102. Americans: repairing, remodelling and ready to vote

29 October 2020 (pre-recorded 26 October 2020)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

James Yardley (JY): Hello and welcome to the investing on the go podcast. I’m James Yardley and today we’re joined by Hugh Grieves, the Elite Rated manager of LF Miton US Opportunities fund. Thanks very much for joining us Hugh.

Hugh Grieves (HG): Thank you James.

[INTERVIEW]

[0:16]

JY: And you last spoke to us in April, and then I think you predicted the bottom of the market. You said it was the time to be buying small and mid-cap stocks and you’ve been proven right. I think your fund has beaten the S&P [500] since then. So what have you bought, which has done particularly well?

HG: I mean, to be honest, it was a great time to buy pretty much almost anything. I mean, stocks were on sale across the board and there was a lot of fear in the market and it was a great chance for us to be a bit greedy and really to, to buy stocks that we’d had our eye on for, you know, in some cases, years. But despite these being great companies, we’d never had the chance in the past really to buy them at valuations that for us really made sense. Where you’ve got a good margin of safety if something goes wrong, but if everything goes right, then you can make an awful lot of money for clients and taking minimal risks.

So, you know, back then, I think we were fairly early on to realise that, with a lot of people being stuck at home, but probably in many cases still working and still earning and not having much opportunity to spend that money on things like holidays and going out, that people would start spending money on what was all around them, ie their home and there were quite a few companies that we identified in the US that really fit in well into that idea that people increasing their spending towards home, repair and remodeling, or just sort of general bits and pieces and furniture.

So, in terms of actually individual stocks that we’ve had the opportunity to buy you know, there’s a couple of things that I’d highlight. One is a firm called Trex, which it manufacturers decking, but rather than just wooden decking, what it does is it takes recycled plastic and makes a synthetic product, which people can put out in their gardens in and front of their houses that doesn’t require the same amount of maintenance that say wood requires. And so it’s a great premium product and clearly they’ve seen sales go extremely well. Another example would be a retailer called Floor and Decor, which you know sells flooring products, whether it’s tiling or whether it’s floorboards, real or synthetic, again, you know, people investing in their floors.

And then finally, you know, perhaps a more obvious example, we purchased one of the largest home builders in America. You know, just as the same as in this country, a lot of people at home in especially in urban environments. Who are looking to move out to houses with more space perhaps more garden as well. And at the same time, you’ve got record low interest rates. So affordability of housing is very good at the moment. So, you know, all the house builders, but in particular Pulte, which is the one that we purchased shares in, have done very, very well. I mean, they’ve seen business growth 30, 40%, and certainly far, far greater than what they were expecting back in March. So that was sort of one sort of theme that’s done very well for us.

But then, you know, there are plenty of other companies that we got a chance to buy that, you know, have been trading on very high valuations for a period of time that had fallen. One example is Goose Head Insurance, which is insurance brokerage that’s growing very fast. Another one is Bright Horizons Family Solutions, which some people may be familiar with in the UK and they operate children’s nurseries. And clearly with everyone working at home, the whole sector has been hit very hard, but as people have been going back to work – and certainly in the States, people have been going back to work much more quickly than here – businesses recovered pretty quickly. Although, you know, unfortunately a lot of the smaller competitors may have been forced out of business, which obviously leaves the larger, more financially stronger companies in a better position to capture market share going forward.

[4:21]

JY: Thank you. And one of the interesting things, when I look at your factsheet, I don’t see any of the big tech names there. Which makes it all the more impressive, you were able to outperform since the bottom. Why is that? And what do you think the outlook is for these names? Cause I mean the headlines are just absolutely dominated by the strength of these big tech names. Do you think they’re just too expensive here or that the story is too well known at this point? What are your thoughts?

HG: I think James, it is a combination of things. I mean, don’t get me wrong, generally these are all very good companies which have demonstrated fantastic earnings growth over long, you know, multiple, multiple years. But, every now and again, you get these periods where you know, the narrative behind a stock is so great, it becomes such an obvious buy, and everyone just piles in and owns all these stocks and they pushed the valuations up to the point where, you know, the shares discounting so much of the future growth. So you kind of have to step back and you think, okay, well, if something was to go wrong, I could lose an enormous amount of money, but if everything goes right, well that might already be in the share price. So I’m not going to make any money that that’s not a great risk-adjusted option.

