Author: Gabriel Grego, Zanshin Capital
Covestor model: Buffettian Value
In mid August we wrote a brief market commentary summarizing the current situation in the capital markets and the world economy. We were of the opinion that however scary the overall picture might have looked, when assuming a long term approach we could not avoid seeing plenty of value in the U.S. equity market. We consequently encouraged all of our exiting and potential investors to take some exposure in quality stocks: “we believe that it is precisely at these times of panic, fear and pessimism that Zanshin’s value-oriented strategy makes the most sense.”
At the time of writing that commentary (August 11), the S&P 500 was trading around 1,120 and it closed last Friday (10/28) at approximately 1,285 – a 14.3% gain in less than 3 months. Once again, the time-tested approach of “being greedy when others are fearful and fearful when others are greedy” appears to have been proven correct.
I would say that together with this equity index, the world economic outlook has improved significantly. Back in August, we observed how three main factors were the source of considerable fear and uncertainty: S&P’s downgrade of the U.S. credit rating, the European financial crisis, and the threat of a U.S. recession. We dismissed the first as largely irrelevant and believed that Europe’s problem would be solvable, if at a considerable cost. Both observations turned out to be correct.
We were more concerned about the third factor and although the current consensus seems to opt for slow growth (but no recession), I would say we are still not out of the woods. However, we still think that an unlikely double dip would probably not be as catastrophic as many fear, given the current strong balance sheets, increasing earnings, and low financial cost bases of U.S. companies.
Europe however does run a considerable risk of going through a recession, and EU companies, given their inflexible cost bases, sub-par management practices, and diminished prospects for growth, would probably have a much harder time than their U.S. counterparts. That’s why we are mostly staying away from them. This said, there are some opportunities in bonds of EU financial institutions, whose yields reflect a possible default which is unlikely to materialize given the details of the latest rescue plan. The latter is far from the ultimate solution it was meant to provide, but it does seem to ensure the viability of most EU banks, in our opinion.
Equity valuations, while still attractive, are no longer the bargain they were back in August and September, despite the excellent Q3 earnings results that we have seen almost across the board. Consequently, at Zanshin Capital, we are taking a backseat from the market and carefully monitoring any new opportunity arising. After all, we went on a shopping spree this late summer. We believe that, thanks to our latest purchases, we have once again created the basis for future outperformance, just as we did back in 2008.
Again, no matter what is your own view on the markets, there are a few likely consequences to the current macroeconomic situation. Among them I would probably mention higher interest rates, inflation and $US and Euro currency devaluations vis-a-vis emerging countries. While their occurrence in the near future is uncertain, the policies undertaken by western governments to handle these crises virtually guarantee that they will be a reality at some point. This makes a very strong case for stocks and a very poor one for holding cash (or fixed income assets).
Notwithstanding the safety one may have felt in the last few years from cash holdings, understand that cash is a very poor long term asset. Companies have the ability to raise prices and match (totally or partially) any increase in inflation. Cash holdings, however, are guaranteed to lose their value as inflation starts to kick in and, unlike a temporary loss in the value of shares, loss of cash purchasing power can NEVER be recouped. While it is difficult to imagine this in a world with a 2/3% CPI, some of you may recall the massive losses in purchasing power suffered in many European countries in the decades following WW2, where governments essentially generated inflation in order to repay the massive debts built up in war time. The situation today is not that different.
That means that, in our opinion, the best long term bet right now is to invest money gradually in a few quality stocks, and sit back and increase the size of that investment over time as opportunities arise. For those who wish to outsource such sensible strategy to a third party, consider mirroring the Zanshin Capital portfolio.
Regards,
Gabriel Grego
