Carlson Capital‘s Black Diamond Thematic fund was up 0.63% net for the first quarter. The fund continues to see tech as expensive and the Fed overly friendly.
Buy more tech?
In his letter to investors dated March, which was reviewed by ValueWalk, Portfolio Manager Richard Maraviglia said the Federal Reserve is about as dovish as it can get in its commentary. Based on the market’s movements during Q1, he feels as if “a friendly Fed really only means ‘buy more technology’ and sell anything that is cheap.”
In fact, he feels that at some points during the first quarter, "one could be mistaken for thinking that no one human was actually watching the market and that computers were switched on independent of any information." He also believes that sales of "true value" stocks are financing purchases of expensive ones. Thus, the firm's biggest conviction call is that "companies with extremely cheap tangible assets are going to dramatically outperform expensive growth and momentum stocks."
Even though they have been early to move on this view previously, they remain excited about the fund's "asymmetric" setup when the reversion does finally occur. He again compared the current market setup to 2000 and the dotcom bubble, both in stock price movements and inflation.
Oil and energy
Maraviglia noted that they said crude oil was oversold in their previous letter, and they turned out to be correct. WTI prices were up nearly 50% while oil and gas stocks remained close to their lows of the year.
He noted that energy stocks do have challenges, and he believes the market "is upset with shale because it is confused as to whether it is a growth industry or not." He doesn't believe it is, and as companies reduce their capital expenditures and turn their attention more fully to free cash flow, he expects the narrative to change. He continues to believe the energy sector is under-owned and at "depressed valuations," citing the significant difference between the performances of oil stocks and crude prices.
For now, he still likes tanker stocks. Following five years of inventory reductions and now with an all-time-low order book, he believes this is a good time to own tanker stocks. Tanker supplies will be reduced due to the International Maritime Organization's 2020 fuel sulfur regulation, which should increase demand. He expects asset values and rates to increase because he believes tanker companies will beat expectations for earnings and cash flow.
He sees this year's fourth quarter as the beginning of "the real excitement" for this sector. He predicts that oil exports will pick up months before the regulation begins, which should be good for tanker companies.
Financials are cheap too
Maraviglia also believes financials are "extremely cheap" since the Fed "helped bond yields and the yield curve to fall." He does like certain non-bank financials with little credit or macro exposure, and he expects upcoming increases in bond yields to push cheap bank stocks up.
Although Carlson hasn't owned any European banks in more than two years, Maraviglia thinks the opportunity now is "attractive." He expects deposit tiering to be addressed or possibly even implemented this year, which would reduce the charge on excess reserves held by German, Dutch and French banks. Although many remain skeptical, he believes equity returns will improve.
Carlson owns Societe Generale, Unicredit and Resona Bank in Japan. Maraviglia believes the financial industry must be consolidated because global scale has become so important. Larger banks are more easily able to invest in technology and data analysis. He now believes Europe has too many lenders.
Long on biotech
Carlson likes biotech right now, and like Maverick Capital's Andrew Warford, Maraviglia is skeptical about the U.S. ever adopting universal healthcare. He notes that concerns about this possibility have helped drive a major decline in biotech stocks, and the fund had been shorting some HMOs. However, he now believes investors are too afraid of something that probably won't happen. He notes that the U.S. is already sitting on $1 trillion in debt, and adding free healthcare and free education could tack on another $2 trillion.
"While we are seeing a global shift to populism and polarization, we do not foresee Americans voting to bankrupt themselves, although the current environment does parallel the 1970s inflation cycle," he wrote. "Free Medicare and free student education will be a topic to watch."
Although Carlson usually avoids biotech (and you may recall Lakewood Capital is short some Korean biotech names), all the companies they have bought have drugs which have been approved or are through Phase III data and have weekly prescription data available. Maraviglia believes some companies like Coherus and Stemline will be able to hit breakeven within two years of launch, which is much faster than many favored software names. He expects positioning and the next election to help reverse the downtrend in the biotech sector.
Still shorting semiconductors
Carlson continues to short the semiconductor space, and Maraviglia notes that memory prices are down 40% to 50% from peak 2018 levels. Additionally, industry revenue fell in Q1 for the first time in two years, and visibility is low due to compressed lead times. He believes reality has finally hit home for the space amid excess inventories, global trade uncertainty and weakness in the end markets.
Although they do feel "vindicated" by the sector's fundamentals, he admits that shorting the group remains a problem because the SOX semiconductor index remains close to multi-year highs. He believes bulls are expecting significant recoveries in the second half of this year, but he expects semi stocks to fade eventually amid weaker earnings estimates and outlooks.
Betting against software
Several hedge funds have talked up software over the last year or so, but Carlson Capital is taking the contrarian view, calling the sector its "new battleground." Although bulls have maintained that software is a non-cyclical growth sector, Maraviglia disagrees.
He notes that the markets are valuing software names based on revenue rather than earnings, and thus these companies have been willing to expand "at any cost." He compared valuation trends in the sector to running McDonald's with no earnings and focusing only on revenue growth. He believes wage inflation is being underestimated for the sector because companies tend to pay employees with stock options, making "already low earnings look better than they would have been due to pro forma adjustments."
He believes the software sector will end up being cyclical after all and notes that most modern-day software names haven't lived through a full economic cycle yet and that many are "guiding as if there will never be a down cycle." Software companies are up about 40% since the December lows, and Maraviglia views valuations in the sector as at "stratospheric levels."
This article first appeared on ValueWalk Premium