Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
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If you take your cues from price rather than values, fear may have recently set in. For Value.able investors, a market correction is a reason for celebration rather than consternation. Roger Montgomery explains why holding on may be the wiser decision. Read Roger’s article
As a young child growing up, the United States was the world’s policeman and Australia was a friend. Part of that picture will change in the lifetime of my children. The US no longer seems to command the authority it once did.
Its waning imperialism is at least partly reflected by last weeks visit to China by Pakistani Prime Minister Yousef Gilani. He described Beijing as Islamabad’s “best and most trusted friend”. Meanwhile, a petition in Pakistan’s High Court has called for the expulsion of the US ambassador.
Its waning imperialism is also reflected in recent news that major Australian miners are taking an interest in China’s promotion of its local currency, the Yuan, for trade settlement.
These are the first furtive steps towards a switch away from the US Dollar. Global reserve currency is moving towards the Chinese Yuan. Once hedging is made easier, the floodgates will be open and the Yuan’s appreciation will ensure the tide cannot be stopped.
China will continue to leverage its massive foreign reserves – reflecting fiscal power – and its military might, whenever old ties between the US and others flounder. As regime change in the Middle East continues, new leaders look to China rather than the superpower that funded and abetted their old foes.
India’s PM (and a US ally) recently visited Afghanistan, offering half a billion dollars for development while simultaneously saying “India is not like the United States”.
We are witnessing history. Sure there will be speed bumps and set backs, but the die has been cast.
In the absence of a World War, the US influence and more worryingly, its role as global cop and providore of reserve currency, appears now to have commenced a drawn-out death spiral.
As Jim Roger’s noted; “the 19th century was the era of the British Empire, the 20th belonged to the US Empire but the 21st will be the era of the Chinese Empire.”
The impact of this shift cannot be overstated.
Meanwhile, back at the ranch…
Last year Lakshman Achuthan explained his Economic Cycle Research Institute’s view that A) a US slowdown is already a done deal and B) the US faces the unfortunate prospect of more frequent recessions over the next decade.
Evidence of a slowdown is now emerging and Achutan was recently interviewed on the subject here and here.
Let me say at the outset, I am not an economist. And don’t worry, I’m not turning into one. Indeed, even if I was, it still may not help me invest any better than I can following the Value.able methodology.
I have, however, been trying to find a reason to expect to find value sometime soon.
And thanks to Lakshman Achuthan, I have found a reason to become a little optimistic, if not about the economy, then about the prospect of finding value, soon.
Longer-term, Achuthan thinks more frequent US recessions are a given.
In economics, a recession is a business cycle contraction or a general slowdown in economic activity. During recessions, economic indicators such as production – as measured by Gross Domestic Product (GDP) – employment, investment spending, capacity utilisation, household incomes, business profits and inflation all tend to fall. Conversely, unemployment tends to rise, along with the number of employers no longer able to afford them.
In a 1975 New York Times article, economic statistician Julius Shiskin suggested a definition for a recession. In Australia we seem to have adopted it; two quarters of negative growth and a recession is in place.
Because of the stigma for a political party associated with a recession, not to mention the economic hardship associated with one, recessions are something best avoided.
The two ways to do it are to either to raise the trend rate of growth, such that the dips in the business cycle never fall into the area of growth below zero, or lessen the peaks and troughs of the business cycle itself.
Raising the trend rate of growth, however, does not appear to be an option (for the US at least) because the trend rate of growth in employment, GDP, personal income and industrial production has been down since the end of World War II. As the trend rate of growth declines, and heads closer to zero, the dips in the business cycle need not be very severe to dip below zero.
Reducing the peaks and troughs of the business cycle such that the dips never result in an economic ‘backward step’ has been claimed as a new norm by economic managers who believe the use of monetary policy has been perfected, and also by those who have put their faith in economic globalisation. Monetary policy however is a rather blunt tool and its success in helping us avoid recessions may just be blind luck.
