Where will all the stimulus go?

• 0:19 - Where are we in the current cycle?
• 2:58 - Breaking down the global economy and the different recovery trajectories.
• 10:59 – Why bond yields are getting so much attention.
• 13:32 – A multi-decade trend supported by ‘mandated-growth.”
• 17:40 – Two companies providing exposure to this theme.
• 21:48 – The thesis for investing in US autos and how to do it.

Transcript 

James Marlay:

Jacob. Great to see you. Thanks very much for coming in.

Jacob Mitchell:

James, great to be here.

James Marlay:

Given the experience that you've got investing through multiple cycles, how would you describe, or how would you characterise, the current cycle we're in at the moment? Where do you see us?

Jacob Mitchell:

It's a good question. I think when you look through history that each cycle has a different flavour. I think in the dot com bubble, though, at one point, investors were discussing market cap per click as a valuation sort of metric. Fast forward to today, and we have expressions like TINA. Everyone's sort of focused on how network effect is so important in every business. We've got winner takes all. There's all these catchphrases that evolve, and then you have the valuation metrics that seem to be specific to that cycle. So today we've got, we look at lifetime customer value divided by CAC: customer acquisition cost. And you can pick holes.

I think, ultimately, there's always elements of truth. And then there's mania when people start to apply them in situations may be where they shouldn't be applied. Or there's a lack of willingness to acknowledge what the weaknesses are in some of these metrics. The uncertainty about how long a customer, in many of these new businesses, how long a customer may actually hang around because you're really thinking about my total gross profit over this customer relationship divided by marketing costs. Well, some of those things are cyclical. They change. And by the way, there's other costs that you need to run the business other than marketing.

So, I think we, as a firm at Antipodes, we're always willing to hopefully take the kernel of truth out of some of these things, but not get carried away in the sort of, I don't know, irrational extrapolation. 

James Marlay:

So are you seeing a proliferation of those reasons, those valuations, those metrics that justify?

Jacob Mitchell:

Absolutely. I think some of them are missing the point and justifying relatively weak businesses. So, it's not all cases; we're first to acknowledge that in this environment of very high P/E dispersion, some of the high P/E stocks and not going to go away, and the investment themes that are powering their growth are not going to change, but there's also going to be a bunch that are being given a free pass because of the interest rate environment and they've imitated disruption, as opposed to being genuinely differentiated businesses. And I think they will get found out.

James Marlay:

What's your view on how things are looking from an economic perspective, and how does that feed down into sort of a central thesis that goes into your asset allocation at the moment?

Jacob Mitchell:

I think you've got to, you really have to think about each of the major economies with a slightly different, sort of through a slightly different lens. The US, let's call it China, Asia, and then Europe.

So let's start with the US. What's probably more exceptional to the actual pandemic has been the policy response in the US; it's extraordinary. I mean, we have not seen this level of fiscal stimulus ever outside of wartime. We're grappling with what that means still. And for example, it probably, it may surprise you that there was when you think about where personal consumption spend is today in the economy, it's roughly a trillion dollars below trend.

So, Americans have under-consumed by about a trillion dollars. Now, they've also been given about a trillion dollars of extra income by stimulus. So their savings are two trillion dollars above trend, and they have another, roughly another rough, let's call it round numbers, trillion dollars coming in stimulus. So, you're talking about, even if you apply a marginal propensity to consume of roughly 30%, you've got excess savings of three trillion dollars. You're going to make up that underspend in the next, I think, in the next sort of nine months. So, that's equivalent to 5% of GDP.

James Marlay:

Well, the US are known for being great consumers, aren't they?

Jacob Mitchell:

Sure. So, it's trying to get ahead of that and thinking, where is that money going to go? Obviously, some of the stimulus, some of the savings have gone into the stock market. Some estimates are roughly a quarter of all the stimulus checks went into the stock market. So, we had the GameStop phenomenon. We had various speculative bubbles, Bitcoin, we've got sort of renewables, you name it, but thinking about how that spend plays out, that's critical, I think for the next, let's call it next couple of years. So, some ideas we have is that look, it's very hard. Most of the underspend is really in the services sector, and it's actually hard to catch up. You can't go out and have extra restaurant meals, and you only get so many holidays. So we think it could come in bigger ticket items like durables or cars. I think you might be looking at a super cycle in US car demand. And we can go into that in a bit more detail.

