“The whole world is simply nothing more than a flow chart for capital.” – Paul Tudor Jones
“It’s still true that the big players in the public markets are not good at taking short-term pain for long-term gain.” – Jeffrey W. Uben, ValueAct Capital
In this week’s piece we (i) revisit our call on cloud-based software stocks, (ii) touch upon Dollar Tree Inc. $DLTR, which we think is poised to outperform in the near term, and (iii) consider the possible ramifications of the recent policy statements by the US Treasury and the Fed.
Cloud-Based Enterprise Software Update
We highlighted cloud-based enterprise plays as a potential long idea in Two Investment Ideas on 14 January, 2019. Two out of our three preferred names, Veeva Systems $VEEV and Workday Inc. $WDAY, are up 16.46 and 13.92, respectively, from market close on 14 January through 2 February. In comparison, the S&P 500 Index is up 4.88 per cent during the same period.
We think it is a good time to tactically take profits in both names and to continue playing the theme through Benefitfocus $BNFT and the two additional names we highlighted in our weekly piece on 21 January. We will look to re-enter long positions in $VEEV and $WDAY at lower levels, should they correct.
Dollar Tree Inc.
We have been long $DLTR for more than a year now. Initially the stock did really well, outperforming the S&P 500 Index. Alas, it did not last and performance was lacklustre between February and December last year.
The underwhelming performance of the stock stems from the declining sales and earnings at its Family Dollar franchise. The company acquired Family Dollar for US dollars 9 billion in a fiercely contested battle with Dollar General $DG during the second half of 2017.
The Family Dollar acquisition was motivated by management’s desire to scale up to better compete with larger players such as $DG and Target $TGT. What transpired, however, is the company ended up buying an under performing business that it has, to date, been unable to turnaround.
What has made the failure to turnaround Family Dollar even more vexing, for shareholders and management alike, is that following $DLTR’s ill-fated acquisition, its direct competitor, $DG, has managed to grow strongly, open up new locations and increase its market share.
$DLTR’s troubles with Family Dollar have attracted the attention of activist investors and in January of this year Starboard Value – the New York Based activist hedge fund – announced that it owned 1.7 per cent of the company and had nominated seven directors to its board.
Starboard wants $DLTR to consider a sale of Family Dollar, even if it means selling it for significantly less than it paid for it. It has also suggested that the company should make changes to its current business model including selling some items at price points above US dollar 1, such as US dollar 1.50 or 2 – something that $DLTR’s competitors already do.
Whether a sale of Family Dollar transpires or not, having an activist hedge fund as a vocal shareholder, we think, is likely to place pressure on $DLTR’s management to make meaningful improvements in the company’s operational performance and create shareholder value.
We have waited on commenting on the stock following Starboard’s announcement as we wanted the initial euphoria to die down and for long frustrated shareholders to take the opportunity to sell following the news.
We think $DLTR is well placed to out perform in the near term and we will be adding to our existing position.
US Treasury Refunding Statement
From the US Department of the Treasury’s press release issued on 28 January:
- During the January – March 2019 quarter, Treasury expects to borrow $365 billion in privately held net marketable debt, assuming an end-of-March cash balance of $320 billion. The borrowing estimate is $8 billion higher than announced in October 2018. The increase in borrowing is driven primarily by a lower than previously assumed opening cash balance.
- During the April – June 2019 quarter, Treasury expects to borrow $83 billion in privately-held net marketable debt, assuming an end-of-June cash balance of $300 billion.
The US Treasury’s deposits held in its general account with the Fed stand at US dollars 411.4 billion as of 30 January 2019.
Based on the US Treasury’s press release, around US dollars 110 billion of deposits held with the Fed will be injected into the global banking system between now and 30 June.
This announcement is important because deposits held by the Treasury with the Fed are unlike deposits held with banks. Outside periods of extreme economic instability, the Fed is not engaged in the business of lending money, it only takes money in as deposits. Cash taken in by the Fed does not percolate through the global banking system, rather it sits idly in Fed’s accounts in New York.
Consequently, the build up of cash in the Treasury’s general account, to park funds generated through the issuance of Treasury bills, tightens monetary conditions while withdrawals from the account tend to ease monetary conditions. With the US Treasury contributing to tightening financial conditions for the better part of 18 months, it will for the next five months, at least, reverse course and become a source of monetary easing.
The Fed’s U-Turn
From the Wall Street Journal:
In what arguably was Mr. Powell’s most significant statement on Wednesday, he struck a dovish tone on this process of “balance-sheet normalization.” The signal was that so-called quantitative tightening would continue for now but end sooner than expected. Moreover, he also raised the possibility that the balance sheet could be “an active tool” in the future if warranted—in other words, more bond purchases if markets or the economy cry out for help. Until recently, Fed officials had been insisting the balance-sheet shrinkage was on autopilot.
As discussed last week, the Fed has little choice but to maintain a large balance sheet if it wants the US banking sector to continue being governed under the stringent Basel III framework. Chairman Jay Powell confirmed as much during his press conference on Wednesday last week.
The combination of:
(i) the US Treasury releasing dollars into the banking system;
(ii) the Fed putting interest rate increases on and introducing language that opened up the possibility that the next move in interest rate could either be down or up; and
(iii) increased clarity on the Fed’s plans for shrinking its balance sheet
we think, should be conducive for risk-assets during the first half of the year.
After a strong showing by global markets in January and the little matter of the US-China trade resolution deadline fast approaching, we think caution is warranted in February. Nonetheless our highest conviction ideas for the first half of the year are: long selective emerging markets, long precious metals, short US dollar and long selective US technology companies.
With respect to precious metals, the Chinese New Year holidays have more often than not proven to be periods of weakness. Those with a bullish disposition should take advantage of this seasonal weakness.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
