The combined information technology and communications sectors today represent slightly more than 20% of the U.S. stock market, and this sector has largely dominated the market over the last 40 years, excluding the rise of finance and real estate over the years leading into the Great Recession and a short resurgence of energy and materials during the early 1990s. But this dominance hasn’t lasted as long or had as large a share of the market as other sectors in the past.

In the earliest days of the market, the financial sector made up almost 100% of the U.S. stock market. Unlike most banks of the time, U.S. banks were corporations that raised capital through issuing securities, made attractive by the development of active trading markets in the 1790s. Thanks to this, the organization of financial institutions that developed was astounding – the number of state-chartered banks increasing from three in 1790 with total capital of $3.1m dollars to 584 in 1835 with total capital of $308.4m and the U.S. experienced the most rapid spread of banking institutions seen in any country over these decades. These were the growth stocks of their time and enabled the development of the economy as a whole, no different from the dominance of the financial sector in many of the emerging markets of today. These stocks were also increasingly bought by overseas investors enticed by the huge potential gains from investing in the emerging market of the time, and this flow foreign capital would reach huge proportions in the first half of the 19th century and in the railroad age that followed.

Within 50 years, the financial sector’s share fell by more than half as transportation stocks began to boom. And while the exploding railroad system in the U.S. certainly made railroad investments seem like the future of the stock market, its greater value came from the astronomical benefits to the wider economy that would ultimately shrink the relative market share of the transportation sector. These rail networks unlocked the vast wealth the U.S. interior and enabled the velocity of commerce to increase dramatically.

Aside from immediate increase in business for the steel and lumber industries that the developing railroad system created, the movement of goods and people allowed entrepreneurship to flourish further now that companies could scale and distribute goods to a wider market. In addition, the railroad infrastructure spanning across the country enabled the quicker and easier deployment of telegraph infrastructure, which would revolutionize communication. The railroad also facilitated the large-scale transport of coal and oil that would power the growing country.

Despite its importance to the industrialization of the U.S. and its role as the transportation backbone of the economy, by the First World War transportation was no longer the leading sector in the economy and by 1925 had shrunk to less than 10% of the total stock market. There was physically no more room to expand the infrastructure and the sector’s relative importance shrank as a result as capital sought out higher rates of return in emerging sectors. Energy and materials would come to dominate over the next 60 years to meet the insatiable demand for fuel and gasoline, energy to keep the economy running and raw materials that served as inputs to the various industries producing new goods, ranging from household appliances to cars and airplanes, for the U.S. and the world to consume. While brief periods of leadership from the emerging technology sector interspersed the dominance of the energy and materials sector, the relative importance of energy and materials would remain until the surge in communications and information technology during the 1980s.

The breakup of Bell System in 1983, the company that held a near-monopoly over telephone services in most of the U.S., triggered a boom in the deployment of fiber-optics networks in the country by new players in the sector that would lay the backbone for the Internet boom in the 1990s. Much of this fiber-optics network was laid along the same railroads that enabled the spread of the telegraph in the 19th century. Around this same time, the personal computer was making its way first into businesses and then into homes across the country. These developments first led to a surge in investments in the telecommunication networks that were creating the infrastructure necessary for this communication. Afterwards, in the 1990s, capital flowed en masse into the innovations and companies that were born as a result of this networking effect.

With groundbreaking developments such as the initial securitization of financial institutions and the paradigm shifting opportunities that the computer and internet revolutions have created, initially there is a massive wave of excitement, speculation and overvaluation. We’ve seen in it in the past and we’ll see it again in the future. But what does that mean for the information technology sector and its top players going forward? The speed of innovation has never seemed faster, but history has shown that the dominant companies that drove the previous waves of technology remain dominant for a long time. And the reach, earnings power and sheer wealth of information, the currency of our time, which these companies possess is larger than anything we’ve seen in the past.

