Commentary —

“Hard” Economic Landing

Scott Morrison

Scott Morrison

Founder & CIO


CIO & Founder, Scott Morrison, discusses what to expect in the coming months as central banks raise rates and how this will effect investors.

As always, we try to focus these comments more on where we are going than where we have been.  Our process is to hunt the world for good-to-great management teams with significant competitive advantages and very strong capital structures, in order to weather any unexpected storms. Panorama not only has investments in North America but, unfortunately at the moment, in underperforming overseas markets as well. We have investments overseas because, as you can see from the below chart, valuations have become very, very attractive versus North America. We also invest overseas in part to get exposure to businesses that Canada does not have companies pursuing.



PANORAMA HAS HAD TOO MUCH EUROPE AND ASIA –
BOTH HAVE GOTTEN CHEAPER AND CHEAPER AND LED TO THE FUND’S UNDERPERFORMANCE

Source: FactSet, Goldman Sach Global Investment Research.


Obviously having investments in Europe while a land war broke out in close proximity to where certain of our investments are headquartered presented certain negative headwinds. Longer-term we believe that Europe will find solutions to its dependance on Ukraine, Russia and emerging Europe for many raw material inputs that are currently dragging their economies down. Historically, if the price of a commodity rises high enough, people will find innovative substitution solutions. I am not saying this will happen in the short-term, but it will happen in my opinion. For example, it took 10 years from the entry of China into the World Trade Organization in the year 2000 to see a commodity “super cycle” play out. As you can see in the below chart, the exposures are very material and understandably caused a knee-jerk sell-off in companies exposed to these regions.



COUNTRY REVENUE EXPOSURE (2021e) TO RUSSIA AND EMERGING EUROPE

Source: MSCI, FactSet, Morgan Stanley Research. * Morgan Stanley has limited coverage of companies in Portugal; the substantial exposure to Emerging Europe ex Russia is linked to Jeronimo Martins, SGPS S.A.

SOFT COMMODITIES SUPPLY DISRUPTION FROM UKRAINE CONFLICT % OF GLOBAL EXPORTS

Source: Credit Suisse.


On the other side of the world, China continues to keep large parts of their country in covid lockdown, i.e., Shanghai. As a result, we have seen Chinese securities trade down to some of the cheapest levels of my career versus global markets. Meanwhile in North America, we are seeing our economies print inflation numbers not seen since the 1970s and early 1980s. Typically in inflationary environments, expensive stocks tend to see their multiples contract. Hence, we are keeping some exposure overseas while admitting this has looked unwise in the recent past. I am a big believer in cycles and that there is a strong potential for a reversion to the mean scenario.



DIMINISHING RETURNS – CHINA’S STOCK BENCHMARK IS NEAR LOWEST SINCE 2014 VERSUS WORLD

Source: Bloomberg.


Eventually we believe that this will allow us to realize outsized gains as overseas economies recover and high inflation levels revert to the mean. As central banks raise rates, you will hear a lot of debate around whether there will be a “soft” or “hard” economic landing. I am inclined to stay positioned in Panorama as though it will be a “hard” scenario. As we listen to company conference calls, we are seeing evidence that the central banks are so very, very far behind economic realities. Therefore, they will be forced to aggressively raise interest rates.  We will have more to say and illustrate on this below.

I founded Wealhouse to better weather investing climates like the current economic and geopolitical set-up. It cannot be said enough that we live in a world in which we have the highest debt loads in history and the highest inflation since the early 1980s. This year we have seen the worst sell-off of my career in the sovereign bond market. Interest rates are moving higher and investors expect that the U.S. Federal Reserve will raise rates from near zero at the beginning of the year to 2.5% by the end of the year. No one quite knows how the economy will react as we take rates from near zero to pre-covid levels. We assume that there will be outsized volatility for many years to come as a result of the excessive money printing. Presently, we find it interesting to note that there are no longer any negative-yield corporate bonds in the world. We also note year-to-date redemptions from bond funds by and large. This is presenting opportunities for my colleague Andrew and his credit fund, Amplus.

As you can see below, the long-bond ETF in the U.S. is off over 19% year-to-date. We have been modestly short TLT in Panorama as a hedge against rising rates. We have also been short the mortgage-backed security and junk bond ETFs in the United States. Special shout out to my colleague Andrew who has been skillfully navigating Amplus much better than the ETFs and his peers, as rates have climbed higher and higher. Andrew is doing very well protecting capital to take advantage of future yield opportunities in his asset class. 



