Generational low interest rates are symptomatic of lower growth and inflation, made acute by central banks reacting to structural factors such as ageing populations, integration of savings rich economies into the world economy, offshoring and more recently deleveraging and excess export capacity. Increasingly, there is mounting evidence that distortions are growing, even as the policy gains are diminishing. The blind assumption of unendingly low rates make markets vulnerable to a cyclical back-up in yields – a risk we believe is asymmetrically priced. Accordingly, we are avoiding the bond proxies as long investments, accumulating selective opportunities in banks, the sector that has suffered the most from yield curve compression, and increasing our shorts on the weaker versions of the bond proxies. In summary, we’re encouraged by the growing valuation dispersion within markets as we think this is indicative of broadening pragmatic value opportunities, both long and short.
The Antipodes Valuation Heat-map provides a more granular illustration of valuation clustering across sectors and regions. Cell colouring indicates the degree to which a sectors’ price to book ratio (relative to the world) is above or below its 21 year relative trend (expressed as a z-score). The warmer the colour, the greater the relative price to book valuation versus history; vice versa for the cooler blues, with extremes highlighted by the boldest of colours.
With reference to Figure 1 we observe broadly:
- Financials (Banks and Insurance) are amongst some of the cheapest sectors globally (outside of Resources); profitability stifled by lower rates and yield curve compression
- Consumer staples or brand stocks enamored for their perceived defensive growth (Profitability and Growth, Chart 6) characteristics, are broadly expensive across regions (with the exception of China/HK)
- Infrastructure stocks across the developed world beguiled for their defensive yield characteristics.
Moving away from sector-level generalisations and with reference to Chart 6, we note that:
- In a quantitative factor sense, the market is celebrating stocks that display high profitability, growth and momentum independently of starting multiple. Further, it’s noteworthy that the market’s willingness to pay-up for growth, profitability and momentum is approaching the heady days of the late 1990’s tech bubble. One can also observe the subsequent derating that occurred as these types of stocks lost their allure, a clear example of how a high starting multiple was absolutely predictive of future sub-par returns.
- Momentum is simply the outcome of the market’s obsession with an ever narrowing group of stocks selected on a systematic preference for high growth and profitability. Whilst clearly growth and profitability matter, for Antipodes Partners these descriptors only offer real meaning in the context of valuation rather than momentum.
- A global preference for small-mid caps over large caps; in many ways an extrapolation of the valuation dispersion observed between hyper growth and mature growth businesses (Chart 6)
- Bond proxies - high yield, low volatility, or both - favoured by passive strategies that confuse momentum with value and low volatility with quality. We underscore the market’s over appreciation of these factors and lack of appreciation for good yield, i.e. yield funded through cash flow.
- The extreme thirst for yield has pushed the global corporate debt cycle (most extreme in China and the US high yield or “junk” segments) into unchartered territory with the stock of debt outstanding and the average leverage ratio expanding significantly beyond the previous 2007 profit cycle peak (Charts 7 & 8)
At the core of our investment philosophy we seek in our long investments both attractively priced businesses (margin of safety) and investment resilience (characterised by multiple ways of winning), with the opposite logic applying to our shorts i.e. no margin of safety and multiple ways of losing. While the investment case will always be predicated on idiosyncratic stock factors such as competitive dynamics, product cycles, management and regulatory risks, we seek to amplify the investment case by taking advantage of style biases and macroeconomic risks/opportunities.
The blind assumption of unendingly low rates make markets vulnerable to a cyclical back-up in yields – a risk we believe asymmetrically priced. Accordingly, we are avoiding the bond proxies as long investments, accumulating selective opportunities in banks, the sector that has suffered the most from yield curve compression, and increasing are shorts on the weaker versions of the bond proxies.
In summary, we’re encouraged by the growing valuation dispersion within markets as we think this is indicative of broadening pragmatic value opportunities, both long and short.
Extra taken from full report here: (VIEW LINK)