Today’s technology is enabling new businesses and innovations in every corner of the economy, revolutionizing how companies do business and expanding the realms of possibility. The dominant technology companies understand these opportunities better than anyone else, and we’re already starting to see them make lateral investments into other sectors, deploying their vast capital and using their troves of data to further redefine the way we live. One sector that we have our eye on and that could be the greatest beneficiary of today’s technology revolution is biotechnology. Often overlooked until it’s too late, our health is our most valued commodity. The possibilities for technology to improve and lengthen our time here, whether that’s through devices that monitor our vitals and recognize irregularities before any doctor could, big data analysis that can identify and help prevent disease, etc., could be the most valuable deployment of capital that’s ever occurred. We don’t know how this will play out, but we’re excited to be along for the ride. read more

On Tuesday, Apple reported “disappointing” 1Q FY19 results, as total revenue fell 5% y/y to only $84.3 billion. Net income was $20 billion, essentially flat y/y, while earnings per share were an all-time high of $4.18 (+7.5% y/y), although this growth was helped by a reduced share count due to buybacks. The fall in revenue was mainly attributed to iPhone revenue (61.7% of total revenue) falling 15% y/y, and management explained that this was entirely due to weakness in Greater China. Guidance for the next quarter also wasn’t very remarkable, with gross margins expected to decrease and operating expenses expected to grow. So why did the Apple’s stock price increase by almost 7% the next day?

If we dig a little deeper, there’s plenty for investors, us included, to be happy about when it comes to Apple’s results. The company posted stronger-than-expected results in virtually every region outside of China and Japan, the latter of which was hurt by decreases in iPhone subsidies provided by telecom operators. The Americas segment (44% of total segment revenues) grew 5% y/y, and new sales records were also reached in Western Europe, Central and Eastern Europe and the rest of the Asia-Pacific segment. Even in China, Apple generated record Services revenue and Wearables revenues were up over 50%.

Besides the weakness of the iPhone, the rest of their business grew 19% to an all-time record. The Services segment grew 19%, up in all of the company’s five geographic segments (including China) to an all-time record of $10.9 billion and posted a gross margin of 62.8%. Wearables, Home and Accessories also reached all-time highs, growing 33%, thanks to the amazing popularity of the Apple Watch and AirPods (demand was so high that Apple was having trouble supplying them to consumers towards the end of the quarter). And while phone revenues will likely continue to fall, the meaningful growth in their other products and services will allow for further monetization of the company’s existing user base.

Looking at the services segment, some were concerned that Netflix’s decision earlier this month to drop support for iTunes billing, cutting out Apple as the middle man and their 15-30% cut of subscription costs, would deal a meaningful blow to Apple’s growth in paid subscriptions going forward, one of their engines for growth. However, Apple reported that it has over 30,000 third-party subscription apps available on the App Store, and the largest of them (Netflix) only accounted for 0.3% of total Services revenue. The company also reported a total of 360 million paid subscriptions across their Services portfolio, an increase of 120 million from a year ago, and they expect to surpass 500 million subscriptions during 2020. In other words, it doesn’t seem they’re too concerned by Netflix jumping ship. It’s also important to remember that while Netflix could afford to leave thanks to their pull with consumers, most other third-party subscription apps depend on being a part of the Apple ecosystem for their survival.

It’s also worth noting that Apple’s Wearables and Services segment revenues accounted for $18.2 billion dollars of during the quarter, which is more than Netflix’s revenue for the entire fiscal year ($15.8 billion). Despite this, however, the combined revenue growth of Apple’s Wearables and Services segment during the quarter was comparable to that of Netflix:

The above chart examines quarterly revenue growth of Apple’s Wearables and Services segment, compared to Netflix and some notable S&P 500 companies with similar total quarterly revenues. The only company that is growing its entire business faster than Apple’s Wearables and Services business is Facebook (4Q18 revenues of $16.9 billion +30.4% y/y). The same Facebook that was recently left in disarray after Apple suspended their access to internal iOS apps. At the other end, the consumer staples giant Procter & Gamble (4Q18 revenues of $17.4 billion) has exhibited low or no growth over the past few periods, but is still trading at a higher P/E than Apple (23.5x vs 13.7x). While many market commentators are harping on the slowdown of the iPhone business, it’s the growth of Wearables and Services business that is just as important going forward. And not only is this business growing at an impressive pace, but it is bringing in more revenue than a number of companies do in total.

