out fundamentally sound stocks and to buy them at a good price when the technicals are in our favor. This is time-tested and helps to take the emotions out of the picture. You will be able to make buying decisions confidently at a point in time where the financial media and the masses tell you not to. We just have to have the conviction in knowing that what we buy are good companies and that they have been bought at very reasonable prices. These are certainties that we can put in place for ourselves. On the other hand, we cannot be certain how the stock market will behave due to the ever changing macroeconomic factors or ever evolving coronavirus variants. And as a matter of fact, no one can ever be successful at forecasting things that are all a matter of randomness. The one and only question we need to ask ourselves is whether the company we invest in is going to continue to earn the same or more profits in the future and eventually the stock price will catch up with the answer to this question.

Our belief is that if we learn how to stock pick and stay invested in these underpriced stocks for the next few years, I believe our downside risks would be kept to a minimum as compared to other stocks. 

Buying out-of-favored stocks

The best time and possibly the most profitable thing to do is to buy something that is intrinsically good when no one wants it at a cheap price. Remember that all great investments will start with enormous discomfort. Imagine the gumption needed to be buying UOB at $19.44, OCBC at $8.66 and Ascott Residence Trust at $0.93 months ago in this screenshot in one of our income portfolio. The day to day market movements in the short term are not a true reflection of what the stocks are worth. The fundamentals of a company or asset doesn’t change from day to day obviously.

The market as it is called, is in fact in the short run, the average of the conclusion by all the market participants which results in herd behavior. They influence one another. The greedy gets greedier. The fearful gets even more fearful. This results in sub optimal pricing of the asset. The efficient market hypothesis is far from the truth at critical turning points of the market.

In 2021, we see many such great buying opportunities to load up on some of these unloved stocks such as Adobe, Mastercard, Alibaba and Facebook. They were down from the highs by 20-60%. We seized the opportunity to load up on them. When the odds are in our favor, we bet slightly heavier than usual. We must learn to react with equanimity to price declines of even 40-50% once in a blue moon even for solid stocks. It is possible for good stocks to experience huge drawdowns which its fundamentals will allow it to recover from eventually. Many China tech stocks such as Alibaba, Tencent, JD and Meituan fell sharply where we would say that we are in a situation where the baby has been thrown out with the bathwater. This is not the first time our curated Moneyball Stocks undergo reasonable drawdowns and neither will it be the last. 

Some investors might have thought that after the huge recovery in March 2020 last year, they would have to wait around for a few more years for any great bargains in the market. And they got what they wished for. But as it always happens, most investors would freeze into action when what they hope for is finally coming. The opportunity is right in front of them, but they are too scared to invest. Either psychologically they are not prepared to handle the drawdowns in their portfolio to continue buying into good companies, or that they have run out of any cash to take advantage of such opportunities. That is why we always emphasized the need to take profits off the table either partially or fully when the stocks are over extended. While you may miss the last part of the run up to the peak, it guarantees and realizes the profits you make that sets you up for the next big opportunity that is bound to come eventually.

We love buying into a good company whose stock price is out of sync with the company’s long term future economics. In the long run, the stock price and the popularity of such a stock can only go up as the downside has been largely priced in. But this is something that is very hard to do in practice, because it means going against the masses or the financial media. While most investors are panicking and liquidating their shares, you are buying them happily. Not only that, you are likely to be having to add to your existing positions which are now having reasonable drawdowns. It is during such times that most money is made. If we understand this, such situations are a joyful process to undergo as it will set the stage for the future gains.

And lastly the market often loves to remain irrational longer than you can remain solvent or sane. It is just against the odds for an average investor to be able to have such temperament, patience and conviction in what they do. We recall how easy it was for some of our students during our simulated stocks investment game to add to their positions convincingly despite all the negative news presented. When real money is at stake, can you still do what you did psychologically? Most investors give up before the market finally agrees with them.  But such is the way to make outsized gains by positioning your capital ahead of the crowd. All that is needed after which is to let the underlying economics of the business eventually lift the stock price. At times, things work out in a matter of weeks or months. Occasionally, it may take years to materialize. But usually the longer the wait, the greater upside there will be eventually. The big money is sometimes in the waiting which is equally difficult as not everyone has the willingness or the holding power. If you want to succeed as an investor, you must have the tenacity to push forward after taking some temporary blows and to develop the delayed gratification gene in you.

The time for stock picking

The S&P 500 index has been pretty kind to their investors for the last couple of years with the exception of the brief crash during Covid-19. The retracements that we see from the index itself are not exactly significant. This is attributed largely to the fact that a small number of stocks are driving up the entire gains of the index. For example, the top few performing tech companies such as Apple, Microsoft and Google which had respectable gains this year made up about 17% of the index collectively.

The historical long term average returns of the stock market is approximately 10% a year. For 2019, the S&P 500 was up by about 31.5%, in 2020 by about 18.4% and for 2021 it is likely to be in the region of about 25%. Based on its historical performances, there is lower odds that it will continue to do above average for several years in a row and we may have to be able to stock pick in order to find value in individual positions. Great companies get caught in negative news or sentiment every now and then. Seize those opportunities to buy at appropriate price points as taught in the Moneyball Investors Playbook. And always buy in stages because low can go lower in the short term purely for emotional reasons.