Investing with Tailwinds
Recently, I was hesitating over an analyst’s pitch and said, “It’s a good idea, but the thing is, I only want to buy stocks that I know are going to go up.” I’m greedy: not only do I want them to go up, but I also want it to be pretty soon. Of course, I don’t actually know that a stock will go up, and I buy enough that don’t, but after three decades of trial and error, I know what I’m looking for. That is, a combination of value and tailwinds.
We all may have different definitions of “value,” but if you read my Substack, I’ll assume you know what kind of stock I’m thinking of. As for “tailwinds,” these can be positive economic trends like growth, interest rates, and inflation. All are important but won’t necessarily have a short-term impact on a market and even less on a particular stock. Emerging markets tend to react more than developed ones to such data, especially in fragile economies like Turkey and Argentina. EM investors have seen the “Turkeytina” crisis story play out enough times that they could write the script. Nevertheless, in 2017 Argentina sold 100-year bonds to optimists (suckers?) who’d somehow missed the entire plot — 3x oversubscribed!
Good macros are critical to performance in EMs in part because company valuations alone are not usually enough to attract global investors’ attention. Right now, there are probably hundreds of stock bargains from Pakistan to Brazil, and relatively few people care in a world where the Mag 7 compete daily for the highest multi-trillion valuation. That’s why EMs need the support of local investors, prerequisite to which are stable economies and politics. These can change quickly — see Russia, Egypt, and China for examples — which is one thing that makes the asset class challenging, as I’ve found out the hard way about once per decade.
Attractive country metrics should work over time, but they’re no more likely than a cheap valuation to make an EM stock go up in the near-term, the result we ideally want. I’m looking for specific market tailwinds, which can include pension fund growth, credit rating upgrades, improving infrastructure/custody, or the market’s inclusion in a larger index. Promotion from an MSCI Frontier Market to Emerging Market brings in significant passive flows; this can also happen at the company level, as an EM stock moves up an index. One of my holdings is knocking on the door of the FTSE 100, a scenario that can become a virtuous circle as a company’s market cap approaches the threshold and arbs buy to front-run the passive money.
On the pension funds, to use a market I know well, Romania has $1 billion per year of inflows to their system, as much as 25% of which may go into the local stock market with only $10 million of total daily volume. Pension fund flows can also become a headwind. Poland’s Pillar 2 funds, whose fast growth had contributed to the WIG 20 Index more than doubling from 2004-07, became a headwind starting in 2015. System reform led to net withdrawals from these funds, helping keep the index flat for the next seven years.
Credit upgrades, by lowering the cost of borrowing, can quickly re-rate stocks, though bonds benefit the most. Downgrades obviously may do the opposite. The arrival of a global custodian to an EM, making it accessible to big institutions, can also drive short-term gains. In a small market, it may take even less than a major global custodian to get things going. In March of this year, Interactive Brokers let clients first buy Slovenian stocks, and within four months the market had risen 25%. Enhanced custody is one tailwind that rarely reverses, though it can happen too, as with Russia since 2022.
For us to buy a stock in an EM with market headwinds, the value proposition has to be compelling and/or it must provide exposure to something we really want and can’t get in a tailwind market. Poland, for example, still has pension fund headwinds, but it also has consumer-facing growth stocks that aren’t widely available elsewhere in our Eastern Europe target region.
If a stock is in an EM with no market tailwinds, its chance of going up in the near-term can be boosted by company tailwinds, e.g., attractive value plus a share buyback program; a large, motivated buyer accumulating the stock; and/or a high dividend yield. Of course, share overhangs, say from a private equity fund selling down its stake, would be a company headwind, and as with market headwinds the value should be compelling to buy it.
In some cases, sell-downs by a controlling person can be a positive. With Halyk Bank, a Kazakh stock we own, the 69% controlling shareholder recently placed 7% of the bank at a nice discount to the market. As the stock had previously traded only $1.25 million per day, too little for many institutions to even look at it, enhanced liquidity from a bigger float was hoped to boost the stock, once the placement was digested. Sure enough, the market has within two weeks absorbed the sold shares and the price is back to the pre-placement level. We’ll see now how much Halyk’s trading liquidity improves, and how that impacts the price.
Finally, if you want to invest with tailwinds, it’s important not to seize on ideas or rumors, as opposed to more solid drivers like an approved share buyback. Especially in developed markets, where an edge is harder to find than in EM, it can be tempting to convince yourself a theory is right and expect quick profits. “Crypto will go up because the Trump family is in it,” would be one example. To know how reliable a tailwind that is, you’d have to be inside Trump’s head, and there’s no more room.
Here’s a taste of a Sail GP race, which is super fun to attend. Formula 1 on water!
This communication does not constitute an offer to sell or a solicitation of an offer to purchase any interest in any fund or investment vehicle managed by Firebird Management LLC (the “Adviser”). Any such offer will only be made pursuant to a confidential private placement memorandum and related offering documents.
Information about specific current or past investments is provided for illustrative purposes only and does not represent all investments made by the Adviser. These examples are not necessarily indicative of the overall performance of the fund or strategy.
Good distinction between macro tailwinds and those very specific market tailwinds like pension flows and index promotions. I enjoyed learning about Romania, Poland, and Slovenia. In EM, there's an edge in understanding the structure and evolution of the local buyer base. It's a different perspective, in a way, to understand who is forced to buy and who is forced to sell.