When it comes to vaccination campaigns, the United States (US), United Kingdom (UK), and Israel continue to lead the way. Following the vaccination of some of the most vulnerable populations, the rate of hospitalizations are decreasing. Efficient vaccination campaigns in the US and UK have increased confidence that economic activity will continue to grow in the coming months. Many indications show strong pent-up demand from both consumers and corporates starting to increase.
In other parts of the world where vaccinations are taking longer, reopening will be slightly delayed. Despite the slow start in Europe, governments are intensifying their campaigns as the supply of vaccines increases. This should enable the economy to reopen and activity to rebound. As restrictions ease, we continue to expect the economy to recover rapidly beyond Q2.
There are some interesting data points that suggest a stronger economic activity as restrictions ease:
Resilience: Similar to what we experienced in the second COVID-19 wave, economies are showing signs of resilience in this third COVID wave.
Business optimism: Strong survey data for the industrial sector suggests that businesses are more optimistic.[1] This could lead to better business activity for Q2. We noticed some businesses commenting on better than expected business trends. After huge cost cutting efforts during 2020, businesses are gradually returning to capex and IT spending.
Some recreational and sports goods have become more popular in this pandemic as leisure options narrowed. Bicycle sales are enjoying phenomenal demand. Suppliers have indicated that stock levels in the supply chain are much too low and that the return to a more normal inventory level would already lead to a high double-digit market growth. RV manufacturers and RV rental marketplaces is another segment that cannot keep up with demand. Thanks to a tight supply chain, strong demand and low inventories, this segment should enjoy good order visibility for 2021 and beyond.
Regarding travel, US domestic and international flights are at the highest levels since the end of March 2020. Europe, which relies more on intercontinental traffic, has not improved much yet, but there are positive signs starting to emerge. The European Commission presented a proposal to create a digital Green Certificate to facilitate the safe free movement of citizens within the EU. Another example is Iceland, which will open its borders this week to visitors who have received the vaccine without the need for testing or quarantine. Australia and New Zealand will also have a similar arrangement starting next week.
Restaurant bookings are soaring in some parts of the US, but also in the UK, as outdoor bars and restaurants opened earlier this week.[2] With a reduced supply of pubs and restaurants, the ones that operate should enjoy strong consumer traffic. Apparently, outdoor tables booked out several weeks in advance after the UK government announced its reopening framework this winter.
These observations and data points are no surprise, as people look forward to leisure activities and travel after months of restrictions. The important variables now are how fast populations are being vaccinated and how efficient vaccines are in terms of preventing a person from carrying or passing on the virus.
[1] Bloomberg – EMEA WEEK AHEAD: ECB to Hold, Russia Hike, U.K. Jobs
[2] https://www.opentable.com/state-of-industry
Global six-month real narrow money growth appears to have edged lower in March, continuing a downtrend since last summer. This suggests that an expected relapse in global industrial momentum will extend through late Q3 / early Q4.
The global manufacturing PMI new orders index reached a new recovery high in March, consistent with a surge in six-month real narrow money growth into July / August 2020, allowing for the historical average 6-7 month lead time. More recent national surveys hint that March will mark a top – see chart 1.
Chart 1
The March real money growth estimate is based on information for the US, China, Japan, India and Brazil, together accounting for 70% of the G7 plus E7 aggregate tracked here. The US component is estimated from weekly data on currency in circulation and commercial bank deposits – official March money numbers are released next week and the Fed no longer provides weekly updates.
Global six-month real narrow money growth appears to have eased further to its lowest level since February 2020, reflecting stable nominal growth and another rise in six-month CPI inflation – charts 2 and 3.
Chart 2
Chart 3
Chart 4 shows the early reporting countries individually. US six-month real narrow money growth is estimated to have edged lower despite disbursement of $318 bn of stimulus payments to households – these were made in the second half of the month and may have a larger impact in April (the money numbers are month averages).
Chart 4
Six-month growth also eased slightly further in Japan and China, with a small rise in India. Brazil moved into contraction although this needs to be placed in the context of an extraordinary surge last summer – 12-month growth is still strong.
Markets could be starting to offer corroboration of the scenario of a global manufacturing PMI new orders peak and pull-back, with Treasury yields stalling and equity market cyclical sectors no longer outperforming – chart 5.
Chart 5
Will global six-month real narrow money growth recover? Six-month CPI inflation is likely to rise slightly further in April / May but could fall back in H2 as commodity prices move sideways or correct.
Fiscal stimulus is acting to push up US nominal money growth but there may be an offsetting drag across the G7 from recent bond yield rises – chart 6.
Chart 6
A revival in Chinese narrow money growth probably requires a PBoC policy shift. The view here has been that policy was overtightened in H2 2020 and the economy would slow in H1 2021. This scenario appears to be playing out, with Q1 GDP disappointing and industrial output falling in March. Core CPI inflation (i.e. ex. food and energy) is at 0.3% and a surge in PPI inflation reflects input cost rises that are squeezing downstream margins. The PBoC has allowed three-month SHIBOR to drift back to its January low, consistent with a switch to an easing bias – chart 7.
