Momentum

Momentum stocks have been on the nose of late. The “COVID beneficiaries” like the tech stocks are giving back much of their gains in the rotation to value and cyclical stocks.

Given just how well those stocks did, it is easy to imagine them falling quite a bit further. And it is broader than just FANGMAN, (the full suite of COVID plays) including Zoom, Peloton, DocuSign, to name a few, and also includes the Consumer Discretionary stocks, which benefited from households with lots of savings and nothing to spend it on bar goods.

We think Consumer Discretionary stocks have peaked for the foreseeable future, which has negative implications for our crop of highly performing consumer names like JBH, HVN, NCK and APE.

Narratives

Some of the momentum trades however, to our mind, were just…difficult to fathom. GameStop (GME) might be the example of the moment, about companies that are trading with a disconnect to fundamentals, but our preferred example remains TLSA.

A core part of our process is parsing (i.e. trying to understand) market narratives, and a very clear market narrative was the belief in the genius of Musk, and the first mover advantage in AV/EV technologies, leading to global dominance.

We thought that reverse engineering a TLSA (by other automakers) would prove easier than scaling up automotive manufacturing (by TLSA).

And the key to deciding which narrative was in effect was the price. As the charts above and below show, the TLSA enterprise value was worth more than all the other named companies combined, by a handsome margin, whilst the sales (and by derivation the capex, R&D spend, and marketing capabilities) were but a fraction.

Disconnects

The danger to momentum (as a factor premium) is that it misses turning points. With TLSA the turning point was the failure to accelerate production.

With AGL, it was the market extrapolation of high wholesale electricity prices, which resulted in an over-earning business, with peak margins and peak sales capitalised into perpetuity.

We’d been watching the price rise with a mix of stunned disbelief, largely because we knew that a number of factors (heatwaves, supply outages, the dislocation from renewables entering the market [which isn’t a negative comment on renewables, but, for the sake of brevity I won’t explore that thread in this note]) had temporarily driven prices higher, and wouldn’t prove sustainable.

In 2017 we had politicians campaigning on public platforms pledging to get prices down. It clearly set up a perfect, potent mix to cause a de-rating, firstly in the P/E multiple, and secondly in the earnings.

The point

So what’s the point?

Often stocks have good momentum, because something favourable is going their way, leading to upgrades, and the market gets behind it.

Often those drivers are temporary, and in the COVID beneficiaries case it was COVID itself (temporary, on the assumption that the virus could and would be defeated).

In TLSA’s case it was the idolatry of the charismatic maverick. Eventually, your heroes outrun their accomplishments.

In AGL’s case it was the weather, the technology, and the politicians.

Where else do we see over-extrapolated earnings expectations?

Well, we see it in the buy-now-pay-later space.

We see it in the commodity stocks (most notably the iron ore names, but steel, as a derivative of the same idea, and for most of the gold names).

And in several others.

But we’ll leave the note here.