Investing in undervalued securities worldwide

Weekly Update 15 August 2022

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Stocks rallied 3% last week after US inflation, at 8.5%, came in lower than expected.

The inflation problem is, however, far from being solved.

Wages are increasing at 7%, the highest for decades.

The Cleveland Fed’s inflation measures indicate underlying inflation is running at 5-6%.

This is consistent with the New York Fed’s gauge of trend inflation, which is also at 5-6%.

Thus, while inflation will surely fall further from 8.5% thanks to plunging commodity prices, it may settle in the ~5% area, absent further action from the Fed.

If so, the Fed will have little choice but to increase interest rates beyond what the market currently expects. The Fed funds rate may end up at 4.25%, as opposed to ~3.5% expected by the market, and the 10-year yield may increase to 4%.

This would be very bad news for the stock market because the higher the interest rate, the lower the fair value of stocks.

Our scenarios for the $SPX500 are:

1 (Recession). Inflation proves persistent and the Fed raises rates to 4.25%. There is a recession. $SPX500 falls to 3000, 15x 2023 earnings of $200.

2 (Stagflation). Inflation proves persistent but the Fed, for political reasons, doesn’t raise rates to bring it back under control. $SPX500 falls to 3900, 16x 2023 earnings of $244, because inflation has historically depressed equity valuations.

3 (Soft landing). Trend inflation falls to 2-3% and the Fed doesn’t have to raise rates beyond what’s currently expected. $SPX500 rises to 4600, 19x 2023 earnings of $244.

We assign a significant probability to scenario 1, while the market seems to have concluded that scenario 3 is by far the most likely one.

Given our view of the probabilities of different scenarios, we continue to hold a defensive posture. This is in part a risk management measure: losing 30% if scenario 1 plays out wouldn’t be fun. Better risk-reward will be available when the economy bottoms next year, in our view.

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@triangulacapital -5.6%
$SWDA.L -11.3%

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$JNJ (Johnson & Johnson) was sold and the position in $JPST increased.

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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.

That is true. But there is also some evidence indicating that portfolios that performed better in the past, do perform better in the future.

“[…] 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.

Compared to traditional mutual funds, the strategy also:

  • holds fewer securities
  • trades more
  • avoids following the index

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

“We find that truly active funds significantly outperform closet indexers. Further, we find that the truly active funds are able to outperform their benchmarks on average by 1.04% per year” Source

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

Higher Risks for Higher Returns

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

The strategy invests in countries 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.

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.