After more than four decades of watching markets move up, down and sideways, money manager François Sicart acknowledges that he can still be surprised. And the surge in U.S. equities since last fall, culminating before Friday’s hiccup in a record level for the Dow Jones industrial average and a near-record for the broader S&P 500, has been nothing short of astonishing.
“Honestly, I can’t compare it to anything that I can remember in my long career,” says Mr. Sicart, founder of Tocqueville Asset Management in Manhattan and a long-time member of the contrarian value club. “Things are not outrageous as they were, for example, in the late ’90s or before the most recent crisis . But they’re not cheaper either, like they were at the beginning of previous bull markets.”
What makes the latest ascent so unusual is that investors don’t appear all that bullish about economic prospects or equities themselves. In fact, U.S. consumer confidence plummeted in mid-March, even though equities and house prices, to which consumer sentiment is often closely linked, were looking up, inflation remained tame and Washington avoided falling off the dreaded “fiscal cliff.”
Mr. Sicart puts the market surge down to a lack of good options for investors seeking some sort of real return, as well as confidence that central banks will continue to keep the money spigots wide open, thus protecting people from losses. “They are looking for alternatives. So they bought some higher-yielding, good-quality stocks, which was a fair bet. You have a lot of complacency, because no matter what you do, the market keeps going up.”
Now, he argues, the market is “fully valued.” He’s tempted to call it overvalued, but has no desire to step into that particular bulls-vs-bears debate. Others are less reticent. Jim O’Neill, chairman of Goldman Sachs Asset Management, said in a Bloomberg TV interview that U.S. economic growth would have to reach “ridiculously strong levels” for the S&P 500 to go beyond 1,600. It closed Friday at 1,560.72.
For his part, Mr. Sicart warns that trouble lies ahead if the market resumes its upward trajectory – which he expects – because it’s not conducive to rational investing and is becoming increasingly unstable.
“Little by little, [fund managers] are being forced to buy into the market, because either their clients or their consultants are telling them: ‘You’re full of cash, and meanwhile the market is going up.’ Eventually, if this continues, they will find reasons to explain why it is happening and why it’s good to be in the market.” That, in turn, will suck in more money from the sidelines. “And then, we’ll be into a bubble.”
These are far from ideal conditions for the classic value investor. “That’s the risk for people like me, because then we’ll be wrong on the market for longer then we hoped. After the [market] recovery we’ve had, together with basically record profit margins and an uncertain economic outlook, which might put pressure on margins and profits, I don’t see a lot of potential to make the kind of gains that you [typically] have in a big bull market.”
Mr. Sicart, a French native who began his Wall Street career during the low-grade recession of 1969-70, is prepared to wait for a better investing climate, but is not sitting out the bull run entirely. “I find occasional ideas. But by and large, all the stocks that I would like to own I would prefer to buy 20 per cent lower.”
Meanwhile, he cautions that investors should not be afraid to leave the party early if they have already had a nice gain.
“That’s the nature of value investing. You buy a stock when you find it cheap. Typically, because you’re not a genius every time, the stock will continue to go down after you buy it. Then it will start recovering and will get to a point where it’s fully valued. Technically, you should be selling then. But because you know the cycle of crowd psychology, it doesn’t just go to fully valued. It goes to overvalued.”
His approach: Shed a portion of the stock once the price reaches what you regard as full value and then the rest a bit later. “Eventually, your sense of value will force you to sell before the crowd thinks it’s overvalued.”
With the market heading skyward, he underscored this point in a recent note to clients. “Our discipline will always lead us to sell too early. So what? The original Baron de Rothschild reportedly claimed that he had made his fortune by selling too early.”
The value investor’s tools, he added, “are more effective and more flexible for buying than for selling. The conclusion we have drawn from this is that the time to sell is when you have identified a significantly better value idea than the stock you currently own.”