Chart 7
This year has started on strong footing for global mergers and acquisitions (M&A). According to Refinitiv, global M&A hit a new record of $1.3 trillion as of March 31st, 2021.[1] What is driving this boom? On the news we have seen many big deals take shape, from GE divesting its business to Canadian Pacific expanding its footprint. But behind the headlines, something else is accelerating M&A activities, especially in the Unites States (US). We are talking about SPAC, which alone represent about 25% of the total deal volume in the US.
The first quarter of this year was also one of the busiest for IPOs, of which, once again, SPACs took the limelight. There were 296 SPACs raising $87 billion, a 20-fold increase over the same period last year.
First, a sponsor raises capital and incurs the cost of an IPO in a new shell company. To make the deal attractive to investors, the units are usually priced at $10 each and provide a warrant to buy more shares. The sponsor then has 12 to 24 months to find the target. If no target is found, or if the investors decide to vote “no” on the deal, the holders can redeem their investments.
We have seen this movie before
SPACs are in their third decade of existence. In the early 1990s, they were marketed as vehicles that helped small companies go public, while offering outsized favourable terms to their sponsors. In the late 90s, SPACs took a back seat. After all, why would a company do a reverse merger when you could easily raise money during the tech bubble? SPACs enjoyed a renaissance in late 2002, peaking at 66 IPOs just before the great financial crisis. They reappeared in early 2016, and have been going strong ever since. According to SPAC Analytics, in 2020, SPACs were 55% of IPOs, compared to 4% in 2013. So far this year, SPACs represent 79% of total IPOs.
SPACs versus a traditional IPO
SPACs are a pure genius way of going public. Since there is no identified target, a sponsor’s prospectus has no information about the business or the strategy. On the other hand, an IPO roadshow raises a lot of questions and invites a lot of scrutiny from investors.
In an IPO, there is no guarantee on the final valuation of the company. With a SPAC, the IPO has been done, and you have negotiated the valuation of your company with the sponsor. Plus the due diligence required for a merger is much less than SEC requirements for a regular IPO.
Cost could be another key factor. An IPO can cost anywhere between one to seven percent in fees for investment banks. With a SPAC, the underwriter may charge about five to six percent. However, there are other fees associated with the merger, which can end up being almost 20-25 percent of the total money the sponsor may raise.
Why are SPACs so popular?
A recent Wall Street Journal article counted 61 sports-related SPACs formed this year alone, compared to just five in 2019.[2] Athletes from Serena Williams, Stephen Curry, Naomi Osaka, Tony Hawk, Colin Kaepernick, and even Shaquille O’Neal, have shown interest in SPACs.
Everyone loves money, especially free money. SPAC founders and sponsors generally get about 20% of the shares of the SPAC as a fee for raising capital, finding the target, and, of course, giving it their brand name. Hedge Funds like it because they can use leverage to buy SPACs and also get preferential access to SPAC deals at the $10 share price. Everyone else has to wait and likely pay a higher price.
Most investors don’t read the annual reports of the companies they own, so they miss out on the fine print in the SPAC prospectus. For example, many are unaware of the lock-up period, which can be anywhere from six months to a year. Once the lock-up period is over, the floodgates open and add pressure to the stock price.
The clock is ticking?
SPACs don’t have time on their side because there is a limited window to close a deal. Targets are well aware of this restriction. They also know that a SPAC is required to spend at least 80% of its assets on a single deal. So the target always has the advantage. SPACs are paying a median price-to-sales ratio of 12.9, compared to 4.1 paid by other companies, according to 451 Research.[3]
SPAC-mania has been going on for a few years now, which means there is a lot of capital chasing deals, combined with ticking clock syndrome, which signals an inevitable decline in deal quality. We could easily see the SPAC bubble go bust once again.
How have SPACs performed historically?
A team of researchers analyzed completed mergers from January 2019 and June 2020, and found that SPACs lost 12% within the first six months, and dropped 35% on average after the first year. Bain & Co looked at 121 SPAC mergers from 2016 to 2020 and concluded that “more than 60% have lagged the S&P 500 since their merger dates, and 50% are trading down post-merger”. The other 40% are trading below the $10 IPO price.
At Global Alpha, we do not invest in SPACs. Our focus is on finding high-quality companies with defensible business models and strong balance sheets that should outperform the small-cap benchmark.
The assessment in the previous quarterly commentary was that the monetary backdrop for markets had deteriorated at end-2020. This was arguably reflected in weak bond market performance during Q1 but global equities rose further as earnings expectations were revised higher. The monetary indicators followed here continue to give a cautionary message for markets while suggesting that global industrial momentum will slow into late Q3. A summer growth “scare” could trigger a correction in equities and a recovery in defensive sectors.