LONG-BOND ETF IN THE U.S.

Source: Bloomberg.


I will always remember touring the south shore of Montreal 20 years ago, at a very large RONA distribution warehouse. It was a massive building that organized and sorted all their store inventory before they were shipped off to individual locations in Quebec and Ontario every night. I recall asking the site manager what item was most recession proof and had the highest inventory turns. His answer was paint. So, when markets have sold off because of recession fears I have always looked to buy leading paint franchises. It almost seems as though every market prognosticator, like we ourselves, is concerned about recession fears due to high levels of inflation. I took a screen shot of our holding in Akzo Nobel from the Netherlands during their recent conference call that highlighted how they are passing on input cost increases to consumers and businesses that use their paint. They illustrate the type of company we are anchoring our portfolio to at the moment, in that they have pricing power.



Q1 PRICING UP 17% – POSITIVE NET PRICING VERSUS
RAW MATERIAL AND FREIGHT COST INFLATION FOR Q1

* Raw Material and other variable cost Euo value includes freights value from Q1 2022 onwards.
** Price only (excluding mix), percentage change versus prior year
Source: AkzoNobel.


Akzo is the number three paint maker in the world, with broad exposure to both consumer and business customers from industries such as automobile, aerospace and marine which have all seen production problems related to covid. This, we believe, will eventually recover and lead to improving fundamentals. And as you can see below, Akzo trades at a major discount versus their U.S. peers, despite having a stock buyback and growing dividend in place.



Below we show a couple of charts that explain why we are increasingly believing that it may be very difficult to expect a “soft” landing. Thanks to the very, very easy past monetary policies of central banks, one could argue that the U.S. consumer has a very strong balance sheet based on housing and stock price appreciation. Therefore, the U.S. Fed may be tempted to think that they can raise rates more aggressively than in past tightening cycles. This will create major economic volatility and cause a significant economic slowdown.



U.S. CONSUMER STRONG ENOUGH FOR MORE RATE HIKES

Source: FRB, Goldman Sachs Global Investment Research.
2005-2009 data are excluded due to distortions following enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.
Source: Admin. Office of US Courts, Census Bureau, Goldman Sachs Global Investment Research.



Again, our thoughts and prayers go out to those suffering in Ukraine. As we all experience rising food prices at the grocery store, increased gas prices at the pump or higher natural gas prices to heat and soon cool our houses, I believe it is important for me to point out the below charts. Their illustrations show how “hard” landings are ALWAYS foreshadowed when commodity prices move as far as they have.



IN EVERY INSTANCE WHEN THE REAL OIL PRICE RISES 50% ABOVE ITS 2Y AVERAGE,
WE HAVE HAD A RECESSION…

Source: Refinitiv, Credit Suisse Research.

…WITH A SIMILAR STORY FOR OVERALL COMMODITY PRICES

Source: Refinitiv, Credit Suisse Research.


The most bullish item we can leave you with at this moment is that sentiment amongst investors is at a very extreme level. Typically, in my career when market psychology gets this bearish you can see a better return backdrop in the months and quarters to follow. We anticipate we will continue to see some very good companies disappoint in the next couple earnings seasons as they have to lower go-forward growth expectations. In a counterintuitive manner, this will be a great opportunity.

I have made the most money in my career after economic setbacks. Such an opportunity is coming again. This will be good for long-term investors. Again, I cannot emphasize enough that my family is invested across all of the Wealhouse funds and again I want to congratulate my colleagues Andrew and Justin from Amplus and Lions Bay, who are consistently weathering the difficult market backdrops.



SENTIMENT IS LOW/CAUTIOUS

Source: Bloomberg.
Panorama

Panorama

Panorama Fund strives to maximize capital appreciation by investing only in securities that we believe offer above-average returns on a risk-adjusted basis. The fund employs a variety of strategies including investments in equity, bonds, currencies, commodities, and publicly traded real estate. The fund also makes prudent use of derivatives to generate yield and enhance or protect our positions.

As Wealhouse Capital’s flagship fund, Panorama takes advantage of market inefficiencies across different geographies, industries, market capitalizations and asset classes to build a balanced portfolio. We actively analyse different risk factors in the markets to better diversify and safeguard our clients’ capital.

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