As we entered 2020, markets were at historic highs, crowding into popular asset classes was rampant and there was a record valuation dispersion between value and momentum sectors. The valuation dispersion was best illustrated by a map of Europe that highlighted that the market capitalisation of coffee company Starbucks was the same as the whole of the Irish market capitalisation. Similarly, you could sell Facebook and use the proceeds to buy up the entire Spanish market, or sell Apple and Disney and buy outright all the companies on the German DAX index. Most recently, with Apple’s gains, you didn’t need Disney to acquire the entirety of the German index - Apple would have done the job by itself!
Sometimes the simplest anecdote best sums up a situation (I still remember Japan at its peak, when you could theoretically swap the implied property value of the Emperor’s palace (284 acres) for the entirety of California (104 million acres). This is definitely not the case now - valuation always regresses to the mean.
Late 2019/ early 2020 brought the first genuine signs of push back on negative rates emerging from European politicians (the majority of the Dutch House of Representatives signalled its disapproval of further monetary stimulus, and even went so far as to send a formal letter to the ECB) and the continuing strength of the US economy, the valuation dispersion was showing signs of closing.
Then came the coronavirus, community panic, Italy panicking, OPEC’s collapse and ensuing investment market chaos. This has not been helped by technical factors at play. The five days leading into and including the meltdown of Monday 10 March, reminds me of the 1987 stock market crash. Back then, there is no doubt in my mind that portfolio insurance played a big part in accelerating a correction. This time, I suspect the lack of liquidity in a passive dominated world, in combination with passive outflows, has also accelerated the correction on the downside.
Short term, it is clearly painful for investors. The real issue is where to from here and thus the medium to longer term outcome. My points:
1. Valuation dispersion is now even more exaggerated. We have highlighted in recent presentations that the commodity sector is at its greatest relative discount to the market in the last 100 years. We also highlighted that as we come to the end of the typical 10-year commodities down cycle there can be one last sell off to complete the process. It is always difficult to tell but I suspect this is it.
2. OPEC has been disrupted and fragmented. I believe its days are over. This will cause significant short term disruption to the energy producers, although what they lose from lower revenue is transferred to consumers and thus a positive will emerge for the economy at some point.
3. Unlike with previous market turmoil, interest rates are not a tool that will help. They are effectively already zero. Only fiscal expansion can assist, implemented by calm minds unaffected by emotional responses flamed by Twitter.
We all know that irrespective of long term fundamentals, the ultimate time to buy is when panic has peaked. The hard part is judging when that point is. It is likely to occur when government fiscal stimulus gets ahead of the curve and/or infection rates subside. The market will not calm down until one or the other – preferably both - happens.
Having said that, there have been some crazy downward price moves so one should definitely be looking at those moves as potential opportunities.
Despite the short term price action, adherence to the long term framework cannot be overemphasised. Given how well markets have performed over the last 10 years, we believe that it is appropriate not to exceed 85%-90% net equity exposures.
We also believe that markets and market opportunities will be very different over the next 10 years compared to the past 10 years. We are seeing significant opportunities in the deeply discounted cyclical sectors of the market. Recalling the Apple versus Germany anecdote, look to Germany in preference to Apple!
The best way to accumulate capital is to find businesses that will ultimately meet your required rate of return over the longer term.
If you have any queries, please do not hesitate to contact us.
This note is issued by PM Capital Limited ABN 69 083 644 731 AFSL 230222 as responsible entity for the PM Capital Global Companies Fund (ARSN 092 434 618). It contains summary information only to provide an insight into how we make our investment decisions. This information does not constitute advice or a recommendation, and is subject to change without notice. It does not take into account the objectives, financial situation or needs of any investor which should be considered before investing. Investors should consider a copy of the Product Disclosure Statement which is available from us, and seek their own financial advice prior to investing. Past performance is not a reliable guide to future performance and the capital and income of any investment may go down as well as up.