The market assessment relies on two indicators of “excess” money, which, according to the “monetarist” view, is a key influence on demand for financial assets: the difference between global six-month real narrow money and industrial output growth, and the deviation of 12-month real money growth from a long-term moving average. The entire outperformance of global equities relative to US dollar cash since 1970 occurred during periods when both indicators were positive. Equities underperformed cash on average when either or both were negative.
Allowing for data publication lags, the indicators gave a joint positive signal at end-April 2020. The MSCI All Country World Index (ACWI) returned 33.9% in US dollar terms between then and end-2020, reflecting both a recovery in earnings expectations and a rerating of markets. The “buy” signal, however, was rescinded at end-December following a cross-over of real narrow money growth beneath industrial output growth – see chart 1.
Chart 1
Global equities derated during Q1 – the ACWI 12-month-forward PE ratio fell by 4.2% – but the index nevertheless returned 4.7% as forecast earnings rose by a further 8.6%. Earnings optimism was boosted by confirmation of additional large-scale US fiscal stimulus, which also contributed to continued outperformance of cyclical sectors. The view here, however, is that global industrial momentum is peaking and will slow through late 2021. This would be a shock to the consensus and could trigger an unravelling of recent market trends.
The slowdown forecast rests on the relapse of global six-month real narrow money growth from its July-August 2020 peak – turning points have led those in industrial output growth by nine months on average historically. The lead time on the global manufacturing purchasing managers’ index (PMI) is slightly shorter, suggesting that a new high in the index reached in March will mark the peak of the current upswing – chart 2.
Chart 2
China’s industrial recovery has already decelerated, with the Markit / Caixin manufacturing PMI falling to an 11-month low in March. Chinese monetary policy was less stimulative than elsewhere in H1 2020 and retightened in H2, explaining relatively weak money trends – chart 3. China’s PMI has led the global measure since the GFC – chart 4.
Chart 3
Chart 4
Global six-month real narrow money growth continued to subside in February. A recovery could unfold into the summer as US money numbers are boosted by disbursement of fiscal stimulus and if the PBoC relaxes policy in response to softer economic data. Such a scenario could result in another “excess” money buy signal by mid-year while suggesting industrial reacceleration from late 2021. A money growth rebound, however, is likely rather than guaranteed and the judgement here is that the focus for now should be on downside economic / market risks.
An industrial slowdown could be offset in GDP terms by services strength if covid developments allow economic reopening. This could, however, contribute to industrial deceleration by reversing last year’s substitution by consumers of goods for services spending. Industrial trends are likely to be more important for markets, partly reflecting a stronger correlation with equity earnings. Services-driven GDP strength could make central banks less inclined to offer support in the event of industrial / market weakness.
Global CPI inflation rates are spiking higher in reflection of recent commodity price moves and base effects but inflation worries could be near a short-term peak if the above industrial scenario unfolds – another reason for doubting that the cyclical / value rally will extend in Q2. Input price components of business surveys will fall away into the summer barring another surge in oil and other industrial commodities – chart 5. Cyclical sectors may be fully discounting “reflation”, judging by valuation relative to defensive sectors – chart 6.
Chart 5
Chart 6
The March rise in the global manufacturing PMI was driven by European components, with the US PMI little changed and China’s – as noted – easing further. Eurozone strength is consistent with a real money growth spike last summer but a subsequent slowdown argues against current levels being sustained – chart 7.
Chart 7
UK money trends, by contrast, are diverging positively from other majors, signalling a relatively bright economic outlook and possible support for UK equities – chart 3. Money growth strength reflects larger-scale monetary deficit financing than in other countries, which may continue given PM Johnson’s big spender bias and a supine Bank of England. “Excess” money could partly flow overseas, suggesting downside risk for sterling, in which speculators appear to have accumulated a significant long position.
The forecasting approach here uses cycle analysis as a cross-check of the monetary analysis and to provide longer-term perspective. The previous assessment, which is maintained, was that the stockbuilding and business investment cycles bottomed in Q2 2020, while the long-term housing cycle remains in an upswing. The suggestion that all three cycles were turning supportive for the global economy and markets reinforced the positive message from monetary trends in mid-2020.
The next scheduled low is in the short-term stockbuilding cycle. Based on an average historical cycle length of 3.5 years, this could occur in late 2023, with the downswing into the low starting 12-18 months earlier, i.e. in mid- to late 2022. Risk markets tend to weaken in the 18 months leading up to a cycle trough – major equity bear markets have usually occurred during this time window.
The suggestion is that the primary trend in the global economy and markets will remain up through H1 2022. Stockbuilding cycle upswings, however, typically unfold in a zig-zag pattern, with an initial upthrust followed by a corrective phase before a final move higher into the peak. The judgement here is that the initial phase is ending and cycle momentum will diminish into H2, consistent with the monetary forecast of an industrial slowdown. The view that the initial phase is mature is supported by the business survey inventories indicator in chart 8.
Chart 8
Market moves since Q2 last year, moreover, have in most cases matched or exceeded averages during 18-month periods following previous stockbuilding cycle lows – see table 1. Developed market equities, cyclical sectors and commodity prices, in particular, have performed strongly, suggesting limited further upside even though a stockbuilding cycle downswing may be a year or more away.
