These are tough times for bargain-hunting investors.
Ever since the financial crisis, most value-oriented portfolios of stocks have lagged the broad market, and for fairly obvious reasons. When central banks are injecting massive amounts of money into the economy, and holding interest rates at record lows, investors have no great reason to be choosy about which companies to buy. The entire market is headed up.
Perhaps that's why there was a distinct sense of being among a persecuted minority when the Ben Graham Centre for Value Investing held its annual investing conference in Toronto this week. The centre, part of the Ivey Business School at the University of Western Ontario, brought in some of the brightest minds in the field to mull the question of where value lies in a market that doesn't appear to give a hoot about valuation.
The essential conundrum was highlighted by Russell Napier, a British investment manager and co-founder of the wonderfully named Library of Mistakes, a public book collection in Edinburgh that is dedicated to chronicling financial blunders through history.
Mr. Napier pointed to a chart of the S&P 500's cyclically adjusted price-to-earnings (CAPE) ratio, which measures the price of stocks against their average earnings over the past decade. He told his audience he was sure they all knew the chart as well as he did, and its key message – that stocks are wildly overvalued at the moment.
The problem, he was quick to add, is that the chart is hopeless at predicting what will happen in any unit of time shorter than a decade.
"If the immediate future for the U.S. is growth with inflation below 4 per cent, equities are likely to go up from here or at least stay high and overvalued for a long, long time," he said.
What may eventually bring the market down, he said, is a rise in inflation to near 4 per cent. While such an inflationary surge appears distinctly unlikely at the moment, it would invite rapid rate hikes from the U.S. Federal Reserve, which in turn would make bonds a far more attractive alternative to stocks.
Mr. Napier suggested one simple technique for timing the market is to keep an eye on Citigroup Inc. "Buy equities every time Citi goes bust," he said. "It's gone bust at every great stock market bottom."
For now, value investors should avoid the temptation to chase performance in a market that has lost touch with fundamentals. "In my firm we like to say: Don't just do something. Sit there," said William Browne, chairman of Tweedy Browne Fund Inc., a venerable New York-based firm that has practised a value-investing style for generations.
He listed the numerous psychological traps that can trip up investors, from overconfidence to the assumption that recent trends will continue into infinity. The best defence? Reminding yourself that, as a shareholder, you are part owner of the businesses you invest in. The real risk for the long-term investor isn't a bit of share price volatility, Mr. Browne argued, but the "chance of opening the front page and finding out that creditors own the business or that a rival has leapfrogged you."
Ole Nielsen, a Danish manager who heads Nielsen Capital Management, demonstrated what he looks for in a business by making the case for his favourite investment – a British insurer called Admiral Group PLC.
It has grown rapidly over the past decade by selling low-cost car insurance over the Internet and keeps operating costs down with modest offices and a tight-fisted approach to cash management. It motivates employees by making them shareholders and is often ranked among Britain's top 100 employers.
The company regularly achieves returns on equity in excess of 50 per cent and pays out nearly all its earnings in dividends. Mr. Nielsen argued that Admiral's move into the U.S., France, Spain and Italy should allow plenty of room for more growth.
Those looking for a more diversified bet might want to look to Japan, suggested Richard Oldfield, investment manager and chairman of Oldfield Partners LLP in Britain. "I have much more confidence in non-U.S. markets, especially Japan, than in U.S. markets," he said.
Mr. Oldfield likes Japan because it is trading at relatively low valuations in terms of CAPE and book value. "Plus there is a huge amount of entrenched skepticism," he said.
For a value manager, that combination of cheapness and unpopularity is tough to beat, even if other investors appear blind to its appeal, at least for now.