Until a couple of days ago, there was a leaning tower of paper hovering over my desk. It was a stack of articles, charts, cartoons, quotes and sport stats that I was sure would be important one day, but in the meantime, was threatening my safety. It had been suggested I wear a helmet. Needless to say, I finally went at the pile, tossing most things, but coming across a few items worthy of further reflection.
Near the bottom (the old stuff), I found a scrap that seemed appropriate for today: “If you are not confused, you’re not paying attention!”
Throughout the pile there were numerous pieces reminding me there are only four ways out of a credit-induced recession: austerity, massive defaults, high inflation and/or rapid economic growth (usually caused by a special event like a war or oil boom). Governments in North America are totally focused on the growth option, but in lieu of an event or other catalyst, they’re using free money to encourage more unaffordable spending. I say, keep government spending under control, allow the distressed to default and bring on the slow, sustainable growth.
Also layered through the pile were reminders of how important valuation is to the investment process. A friend, who was frustrated with the market’s macro mania, sent me this quote by Arne Alsin of Alsin Capital Management in San Diego – “[There] are reasons to become interested in a company. But they are not sufficient reason to buy the stock. … Without an understanding of both price and value, an investor cannot make an informed, rational investment decision.”
With respect to valuations, there’s evidence that the premium being paid for stable, growing companies is getting extreme. Sandy Nairn, the CEO of Edinburgh Partners, our Global manager, puts it this way, “Our view is that investors’ desire for predictability has skewed valuations significantly.”
Among the sheaves on my desk, a chart from U.S. money manager Alliance Bernstein supports Mr. Nairn’s view. It shows that the valuation gap between expensive and cheap stocks (based on price-to-book value ratios) is higher than all but one period in the last 50 years – the tech boom of the late 1990s. This raises the question: Are the shiny, stable stocks too dear and the tarnished, more cyclical ones too cheap?
Investors’ pursuit of dividends has been a big part of the stable stock surge. My not-so-stable tower reflects this trend. There are few new equity products being offered that don’t have dividends prominently featured. Of the client proposals I see from advisers and portfolio managers, it’s rare that a dividend fund (or five) isn’t included. And dividends are even showing up in the staid world of institutional performance surveys. Traditionally asset managers list their core, vanilla funds in each equity category, but increasingly their dividend and income-oriented offerings are being included. Not surprising, the numbers look better.
One trend that emerged from my cleanup was increasing complacency around interest rates. When the pile was started, rates were two percentage points higher and there were real worries about when they would rise. Today, even with rates near zero, the debate is less intense and there’s a strong consensus they’re not going up soon.
That may be the case, but what I find particularly alarming about the recent commentary on interest rates and real estate (a proxy for rates) is the repeated references to “current” conditions: There’s no room for rates to rise in the “current” environment. At “current” mortgage rates, real estate prices have limited downside. In light of Canada’s “current” economic performance, the supply and demand for houses is balanced.
Certainly the recent experience in the United States should teach us not to value assets based on current observations. Until a few months ago, there were no signs of a U.S. real estate recovery, and yet activity is now picking up nicely and housing-related stocks have doubled over the last year.
Well, with the pile under control, I’m safe again. Now I can start accumulating more perspective, but maybe it’s time to go paperless.
Tom Bradley is president of Steadyhand Investment Funds. He can be reached at email@example.com