Now What? Part 2
Yesterday we looked at how the market has behaved over the last decade, and what I think the ideal coronavirus investment would look like. Today we look at whether now is a good time to buy equities.
For this, we need to look at some of the many indicators of sentiment, current valuations, and catalysts that might cause the market to reverse.
Starting with “those in the know”, albeit in the US, management insiders are buying at the highest rate since 2009 – the ratio of buys to sells has now hit 1.75 according to Washington Service:
Insider buying is a funny indicator – on the one hand most company executives aren’t experienced investors so why should they be able to judge the valuation and market sentiment well enough to generate alpha? And what CEO doesn’t have confidence in their business: if they didn’t they would surely move? However, they do have unrivalled access to lots of soft knowledge – the feel of the business and its markets, and so on. The myriad of tiny details that give them a view we can’t have. I wouldn’t place any confidence in a marginal result, but this extreme degree of positivity suggests cause for optimism.
Next, let’s take a look at portfolio cash levels. A large investment bank notes that equity allocation recently plunged to 52.8% (the lowest level since February 2013), and debt increased to 25.3% (the highest level since April 2014). As a result of this, cash increased to 15.1% - the highest level since February 2010.
However, these allocations are apparently explained by price changes, not by changes in the underlying positions. This suggests to me that investors haven’t yet panicked; they haven’t liquidated their equities deliberately into cash.
Interestingly gold has underperformed relative to historic downturns: to me this suggests that investors have been liquidating their gold holdings instead of equities. Perhaps it’s simply a case of where liquidity was most readily available. Or, perhaps investors are sticking with a “buy the dip”, or at the very least “don’t sell the dip” mentality. This could have profound implications for markets – if this behaviour (as discussed in part I) is re-enforced yet again by a swift V-shaped recovery, it may indicate that a majority of investors are now taking a truly long-term approach to markets. On the other hand it may indicate a deeply-ingrained Pavlovian response which could make the point of true despondency, when it comes, utterly devastating for markets. Only time will tell!
Valuation is always important in my view, though at times like this I don’t think it’s the key driver of markets so in the interest of saving time I’ll keep this short and borrow heavily from one of the greats. James Montier at GMO has pointed out that from a valuation perspective we’re well into bargain territory. He recently published the below chart of Shiller P/E ratios around the world, showing that (excluding the US) valuations are as cheap as they’ve been since the early 1980s:
This suggests that there’s significant opportunity for long term upside if you don’t believe that the permanent impairment of profitability that results from this will wipe out thirty years of growth and development. One note of caution here is that CAPE is based on a 10 year earnings pattern that’s been elevated by low rates and other easing over the last decade, so may be baking in too much earnings optimism.
There has been a flood of articles recently suggesting investors move carefully back into the market at this level:
Tom Delic at Seneca interviewed with CityWire’s Wealth Manager magazine, said there are reasons to feel bullish based on valuation – he singles out smaller company value equities in China and Japan, many of which had seen their market caps halved “for just no reason basically other than market panic”. He is taking a medium- to long-term view though, noting that the falls can get more extreme in the short-term.
Bill Ackman at Pershing Square has called the ‘bottom’ of the market. In his investor letter last week he said Pershing Square has closed its hedges and is turning positive on equity and debt markets: however, it maintains a c.17% cash position. He also points out that his optimism is premised on the US government making the right moves to contain the outbreak, but believes that if it does then “These [shares] are bargains of a lifetime”.
Anthony Cross at Liontrust spoke with the same publication, recommending looking at increasing exposure to certain UK equities: “It’s important to stress what is being lost for these companies is [only] a period of earnings”. He comments that while we don’t know how badly earnings will be hit, we should remember that the market has already priced in a significant decrease vs. the start of the year. “Lots of these share prices have been hit 40% or 50% or more. So suddenly, stripping out what’s happening at the moment, these have been de-rated from 20 times down to 10x.” This view implies (and he does in fact state his opinion) that this will be a short-term hit, and that earnings next year will resume trend growth.
Anthony Bolton told the FT that he has started investing again on his own account, saying: “I’ve started to invest. I will say to people I think at these prices there are really interesting opportunities. I wouldn’t necessarily invest all your money at the moment, if you have money to invest — and many people don’t. The key message to investors is don’t get more bearish as the market goes down.” However, he does advocate caution longer term, noting that to reduce liquidity risks and the risk of future bail-outs regulators may start to mandate cash holdings at the corporate level.
Our own research bears this out – we sent a short survey to 1,500 of our investors and found that stoicism appears to be the overwhelmingly largest response to the current crisis:
Source: Capital Access Group March 2020 Investor Survey
Only around than 1 in 20 respondents are reducing their company interaction (clearly there are no face-to-face meetings but we’re offering video conferencing with management teams now: get in touch if you’re interested*!) – impressive discipline, but could it also mean that investors remain too positive, too optimistic for markets to have bottomed yet?
As a sort of counterpoint to those saying ‘invest now’ (and I deliberately use “sort of” here because he isn’t saying “don’t buy now”), we can look to Keith Skeoch, CEO of Aberdeen. He believes that while the “point of maximum panic” has been reached, the “point of maximum pessimism” is yet to come. This latter peak is probably the one that would indicate a trough in valuations and investor sentiment.
Our wealth manager from Part I said that he would buy now for long-term holding if one can stomach the volatility, but believes that being selective is the key here. He doesn’t think he’ll catch the bottom, but he is happy with the valuations at which he’s able to buy certain businesses, even if the share price falls further. However, he does also note that investor optimism remains high, which is a bit of a warning sign to him that capitulation hasn’t yet happened.
One thing that the above-mentioned investors, and indeed all the investors we’ve spoken to, have in common is selectivity as we explored a bit in part I. The attitude is that there are some screaming bargains and some traps out there. This is exactly why retail investors can benefit from active asset management. Passive strategies will be busy buying into everything according to their ratios, which could damage investors’ wealth.
Finally we need to take a quick look at catalysts. It’s my view that in order for the market to bottom we need, as well as investor sentiment, to see some sign of peak in the coronavirus outbreak. We need a win.
Is it likely we will see a meaningful bottom for equities until we get some wins against the virus? I doubt it. Italy and Spain have to see new infections peak. The US has to get its infection under control. Lockdowns need to start being lifted. A cure or vaccination needs to look imminent.
There will likely be a huge upside impact on the market when any of the above happens. However, at present things still appear, globally, to be getting worse, and in some cases still accelerating.
In summary, we’ve looked at what markets have done in the past, specified an idealised (but unrealistic) investment we’d probably all like to buy, and when might be the best time to buy it. As part of this we’ve looked at investor sentiment and valuations. We’ve looked at catalysts for a recovery. Does any of this mean that now is the right time to buy risk assets? I think all things considered there is a good argument to invest now rather than “chasing the bottom”.
First, it’s impossible to accurately pick the actual bottom of a given cycle. We all know there’s no clear signposting or reliable indicator, but we all try to guess anyway. That’s part of the game.
However, relying on these guesses is dangerous because quite often the rebound from the bottom is violently fast and occurs on the back of low liquidity. Therefore even if you catch the exact timing, you may not be able to participate. As such if an investor is happy that the valuations of the companies in which they would like to invest are already low enough to represent a high probability of generating a positive return, then, ceteris paribus, they are better off being early to deploy capital than late.
That doesn’t make the journey any more comfortable though.
* You can let us know which of our clients you’d like to meet on the second page of our 3 question survey here.