The funds underperformed the benchmark for May. Investors last month returned towards speculative tendencies and the more economically sensitive cyclical sectors. These sectors do not meet Insync’s strict quality stock or Megatrend criteria, and explains the short-term below index numbers. This see-sawing in markets towards cyclicals is a normal occurrence of the first 12-18 months emerging from a recession. As short-term market P/E ratios have already expanded to levels towards the top end of their historical range further P/E multiple expansions is unlikely. Therefore, future stock market returns will need to be driven by businesses with consistently strong earnings growth. This favours Insync’s approach as at its core, consistently high earnings growth, is a key attribute of all stocks held. The portfolio remains significantly undervalued based on long-term cash flows of the companies held, and thus sets the stage for outperformance consistent with the longer-term history of the funds. In other words, patience will bear fruit.
Is identifying a ‘trend’ enough?
If only it were that easy. Achieving sustainable compound investment returns with a high degree of confidence from a trend requires a few more things including:
Estimating the total addressable market
Assessing likely trend duration
Pinpointing when best to invest
Identifying the best positioned and most profitable companies in them
Optimising the portfolio weight of a stock and the Megatrend based on acceptable risk and reward
Insync takes a systematic approach to all this, analysing significant amounts of data and applying filters to whittle down the ‘cast of thousands’ to a select few.
Thus, we have a high degree of confidence in both the sustainability of the Megatrend and the best positioned company within it. This is proven to deliver outsized returns.
Most stocks in a Megatrend will still fail
According to history, only 4% of companies listed in the index have driven all the returns in the share markets over the past 90 years. It therefore stands to reason that most stocks in a Megatrend will also fail to deliver.
A cautionary note if using thematic trend-based ETFs/index funds
Researchers have found that thematic ETFs, which invest in narrow trends such as the genomic revolution, robotics & automation, cyber-security, health technology, biotechnology, renewable energy on average underperform the stock market on a risk‑adjusted basis by about 4 percentage points a year for at least five years following their launch.
Thematic ETFs hold stocks with salient characteristics such as:
high past performance,
huge media exposure, and
significant positive sentiment
This makes marketing easier to retail and sentiment-driven investors, which is great for the issuer. After their launch however, most products perform poorly once the hype vanishes and capital goes elsewhere, delivering negative risk-adjusted returns.
This is not surprising as stocks selected in these ETFs are not based on fundamentals such as profitability, valuations, or rigorous assessment of their future sustainable earnings potential. Quite often the selection process is opaque. Many companies in these ETFs only have a sliver of their revenues generated from areas that have anything vaguely to do with the theme in question.
Companies utilised in these ETFs also tend to be significantly smaller, pricier, and less profitable than average. Traits that are associated with higher volatility.
For those considering this path, your asset allocation skills must expand into competent trend selection, weightings and trend timing. Rarely do we see an investor with 16 trends and suitable risk analysis.
Concept + Hope is not ideal
Investors today are aggressively investing more on concept and hope rather than implementing a rigorous approach. As humans, it is very easy to get caught up in the concept of something good.
The internet bubble in 2000 showed that most companies failed in the early stages of a trend. It also wasn’t clear at that time which were the winning companies. A lot of the internet stocks and funds launched back then performed poorly resulting in significant losses and the closure of many funds.
Unfortunately, history repeats itself, which can be seen in the tidal wave of flows into thematic/trend funds.
The ‘reopening trade’ is closing
We do not share the consensus view that we are moving into a much higher structural inflation environment. Our key reasoning is that there is a significant global unemployment issue. Until we get unemployment levels down to very low levels there is very little risk of wage inflation breaking out. Jay Powell told the market that there is no evidence, in theory or practice, that will allow for any persistent inflation until the resource gap in the labour market closes.
This next chart is the broadest measure of the employment rate in the USA. The U-6 (Unemployment) rate reveals the percentage of the labour force that is unemployed, underemployed, and discouraged from seeking jobs. It is considered by many economists to be the most revealing measure of a country’s real unemployment situation.
This chart means in the USA today, a pool of available labour is some 5 million greater than it was pre pandemic. Until this pool of labour is fully employed wages growth is likely to remain subdued. This is also consistent with the post GFC period.
After a global disruption such as this one, there are bound to be choke points in the system re-booting. And this is where we see prices rising in very select areas, whilst a choke point remains. They are easily misinterpreted as systemic inflation.
A mismatch is appearing between market expectations for employment growth and inflation
Most market forecasters are not expecting the United States to go back to that degree of tightness in the jobs market pre Covid; yet they expect the fed funds rate and the inflation rate to rise to the levels of the last cycle, pre-pandemic.
What about commodity prices on inflation?
Some worry about the impact of commodities on inflation, but there is no identifiable relationship between the two. This can be seen in the chart below:
Silver Economy - Megatrend in Focus
This Megatrend is accelerating despite most nations trying and slow it. For Insync investors this is good news.
In the next 10 years the world will experience a number of unprecedented demographic shifts. Each component resulting in winning and losing companies
Insync incorporates demographic data into our analysis to understand where the significant demand shifts are taking place. Examples include the housing sector, specific consumer brands, social media platforms and healthcare products and services. This is an example of why a Megatrend is more than just picking a trend.
Whilst most investors are aware of the ageing population; the rate at which this is occurring is accelerating. Today, there are more than 46 million older adults aged 65+ in the USA. By 2050, that number is expected to reach near 90 million (This is occurring in all developed nations including China). Between 2020 and 2030 alone, when the last of the baby boom cohort reaches age 65, the number of older US adults is projected to increase by almost 18 million. This means by 2030, 1 in 5 Americans is projected to be 65 years old and over.
Chronic disease with age. One negative consequence of a rapidly ageing population is that incidence of chronic diseases surge. The older you get the higher the likelihood of developing one. This next chart shows this correlation (e.g. cancer, stroke, dementia).