With strong growth in Apple’s complementary services and products segments, expect Apple to continue to introduce new products in these categories that will not only help them continue to grow, but also broaden future revenue diversification. Maybe the most important vector is health-related services, as Tim Cook himself has stated that Apple’s greatest contribution will come from its work in healthcare. Given the current health-related abilities of the Apple Watch, ranging from heart-rate monitoring and workout tracking to fall detection and emergency SOS, it’s likely that we see more features and other products being added that continue to exude luxury, while also providing indispensable health benefits.

One way that Apple is making sure that these benefits are known is through its partnerships with two of America’s largest health care providers, Aetna and UnitedHealthCare, which collectively provide insurance to more than 70 million customers. Both have recently announced promotions in which eligible customers can earn a free Apple Watch (paid for by the healthcare companies) by wearing it and reaching specific activity goals. On a business level, this is certain to boost Apple Watch adoption, introduce some non-Apple users into the Apple ecosystem and further cement Apple’s lead in the wearables category. And with this boost in users, Apple will receive far more biometric data that could be used for predictive analytics in some innovative health application somewhere in the not too distant future.

Because of these future growth possibilities, in the health vector and elsewhere, demonstrated growth in their non-iPhone categories, and the continued strength and value of the Apple ecosystem, the course ahead looks as strong as ever. And while these other segments have picked up the slack while iPhone sales have weakened, we can’t discount the strong positive effect that the release of a brand new iPhone (as opposed to an incremental update like the latest models) could have on demand, particularly in China. Once there’s more clarity on the next generation of this must-have product, expect sales growth to return to the iPhone vertical, and with it, further upside to Apple’s stock price. read more

‘Uncertainty’ continues to be the most commonly used term to describe the current price action in capital markets. ‘Uncertainty’ about the US-China trade dispute. ‘Uncertainty’ about the Eurozone. ‘Uncertainty’ about Brexit. ‘Uncertainty’ about the US government shut down. ‘Uncertainty’ about whether the US Fed will pay heed to markets.

No one is immune from doubt, nor or should they be. However, the only thing in capital markets that is ‘certain’ is the past and that too is subject to innumerable interpretations.
So where do we go from here? Well, since US Fed Chairman Powell mentioned that the Fed was “listening closely to markets” on January 4th, financial markets have been in a considerably better mood. As I write this commentary, our weighted average return for January is around +5%. On a standalone basis, this would be a phenomenal result, but in the context of last month’s price action, we will call it ‘progress’.

Going forward, we will be closely monitoring Q4 earnings, not only for our portfolio holdings, but across all sectors. We will be trying to determine whether the Q4 selloff and market panic matched the actual performance of companies across all sectors of the US economy. We will be paying close attention to management commentary and guidance. We will be paying particular attention to the amount of revenues that US companies are generating abroad. We will be also be focusing on corporate vision and execution.

Market sell offs are extremely destructive to investor confidence, but well run companies should not be making decisions based on the short-term movements of their share price. I am certain that Amazon.com has not had a single meeting about the fact that their shares had fallen 36% from their highest to lowest point over the past three months. I am also fairly certain that buying Amazon.com shares under $1500 per share will prove to be a very profitable investment.

On behalf of our Client Portfolio Management team, I thank you for your continued trust and support!
Pauls
FULL DISCLOSURE: Please note that the opinions expressed in this blog should in no way be considered as investment advice or a solicitation to buy or sell securities.

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This year, both Apple and Amazon passed $1 Trillion in market capitalization.

What an awe-inspiring testament to human ingenuity! read more

Our decision to exit most of our technology stocks meant that our participation in July’s fantastic gains was less than it could have been, but sometimes you need to put your feet back on the ground. If you have been reading our commentaries, you know that we also have a keen interest in what happens underground – namely, in the mining sector, which we believe currently offers compelling value.

