Saxo Morningstar MOAT EUR Q3 2020 commentary

Market overview

Important Perspective: Imagine waking up as an investor from the 1980s, 1990s or 2000s. How would you make sense of today’s dynamics? You would see debt levels at all-time highs, economic output at multi-decade lows, widespread job losses, a global pandemic halting most human interactions… yet global stock prices are at or near record highs. If you are left scratching your head, you’re not alone. 

A meaningful part of the narrative is attributable to record levels of committed stimulus. Let’s not forget that interest rates are sitting down at all-time lows for the foreseeable future (at least, that’s what market participants are expecting, with the Federal Reserve hinting that rates will remain low until 2023). 

The challenge, of course, is that investors are also required to climb a wall of worry. Here are just a few current investor concerns: U.S. election nerves, Brexit negotiations, the vaccine waiting game, inflation uncertainty, US/China tensions, political division, and the potential for a rise in corporate defaults. Offsetting this, some participants—including professional and retail investors—appear buoyed by vaccine progress and a growing expectation for a 2021 recovery.

Key Developments: Looking within equities, all is not equal. What we’ve witnessed lately—and Q3 saw an extension of this—is diversity of outcome, with “new world” growth demanding a curiously high premium while “established” businesses fall off the radar of investors (this is true across developed and emerging markets). Understanding this dispersion has become one of the biggest talking points among investors.

Ultimately, it is unpopular stocks that tend to outperform popular stocks in the long run, as validated in several academic studies. Therefore, while 2020 has so far proven to be an outlier in this sense, it is the contrarian investor that has the upper hand probabilistically. This popularity/unpopularity conundrum should not be understated in these extreme times.

Speaking of popularity, interest in ESG (environmental, social and governance) investing continues at pace. This has been undoubtedly supported by sector performance differences, with ESG-friendly sectors generally doing better than some of the “dirtier” industries such as energy (obviously not all of the energy sector is “dirty”, but the composition is an important factor here).

Portfolio performance

Performance is net of all fees

Top Performers

• Livent Corp share price went up 39.5% during the last quarter and according to Morningstar proprietary analysis, the stock trades at a 47% discount to fair value. Livent is a pure-play lithium producer formed when FMC spun off its lithium business in October 2018. Livent should benefit from increased lithium demand via higher electric vehicle adoption, as lithium is a key component of EV batteries. The company's low-cost lithium carbonate production comes from brine resources in Argentina. Livent also operates downstream lithium hydroxide conversion plants in the United States and China.
  
  
• Tata Motors Ltd ADR share price went up 32.5% during the last quarter and according to Morningstar proprietary analysis, the stock trades at 48% discount to fair value. Tata Motors owns iconic brands Jaguar and Land Rover, while offering a broad product line of motor vehicles including compact passenger cars, sport utility vehicles, luxury passenger vehicles and large semi trucks. At 45%, it holds the largest market share of commercial vehicles in India. Tata also operates a financial services business, which supports vehicle sales. 
  
  
• Wesco International Inc share price went up 20.0% during the last quarter and according to Morningstar proprietary analysis, the stock trades at 42% discount to fair value. Wesco International is a value-added industrial distributor that operates across four distinct end markets: industrial (36% of sales), construction (33%), utility (16%), and commercial, institutional, and government (15%). The company offers more than 1 million products to its 70,000 active customers through a distribution network of 500 branches and 10 distribution centers. Although Wesco generates almost all of its sales in North America, the company has a global reach, with operations in 15 other countries. After Wesco acquires Anixter in 2020, the firm's pro forma revenue will increase to over $17 billion, and the combined entity will easily surpass W.W. Grainger as the largest industrial distributor in the United States.

Worst Performers

• Core laboratories NV share price went down 28% in the last quarter and according to Morningstar proprietary analysis, the stock trades at a 44% discount to fair value. Core Laboratories is an oil-services company that helps oil and gas companies better understand how to improve production levels and economics with core and reservoir analysis. Additionally, the company sells a number of products helping its customers to maximize production levels from their oil and gas assets. The company operates in more than 50 countries and has more than 5,000 employees.
  
  
• Telefonica SA ADR share price went down 31.6% in the last quarter and according to Morningstar proprietary analysis, the stock trades at a 61% discount to fair value. Telefonica is the incumbent telephone operator in Spain, which accounts for about 26% of the group’s sales. Besides Spain; Brazil, Germany and U.K. are key markets. Management intends to spin off its Latin American operations, except Brazil. The firm has launched two new business units: Telefonica Tech and Telefonica Infrastructure. Telefonica Tech, a B2B segment offers cybersecurity, the Internet of Things, big data, and cloud services. Telefonica Infrastructure manages the firm’s infrastructure assets (towers, antenna systems, data centers, and greenfield fiber projects).
  
   
• Rolls-Royce Holdings PLC share price went down 54.3% in the last quarter and according to Morningstar proprietary analysis, the stock trades at a 22% premium to fair value. Rolls-Royce Holdings plc operates as an industrial technology company worldwide. It operates in four segments: Civil Aerospace, Power Systems, Defence, and ITP Aero. The Civil Aerospace segment develops, manufactures, and sells aero engines for large commercial aircraft, regional jet, and business aviation markets, as well as provides aftermarket services. The Power Systems segment provides high-speed and medium-speed reciprocating engines, and propulsion and power generation systems for the marine, defense, power generation, and industrial markets. The Defence segment offers aero engines for military transport and patrol aircraft applications; and naval engines and submarine nuclear power plants, as well as aftermarket services. The ITP Aero segment engages in the design, research and development, manufacture and casting, assembly, and testing of aeronautical engines and gas turbines. It also provides maintenance, repair, and overhaul services for regional airlines, as well as business aviation, industrial, and defense applications. 

Outlook

Looking for risk offsets, it is the typical safe-haven assets that investors are looking towards. Gold, despite all its faults, has taken a lion’s share of the headlines in this space. Yet, unsung heroes in times of stress—such as cash and longer-dated bonds—continue to play their role as defensive ballast. Remember that the pledges by central banks to keep rates low has provided some comfort for fixed-income investors, despite the low yields.

Turning to bond holdings, it has really been about balancing credit risk versus the extra return that you can achieve. This spread between riskier holdings (such as lower-quality corporate bonds) and safer exposure (such as government bonds, which tend to offset equity risk) saw a big spike in early 2020, but has narrowed once again, as corporate bankruptcies have remained low to date. Emerging-markets debt remains an area of interest given the high relative yields on offer.

Circling the investment landscape, we can’t forget the importance of currency, which is one of the first places investors express their geopolitical views. This space continues to be important from a risk management perspective, too, although a lot of negative news is still seemingly priced into riskier currencies. In fact, procyclical currencies (those that tend to do well in a growing economy) have improved more recently, perhaps acknowledging the extent by which investors sought safety.