Table 1
Source: Refinitiv Datastream, own calculations
A further consideration is that the current stockbuilding cycle could be shorter than average. The covid shock appears to have extended the previous cycle to 4.25 years. If the current cycle were to display an offsetting deviation from the average 3.5 years, the next low would occur in early rather than late 2023 (i.e. 2.75 years from the Q2 2020 trough). This, in turn, would imply that the 18-month negative period for markets ahead of the low would start in H2 2021.
The latter possibility, it should be emphasised, is not the central case here and would require confirmation from a further fall in global six-month real narrow money growth during H1 2021 rather than the US-led rebound suggested earlier.
The comparison of recent returns with stockbuilding upswing averages, as well as supporting the case for reducing cyclical sector exposure in favour of defensive sectors, suggests relative value in emerging market equities, quality and gold, and scope for a further rally in the US dollar. Stronger EM equity performance, however, may be conditional on a recovery in Chinese money growth, probably requiring a prior PBoC policy shift.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
Marketing Communication.
This week, Global Alpha is taking a look at one of the more remarkable consequences of the COVID-19 pandemic – the impact on the pet industry. Pets4Homes, the United Kingdom’s (UK) leading free pet classifieds and information site, produced a report on the UK pet trade. At the peak of the first lockdown last May, demand for puppies more than doubled. This is unsurprising given that 94% of pet owners said having the companion animal helped their mental health. Further, 86% said owning a pet improved their mental health, and 84% said having a pet made them less lonely. It is likely that prospective owners wanted to experience the benefits of owning a pet as well.
There were 420 prospective buyers for each puppy offered for sale in the Pets4Homes classifieds, and the average price of puppies for sale in 2020 was £1,875, an increase of 131% from the prior year. And we thought the residential housing market was hot! The demand for cats and kittens also rose during the pandemic, but the average price increased a more moderate 42% from 2019. However, this price dynamic also resulted in more unsavory aspects – the rise of online scams and thefts. Dog thefts increased 170% in the UK compared to 2019.
The supply and demand disconnect has eased somewhat since the peak in May 2020. Increased activity from breeders has helped the supply side of the equation, while gradually easing lockdowns and increased pet ownership has helped slow demand. COVID-19 has undoubtedly given a positive tailwind to a market that was already undergoing structural growth. In 2020, the population of cats and dogs reach 21 million, an increase of 1.4 million from 2017, which in turn increased the estimated market size to £7 billion. The trend of humanizing pets can be seen in the increase in average spending. Dog owners, for example, spend £80 a month on medical treatment, food and insurance. Also, 59% of dogs have some form of insurance, while cats sit slightly lower at 41%.
CVS Group (CVSG:LN), a core holding in the Global Alpha portfolios, is a leading vertically integrated vet services provider in the UK. As well as a large UK presence, CVS Group also operates practices in the Republic of Ireland and the Netherlands. The integrated nature of the business allows CVS group to provide services throughout the life cycle of a pet. The typical life expectancy of a dog is 12 years, while for a cat the life expectancy is between 14 and 17 years. This translates into a lifetime cost of pet ownership for a dog of £16,800, while for a cat, it is estimated at £8,800[1]. CVS Group offers first opinion practices, laboratory tests, specialist referral interventions, online food sales via Animed Direct, and compassionate end of life care and cremation services.
Consolidation of UK veterinary practices has been a significant feature of the market, yet the market is still fragmented. CVS Group is the second largest player by number of premises with over 450 in the UK. IVC Evidensia, a private company is Europe’s largest veterinary care provider, operating over 800 premises in the UK. CVS Group has completed eight acquisitions thus far in the financial year, which ends in June. The focus continues to be on small animals and the company states that the pipeline of acquisition opportunities is strengthening. With a strong balance sheet, CVS Group possesses the funds to continue this strategy.
In a recent trading update, CVS Group continued to exhibit strong growth, driven by the core practices business, but also supplemented by very high growth from the online Animed Direct division. Vacancy rates for veterinary surgeons, the largest determinant of profitability, remain stable, meaning excellent growth at this level also. Around 40% of active small animal customers (430,000 customers), are signed up to the Healthy Pet Club. This service offers discounted products and services for a monthly fee.
To conclude, a rising number of pets, the continued humanization of companion animals and the increased value placed on their care, advancements in treatment and resulting in an extended average life, make the long-term dynamics of the pet market very appealing and Global Alpha continues to see CVS Group as well positioned to benefit.
