In this March 2022 Quarterly Commentary, our sister company Orbis discusses its global equity strategy and current positioning. 



Prior to Russia’s invasion of Ukraine on 24 February, the Orbis Global Equity Strategy had less than a 2% position in Russia. We were concerned for some time about increasing tensions between the two countries and trimmed our overall exposure to Russia in recent months. With the benefit of hindsight, we should have eliminated the position much sooner. At present, we have little confidence in our ability to recover value from these positions and wrote them down to zero in early March. As noted in our president’s message, we have suspended investing any new capital into Russia, and when trading resumes for foreign investors, we will seek to exit our Russian holdings in a manner that is in the interests of our clients. Our thoughts remain with those in harm’s way and we hope for a prompt and peaceful resolution.

“Our thoughts remain with those in harm’s way and we hope for a prompt and peaceful resolution.”

While investors seem to be focused on understanding the immediate impact on markets, we think this misses a much bigger point. Russia’s funding ultimately comes from energy exports more than anything else. To date, these exports have continued, but it is increasingly likely they will come under pressure either from explicit sanctions or self-imposed decisions to suspend dealings with Russia. Even if Russian oil and gas can escape Western boycotts via other countries such as China, there is insufficient infrastructure to fill the gap straight away, as much of it is delivered to Europe.

The real question is what happens if there is a more sustained disruption in Russian energy production itself. For example, a ban on the sale of equipment to Russia for oil and gas extraction could impair long-term production capacity. The old adage that “the best cure for high prices is high prices” remains true—other suppliers will happily step in to fill the gap left by Russia. But so far that supply response has been limited for a variety of reasons, and supply was already very tight prior to the invasion. In fact, it is precisely because fossil fuels have been so deeply out of favour for so long that the supply crunch exists in the first place. In our view, many investors are only beginning to grasp many of these longer-term implications.

Nor are energy prices the only concern. Other key commodities ranging from wheat to nickel have surged as Russian and Ukrainian supplies have been cut off or severely constrained. Even more obscure chemicals such as neon—which is just as essential to making semiconductors as it is the flashing signs in Soho or Times Square—are in short supply and will almost certainly affect the pricing of many other products. The US Federal Reserve is clinging to the view that inflation will be “transitory”, but this does not inspire confidence. In fact, the Fed’s limited response thus far probably raises the odds that inflation will persist.

For investors, the resurgence of inflation is a potential game-changer. The current situation can be seen as a mirror image from the last major shift in inflation in 1982. Back then, after a very painful period of rising prices in the 1970s, inflation was finally crushed when the Federal Reserve led by Chairman Paul Volcker raised short-term interest rates as high as 20%. Still, investors didn’t believe inflation had been defeated, so they continued to price assets as if nothing happened. Corporate profits were roughly 5% of US GDP and the S&P 500 traded at about 8 times earnings (or 40% of GDP) and it was a phenomenal opportunity to buy stocks.

“The old adage that “the best cure for high prices is high prices” remains true.”

Today corporate profits are roughly 8% of GDP and the S&P trades at about 25 times trailing earnings—200% of GDP. Real interest rates have plummeted to near -8% in the US, when they should arguably be above normal (perhaps 3%) to help fight above-trend inflation. This hurts stocks that are priced at inflated multiples of revenue or earnings (if any)—and it should be no surprise that many of the market darlings of the pandemic era have suffered in recent months.

Said differently, the market environment in recent years has been characterised by a TINA mentality – There Is No Alternative – in which investors have had little choice but to chase increasingly frothy equity returns rather than sitting in cash at 0% yield or the “return-free risk” offered by many government bonds.

At Orbis, we don’t get along very well with TINA. As value-oriented investors, we struggle to keep pace in the latter stages of valuation cycles as equity markets become increasingly expensive, as has been the case in recent years. We prefer TASHA – There Are Some Healthy Alternatives – and that’s exactly the mindset that we bring to the opportunity set today.

“It should be no surprise that many of the market darlings of the pandemic era have suffered in recent months.”

Commodity producers are one such alternative. Teck Resources—a Canadian mining company—offers a 25% free cash flow yield at current commodity prices. Put another way, owners of the business may get all of their money back after just four years if prices remain at current levels. But even if there is a correction in commodity prices, Teck still looks reasonably attractive under more conservative long-term assumptions.

Brazilian iron ore miner Vale is another good example. Prior to the end of 2021, iron ore prices had previously halved from their recent peak on China property fears headlined by the Evergrande crisis. Vale is one of four iron ore majors globally and is also the world’s largest producer of nickel, a critical component for electric vehicles. It has net cash on its balance sheet and trades at just 6 times 2022 earnings forecasts. At current production levels and iron ore prices of $150 per tonne, Vale generates a free cash flow yield of about 25%, but even at $80 per tonne it would still deliver about 8-10% free cash flow yield. That tells us that the stock is fairly valued with ore at $80 and a steal if current prices persist. Of course, the current levels may be unsustainably high, but high commodity prices provide a reassuring margin of safety. The longer high prices persist, the more cash will flow back to the owners of the business, which in turn provides fundamental support for the share price.

“The market environment in recent years has been characterised by a TINA mentality—There Is No Alternative.”

If we are correct that the stock picking environment is changing, then banks may offer yet another healthy alternative. One of the key arguments against owning banks has been that low interest rates compress lending spreads, and the longer that persists, the more pressure it puts on net interest margins. But interest rates have recently been the lowest in 5,000 years of knowable history and it would be unreasonable to assume that this will persist indefinitely—particularly in light of the sharp uptick in inflation. For banks, the headwind from interest rates should now fade, and perhaps at some point turn into a tailwind.

KB Financial Group—one of the leading lenders in South Korea—has loan growth targeted at 5-6% for 2022, with a small amount of net interest margin expansion too. KB is paying about a 5% dividend yield—which should rise over time as it boosts its payout ratio—and it trades at just 50% of its book value. Valuation figures like these might normally be signs of distress or weak fundamentals for a bank, but KB has an impressive track record of profitability and is well-capitalised, looking poised to reward us over our long-term investment horizon.

“Being underweight the most expensive parts of the market in favour of our selection of healthy alternatives has been a tailwind. One we believe has far more room to run.”

Interestingly, “boring” companies like Teck, Vale and KB now compare favourably to some of the more fashionable stocks that tend to get far more attention from investors. A general perception in recent years has been that tech companies and other “disruptive” businesses are the only real source of robust and growing cash flows—consistent with the TINA mindset—but we think some of these more mundane businesses deserve a second look. And not just from a value perspective, but on the strength of their fundamentals as well. Many are now in a position to return significant cash to shareholders, have very healthy balance sheets and are trading at vastly lower multiples than the stockmarket darlings of recent years.

In our view, there are still plenty of healthy alternatives to choose from in the current environment, particularly as growth rates fade and valuation multiples are squeezed by rising interest rates. While the likes of Teck, Vale and KB are just a few examples, they are representative of the types of new opportunities that we have been focusing on of late. That said, we are still every bit as enthusiastic about many of the other top holdings that we discussed in our “tour” of the portfolio in last quarter’s commentary.

While Global’s performance in the first quarter was similar to that of its benchmark, we got there very differently. It has been frustrating that our exposure to Russia and China has hurt performance, but being underweight the most expensive parts of the market in favour of our selection of healthy alternatives has been a tailwind. One we believe has far more room to run.


Commentary contributed by Ben Preston, Orbis Portfolio Management (Europe) LLP, London


Financial advisers can contact their local regional manager to learn more about the Orbis Global Equity Fund.