For all value investors, it’s time to earn your keep and shine.
Barron’s interviewed portfolio manager Matthew McLennan of First Eagle Global (FEG) Fund in this week’s edition. McLennan brings up some salient points in the current market for value investors.
McLennan believes that investors should curb their enthusiasm for the market in 2019.
Increasing and high levels of consumer and corporate debt are significant risk factors. Increased levels of risky debt will be a headwind for those companies who are overleveraged when the economy turns south. The robust profits of the current market has a way of covering up these blemishes. As Buffett says – “You only find out who is swimming naked when the tide goes out.”
Economically, the macro signals are pointing to an “economic high point”. How much better can things get? Unemployment around the world is at historically low levels. Profits are at peak levels. There is not much slack to add more to profitability.
Parallels to the 1998, 2000 and 2007 markets are showing. In those periods, the markets were robust and looking like the troubles were behind them, but, if you looked closely, you could see issues creeping into the mix that many were ignoring. Today, high debt levels, expanding risky debt, increasing rates and growing tariffs are just a few that many are ignoring.
Given the current market conditions, it is time for those value investors to position for the future.
While US markets are currently down about 10 percent, international markets are down even much greater. As the market drops off, it is a great opportunity to trickle cash holdings into high quality companies that are conservatively leveraged. No one knows where the bottom will be, but with the market dropping down, more of those strong companies can be purchased at reasonable price levels.
FEG has dropped their cash from about 20 percent to the mid-teens. Having a good supply of cash in a decreasing market can be a significant advantage. You have money to buy the bargains!
Owning companies who have what Buffett calls a “durable competitive advantage” is essential. Also, owning companies with conservative debt level plays well when times get difficult. When overall economic profits sink, these companies will be less exposed. Those who do not have these attributes could be subject to an economic cliff and plunging share values. At worst, the weak could experience economic death – bankruptcy.
Being internationally diversified is essential. After all, no one has a crystal ball. Some looks into the future will be right while others will just be plain wrong. No one has a monopoly on insight into the future.
FEG’s turnover is below 10 percent in a universe where funds have turnovers of 100 percent or more. With each sale, the tax man must be paid which means there is less after-tax money to earn returns in the future. Switching investments at a fast rate may provide the illusion of “great management”, but, more often than not, it only erodes the amount of capital – especially in down markets!
So, now is the time for value to shine. While you can’t expect returns to flourish immediately (remember the law of the farm), it’s time to strategically place chips on the table on those firms having the characteristics to be long-term successful.
Gentlemen and ladies, all bets down.