[1] Pet Care – A Dog is For Life Charles Hall (Peel Hunt), March 22, 2021
Tesla was the best-selling brand in 2020, delivering half a million units, up roughly a third from its 2019 results. German carmaker Volkswagen Group (VW) is still trailing Tesla for EV sales, but the gap is closing fast. VW delivered 231,600 BEVs in 2020, tripling its deliveries in 2019, and is expected to surpass Tesla to be the biggest EV maker by 2025, if not sooner. In fact, VW has already become the number one EV maker in Europe in 2020. On its first Power Day held in mid-March 2021, VW laid out its plan to expand its e-mobility business by 2030, including building six gigafactories in Europe, using unified cell technology to lower battery costs by 30-50%, and expanding its global fast-charging network. The company targets 70% of all the cars sold by VW Group to be pure electric by 2030. Many other traditional carmakers have similar targets. BMW, for example, projects that fully electric models will account for at least 50% of their global deliveries by 2030; Renault-Nissan-Mitsubishi expects half of its EU launches will be pure-electric by 2025; Honda aims for 100% of its EU auto sales to be electric by 2025. It is estimated that the number of EVs sold will rise to 30 million in 2028, and EVs will represent nearly half of all passenger cars sold globally by 2030.
Increasing adoption of EVs also means growing demand for metals. The demand for copper, for example, is expected to increase tenfold between 2019 and 2030. Copper is used throughout electric vehicles and in charging stations and supporting infrastructure, due to the metal’s durability, high conductivity and efficiency. On average, an internal combustion engine (ICE) car contains 23kg of copper. Conversely, a BEV takes around 83kg of copper, about three times more. On top of this, several other secular trends are also driving demand for copper, including the increased consumer use of electronics and clean energy transition. In fact, copper is used in nearly all green technologies, particularly solar PV, wind, and energy storage. Fitch Solutions forecasts a shortfall of 489,000 tons of copper in 2024, and a shortfall of 510,000 tons in 2027. Recycling is an important part of the solution to meet future copper demand, as copper can be recycled as often as desired without a loss of quality. Currently, around 35% of global copper use comes from recycled copper, and this rate is expected to go higher.
Aurubis AG, one of the companies we own in our portfolios, is the largest copper producer in Europe, the second largest in the world, and one of the largest copper recyclers worldwide. The company produces over 1 million tons of copper cathodes annually, and they produce copper cathodes with a roughly 40% smaller CO₂ footprint than the global average for copper smelters. This is due to their high level of recycling and more efficient production methods.
Price, range, charge time, and charging infrastructure are among the main challenges to mainstream EV adoption. Enhancements to battery technology is the key to reducing the cost and improving EV’s performance. Gentherm Inc., a global leader of thermal management technologies and a holding of Global Alpha, provides a battery thermal management system. The system improves the performance of the battery packs in hybrid electric vehicles by heating the battery during cold conditions and cooling it during warm conditions, which increases the life of a battery pack. They also have a cell connecting system to provide a reliable and continuous flow of temperature and cell voltage information during the charging and discharging process, ensuring performance and safety. Horiba Ltd., another company we own in the portfolios, provides analytics and measurement equipment. While Horiba’s mainstay business is its automotive emission testing system, they also provide test and diagnostic systems for fuel cells and batteries through its subsidiary — Horiba FuelCon. The demand for fuel cells and battery testing was very strong and Horiba FuelCon tripled its production capacity in 2020. On the other hand, the demand for emission testing will not disappear any time soon, given tightening emission regulations, and the fact that emission testing is still needed for hybrid electric vehicles.
The increasing charging demand will put significant pressure on the aging grid, especially during peak charging hours. The smart grid is the key to support this demand. With a smart grid, utilities can predict and manage EV charging. It also enables utilities to provide consumers with greater insights into their EV experience, including better understanding the cost of charging, and helping users set optimal charging preferences. Landis+Gyr Group, a holding we talked about in the weekly commentary on May 22, 2020, is a leading global provider of smart meters and smart grid solutions. Although there are delays with regulatory project approvals and installations of smart meters due to COVID-19, the mid- to long-term growth prospect remains intact. In addition to providing smart meters, Landis is making active investment in software development to add more higher-margin and less volatile revenue streams. In December 2020, Landis signed a partnership with Google Cloud to innovate the next generation cloud-based energy management solutions, which is the first partnership of this kind for the energy management industry. With a solid balance sheet, Landis is in a good position to make investments and benefit from the global megatrend.
From the onset of the COVID-19 pandemic in 2020, questions were raised about the feasibility of hosting events, such as the Tokyo Summer Olympics, which were expected to be one of the more notable economic casualties. In what marked a year of many firsts, the International Olympic Committee (IOC) made the unprecedented decision to postpone the event to 2021, instead of cancelling it. Why is that? An easy answer would be that the only other times this decision had to be made, during World Wars I and II, decision-makers did not know how long the Olympics would have to be postponed, making it an easier choice to cancel the games altogether.
A more thorough look at the economics of Olympic events provides a more complex answer. It is well known that hosting the Olympics is a costly endeavor, and has become more so over the years as the number of participating countries and number of sports have increased significantly. Since 2000, the average cost of hosting the summer Olympics has been upward of US$5 billion in infrastructure investments and operational costs. Further, the benefits of hosting the event are heavily debated, with many arguing that there is no net benefit, even when accounting for indirect gains from tourism and other variables. As such, following the US$45 billion Beijing games in 2008 and the US$20 billion Rio de Janeiro games, many cities voiced their skepticism and withdrew their candidacy for the 2022, 2024 and 2028 games. The wave of withdrawals forced the IOC to assign the 2024 and 2028 Olympics to Paris and Los Angeles as early as 2017, as they were the only remaining viable options.
