May comment

Madrague had a very poor month in May: -6.3%.

This month is nothing short of a disaster and we are extremely disappointed with the numbers. We had a very good month in April where we took down net exposure and started to be more cautious in some more cyclical sectors (Capital Goods and Autos mainly). This did not stop the bleeding though. Our thesis with being long deep cyclicals where some companies are trading below replacement costs proved to be very expensive in May. We saw some extreme rotation in combination with very weak equity markets. On Morgan Stanley’s numbers the valuation difference between value and growth in Europe is even more extreme than during the height of the IT bubble in March 2000. Our interpretation is that investors are being squeezed into the equity market because of a lack of investment alternatives. If an investors want yields that are more than just a few basis points they need to either go quite far out on the risk curve in the bond market or start looking at equities. Those investors are more prone to safe haven equities with less cyclicality. This is a consequence of the low interest rate policies across the globe and we can understand the behaviour even though we need to stress that steady cash flows do not mean no price risk. A cash flow that has been repriced from 4% to 3% does carry a risk of reversal.

Sectors of note in May:

Media: +0.3%

The sector was one of very few positives in May. Our short positions in Mediaset Spa, Publicis and ProSieben were the main contributors. All of them are facing structural headwinds in the new media landscape, but there is a price for everything, so we covered our short in Mediaset towards the end of the month. We increased the short in ProSieben on the announcement that Mediaset is buying a stake in the company. Our view is that it is a defensive move which won’t solve the issues these companies face.

Technology: +0.2%

We wrote about the sector and Ovzon in our last monthly letter. Ovzon was for a second straight month our best position and we continue to see significant upside to the share price. On the negative side was our long position in Nordic Semiconductor (NOD). We did not change our positions in either company in May.

Financials: -0.8%

Long positions in Credit-Suisse, ING and Unicredit were the biggest drag on the sector performance. On the positive side were our short positions in Svenska Handelsbanken and Nordea. The sector has derated dramatically in the last year. The big picture argument is easy to make; negative interest rates, flattish yield curve, increased compliance cost, competition from fintech and exposure to sovereign bonds to name but a few. We acknowledge all those risks, but we do think there is a price for risk and that this price is very close to where we are currently trading. The one worry we have a hard time fending off is a general downturn in the economy, the end of the cycle, with corresponding credit losses increasing dramatically. This is an ever-present risk with banks, and we have experienced it in recent history in the south of Europe. Our financial positions are about a third of what we would consider fully invested due to the poor performance and general unwillingness of the market to buy this type of risk.

Retail: -1.2%

The sector did a complete reversal from the good April performance. Main drag were long positions in H&M, Byggmax and Anheuser-Busch. On the short side our shorts in ICA and Axfood were painful. On the positive side was our long position in Oriflame which received a bid from the founding family, von Johnich. H&M has been squeezed by the move to online consumption and that they have been slower than competition to adapt and change their point of sales. We believe the company has turned a corner which should start to bear fruit in the coming years. This is clearly against consensus in the market where we see 4 buys, 10 holds and 18 sells from sell side analysts. Optically the stock looks a bit on the expensive side at c17 times 2020 earnings, but if we are correct that it can turn performance this is a bargain. ICA and Axfood have benefitted from a general trend where investors love anything which is perceived as safe and steady cash flows. We think valuation is excessive on its own and couple that with the challenges they face in from the online segment. We are still short ICA/ Axfood and long H&M. Oriflame will be sold as the likelihood of a competing bid is very low.

Chemicals: -1.3%

This is the sector where we have had the biggest position with long deep cyclicals vs short defensive cyclicals. It worked to a certain extent in April, but the reversal in May was brutal. The thesis is that you can now buy world class assets below replacement cost because of, what we believe, cyclically depressed earnings. The market is clearly not on our side and we have consequently cut a large part of the exposure and are monitoring price developments to re-engage in the trade. Even though momentum is clearly in the other direction we can not invest against our conviction. This results in very low exposure until we find a bottom in this trend. Biggest losses where in long positions in Elkem, Covestro and BASF. Our short positions in Henkel and Umicore were small positive contributors to the sector p&l.

We reduced our gross exposure from 191% to 143% in May. Our net exposure was left unchanged at 29%. Our option protection shows the same characteristics as always, i.e. a gap move down 5-10% and we would have zero net exposure to the equity markets.

As always, you are more than welcome to contact us should you have any comments or questions on our investments or the views expressed in this letter.

Lars Frånstedt

Chief Investment Officer