And then you've got also just the fact that markets central bank intervention is just holding real rates very, very low across the Western world. So it used to be just Japan and Europe. And now the US has joined that brigade. Negative, yeah, the yield on the 10-year TIP is negative, let's call it 60 basis points roughly. That just seems extraordinary to me, given what we think is going on in the economy. You've got this supercharged second half of the year, reopening, warming of the of the northern hemisphere, case counts will be very, very low.

James Marlay:

Vaccine rollout.

Jacob Mitchell:

Vaccines, et cetera. Spending balance sheets are really strong. They're pretty big numbers we're talking about. So, the US will probably be roaring, but then it's the hangover. What's the hangover in the US? So, you've got to pay at some point the the extraordinary fiscal deficit. You'll have high taxes, and I think higher real yields. And that will be, I think, that will lead to some of this multiple dispersion starting to contract.

James Marlay:

Just that hangover period that's three to five, is that sort of in that three to five-year window?

Jacob Mitchell:

Look, it's hard to pinpoint. You’ve just got to keep your eyes open. I don't think there is a free lunch here. There will be high real yields, and then taxes are going to become an issue. Corporate taxes are likely to go up, and look, let's face it. A lot of the stimulus is priced in. So it's also keeping your eyes open, I think, for being selective, picking the winners. That P/E dispersion's given you, I think, the opportunity to pick winners, but there's going to be lots of losers which we can benefit from running a long-short portfolio.

And then you go to China. It's the opposite. China has normalised the environment with a very moderate response, and you've got real yields of 3% in China. China's become a magnet for capital. It's competing very aggressively for global capital because it's offering such great yields. People need to keep that in their field of vision. And that, I think, puts longer-term pressure on the US dollar as the reserve currency. And that's the other cost, probably high real yields, high taxes in the US and maybe a weaker currency longer term. So China, more normal sort of recovery, probably more flexibility in a policy sense. If there is a big hangover that hits the global economy, China, I think, has the flexibility to loosen policy.

So I think you play the longer game in China. It's less about rotations from value stocks to growth stocks and more about just picking longer-term winners and not overpaying for those exposures, exposures to services growth in the economy, consumption growth in the economy, that ongoing transition away from investment.

And then Europe. Europe's always muddling through. It's more a federation rather than a Republic. And yeah, probably where Europe is able, I think where the economies can catch up a little is the services sector. The services sector there hasn't seen this uber large income stimulus in Europe. So, the sector is heavily biased towards tourism. So it should be able to, the service sector should accelerate. The manufacturing economy is doing quite well because it's geared towards global growth and to China. So, then the question is can Europe get an investment cycle going?

Look, we think it's got a good chance of doing that around de-carbonisation because it has an existing emissions trading scheme, and it seems to have enough political, let's call it cohesion, to go down that path. So, we have a reasonable exposure to some of the companies that benefit from that investment spend.

James Marlay:

What is your take on what we've seen with the recent spike up in bond yields?

Jacob Mitchell:

Look, I'm surprised at how much media attention it's received given. Yes, it's a move, but in the historical context of where yields have been, it's not a particularly dramatic move. Maybe there's more pain in portfolios; that's what is being reflected in the media. So, I think the issue is probably that investors are losing money on their bonds for the first time in a long time, and secondly, equities have been relatively correlated. Equities are meant to give you some protection from that, but because of the prevailing bias inequities is towards bond proxies, the market cap tends to be dominated by, let's call it, quality growth at a price or, in some cases, at any price. Equities are becoming more correlated to bonds, which is, I think, a longer-term issue in terms of how do you achieve downside protection from portfolio, from asset diversification? There's probably a natural limit, right, where they move in bonds higher starts to choke off some of the recovery, but I don't think we're there yet.

And because most of the move in the nominal bond has really been a rise in inflationary expectations and given the economic recovery that we're seeing, I think you could justify real yields being higher, and it comes down to what you think the Fed's reaction function is. I would've thought they would want to see some normalisation in interest rate markets to potentially puncture some of the most egregious examples of speculation before they start to discuss yield curve control. Yield curve control is quite a dramatic policy shift, and they've got to be very careful, they don't want to create panic. I think normalisation in bond yields is a healthy thing. If it's driven by a normalisation in the economy, which we think it is, but it will be a headwind for very high, multiple stocks that may be really representative of resilient businesses.