So, you know, we have owned these stocks in the past. We haven’t owned them recently because of too many people pushing the share price up too high. As you say, it will end at some point. It always does. You know we’ve seen these periods before in the past, you know. You go back to the eighties, you know, IBM was the stock of the day. You know, IBM dominated the PC market. PCs of course, were going to take over the world and everyone was going to have one at their desk. And IBM then got the record of the largest weight in the S&P 500 – over 6% – which has only just been that record has only just been taken by Apple, which is now the largest ever holding the S&P 500, because of course, you know, iPhone is going to take over the world forever more.

All of these things come to an end at some point. You know, you go back to, I think it 2005, 2006 Exxon Mobile was the largest company in the US. Well, you know, now that oil companies have fallen out of favor, for reasons we all know. Interestingly, this week NextEra energy partners, which is the biggest operator of renewable energy sources, wind and solar, et cetera. Now has a larger market cap than Exxon Mobil. So, you know, the wheel keeps turning and just because you’re leading one period, doesn’t mean you’re going to leave the next. And ultimately all of these things come to an end.

But you know, here we are today and, you know, you look at, you know, certainly every North American fund and all of these names are the top 10 and lots of the global funds. And even, you know, these names have pulled the rest of the technology sector along with it. So that when you look at, say an S&P 500 tracker fund, you know, over 40% of an S&P 5[00] tracker fund now you could really call technology if you throw in things like Amazon and Google.

So as you say, you know, mostly the question is when does it all end? And I think the first thing to recognise is why these stocks have done well at specifically over the last two years, especially. And a big part of that has been because the actions of the federal reserve in the US pushing down interest rates and, you know, large part of the valuations of these companies is really, it’s a factor determined by interest rates and as interest rates go down, the earnings multiples on these stocks go up.

[7:59]

JY: Does that, has that pushed you a bit more into the value side of the market? Cause, I mean, obviously we’ve seen this extraordinary divergence between the value and the growth stocks, obviously growth stocks just keep doing better and better and better. Value stocks keep doing worse and worse. And the coronavirus just seems to have accelerated that. Are you now finally getting to that point where you’ve just got to put a bit of the portfolio into value because it’s just looking so cheap because…

HG: I think that makes perfect sense…

JY: Because I think that’s very painful for a lot of fund managers who’ve been early on that.

HG: You’re absolutely right, it has been very painful for many people. But you know, these things do go in styles and growth historically you look back and there’s periods where growth has done well and value has done well. And then it gets tipped back and forth. There’s no reason why one will carry on forever. And it, it may be the point right now where we are starting to get this turn. And there’s a couple of factors that will make that change.

First of all, as I mentioned earlier, the interest rates maybe increasing. You’ve also got the impact of the recession and the virus, which typically value stocks do well, as the economy comes out of a recession, which is what we’re expecting over the next 12 to 24 months. And then there’s the third factor, which is if we do get, say a Biden win next week and maybe we also get the Senate going Democrat, then you would likely see a big fiscal stimulus package, which would be great for accelerating growth in the economy, which is good for value stocks. So, you know, for all of these reasons that are sort of coming to the head right now, you know, I think you are starting to see a bit of rotation already, and I think that will only continue.

And I think it’s important for investors to realise that, you need to be ahead of these big changes when they happen in the market. Because, once you start looking at them in the rear view mirror, it’s very hard to change portfolios around because you always think, oh, I’ll wait until it goes back again. And then that’ll give me a chance to do it at a better price. And those sort of things don’t happen.

And certainly for a lot of fund managers…people have made so much money in all of these stocks for such a long period of time. You know, it’s been a great party and nobody wants to leave the party, but everybody knows at some point, you know, the police are going to turn up and it all, then they’re going to turn the music off and everyone’s going to get into trouble. And so everyone’s standing by the door. We’re thinking you know, as soon as the police turns up, I’m going to be the first out of the door. Well, guess what? It’s a really small door and there’s an awful lot of people standing there. And I think that’s going to be a problem that we’re going to see going forward.

