Are you sitting comfortably?
With the equity markets showing some signs of volatility recently, and several commentators starting to flag the possibility of a pullback, we thought it may be timely to revisit our stance on valuation and portfolio composition.
We previously set out some analysis of the Australian market, which showed that the market currently looks to be on the expensive side. Considering our preservation-of-capital mindset, we move towards cash when valuations start to look stretched – meaning we currently have a significant portion of our funds on the sidelines, awaiting better opportunities.
Nothing has changed in terms of our assessment of value, and we don’t see much profit in trying to forecast the short-term direction of the market, but we do have one additional thought to add, and it follows.
Global markets tend to be interconnected. When prices fall in one major market, it has implications for other markets because of the way investment capital flows from one place to another. If a market becomes cheap because prices fall, then capital will flow out of expensive markets and into the cheap market. As a result, markets tend to move together.
This means that our consideration of value should be a bit broader than just the Australian market. We should also have regard to large global centres, with the first port of call being the US.
A simplistic analysis of the US market provides no comfort on the broader valuation question. Many of you will know the US market has significantly outperformed the Australian market since the GFC, as shown by the price chart below. While the Australian market has some way to go to pass its 2007 peak, the US market is already well beyond that level.
Of course, price is not value, and we need to look at valuation metrics to see a more complete picture. The chart below sets out the aggregate price-to-book ratios for the US and Australian markets over the same period, and suggests to us that the relative price growth in the US is reflective of increasingly favourable valuations.
Having said that however, we do note that the absolute level of price-to-book in the US remains below its earlier peak, and so there may well be some room for continued growth.
Having broadened our perspective slightly, we are left in the same position as we started. Markets appear expensive, but not wildly so. With this in mind, we are comfortable sitting with a significant cash holding, yet mindful that prices could easily continue to rise for some time yet.
Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
