Valuations look very reasonable
While many investors would argue valuations are extreme, we see them as being very reasonable. In this video and transcript, we identify three areas trading on ten times or less, and make the case that real long-term alpha opportunities are increasing.
Economy is tighter than people realise
It has obviously been a little bit more volatile this quarter. Point-to-point, not much action; but a lot of action in between. One of the most common questions we got on our recent roadshow was about tariffs, and the risk that they would bring to the economy. Now, the reality is if we have a trade war, we know it's not going to be good for markets. But I think though that investors need to look at the real issue longer term. Stay away from the noise: Trump's comments on tariffs and China biting back.
The real issue is that the US has been running with a trade deficit for 20-plus years. If you think about it, the United States of America rebuilt Asia, Korea, Japan, China, Taiwan, all on the back of their consumption, which was a trade deficit in the US and trade surpluses in Asia.
So, Trump's basically saying, "Enough is enough. We need to deal with this problem”. And they DO need to deal with that problem. That's why you're getting all the headlines and the initial tariffs. It's really a ploy to bring everyone to the negotiation table and deal with an issue that needs to be dealt with.
I'm not sure how it's going to play out. It's always too hard to really come to a firm conclusion on macro and political, and that's why we say avoid it.
What you saw during the quarter was really the first signs of liquidity coming out of the system. It's what we referred to as Bondnado 2.
Market scares are now going to be very much on the back of inflation. That's what you've seen, and we're going to have more of them along the way because the underlying economy is a lot tighter than people realise.
Focus on the stocks
In terms of the stocks, the reality is valuation still looks very reasonable. With the minor pullback that we have had in the markets:
- Banks are on 10 times again (as cheap as they've been in many, many years),
- Alternative investment managers are selling on 10 times or less, and
- Homebuilding stocks are selling between 8 and 9 times.
So, I'm not too worried about valuation.
The real issue going forward is: can they grow their earnings and can the market growth their earnings. So far that looks as though the answer is yes. As a result, we're continuing to commit to our investments.
We still think that one has satisfactory rate of return, but we have noted that the risk/reward has changed and that's why we believe going forward that a maximum 85 to 95% invested position is what we want to deal with. You do need to be more conservative. You don't want to be leveraged, but we still think we can make an acceptable rate of return.
More long-term alpha on the table
So in summary, markets are going to be a little more difficult going forward. You need to be very focused. The risk/reward has changed. You need to run with more conservative positions.
There was some good news in some research from Bank of America Merrill Lynch that we recently came across, which basically highlights that although short term valuation discrepancies are becoming fewer in nature, when you look at longer term, the real long-term alpha opportunities are increasing demonstrably.
So, I think that's hopefully good news for stock pickers, and that's really the sort of market that we're going to be faced with going forward. It's back to the old days of a genuine stock picker’s market.
I'm PM Capital’s founder, CIO, first investor in our Global Companies Fund and its portfolio manager since its inception in 1998. Across all of our funds we invest independently, with integrity and in the best interests of of our co-investors.