James Marlay:

You've mentioned a few times de-carbonisation. Could you talk me through why you think it's an attractive opportunity and particularly talk to some of the data points that you think sort of back up and reinforce why de-carbonisation is an interesting opportunity for investment?

Jacob Mitchell:

Given there's been a bubble and renewable stocks, maybe investors think, well, it's too late. Look, we are really in the early innings. If you think about primary energy output across the global economy, we have to generate electricity, and then we obviously have to move things around for transport, and then we have blast energy that we use in manufacturing.

If you count all of that energy output, renewables account for about five percent of total energy output. Obviously, at some point, you really want to decarbonise completely. That's the goal. So, you're talking about a multi-decade investment cycle. So, we think absolutely it's going to be similar to what happened in 2000, you came out of the dot com bubble. It was a bubble in that you had that P/E dispersion, and everyone was celebrating a whole bunch of new companies as winners. And a few of them did end up winning, but a lot of them disappeared.

And then you had resources stocks, and financials and housing stocks, which all embarked on a big super cycle. China came into the world trading system, which really led to a whole lot of investment. Tt structurally changed the demand outlook for resources. And the US had a housing cycle, financial cycle, via the global financial crisis, you had the market cap of the US-dominated by financial engineering financials. It couldn't be a more different environment. So yes, things change. And I think de-carbonisation is going to drive a big change over the next couple of decades. There will be companies that emerge as massive beneficiaries of that.

So, we see three different ways of benefiting from this. If we think about the US-China, Europe, they all have different incentives for de-carbonisation. China, it's as much about reducing pollution from fossil fuels as it is about reducing emissions. And China has a very carbon-intensive economy because it's still an economy that is investing a lot, construction generates a lot of emissions.

So, the US, when they de-carbonise, there's not a big multiplier on the investment because they have a big fossil fuel industry. So, they're building a new source, clean, let's call it a renewable generation, but replacing investment in fossil fuels.

Europe: you've got the best of both worlds. They're a massive, they're a big importer. They spend just over one percent of GDP on fossil fuel imports. And de-carbonisation actually creates jobs. It's, we think, just to achieve their goals of bringing emissions down by roughly just over 50 per cent. You're talking about at over two per cent additional investment for every year, for the next ten years. So, you've got two per cent additional investment, plus you reduce the import bill by one per cent of GDP. So, it's s quite a big multiplier for Europe, which has always been looking for a growth angle.

So, it doesn't mean you have to buy European companies, but it just so happens that some of the most, let's call it, advanced or some of the best de-carbonisation players do happen to be European.

James Marlay:

Well, talk me through an example. You've talked about some of them being out of the bubble. Clearly, you found a few that you think represent good value.

Jacob Mitchell:

Broadly speaking, Siemens is a great way, and Siemens and it's subs. Siemens Energy. Siemens Energy owns Siemens Gamesa, which is the maker of wind turbines, one of the leading makers of wind turbines globally. It also has a great transmission business. So it builds high voltage transmission. It has the capacity to build electrolysis plants for making hydrogen. So, grid investment is going to be one of the biggest, building wind and solar generation capability and investing in the grid. And then thirdly, building battery plants so that we can build EVs. They're the three biggest areas of investment when you think about that two percent of GDP. Where's it going to go? They're going to be the three big buckets.

So, you've got the targeted ways of playing it, but also in Siemens, you've just got a broad proxy for investment. Siemens allows you to sell software and automation gear that goes into all sorts of manufacturing facilities. And you can imagine what's going on in autos. They're rebuilding themselves; they're going away from, let's call it, the assembly lines that are built for internal combustion engine-based manufacturing to needing battery plants, and then a slightly different configuration. And so Siemens is just a great proxy for that.

Norsk Hydro which is aluminium. We thought there was both a cyclical and a structural element to the story when we were looking at it initially to invest. The cyclical part of the Norsk Hydro story is simply that the supply China has always added a lot of aluminium supply, but we were looking at the rate at which supply was being added in China, and that was starting to slow down.