With trend growth declining for 50 years, each dip in the business cycle gets closer to regularly falling below zero. And with luck largely determining the success of policies attempting to smooth out the business cycle, its likely luck will run out, just as the globalisation of the supply chain causes the business cycle to whip even more violently than ever before.
Governments usually respond to recessions by adopting expansionary macroeconomic policies. They can increase the money supply, increase government spending and decrease taxation. But with a flood of US dollars that only Noah could survive, and government deficits already at historic extremes, these measures would only make the situation worse.
If you are investing in equities, the message is simple. Only buy the best quality businesses. And only when large discounts to your estimate of their Value.able intrinsic value are present.
The Value.able recipe is simple and it works. And you don’t need to be an economist to make it work. Whether the idea of more frequent recessions is right or not, the dearth of value suggests one should applaud the fact that markets may react to the risk of more frequent recessions, offering the best stocks for prices less than they’re worth in the process.
Posted by Roger Montgomery, author and fund manager, 1 June 2011.
Everyone in the stock market wants to buy value. That is, a stock they can be confident will rise in price. But what is value is hard to find? Roger Montgomery discusses how to find value in the fluctuating stock market. Read the article.
The prices of rare earths have rise, but share prices of the producers have fallen. What’s the bigger picture? Read Roger’s article at www.eurekareport.com.au.
Roger Montgomery shares his insights and Value.able intrinsic valuations for BHP, RIO, WBC, ANZ and LEI. Roger also talks to Ross Greenwood about China’s demand for steel and US hedgefunds’ bullish attitude towards coal and iron ore. Listen to the podcast.
With June 30 fast approaching, and following a series of reports that highlight a decline in global economic growth, analysts around the globe have begun to reassess their assumptions about commodity prices, inflation, China and company earnings. But every dark cloud has a silver lining. With that in mind, Roger Montgomery suggests five businesses to put on your watchlist. Read Roger’s article at www.eurekareport.com.au.
Roger Montgomery’s Value.able way of investing required you to turn the stock market off, think of businesses rather than stocks and focus on value rather than price. Read Chapter 13 of Roger Montgomery’s Value.able stock market guide book and discover how you too can calculate the intrinsic value of any business. In this interview with Ross Greenwood, Roger also reveals 5 businesses at the top of his watch list. Listen to the podcast.
The best online businesses are lists – seek.com.au, realestate.com.au, carsales.com.au and Wotif.com.au are just four listed on the ASX. What are the risks associated with investing in online businesses? Loss of competitive advantage. Is carsales.com.au at risk? In this appearance on Switzer TV Roger Montgomery also reveals his Value.able intrinsic valuations for Carsales, Seek and Wotif. Watch the interview.
Tech companies face the risky choice of taking what they can today, or holding out in the hope of making more tomorrow. Roger Montgomery, one of Australia’s most respected analysts takes the view that if an offer lands in your inbox, you should take it with both hands. Read the article.
You may have noticed my recent posts are not filled with stock ideas. Don’t worry. The drought will end, once the market resumes serving up mouthwatering opportunities
For many businesses, Australia may not seem like the ‘lucky country’ right now. A litany of evidence suggests the economy is cool. Recent bank results reveal credit growth is slowing, if not stalling. Significantly fewer homes are being put to auction and of those that are, clearance rates are not inspiring.
Australia’s savings rate has risen and thanks to rising fuel costs and utility bills, we haven’t got as much to spend as we used to. Then there’s the prospect of rising interest rates. I wonder, given all anecdotal evidence of weakness, whether an interest rate cut would be more justified?
Some of Australia’s ‘blue chips’ have reported weakness or downgrades. Seven West Media reported a softer advertising market, which has also affected Fairfax and APN. OneSteel cited a strong Aussie dollar, as did BlueScope. And you can almost guarantee food manufacturers are going to complain about higher commodity input prices.
Indeed higher input prices, combined with pressure on consumers to pay more for daily essentials – gas, electricity and petrol – means many companies have lost their ability to pass on rising costs. Naturally, this leads me to think that this is precisely the combination of influences that will reveal which companies have a true competitive advantage?
