Only when the tide goes out do you discover who’s been swimming naked.
This is one of our favourite Warren Buffett quotes – and it seems especially prescient in the present environment. For while we are wearing wetsuits, here on The Value Perspective, we fear there may be a lot of skinny-dippers out there.
Over the first four months of this year, most investors will have had a great time splashing about, with the S&P 500 index in the US up some 16% to the end of April, the MSCI World index up around 14% and even the UK’s FTSE 100 index up almost 10%. Over the last few weeks, however, the water has not looked quite so enticing and, as the following chart shows, the warning signs have been there (remember past performance is not a guide to future performance).
Source: Bloomberg, Yale/Robert Shiller; John Hussman. Crescat Capital LLC
The chart, created by a competitor, focuses in on the S&P500 and, as you can see, as of March, the US’s benchmark index was looking historically expensive on not one but eight different metrics.
This includes a cyclically-adjusted price/earnings ratio, or ‘CAPE’, of 33.2x, which puts it in the 98th percentile of all such measures – from a data set going all the way back to January 1871.
In other words, the US stockmarket is looking especially expensive – and indeed the S&P500’s CAPE has actually been above 30x since 2017.
So, while being ‘underweight’ or ‘overweight’ a benchmark is language we would use extremely rarely, here on The Value Perspective, it is no exaggeration to say we are now struggling to find attractive investments in the world’s biggest market – and, as a result, our global portfolios are some 40% to 45% underweight the US.
Furthermore, as the next chart shows, some ‘factors’ – that is, styles of investment – are looking very expensive too.
Source: FactSet, Morgan Stanley Research
The main takeaway from this chart is that, with the valuations of so-called ‘quality’ stocks in Europe now standing close to record highs, we have no exposure to this area in our portfolios.
The simple truth is, if we do not believe a share is attractively priced, then we will not invest our clients’ money there and, if that causes relative short-term performance drags – as is currently the case – then, as we have done previously, we will be patient for the long-term benefit of our clients.
When the tide turns...
Our intense focus on value may mean we are not exposed to the strongest currents at present but you only have to look back to the end of last year to see the dangers of getting caught when the tide turns against you.
In December when the tide went out, our global portfolios outperformed by some 450 basis points to stand among the very best performers in their peer group – all were among the top 10% (past performance is not a guide to future performance and may not be repeated).
Around the time markets were beginning to turn downwards last autumn, a piece on The Value Perspective discussed how, after seven very successful decades managing money, one of Buffett’s own heroes – Philip Carret – concluded the secret of long-term investing could be summed up in a single word.
That word was ‘Patience’ or as Carret trenchantly put it: “Traders rarely die rich, patient investors often do.”
The following quartet of charts combine to underline that point.
While they may initially look complicated, what they are highlighting is that, while valuation may not drive markets in the short term (Panel A relates to a one-year time horizon), it very much does over the longer term (Panel C and Panel D relate to time horizons of 10 and 20 years respectively). We are positioned for the long term.
Correlation of CAPE Ration with S&P 500 Index Real Return (1881 - Oct 2017)
Source: Research Affiliates, LLC, using data from Robert Shiller database
Here on The Value Perspective, we strongly believe that, in relative terms, our portfolios are very attractively positioned on a three to five-year view – or, to put it another way, while plenty of investors may currently be out there skinny-dipping, we are happily swimming away, kitted out in our wetsuits.