If you're trying to beat the market, you need to develop a variant perception -- a strong viewpoint that differs from the market consensus. To do that, you need to focus on situations or information that the consensus view is under-weighting or ignoring altogether.
This week we look at an example of an incumbent consumer brand's eroding advantage, a charge of price manipulation in the bitcoin market, and Goldman Sachs' case for a correction in the stock market.
Halo Top, the giant slayer
You don't have to be a high-technology start-up to compound value at an astonishing rate. Take the remarkable story of low-sugar, high-protein ice cream brand Halo Top, as highlighted in last weekend's Financial Times. Last month came news that Unilever plc (NYSE:UL) (NYSE:UN) had decided against acquiring Eden Creamery LLC, the company behind Halo Top, for a cool $2 billion.
Or consider that Eden Creamery announced last January that Halo Top had become the top-selling pint of ice cream, overtaking Unilever's Ben & Jerry's and Nestle SA (NASDAQOTH:NSRGF) and General Mills, Inc.'s (NYSE:GIS) Haagen-Dazs.
Last October, Unilever, the world's biggest ice cream manufacturer with its Magnum and Ben & Jerry's brands, reported a fall in volume in its refreshment division. Speaking at the time, Graeme Pitkethly, Unilever's finance director, highlighted "how very, very quickly," Halo Top had "taken 1.5 share points from us."
In this same column two weeks ago, I highlighted another FT article that argued that large consumer brand companies' competitive advantage has eroded:
Jorge Mesquita, chairman of Johnson & Johnson's consumer division, last year noted how barriers to entry in the form of access to manufacturing, logistics, and marketing were coming down across the world. In the "last few decades in this industry," he said, "there were a series of barriers for entry or sources of competitive advantage that were well established, but those are becoming less and less unique. You see a new class of competitors emerging, and now we have our classic multinational, well-established competitors and you have these new entrants to contend with."
For example, to take on entrenched razor-blade brands, Dollar Shave Club chose to outsource manufacturing and distribution to focus on product design, marketing, and customer service. Last year, the then five-year-old start-up was acquired for $1 billion by... Unilever. Similarly, Eden Creamery, founded in 2011, has outsourced the production and distribution of its ice cream; the company's competencies are product development and brand management.
I'm convinced the stock market does not appreciate the full measure of this shift in power and opportunity in the consumer brand sector away from established companies toward upstarts. For value investors, who have long looked to these companies as a reliable source of growth and profitability, this phenomenon is particularly consequential.
Bitcoin: What was really behind the rally's last gasp?
Although the following story concerns bitcoin and received appropriate coverage, its value for stock market investors cannot be overemphasized. Being able to recognize a financial bubble may not be a source of big gains, but it can prevent you from suffering enormous losses.
Following a brutal decline last month, bitcoin has lost 14% of its value over the first two trading days of February, according to data from Bloomberg. At $8,570, the cryptocurrency has now fallen by more than half from its mid-December high.
The most recent decline was associated with the news this week that the world's largest bitcoin exchange, Bitfinex, has received a subpoena from the Commodity Futures and Trading Commission. A virtual currency company named Tether that shares the same chief executive also received a subpoena.
Tether "issues" a cryptocurrency by the same name with a fixed value of $1 per token; the company claims that the supply of tether tokens is backed in full by dollars held in segregated accounts, and, as such, the value of a tether does not fluctuate.
That claim is under increased scrutiny, and so is the opaque relationship between Bitfinex and Tether. As The New York Times reports:
In recent months, however, many investors have been raising alarm bells about Tether. Hundreds of millions of dollars worth of new Tether were created, almost always when the prices of other virtual currencies were heading down. The Tether were used on the Bitfinex exchange to make big purchases of bitcoin and other tokens, helping push their prices back up, according to multiple analyses of data from Bitfinex.
"This became more and more concerning, because every time the markets went down, you have seen the same thing happen," said Joey Krug, the co-chief investment officer at Pantera Capital, which runs several virtual currency hedge funds. "It could mean that a lot of the rally over December and January might not have been real."
The red flags concerning Tether and Bitfinex are so numerous and glaring that the situation is only possible when participants' greed and fervor have suffocated their common sense. Both organizations have already been hacked, for example -- to the tune of over $100 million, in aggregate. Meanwhile, Tether has parted ways with its accountancy, Friedman LLP, which stated that it has not verified the legitimacy of Tether's records.
Given the level of activity on Bitfinex, this ought to give all bitcoin speculators pause. If you've read Edward Chancellor's excellent Devil Take the Hindmost: A History of Financial Speculation, you will know that fraud is a dependable component of financial bubbles, particularly at the end stage. My advice? Listen to an investor who has achieved an unparalleled long-term record spanning many episodes of mania. Last month, Berkshire Hathaway CEO Warren Buffett told CNBC that "[i]n terms of cryptocurrencies, generally, I can say, almost with certainty, they will come to a bad ending. ... It's a mirage, basically -- it's a method of transmitting money. The idea that it has some huge intrinsic value is just a joke, in my view." Caveat emptor.
Goldman Sachs: The correction is coming
On Monday, Goldman Sachs' chief U.S. equity strategist, Peter Oppenheimer, warned clients in a note that the days of smooth sailing to ever-new highs without so much as a hint of rough seas may be numbered:
Whatever the trigger, a correction of some kind seems a high probability in the coming months. Our Goldman Sachs Bull/Bear Market Indicator is at elevated levels, although the continuation of low core inflation and easy monetary policy suggests that a correction is more likely than a bear market. ...
Drawdowns within bull markets of 10% or more are not uncommon. The average bull market "correction" is 13% over four months and takes just four months to recover.
While Oppenheimer believes the risk of an outright bear market remains "low," he pointed out that the S&P 500 has entered the longest period since 1929 without a correction of more than 5%.
With the S&P 500 (SNPINDEX:^GSPC) down 3.9% for the week, its worst weekly performance in two years, and the VIX Index (VOLATILITYINDICES:^VIX) at its highest level in over a year, Oppenheimer's warning now looks well timed. However, the plain, though continually ignored, truth is that no-one knows when a correction or bear market will rear its head, only that one will do so eventually. A bull market cannot go on forever, and therefore it will stop, to paraphrase economist Herbert Stein.
How does one invest in this current environment? I like Howard Marks' advice. In his latest memo, the co-chairman of Oaktree Capital Management writes [emphasis mine]:
Thus Oaktree will continue to invest on the basis of value and its relationship to price, and to refrain from trying to time markets based on predictions regarding economies, markets or psychology. ...
Our post-2011 mantra ["Move forward, but with caution"] remains in force: We're investing when we find reasonable propositions, albeit with caution. We're investing, and ... we aren't intentionally uninvested. If we find things with decent return prospects, structure, and risk, we don't pass them by because we think they'll be cheaper a year from now.
Enjoy your weekend!