In July, the mining company Largo Resources became our largest equity holding. Largo mines vanadium, which is used to harden steel and is featured in Vanadium Redux Flow batteries. In the past year, Chinese environmental restrictions have reduced the supply of vanadium gained from processing iron slag. Concurrently, China will be implementing higher quality standards for steel rebar as of this November, which will further increase vanadium demand. Largo finished building the best vanadium mine on earth two years ago, and in the past year, the price of vanadium has risen 169%. I have been following Largo for the past 12 years, and the cyclical stars are finally aligning. It turns out that legendary investor Leon Cooperman, who ran Goldman Sachs’s research department in the 1980s, founded Goldman Sachs Asset Management and established his own very successful hedge fund ‘Omega Advisors’, also likes Largo. On July 24, Cooperman’s mention of Largo on the popular CNBC network sent the stock flying by over 50% in the span of five minutes, before settling back down. Nevertheless, as I write this commentary, we have gained over 90% on our initial holdings and have added on strength. While most financial pundits talk about high valuations in equity markets, we have patiently built a position in a company that has no near term competitors, trades at a 3.5x forward price to earnings multiple and could be debt free on net cash basis by the end of this financial year. As Vanadium Redux Flow batteries gain traction in green energy installations (they can be simultaneously charged, and drained, and have longer lifespans than lithium batteries), it is interesting to ponder whether vanadium might begin to be considered a battery metal, and whether this would result in high purity vanadium producers trading at similar multiples to lithium companies. For example, US lithium producer Albemarle (ALB US) currently trades at around 19x Price to Earnings, but has traded at PE multiples of over 30x. This, of course, is not the only relevant valuation metric, but it speaks to possibility.

Turning to fixed income, July’s positive sentiment helped emerging market bonds rally from their June lows. Unfortunately, in August, the economic situation in Turkey has worsened considerably and has sparked panic in emerging market securities. As a result, we have given up many of July’s positive returns. US treasuries also continue to lack direction. In one sense, you would expect them to be a safe haven in an uncertain market environment, however, their inherent liquidity means that they are the first thing to be sold by foreign central banks looking to defend their sinking currencies. On the other hand, strong US economic data continues to put pressure on the US fed to raise rates (bad for holders of existing US treasuries).

We continue to find ourselves in a very interesting environment both economically and geopolitically. Nevertheless, we remain focused on finding compelling investment opportunities for our clients and keeping a steady hand in stormy seas.

On behalf of our Client Portfolio Management team, I thank you for your continued trust and support!
Pauls
FULL DISCLOSURE: Please note that the opinions expressed in this blog should in no way be considered as investment advice or a solicitation to buy or sell securities.
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In terms of investment strategy performance, our weighted average net returns for June were (a) -0.46% for conservative strategies, (b) +0.65% for balanced strategies, and (c) +0.16% for aggressive strategies.

Trump’s trade war antics took center stage in June, causing broad weakness in emerging market bonds (-1.49%) and equities (-4.54%), as well as base metals (copper -3.72%; nickel -2.18%; zinc -6.89%). The effect of trade wars is simple: tariffs increase costs to producers, which they then pass on to consumers. Higher prices for consumers lead to lower demand. Guess who wins? No one! Now carry this dynamic over to companies with multi-national supply chains and consider the disruptions tariffs might cause. Fun, right? And so, because markets dislike uncertainty, we saw considerable sell-offs in exporters and raw goods suppliers. No one can say for certain how long Trump’s trade war tactics will endure, but the longer they persist, the greater the chance they will damage economic sentiment.

Despite the unwelcome scenario of a base metals sell off, our top performing position last month was actually Arizona Mining Inc. (+49%) – a mineral exploration company that is being bought out by their strategic investor South32 Ltd. Nothing is ever guaranteed, but this transaction showed that great assets, experienced management and patience can lead to phenomenal investment gains.

In June, we sold most of our exposure to the US technology sector, booking substantial profits, including our former top equity holding Shopify (SHOP US). This is the second time we have sold our entire position in Shopify, which we had re-purchased below $95 in mid-October of last year and sold for around $170 in mid-June. We also initiated positions in US homebuilders based on favourable valuations and continued strength in demand for new homes in the US. We currently have more cash on-hand than we have had in quite some time and are hard at work looking for new opportunities that present compelling value for our clients.

On behalf of our Client Portfolio Management team, I thank you for your continued trust and support!

Pauls

FULL DISCLOSURE: Please note that the opinions expressed in this blog should in no way be considered as investment advice or a solicitation to buy or sell securities.

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