AI picks and shovels, we’re in a recession, and a potential return to home bias

Welcome to this week’s Market Pulse, your 5 minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.

Our stories this week are:

1. Picks and shovels (at a reasonable price)
2. A shallow recession
3. A British ISA and a dash of home bias

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It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.

As with all investing your capital is at risk.

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1) Picks and Shovels (at a reasonable price)

We believe a big part of being a good investor is first and foremost being a good historian. So, with that in mind, let's jump into our time machine and head back to 1999.

We have a strong hunch the internet is going to be big. Really big. We recently read a few good books on long-term investing and came across a Mark Twain quote that sounded sensible: “During the gold rush, it’s a good time to be in the picks and shovels business”. So, we start doing our research. We are looking for companies exposed to what is surely to be one of the biggest growth themes in recent history. Who’s in the internet ‘picks and shovels’ business?

It doesn’t take long until we come across Cisco, the worldwide leader in networking equipment. Sales have grown 6-fold over the last 4 years and the future looks like it might be even better. Cisco has a market capitalisation of $400bn, and around $12bn in revenue. Sure, at 33 times revenue it seems expensive on the surface but the internet is going to be absolutely huge. We are convinced people saying it's too expensive are just not seeing the future potential. They just don’t seem to ‘get’ exponential growth. After careful due diligence we decide to buy some shares[1].

Now fast forward 24 years. The internet has grown far beyond even our most optimistic forecasts back in 1999. We absolutely nailed the big picture. It turns out there are now more than 15bn connected devices globally[2]. Surely the Cisco share price skyrocketed. It’s up 76.5% (GBP) over the 24 year period. Not bad. But wait, that barely outpaced inflation and the SP500 is up 589% (GBP), almost 8x more[3]. It gets worse, Exxon Mobil, an oil and gas company, is up even more than the SP500. Yes, an oil company beat what was, at the time, the global leader in the ‘picks and shovels’ that facilitated the rise of the internet. We didn’t see that coming.

Source: Bloomberg LLP

While we agree that the companies making the AI ‘picks and shovels’ today stand to benefit from what could be explosive growth in demand, we also remember the important lessons of history. Just being right about the big picture and staying invested for the long-term is not necessarily enough to outperform the broader stock market. We know that the price you pay ultimately determines the return you get.

Note: We hold Nvidia in Flagship.

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2) A shallow recession

Japanese GDP shrank 0.1% in the final quarter of 2023, after a 0.8% decline in the previous quarter. This puts Japan in a technical recession. Sure, this is preliminary data and could be revised up next month but there seems to be some real underlying weakness. Wage growth in Japan hasn’t kept up with inflation and this seems to be making consumers reluctant to spend. The market is expecting the Bank of Japan to increase interest rates later this year. This will be the first hike since 2007. Tapping the brakes by hiking interest rates just as the Japanese economy seems to be deteriorating has us raising our eyebrows here[4].

It’s not just Japan that’s in a tough spot. Here at home, the UK also slipped into a technical recession after GDP fell for a second consecutive quarter. This is bolstering the case for interest rate cuts later this year. It’s also shining a potentially unwelcome spotlight on the Conservative Party promise to ‘grow the economy’, especially in an election year.

Andrew Bailey, governor of the Bank of England, tried to paint an upbeat picture by saying the recession is most likely to be shallow[5]. We think he could be right and expect UK growth to accelerate over the course of 2024.

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3) A British ISA and a dash of home bias

Home bias is the tendency for investors to over-invest in domestic equities despite the benefits of diversifying into foreign equities. Institutional investors, like UK pension and insurance funds, have long understood the potential benefits to be had from investing overseas and as a result their exposure to UK companies has dropped from close to 50% in 1997 to less than 5% today[6].

Part of this shift was likely related to relative performance. The UK stock market has had a difficult 30 year run of performance when compared to our US friends across the Atlantic. But luckily for us here in the UK, it’s relatively easy to invest in best-in-class US companies like Apple or Microsoft. As an added bonus, and to help savers save up for retirement, the UK government has various tax free wrappers, like ISAs, where investments can compound without a tax drag[7].

Source: Bloomberg LLP

But there are some in the current UK government, like Jeremy Hunt, that are concerned about the lack of investment in UK companies. Some proposals to address the issue include shaking up ISA rules by potentially giving a tax break to investors who choose to invest in British companies. While this might have the intended effect, increased investment in UK listed companies, it could have a material impact on long-term performance if history is anything to go by[8].

Instead of incentivising people to invest in companies they are clearly not choosing to invest in at the moment, we believe the government should instead use resources to support the start-up ecosystem. Empower smart, highly capable founders to build world class companies and encourage them to IPO their companies here in the UK. If the government can succeed in doing this, we’re convinced investors will choose to invest in exciting high growth UK companies.

Note: We hold both Apple and Microsoft in Flagship.

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References

[1] https://www.morningstar.com/stocks/nvidia-2023-vs-cisco-1999-will-history-repeat

[2] https://iot-analytics.com/number-connected-iot-devices/

[3] https://www.officialdata.org/us/stocks/s-p-500/1900

[4] https://www.ft.com/content/610ef0bc-a199-4e33-9350-a09d3ca0aa07

[5] https://www.ft.com/content/b48cfce5-6a0b-4811-9e17-847da43d9a33

[6] https://corporate-adviser.com/pension-fund-investment-into-uk-shares-falls-to-new-low/#:~:text=Just%204.2%20per%20cent%20of,declined%20significantly%20in%20recent%20decades.

[7] https://www.gov.uk/individual-savings-accounts

[8] https://www.ft.com/content/728d2983-db84-4a85-b234-6db987798d12

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Notices

Please remember, investing should be viewed as longer term. Your capital is at risk — the value of investments can go up and down, and you may get back less than you put in.

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