The more structural story is, well, when you, if you want to decarbonise, you have to adopt EVs. And if you adopt EVs, you're talking about very heavy batteries. So, you have to offset weight elsewhere in the motor vehicle. And you do that by using more aluminium to replace steel. So, it's a light weighing metal. It's very strong, but it's also very light. And so the demand profile already, roughly 25 percent of aluminium demand is used in transport: cars, et cetera. So, that 25 percent can actually grow quite fast as you have EV adoption. And most investors, aren't really thinking, they're not putting that into their demand models for aluminium. Combined with the fact that we think China's generally discouraging investments in emissions-intensive industries, whether it's aluminium or steel, we think the market's been slow to understand that some of these traditionally unloved parts of the market are actually going to go through, I think, a period of fairly strong pricing power.

And it is ultimately underpinned by replacement value. If you want to build an aluminium plant from scratch, and you want to do it with hydropower, which is what Norsk Hydro has, that's the problem with aluminium, it takes a lot of energy. We think there's great, lots of different ways that this investment works. It has multiple ways of winning.

Finally, the third way you can think about de-carbonisation, I think, is owning some of the utilities that are going to deploy the capital in the same way that data centres, stocks ended up being growth rates or growth bond proxies. I think some of the utilities can end up being growth, as long as they're not being priced for that growth, even in a high rate environment, I think they can work.

James Marlay:

Can you talk me through the investment thesis behind vehicles in the US because you talked about all of that pent up capital that needs to get deployed. And you talked about paying it through automakers. So, I was wondering if you could just explain that thesis and maybe talk about how you're playing it.

Jacob Mitchell:

The auto space is again, you've got Tesla at one end, and then you've just got everybody else. And I think the market cap of everybody else is less than the market cap of Tesla. So, it's a good example of, once again, this sort of massive valuation dispersion in the market. When we step back, there's a cyclical opportunity, which I've highlighted in the case of the US. There's been over time and ageing of the auto fleet. Now, that's normal because we make cars better, they last longer. But we think that ageing has probably got to the point where there is just pent up demand. So, the total auto output was down as a result of Covid and certain shortages. We've got semiconductor shortages. So, we've almost got the perfect environment for demand or for price, and carmakers have more leverage to price. Profits have more leverage to price than volume.

And you've had incentives that have been relatively high in the US, but you've got a shortage of supply. Automakers are just struggling to build cars because of a shortage of semiconductors. Now, that's temporary, that will go away. Used cars prices are very high. Households are diverting spending from international travel to local travel. We think that will continue even with vaccines and opening up. I think consumers will be slow to go back to travelling; they'll jump on a plane, maybe do a domestic flight; it may take another year before they go and do the international holiday. All of that spending, those excess savings that I referred to earlier, we think there's a good, there's a lot of, I think there's a very high chance that will go to upgrading the car.

What about the long-term story? So the market's telling us that most of the incumbent automakers have very little terminal value, right, in the way that they're priced today. So, we own Volkswagen and Honda. VW is our biggest position. We own that stock because we think the structural story is really good. If you go back to diesel-gate. Diesel-gate was a blessing in disguise because it forced VW to fast-forward the transition, to reconsider its whole operating model. And at its core, it's embraced an early adoption of EVs. So not token EV; there's a lot of auto companies in the world today who can make an EV, but they haven't invested in a platform that they can use across all their brands in a scalable way. Whereas VW has made that R&D investment, and it's ongoing, and they're doing it within their existing CAPEX budgets.

So, we think within a couple of years, there's every chance they can be making more EVs than Tesla. And we also think there's a pathway of them doing it without margins falling. We think margins could actually improve slightly as they make that transition. So, they've gone all-in on EVs.

And then the question is, what are you paying for that exposure? In 2022, you're paying basically a forward P/E of seven times. If you want to think about free cash flow yield, it's on a 10 per cent free cash flow yield. Tesla's on a ten times revenue multiple, not a ten times cashflow multiple. So, we think it's got loads of pragmatic value, and it's got cyclical tailwinds as well as structural tailwinds.

James Marlay:

Good. A good point to finish upon. Thank you very much for coming in today. I know we tried to hook it up the last few times last year, but it's a great time to be talking about markets. So, I appreciate you coming in today.

Jacob Mitchell:

No, it's great to be here. Thanks, James.

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