2020 Crystal Ball

A gentle reminder was provided by the market last week as to its unsettled nature.  Essentially, headline risk is at the forefront tossing the market based on the sentiment of the day – oft times lubricated (or diverted) by a Presidential tweet. Granted, this is little changed from the past but we do have an increasing clarity to use as a guide.

What is unchanged is that US valuations remain elevated.  Sure, there were some stumbles during the recent earnings season and some cautionary guidance presented.  Barring a black swan event it does appear the next recession (US version) has been punted into the future – at a time post election.   There are – and will continue to be – pockets where value can be had, but I see this opportunity being readily available only to individual stock pickers willing to accept a slightly higher risk factor.

Headlines have also illustrated a measured success that Presidential bashing of the Fed failed to accomplish.  The dollar weakened – a little. On the heels of the results from the UK election, Sterling strengthened. My opinion being this is a relief rally at seeing an end to the Brexit saga as the real work now can now begin in earnest.  These negotiations may get bogged down a little – particularly trade – which could provide a reentry point for Labour and their agenda of nationalization. I see the UK as a viable alternative but with risk associated in telecoms, energy, utilities, rail and mail.  Perhaps a mid-term view is required with an entry point sometime after the first of the year.

Much the same boat for China as the renminbi strengthened against the dollar as the news of a “phase 1” agreement on trade crossed the wires.  What this means probably remains debatable, but if a truce is effective going into the new year it is a likely positive for US equities, tempered by the fact that their currency is a daily peg rather than free-float.  The risk here is twofold – on and off again tariffs and US involvement in their political affairs (Uyghur Human Rights Policy Act and Hong Kong Human Rights and Democracy Act). The bills appear to be more show than substance but could flare tensions. The investment thesis should note the alleged Human Rights abuses along with the minimal sanction levels.  If these pitfalls are successfully navigated, opportunities do exist.

Then there are the fintech darlings, the newest variant being the so-called ‘Challenger Banks” or neobanks.  Though awash with cash from private funding rounds, they all have one glaring defect – they aren’t really banks.  They are apps – generally mobile – with a compelling interface and a few niche benefits targeting the millennial audience.  A couple have started the process to really become banks but most are content to partner with real banks – sweeping funds into accounts that have FDIC insurance.  My research remains incomplete but with three exceptions, the partner banks pay no dividend or are private. I currently own the exceptions, GS, JPM and WSFS but don’t expect the challenger funds to be a significant revenue driver.

Perhaps the largest driver of ‘hot air’ time in the new year will be the election.  The obvious beneficiaries being media companies who are able to capitalize on both sides of an argument.  However fragmentation, targeting and scope make it more difficult to call any winners unless any campaign goes on a deep targeting offensive which would benefit social.  From a messaging position, only health care moves the needle much where companies like UNH, HUM and CVS stand to benefit as the attacks subside.

The commonality between these issues?  None are long term. Yet the nature of capitalism is its’ cyclical nature.  There is always a correction to drain the excesses. The timing and severity are always debatable, but rest assured one will arrive.  My approach to the new year will be to take some marbles off the table by pruning some non-core positions and reassessing some strategic plays. To place this in context, I have three new positions on my watchlist and ten to fifteen under review which if fully implemented would be roughly a 5% churn rate.  My comfort zone is now squarely with Staples and Utilities … items necessary for consumer consumption regardless of the overall economy. Yes, the upside is muted with these companies, but more importantly the downside risk is mitigated. A rising dividend stream exceeding the rate of inflation is the core goal in these times in spite of politics or political persuasion.

And so goes my crystal ball for 2020 …

Investing in CBD

Subsequent to the passage of the Agricultural Improvement Act of 2018, signed into law December 21st, there has been a significant amount of speculation as to the rise of the market for CBD oils, edibles, supplements and derivatives. Migrating across the country are calls to create a system – or infrastructure – if you will, to enable this budding (pun intended) industry to grow and thrive. This bill clarified two gaps in prior legislation related to industrial hemp, namely removing hemp from the definition of marijuana and and creates an exception to the THC in hemp – essentially declassifying it as a Schedule I narcotic, as long as it has no more than 0.3 percent. Then the state has to enact processes – subject to USDA approval – before being legal. The most onerous of which is mandatory testing of the THC threshold.

In a role reversal of sorts, the new reality is that CBD is legal at a federal level with a hodge-podge of regulations at the state level with a degree of federal oversight. For the time being, one can assume differing laws depending on the state. This is also subject to change regularly. For purposes of this discussion, we’ll assume Texas is moderate – neither at the bleeding edge nor trailing the pack – as HB1325 was signed into law last month and retailers are already making an appearance – pending registration. Many – including myself – are attempting to identify ways to profit from these endeavors with no clear answers. DivHut (via a guest post) tackled this question and laid out a great foundation before withering away at the end. I do have to concur there may well be room to run in this space, the key being in what way – which we’ll explore a little further.