One of the more direct ways for host cities and the IOC to recoup their costs is through sponsorship programs. The highest level of partnership is through the Olympic Partner Programme, which grants category-exclusive marketing rights to the Summer, Winter and Youth Olympic Games to a select group of global companies and is used to fund IOC activities and costs. Created in 1985, the Olympic Partner Programme provides the IOC with a range of support, such as technology, staff deployment, marketing, essential services to athletes, and broadcasting experience.
Under the Olympic Partner Programme there are three categories of local sponsorships to support the staging of a specific Olympic event. The local sponsorship programme for the Tokyo Olympics is comprised primarily of Japanese companies that stand to enhance the image of the events. Unlike other sporting events, no commercial advertising is allowed at the venue under the Committee’s clean venue policy. Instead, the sponsors obtain various levels of rights to use Olympic and Paralympic designations and imagery, such as the logo, as well as to the right to supply their products and services to athletes and spectators.
Global Alpha owns shares in a company that is directly involved in the local sponsorship programme for the Tokyo Olympics: ASICS. ASICS is a renowned manufacturer of sports shoes, sportswear and sports equipment that sponsors many Olympic athletes around the world involved in activities such as tennis, running, wrestling and more. Headquartered in Japan, the company was created in 1949 under the name of Onitsuka Tiger. The modern name ASICS is derived from the Latin proverb “Anima Sana In Corpore Sano,” which means a “sound mind in a sound body,” and the company has remained committed to this philosophy to this day.
In 2015, the 2020 Tokyo Olympic Committee announced that ASICS was selected as a gold partner of the Tokyo 2020 Olympics, the highest local sponsorship level, and that it would be supplying the uniforms for the Japanese teams and volunteers. Under the IOC product-category exclusivity policy, ASICS is the only company allowed to advertise under the sporting goods section, often thought to be one of the more lucrative sections. We expect the company to hold up well to the scrutiny stemming from the exposure.
Strength
Solid brand recognition
Strong expertise in biomechanics and material science, reflected in their shoes’ quality
Outstanding ESG profile
Weakness
Lagging in fashionable sports shoes and sportswear
Opportunities
Growing worldwide interest in healthy activities, especially performance running
China embracing performance running, as reflected in the number of marathon events rising rapidly
Threats
Competition within the industry
Rising costs of raw material and labor
While the company is not allowed to disclose the cost of the sponsorship, it expects to spend a total of $US128.5 million on event-related expenses. Unlike some of the experiences of past host cities, there is good reason to believe that Asics will be able to make a profit from its investment, and that the event will provide a good tailwind for the company over the next few years.
Global six-month real narrow money growth is estimated to have fallen further in February, based on monetary data covering 70% of the G7 plus E7 aggregate calculated here. The decline from a July 2020 peak suggests a slowdown in industrial momentum extending through Q3 2021.
Turning points in six-month real narrow money growth have led turning points in the global manufacturing PMI new orders index by 6-7 months on average historically. The July money growth peak, therefore, suggested a new orders peak in January-February. The current high point of the orders index is November 2020 but this may have been surpassed in March. These are details: the key point is that the index appears to be reaching a peak on schedule, with money trends suggesting a significant relapse by end-Q3.
Chart 1
Cooler consumer goods demand is consistent with a coming industrial slowdown. Global retail sales fell between October and January, with early data suggesting another decline in February – chart 2.
Chart 2
Industrial output growth appears to have been sustained by a continued recovery in investment goods demand and – probably more importantly – a rebuilding of depleted inventories. Restocking, however, will have been accelerated by softer consumer goods demand and the associated output boost may be peaking.
A key point, often neglected, is that the level of industrial output is related to the rate of change of inventories. These are probably still lower than desired and restocking should continue. A slowdown in the rate of increase, however, is sufficient to exert a negative impact on the level of output.
A normalisation of US six-month real narrow money growth has been a key driver of the slowdown in the global measure, although smaller declines have occurred elsewhere – chart 3. US money growth should rebound strongly in March / April as the Treasury transfers cash to households from its account at the Fed (i.e. helicopter money).
Chart 3
A US rebound could drive a pick-up in global six-month real narrow money growth, signalling industrial reacceleration in late 2021 / H1 2022. This isn’t guaranteed, however: a further inflation rise will drag on real money growth near term, while nominal money trends elsewhere may continue to cool.
Analysis of US narrow money trends has been complicated by banks reclassifying some savings accounts as transactions accounts following a Fed decision to lift restrictions on the former. This artificially boosted the old M1 measure in 2020, particularly later in the year, when its six-month growth rate rebounded strongly – chart 4. The numbers used here attempt to correct for this distortion but the suggestion of a significant slowdown was disputed by some readers.
