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When the market overreacts

By Simon Angelo

A common view against active investing is the Efficient Market Hypothesis.  It suggests that the market has already absorbed all information concerning a stock and thus it is priced efficiently and correctly.  However, as Warren Buffet pointed out, the Efficient Market Hypothesis only works sometimes!  

Judging overreaction

Markets mirror the human frailties that underlie them, especially when it comes to fear and greed.  Perhaps the most irrational fear is fear of loss.  Studies have shown that the strength of emotion behind fearing losing what we have is much greater than the joy or anticipation of gaining something more.  It's called Loss Aversion.  And it's this sort of thinking that holds back 99% of people from taking the risks needed to flourish, especially financially.

Let me share a secret

As a share buyer, some of my best trades have taken advantage of market overreaction, especially when the market fears loss.  When the Brexit vote in the UK succeeded in 2016, we took the opportunity to buy some quality companies at oversold prices.  The month after, we were up 7.50% - in a single month.

IGD Italy

This happened again a few weeks ago with an Italian business we've been watching for some time - IGD (Immobiliare Grande Distribuzione), the largest owner of shopping malls and hypermarkets in Italy and Romania.  As a significant, listed player in the Italian retail market, the stock price is aligned to the fortunes and expectations for the Italian economy.  There have long been concerns with the economy in Italy, not least with public debt levels, and as a result IGD has been cheap - with book value per share currently at around 60% of asset value.

Sunday trading

Most recently there was the announcement that the Minister of Labour, Luigi Di Maio plans on banning Sunday trading to defend family traditions in Italy.  This dragged down IGD's price further to bargain territory as it generated fear.

Looking at the situation more closely, 25% of stores would still be able to open on Sundays on a rotating basis under the proposed law.  Sunday bans in other places simply spread shopping revenue onto other days - particularly relevant in the case of IGD properties which are often anchored with a supermarket or hypermarket such Ipercoop (whom is also a significant shareholder via their parent company).

The fear settled and the market started to recognize IGD had probably been oversold.  We had already purchased for account holders, so notched up a 6% gain the week after, not to mention the 7%+ pa dividend yield enjoyed via the holding.

Long term view

The controversial new Italian government may further help IGD's stock price.  The populist government - formed by leftist Five Star Movement and the right wing Lega have promised among other things, drastic cuts to corporate tax rates, slashing red tape and guaranteeing all Italians a minimum monthly income of up to 780 euros.  This may not find favor with the EU, already concerned with a free spending Italy - but it'll be great for the malls.

What about debt in Italy?

Fitch, the ratings agency recently cut Italy's credit outlook to negative but maintained the long term rating at BBB.  Government debt is the highest in the Euro area after Greece, running at 130% of GDP.  However the finance minister has reiterated an intention to bring this down.

This is not as worrying as it might be however when you consider other factors in relation to the Italian retail sector.  Household debt in Italy is actually relatively low at around 41% of GDP - beneath that of Germany, France and the UK.  Ironically an increase in interest rates benefits Italian households as they have a higher savings ratio.  In terms of IGD, their debt level is stable with a loan-to-value ratio of around 46% and average cost of debt at only 2.7%.

Of course, there remains the wider view that malls will continue to be battered by online shopping.  However retail footfall seems to continue to grow, albeit not at the rate of online.  My own view is that people get tired of staring at screens and want to get out, especially to cafes and supermarkets, which are prevalent in IGD malls.  When I visited their Mondovicino mall in Piedmont last year, it was thriving.

An Ipercoop hypermarket at IGD's Mondovicino Shopping Center.  Such large scale markets fend off online shopping as most people visit not only for food but inspiration too.
Performance update
September 2018 saw a pleasing 1.94% return for the month across the composite portfolio (comprising those accounts containing the full strategy positions).*  The annualized return now sits at an average rate of 18.04% pa from inception in 2014.*  You can view the full performance chart here.

The British pound saw quite a bit of volatility as it first rallied on positive Brexit news and then pulled back.  It has been more challenging for Australasian currency holders to buy US and European stocks, especially as the New Zealand dollar is now at its lowest rate (against the USD) for two years.
Stock take
Amit Parmar has recently joined our firm as analyst, specializing in Australian equities.  With a strong background working at major investment houses, he has a passion for financial markets and financial modelling.  Here he shares his view on AGL Energy. 
AGL Energy Ltd is Australia’s largest energy provider.  What makes AGL special is its history.  It has been around in Australia since 1837.  The leaders running the company understand the business very well have run the company successfully over the last 180 years.
AGL has a market cap of AUD $12.93 Billion.  Currently it is trading at a P/E ratio of under 8 times, dividend yield of 6.13% and Debt to Equity of 33%. The broad sector is trading at 28.43 times, dividend yield of 5.6% and the sector debt to equity is 122.83%.  AGL is spending AUD $2 billion on expansion of electricity generation across Australia.  The internal directors are adding to the position within their portfolios. The company is on track to add AUD $120 million back to the bottom line by optimizing operations and reducing the cost by FY2021.
In conclusion the above factors make AGL an attractive investment in this rising market as the market does not see it very favorably based on future profit guidance.  However this security offers good opportunity to the contrarian long-term investor looking for durable competitive advantage.
The month ahead
A few months ago I moved back to our Auckland house.  After living in an apartment in Europe, I'm enjoying getting out and doing some work in the garden again.  

Maintaining a good sized garden has many similarities to investing.  Primarily you're looking to select and nourish plants that grow well, as you are with stocks.  In Spring you're also looking to enjoy the many blossoms and flowers - as we do dividend income from the shares.  And you also need to pull out a few weeds and replace under-performers.

We go into October still with 'weather' uncertainty.  Will the Brexit position clarify further?  How will the trade issues between the US and China continue to unfold?  Of course we need some overreactions to all this uncertainty to reveal some buying opportunities.  Ultimately I'm an optimist - so if you pick your positions well, I think it's time to plant while the sun shines.

Wishing you a great October and sunny returns ahead.
If you're a client, thanks for taking the long view with Vistafolio.  If you'd like to find out more about our innovative, managed account solutions for eligible or wholesale investors, please visit

*Past performance is not an indicator for future performance. Your actual portfolio will differ from the composite portfolio mentioned. Annualized returns are after management fees and after withholding taxes. The information contained in this document does not constitute an offer to sell or a solicitation to buy an investment, nor should it be construed as investment advice.  It is recommended that potential investors take appropriate tax and/or investment advice before making any investment.
Copyright © 2018 Vistafolio, All rights reserved.

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