PM Capital amid dislocation and value dispersions

One thing experience can give you is perspective, writes Paul Moore.

After running its global equities strategy for over 22 years, PM Capital has experienced a range of market conditions, triggered by reasons as varied as the Asian currency crisis, ‘Tech Wreck’, the Iraq War, 9/11, the GFC and associated quantitative easing, the Greek debt crisis, and now the COVID-19 pandemic.

Whatever the reason, investors’ behavioural biases and the associated rise and fall of markets inevitably produces disparities in valuations between asset classes, countries, sectors, and/ or individual stocks that has provided opportunities for patient and committed investors.

During and immediately after market disruption events, the overall market direction and path to recovery is usually very uncertain. Utilising a long term investment horizon, combined with selectively identifying those stocks/ sectors with valuations that are unnecessarily depressed relative to others, it’s possible to develop the conviction needed to take advantage of dislocation and uncertainty. The reason being that buying at attractive valuations and then allowing sufficient time for valuation disparities to adjust acts to protect investments even if the overall market is producing less than desired returns.

When you look past the day to day market ructions associated with COVID-19, one of those valuation disparity situations is occurring right now. In fact we believe the record disparities between the “growth/ defensive” sectors of the equities markets, their current stars being technology stocks, and what are labelled “value/ cyclical” sectors, such as resources and/or industrial stocks, are extreme. 

While the valuation disparities between these different stock categories was observable in late 2019 and early 2020, it has actually been further accentuated by the COVID-19 pandemic. In December through January we started to observe a rotation away from expensive growth and towards value, however, the subsequent large-scale shutdown of the economy has seen investors again angling towards the growth (tech) and defensive stocks that are relatively less affected by the ‘IRL’ (in real life) shutdown, and away from stocks that are more underpinned by economic fundamentals.

For example, as at the time of writing the share prices of the FAANG complex (Facebook, Amazon, Apple, Netflix, Google) are in positive territory for 2020, while the S&P500 Value Index is down 19.3% (to 22/5/20). In the past decade, the S&P500 Value Index has risen 82.0%, while the S&P500 Growth Index over the same period has risen 223.1%.

It is at the points of extreme valuation dispersion, like those currently being witnessed, combined with general market disruption, that the PM Capital Global Equities strategy has historically added the most value to client portfolios:

Post-Tech Wreck

As the tech-heavy NASDAQ index approach it peak in early 2000, so-called “old economy” stocks were severely depressed from both a relative and absolute valuation perspective. Over the following  seven years (to end December 2006), the PM Capital Global Companies Fund outperformed the MSCI by 10.0% per year.

In total terms, the MSCI World Index produced -5% over that period, while the PM Capital Global fund produced a 114% return, benefiting from investments in stocks that had been ignored in the lead up to 2000, including commodity stocks like Alumina, Rio Tinto and Western Mining, and similarly depressed cyclicals like Interbrew, Bank America (as it was) and JP Morgan.

Interestingly, the MSCI did not recover its 2000 peak  until September 2014, during which time PM Capital delivered a total net return of 88%.

Post-GFC

Although in general terms a handful of ‘unicorn’ growth stocks have assisted growth stocks outperform in the period post-GFC, the PM Capital Global Companies Fund benefited from Paul Moore’s belief that the post-2009 period provided a once in a generation opportunity in equities (and a once in a lifetime opportunity in credit).

Although some bank holdings were affected by lower net interest margins, the portfolio’s holdings in stocks including those exposed to US and European housing, private equity companies – all of which benefited heavily from falling interest rates – and monopoly providers like Visa and Mastercard saw the Fund rated  #1 in its Morningstar peer group for the 10 year period to Feb 2019, outperforming the market by 4.7% per annum in that period.

Post-Brexit

Stocks deemed sensitive to UK and European economic growth provided good opportunity immediately after the June 2016 Brexit vote. In the twelve month period post the Brexit vote, PM Capital’s global strategies were again ranked #1 in the Morningstar Peer Group  over 1, 3, 5, 7 & 8 years to 30 June 2017.

PM Capital has tended to outperform following times of dislocation and anomalistic cross-sectoral valuation dispersion. The COVID-19 outbreak and its consequences has dislocated both the real world and financial markets, providing the fastest bear market ever, entrenching commodities stocks at their lowest market relative valuations since the Great Depression,  and further accentuating the disparities in valuation between growth and value stocks.

PM Capital’s portfolio also tends to be overweight stocks seen as lower priced ‘value’ plays. In fact, we are of the view that quality cyclical/ industrial businesses are at all-time low relative valuations, with the upside return possibility equal to or greater than what I saw post-GFC with the market in general. We feel the pandemic has not simply delayed our thesis, but the fiscal and monetary actions will have the effect of essentially making the thesis inevitable. The unknown factor is the timing of this - in the short term behavioural biases have not declined, and their effects will be exaggerated by the weight of the index funds. This is why it is so important to have a longer time horizon so as to let the thesis play out to its full extent and in doing so profit from it.

PM Capital has demonstrated an ability to see through market dislocations and valuation disparities so as to put the portfolio in a strong position to provide attractive returns in the period following these events. 

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This communication is issued by PM Capital Limited (ABN 69 083 644 731, AFSL No. 230222) as responsible entity for the PM Capital Global Companies Fund (ARSN 092 434 618). It contains general information only and does not constitute an offer, invitation, solicitation or recommendation with respect to the purchase or sale of any securities. The information herein seeks to provide an insight into how and why we make our investment decisions, and is subject to change without notice. It does not constitute product or investment advice, nor does it take into account any investors’ investment objectives, taxation situation, financial situation or needs. All investors should seek their own financial advice, and must not act on the basis of any matter contained here in making an investment decision but must make their own assessment of the securities and conduct their own investigations and analysis prior to making a decision to invest. Past performance is not a reliable indicator of future performance and no guarantee of future returns, unit/ASX prices, or liquidity is implied or given. It is not intended for any person outside, or non-resident, of Australia or New Zealand. See pmcapital.com.au for further information.