The debate has now been resolved by the recently released Q4 financial accounts – these contain M1 flow data adjusted for reclassifications and other discontinuities. The fall in six-month growth of the break-adjusted M1 series during H2 2020 was similar to that of the corrected measure calculated here.
Chart 4
A global industrial slowdown in Q2 / Q3 may not be reflected in GDP data because of services reopening. The latter, indeed, could contribute to industrial softening as consumer demand switches back from goods to services. The judgement here is that industrial trends are a better guide to underlying economic momentum and a more important driver of markets, partly reflecting a stronger correlation with equity market earnings.
A simple rule for switching between global equities and US dollar cash discussed in previous posts holds cash when six-month growth of global real narrow money is below that of industrial output. A negative cross-over occurred in October 2020 and – allowing for data publication lags – resulted in the switching rule recommending a move to cash at end-2020.
Real money growth was below industrial output growth in January and early indications are that this remained the case in February – chart 5. The rule, therefore, will continue to recommend cash in April and, probably, May. The rule is currently about 4% offside since the end-December switch. Such a drawdown is not unusual and compares with a 32% gain when the rule was in equities between end-April and end-December 2020.
Chart 5
COVID-19 has led to a turbulent economy characterized by faster adoption of technology, increased environmental urgency and inflation from unprecedented stimulus. The widespread government support is resulting in inflation across many goods as economy rebounds quickly. Fortunately, the debt service ratio of consumers in the United States (US) is at a 40-year low, meaning they can probably handle rising prices for some time.
While certainly not linear, inflation is exacerbated by the unprecedented stop-and-start occurring across economic sectors, especially when comparing goods versus services. Demand is high for some products such as those related to home improvement, yet low for others like restaurant equipment. Demand for goods are presently outweighing demand for services in a major way. The imbalance is inflating prices notably through a supply chain shock that has significantly increased transport prices. The US Consumer Price Index is higher by 11% y/y at the goods level, while its service counterpart is down 5% y/y.
The rush for certain goods, such as personal electronics has created a global semiconductor chip shortage. As a result of increased demand, the personal computer sector grew by 10% in 2020, and surging demand in the fourth quarter reached 25.4%. The impact of this high demand was felt across the entire technology supply chain.
Why are automakers shutting down production?
Automakers spent $43 billion on microchips in 2019, representing 10% of global semiconductor sales. Chips are more critical to automakers than automakers are to chip manufacturers. In 2020, car manufacturers planned for a 35% drop in sales, but ended up with a drop of 8%, thus they quickly needed more chips to fill inventories. These emergency chip orders went to the back of the line behind larger electronics clients, which had better estimated their future needs during the crisis. The impact on 2021 production could mean 1.5% of new cars not being available, a material number that will certainly affect availability and pricing.
The average electric car features roughly 3,000 chips. Cars have become a laboratory for human machine interface, where manufacturers continue to innovate at a frantic pace. This will certainly continue to provide us with interesting investment opportunities. There are a number of emerging human interface trends that will change the way we use our cars, including:
Screens: A full-screen interior, with infotainment screens up to 48 inches wide on the dashboard.
Voice commands: As voice recognition technology evolves, so does its complexity, with functions from adjusting following distance in adaptive cruise control, to fully self-driving cars that don’t require physical steering, braking, or acceleration input.
Touch to movement: BMW is already using gesture control technology, where cameras “see” hand movements to perform in-vehicle functions. Taking it further, under development is technology to give the sensation of virtual touch response in the air using ultrasound.
Driver assistance: Rather than the constant go, stop, and steer motions a driver must perform, driver assistance commands are alleviating the need for attentiveness and active participation.
Virtual assistants: Based on emotional and physical demeanor, machine learning can predetermine the best outcomes for driving routes, temperature control, communication and musical preferences.
Global Alpha is exposed to the noted trends and futuristic electronics in the automotive sector. Gentherm (THRM:US) is the uncontested leader in thermal management with heated and cooling seat systems. Among new smart products, Gentherm is launching its ClimateSense system, featuring sensors that detect heat from each passenger and optimize the climate with exterior conditions throughout the car. The company expects to save up to 50 miles driven in electrical capacity.
Cerence (CRNC:US), a leader in speech integration and digital content delivery for the automotive industry, is launching Cerence Look, a new product enabling drivers and passengers to interact with points of interests outside the car, like a machine co-pilot. Mercedes-Benz is the first carmaker to launch this technology in its Travel Knowledge feature.
These trends confirm that carmakers will continue to increase their dependence on technology and semiconductor chips.
The chip shortage will subside but could signal an onshoring trend in semiconductor production. Taiwan-centric TSMC, the world’s largest semiconductor manufacturer, controls over 70% of the world’s chip production.
Industry players sensed the importance of strategic semiconductor assets, and 2020 was one of the highest years on record in terms of M&A activity. Global Alpha is participating in this phenomenon, as three different companies have publically disclosed their offer to acquire one of Global Alpha’s holdings, Coherent (COHR:US), a leading provider of laser-based technologies to the semiconductor industry.
