Volatility Brings Opportunity in a Challenging Year Ahead
Dwight Mann - Nov 28, 2018
We believe that the economic and market cycle is mature as it is now past the eighth anniversary of this current bull market rally. One classic characteristic of late stages of market and economic cycles is a ramp up in merger and acquisition activity. There is a long list of companies that are priced very attractively from an asset value perspective, and there are industries that will continue to face headwinds from industry disruptors.
Historical patterns indicate that capital spending also tends to be a late-cycle performer and the move by the Trump team to ease regulatory burdens and boost profits via tax reform should further accentuate this pattern.
The monetary policy divergence between the Fed raising interest rates and other central banks standing pat or possibly easing further, not to mention the election uncertainties in France and Germany will ensure that the US dollar remains strong. This may be a crowded trade, but the balance of probabilities suggests it will be the correct trade. Canada and other exporting countries should be beneficiaries of this, from even more “competitive” currencies versus the US dollar.
With regards to valuations, although the market as a whole is expensive, one must keep in mind the disparities that lie beneath the surface. There are 75 companies in the S&P 500 trading at a forward price-to-earnings multiple of 20x or greater; but there are 150 companies in the S&P 500 trading at a forward multiple of 12x or less. This to us represents quite a bit of opportunity, especially in a year where we strongly believe that “value” will outperform “growth”.
Internationally, we see a growing investment potential in countries like Japan, which is benefitting from signs of a pulse finally emerging in domestic demand growth and, of course, the benefits of the even-weaker yen. Even with recurring political turmoil in Europe, there are a number of mispriced assets that are presenting some interesting arbitrage opportunities.
In addition to heightened volatility this will be a year where we have to be cognizant of the Fed and a flatter yield curve, focus on sectors that work well late in the market/economic/credit cycle, and have a heavier emphasis on balance sheet quality and valuations that are compelling (as in, buying stocks that have recession probabilities priced in already). We still have a preference for “value” over “growth” investing right now, but we are mindful of how the backdrop could change.
We will have an additional tailwind knowing that active investment management will “trump” passive styles in what promises to be a roller-coaster year of quickly taking profits and quickly stepping into underpriced opportunities when they present themselves.
In other words, 2017 will be about special situations and unique opportunities beneath the surface of the major averages. The major point is that the real money will be made based on classic value-investing that focuses on company fundamentals as opposed to counting on Trump-onomics.