Q1: Opportunity to Higher-Grade the Portfolio with Great Businesses

This article is excerpted from a letter by Peter Mantas and Matthew Castel, general partners of Logos LP, based in Toronto, Canada.

Peter participated in MOI Global’s special online event, Intelligent Investing in Crisis Mode, in late March 2020. Replay the session.

“Nature does not hurry, yet everything is accomplished.”
—Lao Tzu

It is no secret that markets rolled over this past quarter from the COVID-19 shutdown creating what looks to be the deepest recession since 2008-09. Over 17 million North Americans are now unemployed (a 35 sigma event) and businesses of all sizes have grinded to a halt in a matter of weeks. As a result, Q1 was by far the most active period in the history of the fund as we experienced what we believe to be one of the greatest buying opportunities for the patient long-term investor since the Great Recession of 2008-2009 and perhaps one of the greatest buying opportunities in the history of the capital markets.

While we monitor specific stocks on our watchlists, we also dive deep into the data using evidence-based research which helps to provide insight regarding sentiment. This view of investor sentiment can increase the probability of deploying cash with a more favorable risk/reward profile.

Although it is an impossible task to time markets, understanding the temperature of the market and thereby making informed inferences as to the market’s probability of swinging from one extreme of the pendulum to the other is possible. It is during these times of great short-term pricing dislocations brought on by sudden economic shocks that high quality stocks trading at what we believe to be below their intrinsic value can be identified.

While we have found several data points suggesting a near-term bottom, the following represent a list of those we found of most interest (courtesy of our friends at Sentiment Trader and Tom Lee from Fundstrat) during the Q1 selloff:

1. Over 23 days in the past seven weeks we have seen the S&P 500 move more than +/- 3%. The previous records were October 1932 and November 2008. In those two cases, the S&P 500 staged rallies of +40% and +27%, respectively, over the next 12 months.

2. MSCI Emerging Market Index price-to-book ratio hit under 1x on April 2nd, 2020. The only other times the index hit those levels were bottoms in 2002 and 2008.

3. March 2020 saw the second largest one month change in aggregate cash holdings in AAII survey history.

4. On March 31, 89% of S&P 500 stocks have triggered a MACD buy signal, which at the time was the highest in recorded history. This has only occurred ten times in the last thirty years and every time this happened, the Nasdaq Composite has rallied six months later by a median of +18%.

5. As of March 20, the average five-week percentage change of 21 developed markets was -31.3%. This was the worst five weeks ever for global stock investors, beating 2008-09 Great Recession.

6. On March 25, more than 90% of NYSE issues were positive. The S&P 500 is up 100% of the time over the next year by a median of +29% every time this happened.

7. The S&P 500 is at 2,845 (which is well above 50% retracement loss level). In the 1987, 2003 and 2008 crashes, “bear market rallies” fail at 33% retracement decline. For all three previous bear markets, the bottom was confirmed with a 50% retracement.

Does this mean that we have hit a bottom and things go straight up from here? Unlikely, as we have to consider the current situation in the context of unprecedented uncertainty and the weakness of analogies to the past.

Furthermore, the answer to this question of whether we have hit a bottom should not overly pre-occupy the patient long-term investor. Why?

We never know when we have hit a bottom as a bottom can only be recognized in retrospect. As Howard Marks has recently written:

“The old saying goes, ‘The perfect is the enemy of the good.’ Likewise, waiting for the bottom can keep investors from making good purchases. The investor’s goal should be to make a large number of good buys, not just a few perfect ones.”

“So it’s my view that waiting for the bottom is folly. What, then, should be the investor’s criteria? The answer is simple: if something’s cheap – based on the relationship between price and intrinsic value – you should buy, and if it cheapens further, you should buy more.”

Successful long-term investing isn’t about buying only at bottoms and selling only at tops. It is instead about the gradual re-adjustment of one’s portfolio as a function of the significant price movements of individual stocks.

This is precisely the approach we have tried our best to stick with during these unprecedented times. We were able to re-position the fund into stocks that we have been monitoring for some time at what we believe to be good prices. The future is uncertain, the economic shutdown remains a very fluid situation and the amount of unprecedented fiscal and monetary action that has occurred in such a short period of time is unlike anything we have ever seen in human history (balance sheets of G4 central banks – the Bank of England (BOE), the Bank of Japan (BOJ), the Federal Reserve (FED), and the European Central Bank (ECB) – have expanded to 40% of gross domestic product). We don’t know what the precise long-term implications of this shutdown will be past 2020, but one thing we can predict with a degree of certainty is that certain businesses will continue to thrive long after the dust has settled.

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About the general partners of Logos LP:

Peter Mantas has an assortment of business and financial experience at global institutions. Peter’s prior experience includes senior managerial roles at large information service and enterprise technology companies in addition to legal experience within the capital markets, alternative investments and tax groups at McCarthy Tetrault LLP. Peter has also been involved in a variety of private equity transactions, ranging from retail to renewable energy, in addition to leading a proprietary trading team for a boutique desk. Prior to this, he held various economic research positions at the Export Development Bank of Canada, Statistics Canada and other various federal government departments. Peter has both an LL.B. and B.C.L. from McGill University’s Faculty of Law. Prior to studying law he obtained an Honours Baccalaureate in Commerce, Magna Cum Laude, from the University of Ottawa, Telfer School of Management, where he received several awards of excellence.

Matthew Castel has diverse legal and business experience encompassing large enterprise technology companies, high growth technology companies, international legal firms (Davis, Polk and Wardell LLP and Fasken Martineau LLP) and government. Within the global capital markets, Matthew has also been involved in a variety of real estate and private equity financing transactions. His research on the societal impacts of emerging technologies such as artificial intelligence and robotics has been featured in several respected academic journals as well as lectures at leading Canadian Universities and Organizations. Matthew has both an LL.B. and B.C.L. from McGill University’s Faculty of Law. Prior to studying law he obtained an Honours Baccalaureate in International Development and French Literature, Magna Cum Laude, from the University of Western Ontario. He has also completed a diploma of International Affairs from the Graduate Institute of International and Development Studies in Geneva as well as certificates from the Northwestern University School of Law, the Stephen M. Ross School of Business and the Wharton School of Business.