The chip shortage crisis provided additional insights, including a supply quasi-monopoly by TSMC with its mega factory, heightened international trade tensions, and the erratic effects of an intense stimulus or expansive monetary policy. Historically, the situation is very similar to the 1970s oil crisis, without the geopolitical catastrophe. Interestingly, the semiconductor has become the new oil; the most critical component to every machine we use. Now, we just need to hope that lessons learned from the 1970s can help us handle higher levels of inflation.
Every day we deal with vast and rapidly growing amounts of data. Some of us might even feel like we are drowning in this deep ocean of messages, emails, spreadsheets, images, sounds, and videos. To make sense of it, various organizations employ diverse data analytics tools that help them gain insights and identify new opportunities. If acted upon appropriately, they can lead to improved decisions, better outcomes, and happier stakeholders. However, we should not neglect the risks associated with data and sophisticated technology. Hackers, criminals, and terrorists also leverage technology for their benefit, often at the expense of companies, citizens, and governments. To mitigate these risks, organizations worldwide need to stay ahead of them by processing their data and identifying actionable insights.
This is exactly what Cognyte Software, one of our portfolio companies, has been enabling its clients to do. Its security analytics tools help to fuse and analyze the data siloed across organizations, connecting the dots and providing critical information at the right time to prevent multiple threats before the damage is done. The environment is highly fluid, as well-funded and organized perpetrators relentlessly evolve their skills and methods to achieve their goals and avoid detection. Security organizations, in turn, cannot afford even a moment of complacency.
This brings to mind the Red Queen effect, in that organizations must adapt and evolve to survive. Cognyte turned that challenge into a big opportunity, recognizing the need for a scalable, open-analytics platform that provides real-time, actionable intelligence that can help find a needle in a haystack. Its cutting-edge solutions are driven by artificial intelligence, and are used by the most sophisticated security organizations across the globe. In one reported case, a European client’s investigative team leveraged Cognyte’s platform to prevent a radical group from driving a large vehicle into a crowd. More than 1,000 corporate and government clients in over 100 countries see Cognyte as their reliable partner to manage their security challenges and empower them to protect lives and assets and make the world safer.
Cognyte operated as a division of Verint Systems for more than two decades until a spin-off was completed in early February 2021. As a global leader in security analytics software, Cognyte empowers governments and enterprises with actionable intelligence to address a broad range of security challenges, including threats to national security, business continuity, and cybersecurity. The company has a strong track record of solving complex security challenges and unmatched domain experience. Over 400 government customers account for 80% of total revenue, while around 600 enterprise customers make up the other 20%.
Revenue mix
Software revenue (42%), including primarily term-based and perpetual licenses.
Software service revenue (45%), including support and cloud-based SaaS subscriptions.
Professional service and other revenue (13%), including installation and integration services, customer-specific development work, and others.
Target market
Cognyte estimates its total addressable market at $30 billion, evenly divided between government and enterprise sectors, with a steady growth rate of 10% per year1. Security challenges are becoming more complex, with rapidly growing data and the increasing adoption of open analytics tools by security organizations among the key industry tailwinds.
The market is highly fragmented. Despite being one of the leading players, Cognyte has a market share of 1.5%.
Some public peers include a point solutions vendor, FireEye, and big data analytics vendors, Palantir and IBM. Cognyte differentiates itself from competitors through a focused security analytics approach, deep domain expertise, and by creating a holistic view of data in delivering actionable insights. However, Cognyte primarily competes with organizations’ in-house capabilities. Governments and enterprises have traditionally approached their security challenges with homegrown solutions. In our view, these tools cannot keep up with the evolving threats, are costly to build, and complex to maintain. For this reason, we see a secular shift towards open-analytics platforms.
Growth strategy
Increase penetration of existing customers.
New client wins.
Developing partners to expand in enterprise vertical.
Bolt-on acquisitions.
Strengths
Cutting-edge security analytics and artificial intelligence (AI) technology. Broad portfolio addressing a wide range of security challenges.
Unparalleled security domain expertise and focus.
High revenue visibility. Large portion of recurring revenue (~50%), significant contribution from repeat customers (~90%) and a healthy backlog1.
Well-diversified client portfolio (across segments and regions).
High customer stickiness.
Strong balance sheet.
Seasoned management team with strong track record.
Opportunities
Margin expansion.
Fast and wide adoption of open analytics software.
Industry roll-up opportunities.
From 2018-2020, as a division of Verint Systems, Cognyte recorded strong financial results, with revenue and EBITDA compounded annual growth rate of 8% and 26%, respectively1. EBITDA margin saw a very impressive expansion of 500 basis points to 18% over the same period. As a standalone public company, Cognyte announced three-year financial targets of double-digit revenue growth and EBITDA margin expansion, driven by faster adoption of open analytics software and ongoing revenue mix improvement. Given the strength of the underlying business and vast opportunities ahead, we believe this trajectory could prove to be conservative.