[10:36]

JY: Very interesting, and in regards to the US selection then, are you predicting a Biden win? And do you think the Democrats can win all three houses?

HG: I think certainly a Biden win looks the most likely at the moment, unless something dramatic happens in the next couple of days. The big question is whether the Democrats can win the Senate as well because if they managed to hold on, if the Republicans managed to hold onto the Senate, then they can block a lot of things that Biden would like to be able to do. But if they can win, then you are more likely to get a big change in fiscal stimulus. So a lot more government spending being pushed into the economy. And then the other thing is almost certain to happen, going back to talking about the FAANGs, is you’re going to see a lot more regulation of big tech. So people you know, the Democrats would like to break up Amazon. They see it as too powerful. They would like to restrict what Facebook and Google can do. You know, all of these companies, people see as, the Democrats see as a threat. And, you know, I think that’s another risk to these companies above and beyond, you know, the things that we’ve talked about already.

But you know, I guess we hope that we get a decisive outcome next week because the worst possible outcome for the market I think would be uncertainty. And if it is too close to call, then, you know, there’s a potential for a whole can of worms to be opened. And you know, if you recall back in when it was Bush versus Gore, and it all went to the Supreme Court, you know, the stock market went down 12% between the election day and resolution. And I think there’s a risk that you could see something similar if we get some level of uncertainty in next week. As we wait to see what happens, as the results come in.

[12:23]

JY: Very interesting and thinking more about the, the sort of broader macro[economic] picture, where do you think we are now, do you think we’re going to get a vaccine? Do you think we’re going to see a sharp rebound or has the damage already been done? Is this a long protracted recession or do we bounce back now?

HG: It’s a great question. I do think we get a vaccine. I think we get multiple vaccines. The question of course is how effective they all are and how many people actually take them. And you know, we’ll have to wait and see. You know, in terms of how well the economy is doing, I had someone described it to me the other day really well. And they said look the US economy is a four lane highway. Right now, three of the lanes are in really good shape. In fact, one of them might even be better than it was before. But one lane is really bumpy and that’s the, you know, it’s the travel industry, the hospitality industry, leisure industry, all of these sectors, which require people to go out and mingle together. They’re having a really tough time, but the other three lanes are all doing fine. And certainly, things like home improvement and the housing market are on fire. So, you know, I think we will see the economy continue to recover, but we are going to see it recovering at different speeds. And it’s very interesting just to look at one sector and say, it’s all great. And one sector and say it’s all bad, but overall, I think we’re steadily moving in the right direction now.

[13:47]

JY: And what do you see for the trade war between the US and China? Do you see that changing potentially if we do get a Biden win or are we going to see more of the same there? And what does that mean to your portfolio as well, do you sort of go more domestic or you happy to buy the big multinationals as well?

HG: You know, I think it’s at least more of the same. I mean, the Democrats have never been big friends of international trade. And I think their tendency is always to increase trade barriers rather than reduce them. In terms of, you know, just generally thinking about how, how the US regards China, I think definitely now it regards China as a threat, as a major competitor in a way that it didn’t think about China four or five years ago, and that’s permanent, I think that’s going to be around with us for a long period of time. You are going to see companies bringing production out of China, whether it’s to Vietnam or whether it’s to Mexico or whether it’s back to Texas or California, who knows? But I think the relations between China and the US, it’s like two icebergs and they’re gradually moving apart and nothing is going to change that.

But what I do hope, maybe if we do get a Biden victory is you know we get a period of more predictable international relations. Things are a bit more stable. And we go back to what we were more used to, more familiar with, back in say the Obama administration really.

JY: Well Hugh, thanks very much for your thoughts. Always interesting to hear what you have to say. Well done on the sort of recovery and the performance of the fund.

HG: Thank you very much, absolute pleasure.

JY: And if you’d like to learn more about the LF Miton US Opportunities fund, please visit fundcalibre.com. And please remember to subscribe to the Investing on the go podcast.