Investing in undervalued securities worldwide

Weekly Update 18 July 2022

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Stocks fell slightly last week. Moves up and down were driven by inflation data releases (higher inflation = stocks down, lower inflation = stocks up).

Bank of America chief investment strategist Michael Hartnett published an interesting note last week fleshing out his secular (10 year), cyclical (1 year), and tactical (1 month) market views.

In Hartnett’s view, the 2020s will be a challenging decade for stocks. Higher inflation and interest rates will lower valuations, taxes will go up, politics will become more populist, and geopolitical risks will cast a constant shadow over markets.

Hartnett believes that cash, real assets ($XLRE, $BIP (Brookfield Infrastructure Partners LP)) and small cap stocks ($IWM) will outperform bonds ($TLT) and Technology stocks ($XLK) over the decade.

Moving to the cyclical time frame, Hartnett is bearish on stocks for H2 22. Higher interest rates will slow down the economy, possibly leading to a hard landing and a recession, while earnings estimates are still too optimistic and should be revised downwards.

Hartnett has an end-2022 target of 3600 for the S&P 500 index ($SPX500). He views 3300 as a good level to start buying. If the index reaches 3000, investors should buy aggressively, in his view.

Tactically, Hartnett is more positive. Sentiment is poor, and a shallow recession is already priced in. Thus, there may well be a summer rally in July and August. This prediction is supported by last week’s trading, which showed that bad inflation numbers cannot scare the market any more.

What happens after August is more uncertain. Hartnett hopes for a big plunge in Q3, which would create a good buying opportunity in the September-November time frame.

Another scenario is 3-6 months of range-bound trading, like happened in 1973, before a second 33% drop in 1974 took stocks to their final low of the 1973-74 bear market.

Our view is that more bad news (not just inflation) will need to emerge before markets fall more, so this bear market may prove to be a protracted 2-year affair, with the final low set only in mid-to-late 2023.

Supporting our cautious view, some models indicate that the stock market is 40% overvalued,

while economic momentum remains extremely negative.

Thus, we continue to prefer cash to stocks, although we expect range-bound trading with an upside bias in the near term.

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@triangulacapital -4.2%
$SWDA.L -19.7%

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Pietari Laurila is not a registered investment advisor and does not offer investment advisory, fund management or wealth management services.

Triangula Capital is a brand name, not an incorporated entity.

This page is provided for information purposes only. It is not a recommendation to copy the Triangula Capital strategy or to invest in any fund or security.

2009-2020 performance figures are from Pietari’s personal Interactive Brokers account. They are time-weighted returns calculated in accordance with the Global Investment Performance Standards (GIPS).

From 2021, performance is calculated by eToro.

Past performance is not indicative of future results.

Track Record

It is often said that past performance is not a guarantee of future performance.

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“[…] top-decile prior-alpha funds produce annual future alphas of about 150 bps, net of fees” Source

Risk warning: That is only one study. In general, past performance is not indicative of future results.

Aligned Incentives

Pietari invests the majority of his net worth in the strategy. This ensures that his interests are aligned with investors who copy the strategy.

“Funds with high-incentive contracts deliver higher risk-adjusted return, and the superior performance remains persistent. The top incentive quintile of funds outperforms the bottom quintile by 2.70% per year” Source

Risk warning: Pietari holds accounts with multiple brokers and may therefore have a conflict of interest when deciding which accounts he should trade in first.

Unconstrained Investments

The strategy has fewer constraints on its investments than traditional mutual funds.

The strategy portfolio can be invested in stocks, bonds or cash and these allocations can vary over time.

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Each of these points has been shown to be an important predictor of portfolio performance.

“We […] find that portfolio concentration is directly related to risk-adjusted returns for institutional investors worldwide” Source

“A one-standard-deviation increase in turnover is associated with a 0.65% per year increase in performance for the typical fund” Source

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Risk warning: Concentrated portfolios with few positions can suffer large losses if bad news arrives about any of the companies in the portfolio.

Cheap Stocks in Cheap Sectors

The strategy invests in geographies and sectors where values have collapsed due to macroeconomic problems.

Within these geographies and sectors, the strategy overweights stocks that trade at low valuations on measures such as price-to-earnings or price-to-net asset value.

Every stock in the strategy portfolio must also be a good company, with no obvious red flags or long-term threats to its business model.

The aim of the strategy is to maximize returns, even if this means taking more risks than usual.

Risk warning: The strategy portfolio tends to be concentrated in risky stocks, which means that its losses in any market downturn will likely exceed those of the market index.