Investment Idea

Large relative movements tend to increase buying activity

Mikael Syding
14/12/2022 | 6 min read

When the whole ocean storms due to major macroeconomic and geopolitical events, the result is often significant relative price changes. Inflation and interest rate hikes not only cause more expensive mortgage rates, housing price collapses and higher food prices, but also cause expensive technology companies to fall much more in price than sectors and companies with lower valuation multiples. The effect is not only felt between asset classes and sectors, but also between similar companies in the same field. All these relative movements provide huge opportunities for investors to use gains in one asset to buy more of another.

For example, if you owned gold during the stock market crash, you could swap it for all the more shares now. So you increase the amount of gold again in the future by selling shares when the latter have done relatively better than gold. That is not a recommendation, because I believe that gold has much more to offer relative to a broad stock index. After all, we haven't even seen the beginning of the recession that is likely to result from the ongoing interest rate hikes by central banks. A recession typically causes earnings forecasts to fall by around 20% and stock prices to fall by the same amount. It's not an exact science of course but given that valuation multiples today are reasonably average and forecasts for 2023 are positive, there is a clear downside for the stock market. At the same time, the gold price seems a bit depressed by rising interest rates, rates that in 2023 may well start to fall as the recession bites into inflation. In that scenario, gold could rise as much as the stock market falls, providing a much better opportunity to swap some of your gold for equities.

That's far from the only relative move to take advantage of in 2023. This year, oil stocks have surged in price while tech stocks and other bullish Covid stimulus winners have plummeted. You get a lot more Meta and Tesla, for example, for their SLB or COP, than you did a year ago. I do expect that the relative movement between tech and oil in general also has a long way to go, because many people haven't even started to move the other way yet. So at least through the spring of 2023, I'll hold on to my longs in value companies like Occidental, COP, SLB, Agnico, SHB, Danske Bank and even just Meta, as a counterweight to select potential shorts like Tesla, LULU, Netflix, Shopify, Snowflake and index anchors like Amazon and Microsoft.

Depending on the "day's form", I reweight a bit back and forth monthly between the companies and sectors, because things can swing quickly in companies like extremely expensive Tesla and the affordable oil services company SLB ("Schlumberger") even if the longer direction is given. It's much like gold. If I were to switch back from oil to technology today, I'd have taken a huge winners' leap up the funny house staircase. But I can see how there's an equally big leap to take. Of course, timing is not easy and choosing the right company to express your views with is not easy. It's also complicated by the fact that not all tech companies are equally good or equally bad or equally expensive. GOOG, for example, is a cash flow machine with a relatively low valuation relative to its growth and not least its competitive advantages, while Tesla is 5-10 times as highly valued per revenue crown as the very best other car makers, despite management being pressed in the media and extremely stretched between their duties in many large companies at the same time. ad seller Meta Platforms has crashed both because of the tech sector's general decline but even more caused by the questionable bet on Metaversum. I think Meta is on to something, that it's kind of like when Microsoft pivoted from licensing software on disk to becoming an internet company. It took a long time and Microsoft fell 75%, but then an investor got almost +1500% from the bottom. The added kicker with Meta could be that it is of course possible to back away from the Metaverse venture in its current form and become a bit more like before, or just halve the investment rate, to make the stock look very cheap again. Already it is valued at just about 11 times earnings this year, a gain a third below last year's. Sure, one should watch out for ad companies (SNAP, META, GOOG, ADBE et al) in the face of a recession, but there are limits to how relatively cheap a large company with an extreme "reach" to 3 billion users and a proven competent CEO can become.

Stranger things have happened, by the way, than META being bought out here, just as perennial loser Twitter was by perennial winner Elon Musk. There are many companies that would pay dearly for a friendly merger with META and Zuckerberg and their technology portfolio and user base. The big question is mostly which buyers the authorities would allow and which would dare to try after the FTC's rejection of Microsoft's bid for Activision. Speaking of which, Microsoft suddenly has $70 billion left over now to buy something else that has fallen in price relative to the company.

The theme, then, is what relative price movements are clear, can be expected to continue, or even reverse, and in what cases the differences might trigger buyout activity. Earlier this year, for example, we saw the tobacco company Philip Morris buy out my largest holding Swedish Match. It was a welcome dressing down this year for my subsequent loss on salmon company Austevoll when Norway proposed a punitive tax on salmon farming. When there are synergies in both costs and distribution and multiples are relatively low, bids tend to hail when some companies lag a bit. I think the mining industry, for example, is becoming ripe for more deals. The world is beginning to realise the value of commodities such as classic industrial metals, precious metals and, not least, battery and electric motor metals and minerals. There have already been some smaller deals in lithium, graphite and rare earths, but no giant mergers yet in coal, copper and iron, or oil for that matter. That's mainly where I'd be looking, but the fact is that in almost every sector there are prospects for deals in 2023. In pharmaceuticals, there are big differences in value growth and financial strength after last year. The same goes for pharmaceuticals and medical devices, automotive, defense, engineering, banking, insurance, telecom, gaming, etc.

I can't give a bottom line of course, but the tip is to selectively invest in companies just below the very largest in each sector and carefully pick out those with clear advantages in terms of technology or specific markets and customer groups. For this to make a difference (but without annoying the competition authorities), the biggest and strongest need to buy fairly large companies. And for it to be a good idea, the acquisition must of course contain something of value. Although it's hard to tell from the outside, if the company is already quite large or very successful in its niche - like Elekta or Getinge, for example - the likelihood increases. If you're brave, you dare to sell expensive giants against them, as they can be perceived as overpaying for acquisitions and taking on more debt when interest rates are high. Atlas Copco, for example, seems dangerously overvalued given the economic situation. It may be time for a double dip on the downside in terms of both forecasts and multiples, a bit like the one in 2008.

Looking ahead to 2023, I'm holding Nordic retail banks, US oil giants, selected buyout targets like Kindred and Elekta, gold miners like Agnico, and some special cases like Austevoll, Meta, SSAB and Stellantis. On the shorts side, there's the Who's Who of ARK's holdings in cloud software at 10-20 times sales, and of course the likes of Apple and Tesla, but Tesla in particular goes in and out of the portfolio more often than other stocks to take advantage of unreasonable monthly moves in either direction.

In 2023, I will also more systematically look for just potential buyout targets among somewhat forgotten quality companies, or companies in unjustifiably unloved industries, in the $10-100 billion market cap range, that have medium-high earnings or sales multiples, of around 12 and 1.5, respectively. Food, fertilizer, agriculture, oil, pipelines, cars, mining, gold, manufacturing, banking, bombed-out tech stocks in semiconductors, pharma, medtech, entertainment (Spotify), advertising (Meta), etc. There's plenty to buy... And just as much left to short, because the recession and high interest rates haven't yet had nearly enough of an impact on, say, expensive SaaS companies with no particular unique advantages. There's a long way to go on the downside for a lot of the very largest index carriers whose valuations are held up by index algorithms and automated capital flows. Better relative options as well as direct outflows could turn that process into a nightmare loop for many ETFs. ARK was perhaps just the forerunner. The main tip for 2023 is probably still not to do like everyone else but dare to go your own way, i.e. avoid headless bottom fishing and mindless Buy And Hold strategies.

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