To my fellow shareholders,
Since my last report, the market has staged a remarkable rebound from the March lows. At the end of June the ASX 200 is up close to 30% from the low set on 23 March 2020. It is fascinating to watch optimism return so quickly in spite of:
- RBA projecting GDP to fall by 10% in the first half of 2020;
- RBA estimating unemployment rate to rise to 10% by June 2020;
- In 2019, 8.7 million international tourists visited Australia and spent $45 billion. It is now down to zero with no firm date for reopening of borders. It is same with international student education which in 2018/19 contributing $37.6 billion to the economy.
The chart below shows the ASX 200 index (market) and its price earnings ratio (P/E ratio). The P/E ratio is calculated by using the market capitalisation and divided by earnings.
At the end of June 2020, the market’s P/E ratio was 19.5x, which is roughly 8% lower than where it was at the end of January 2020 before Covid-19 hit Australia. I find it remarkable that the market is just 8% lower despite the unprecedented economic headwinds we are currently facing. On a forward P/E basis (taking current market capitalisation and divided by future earnings), the market is likely to be trading on higher levels now compared to pre-Covid 19 as corporate earnings (denominator in the P/E calculation) are very likely to fall more than 8% in FY2020 and possibly into FY2021 in comparison to earnings in FY2019.
It appears to me that the market is pricing in a “V” shape economic recovery and corporate earnings to return to pre-Covid 19 levels relatively quickly. A major hurdle to this is of course the trajectory of the pandemic and humanity’s efforts to develop a vaccine. I am neither an epidemiologist nor vaccine expert but I’ve read enough to know that the besides the technical challenges in developing a vaccine, it must also be produced in large enough numbers (billions of doses) and at a low enough cost to be able to provide herd immunity for the human species. Even if a vaccine was rolled out today, there is still an economic anchor of a high unemployment rate (7.4% in June 2020) and risk that it may go higher once the Jobkeeper and other government assistance programs end. Of all the possible future scenarios, a quick recovery in corporate earnings feels quite optimistic to me.
In the short term the stock market is an unpredictable animal and over the long term it usually goes up. So even if corporate earnings turn out to be dismal it does not automatically mean that the stock market will fall. From my vantage point, there are many powerful forces driving the market higher such as the historically low cash rate and very low bond yields (for e.g. the 3 year Australian government bond yield is at 0.29% and 3 year A rated corporate bond yield is at 1.32%) which forces investors searching for yield (cashflow) into the stock market due to the higher dividend yields.
This is my long winded way of saying I think the market has run ahead of itself and I believe the probability of a correction is elevated. However, since I can’t predict market movements, my strategy is to move forward with caution. We will stay invested in good quality companies but keep a prudent amount of cash to take advantage of potential market falls.
We sold our position in Capral (3.5% position in March). Overall we made a 7.5% loss (inclusive of dividends and franking credits) on this investment. Whilst I still believe that Capral is trading below its intrinsic value, I decided to sell for the following reasons:
- It was not a high quality business and I felt that there are currently better opportunities in the market and if the market does fall there will be even better opportunities then.
- Capral is a building products supplier and the demand for housing in the short to medium term looked pretty lacklustre given the near close to zero immigration and international students arrivals coupled with a 20 year high in unemployment. Cheap import competition has negatively affected Capral’s earnings for the last decade and coupled with the housing downturn, I believe the the outlook for earnings is poor.
We participated in 4 share purchase plans (SPP) as part of the strategy laid out in the March 2020 report. These were very profitable trades from a percentage return point of view. So far we have made about $9.5k from a cost base of $100. These are very low cost trades with potential to earn an outside return but there is some luck involved as a few ducks must line up. Therefore, due to the “long shot” risks associated with this strategy, it only makes sense to put a small amount of capital to this strategy. It’s more of a side hustle than anything else.
We raised some capital in May 2020 at $1.031 per share.
I have decided to change the financial year for the fund to align to the Australian tax year. This will reduced our accounting fees moving forward. Given this change, 30 June 2020 will be the end of the new 2019/20 financial year (roughly 6 months) and 1 July 2020 will be the start of the 2020/21 financial year.
CV Capital return for FY2020 (14 Jan – 30 Jun) is (11.3%) and since inception is 4.4% on an annual compounded basis. Our cash and cash equivalent positions are circa 18% of the portfolio and the unit price (including franking credits) as at 30 June 2020 is $1.11.