Retail is the obvious starting point with CVS and Walgreen are dipping their toes in the water while Amazon is marketing CBD-less hemp oil. The bad news, if any, is that any sales made by these giants would be negligible to earnings. This isn’t to ignore the mom-and-pop shops or franchise operations appearing, only that as a passive investor the options currently limited.

Manufacturing is the second area for research but winds up being the most convoluted depending on your interest, e.g., topical, edible, oil, prescription drug, THC or CBD, et.al. My approach is to categorize into two segments: Consumer and Cultivation. The consumer side being a product supplier to a retailer or consumer direct. Cultivation is a little trickier in that the Texas bill legalizes hemp farming and the sale and possession of hemp-derived CBD oil containing less than .3% of THC. Meanwhile growing hemp is not yet legal until the USDA provides guidelines and approves state applications. This could be considered a quagmire of sorts, but of a temporary nature.

Extraction and Testing is the final area to watch as this is where the heavy investment will take place. One piece of the Texas Law is, ” the laboratory must be accredited under ISO/IEC 17025 or other comparable standard. License holders may not use their own laboratories for state testing unless the license holder has no ownership in the laboratory or less than a ten (10) percent ownership interest if the laboratory is a publicly traded company.” Consider that most – if not all – of the law enforcement labs require upgrades to differentiate between now legal and still illegal products. Xabis, an independent lab, has forged a deal with Westleaf that includes equity based compensation.

So who currently has my eye?

  • Retail – Elixinol Global (ELLXF). Assuming this Aussie company can navigate through the FDA regs unscathed.
  • Manufacturing – Canopy Growth (CGC) – pursuing a license to process hemp in New York state
  • Testing – Eurofins Scientific (ERFSF)

All of which are highly speculative – so tread lightly and do your due diligence. Is this a space you too are looking at (additional suggestions are always welcome)!

Update 4 Aug 2019: On Aug 1 I initiated a position in Innovative Industrial Properties Inc. (IIPR), a REIT in the medical space.

April Showers

Below the shifting landscape that debates the notion as to whether tariffs are a negotiating ploy or the real deal, some pig farmers are now operating at a loss of thousands of dollars per week (futures markets have priced in tariffs) and soybean growers are considering whether to reduce their plantings to avoid the same fate.  Meanwhile the impact on our NAFTA partners is also being considered across the borders.  Canada can increase their soybean and pork sales to China but the net impact will still be negative to them considering the magnitude of trade volumes.  Mexico is expanding ties to China in an effort to mitigate the ‘Trump’ effect.  All the while, the administration has to be aware that China holds the ultimate ‘trump’ card in the debt held.  Some bearish views posit US interest rates could rise to 14% if China ceases their bond purchases.

With these headlines staring at us, it would be excusable to have missed some of the underlying news – one being in healthcare.  Two of my companies made the news this past week with possible or rumored deals; Shire (SHPG) and Humana (HUM).  Takeda’s interest in Shire has all the appearances of industry consolidation, Wal-Mart and Humana’s discussions are more along the lines of being one of the last gorillas.

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Shifting Sentiments

Generally I put together a watch list quarterly based first on overall portfolio goals.  As an example, the first quarter typically is used to readjust weightings where they’ve gone a little awry – particularly in my anchor and core positions.  This next quarter has historically been goosing returns as its’ priority.  Meaning, adding to out of favor positions (depending on the reason) which carry the highest current yield.  You could say it’s a personalized Dogs Of The Dow approach.  As always, market valuations have the final vote on my actions.

In preparing the list for next quarter, I’m finding more compelling reasons to avoid sectors as opposed to buying:

  • Example 1 – The first legislative test facing the Trump team is today’s vote on health care.  Even putting campaign rhetoric aside which placed a spotlight on the likes of CVS, the actual bill aims directly at Medicaid and indirectly at Medicare recipients.  Assuming the bill passes in its current form (unlikely), estimates are roughly 20 million people will become uninsured.  The indirect impact to health care REITs could blindside some investors.  Using CCP for one, some providers to which they lease could face reimbursement issues.   Simultaneously, the DOJ is pursuing a case alleging Medicare fraud against AET, CI, CNC and HUM.  Then there’s fraud in diagnostics resulting in one bankruptcy.  I think I’ll let the dust settle in this segment before treading any deeper.
  • Example 2 – My expansion into Hong Kong encountered some headwinds.  Swire announced a dividend which was effectively a cut (still figuring the magnitude, but about 38%) primarily on the heels of their 45% ownership stake in Cathay Pacific (CPCAY).  At least the poor fuel hedge (that my analysis missed) expires next year.  And, no, my efforts to increase my diversification outside the US are still intact.  If only the Yen would weaken …

Perhaps a correction is on the horizon as UBS suggests. perhaps not.  But the one certainty is there is plenty of uncertainty – especially with earnings season set to begin again.  I guess I need to finish my taxes to see what the budget for purchases looks like.