The Value.able community has spent a great of time exploring, discussing and naming competitive advantages – retailers, Apple, your insights. The current economic headwind will reveal who actually has one.
Take a look at the companies in your portfolio. Can they pass on rising costs in the form of higher prices, without a detrimental impact on unit sales? Can they grab market share from competitors whose margins are slimmer, by cutting prices? Is your portfolio overflowing with A1 businesses, or are there some C5s in there that may struggle through post-reporting season?
Now despite current pressures, which of course you must refrain from believing is permanent (and indeed cease focusing on), analysts haven’t brought down their earnings expectations.
Macquarie’s equity analysts are forecasting aggregate profit growth of 19 per cent and according to JP Morgan, non-resource companies are expected to grow profits by 13 per cent this year. These growth rates are a significant revision down from 6 months ago. Are more downgrades to come? Thirteen to nineteen per cent does seem more appropriate for a rosier economic environment…
Lower profits have a real impact on intrinsic values. For companies generating attractive rates of return on equity (at last count, 187 listed on the ASX generate a ROE greater than 20 per cent. Of those 103 are A1/A2), lower profits reduce the quantum of that return, as well as the amount of retained earnings and therefore the rate of growth in equity. All of those changes are negative. If Ben Graham was right and in the long run, price does follow value, that means either lower prices or prices that cannot justifiably rise much more. And this is where Value.able Graduates’ attention should be focused, not on the bailout of Greece or Portugal.
What does this all mean?
I don’t have a crystal ball, so I simply don’t know where the market is headed. Thankfully it isn’t a brake on market-beating returns.
What I do know, is that of approximately 1849 listed entities, 1175 made no money last year. Of the remainder, 56 are A1s and of those, just 13 are trading at a discount to our estimate of intrinsic value. Six are trading at a discount of more than 20 per cent and of those six, The Montgomery [Private] Fund owns two. We have been decidedly slothful in buying and, as a result, while the market has been falling, the Fund’s value hasn’t.
Steven wrote on my Facebook page yesterday “Who cares? this market is… only ugly!” It’s only natural to want to throw up your hands in dismay, but this is where the rubber hist the road – Keep Calm and Carry On Value.able graduates. Look for extraordinary businesses at prices far less than they’re worth.
Just under 11 per cent of The Montgomery [Private] Fund is invested in extraordinary businesses. Even with 89 per cent of the Fund in cash, we are outperforming the S&P ASX/200 Industrials Accumulation Index by 5.29 per cent since inception.
My team and I continue to be inspired by the 1939 poster in which England advised its citizens to “Keep Calm and Carry On”.
Low prices should not bring consternation, but salivation. As sure as the sun rises, low prices for A1 companies will not be permanent.
Beating the market does not mean positive performance every week, every month or even every year. I have no doubt that some investments I will make for myself and the clients we work for will not perform as expected. Not every A1 at a discount will prove spectacular. We can however mitigate some of the risks of course. Sticking to a diversified basket of the highest quality companies (A1s perhaps?) purchased at big discounts to intrinsic value, won’t prevent the market value of the portfolio declining in the short term, but it can help to generate an early, eventual and more satisfying recovery.
With a falling market (and falling prices for A1 companies too) the daggers will come out, so also be prepared for those of weak resolve. They may try to discredit our Value.able way of investing.
A contest isn’t won by watching the score board, looking in the rear view mirror or mimicking those with a demonstrated track record of success. You have to play. And play your own game. Over long periods of time, sticking to good quality A1 companies works. Given that returns are dependent on the price you pay, lower prices (and greater value) works even better!
The issue of course is not the reliability of the Value.able approach, but the patience required to execute it. Remember the ‘fat pitch’? Irrespective of the turmoil that impacts markets, we must Keep Calm and Carry On.
So what do you think? Where do you think the market is headed? What are the factors you are watching? Have you picked up something in your research that you’d like to share? Go for it!
Posted by Roger Montgomery, author and fund manager, 18 May 2011.
