Finding bargains as stock markets continue to hit record highs is increasingly difficult, says value investor Josh Jones.
The ongoing rally means the prices of equities are rising significantly faster than their underlying earnings, creating record price/earnings ratios. It has largely been propelled by growth stocks led by tech companies, prompting fears of another market bubble.
The high valuation multiples make it harder to find inexpensive stocks – those companies whose share prices do not reflect the true earnings potential of the company – says Jones, co-Portfolio Manager of the Global Premium Equities strategy.
“What we’re seeing is a very growth-driven late-cycle market where growth indexes are 6-8% above the core indexes,” says Jones. “We’re ahead of the MSCI World Value Index, but trail the MSCI World Index partially due to the high-flying growth stocks included in the index – names that we simply would not purchase based on our investment criteria.”
“Since late 2014, earnings on the S&P 500 have cumulatively grown by 4%, and the index is up almost 30%. People are chasing top-line growth and concepts, and that’s very characteristic of late-cycle investing. But we’re not going to buy expensive momentum as value is our building block, so if we’re not finding the right prices for businesses, we’re not going to chase them.”
“Some companies that historically have traded on 15-17 times earnings are now on multiples of 23-25, when their revenues and profits are slowing. These businesses are generally low-volatility stocks, mainly Consumer Staples, Utilities, Telecoms and Real Estate that are now at record valuations, despite being the same businesses, or in some cases worse businesses than they were in the past when they traded at a cheaper level.”
“The portfolio is currently valued at 15 times earnings and we’re working really hard to find businesses that are still reasonably priced. But I’m increasingly of the opinion that alpha generation in the next two to three years is going to come from what we don’t own rather than necessarily what we do own.”
Alpha generation is going to come from what we don’t own
Being a value investor also means avoiding expensive regions. “Europe is pretty heavy on banks whereas the US is heavy on tech, and when you adjust for that, Europe is not cheaper than the US. Europe hasn’t had much earnings growth in the last four or five years and we see earnings momentum deteriorating at a time when valuations are up, so, generally we’ve been selling Europe,” Jones says.
“The US still has a lot of momentum but it’s increasingly very expensive, which is why we’re also underweight the US. In the US, most of our exposure is centered around the banks, technology and energy, but there isn’t widespread value. If you want value, you have to go elsewhere.”
“We think the majority of emerging markets are reasonably valued – they’re not super-cheap, but there’s enough earnings momentum, so we’ve increased our weighting as we find bottom-up opportunities. We’re still cognizant that emerging markets are the tail of the dog, so if we do go into a downturn, they will underperform, and we would use that as an opportunity to add to our holdings.”
“Additionally, pockets of the domestic UK market are still cheap – not quite as cheap as they were post-Brexit, but they’re still cheaper than the rest of Europe or the US. In the UK, Lloyds Bank is an interesting one: it’s generating a 12% return on its tangible capital which means in Europe or the US it would easily trade at 12-15 times earnings, but because of skepticism around Brexit it trades at 9 times. It’s not a momentum stock now, so it might take some time, but it’s a large valuation anomaly relative to where other banks are trading.”
Meanwhile, the end may be near for the growth-fueled cycle as the US Federal Reserve becomes the first of the major central banks to begin unraveling trillion-dollar stimulus programs. “The stock market has responded to QE, and the Fed has now started to unwind its balance sheet, so this is the start of tightening liquidity, and we’re probably nearing the end of this cycle,” says Jones.
“The current high valuations would tell you to be careful. People have been prepared to pay high prices for businesses when stocks are getting very expensive, and we really do not want to overpay for businesses. If that means lagging for a bit, then we’re OK with that. You never want to lag, but we’re not going to chase stuff that’s driving the market. These things are always cyclical, and value will come back into style.”
The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.
Please read this information carefully.
This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.
2. Important risk disclosures
Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:
3. Local legal and sales restrictions
The information contained in the Website is being provided for information purposes.
Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.
4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.
5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.
6. Third party websites
Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage.
7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.
8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.
10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong.