Have low interest rates made risk assets too expensive?
Around the world, plunging interest rates have led to a stampede by investors into risk assets, like shares and property. With the prices of these assets now looking quite inflated, investors need to do more research than ever to find under-valued assets.
While I take it for granted that falling interest rates exert a positive influence on asset prices, it is perhaps not as obvious to others who might allow their investments to jump at the shadows of trade deals, Trump tweets and Brexit concerns.
As the year begins, it is worth keeping in mind the power exerted on asset prices by interest rates. As we witnessed in 2019, that power exceeds all the fears that might have inhered in short-lived geopolitical and financial machinations.
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.
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.
Mark
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Hi Roger
Love the commentary, but when all is said and done, I’m looking for a less ambiguous way of assessing what actually represents an attractive entry point, especially for a growth stock… it’s hard using fundamental measures, and the market hype, plus central bank policy, doesn’t help. That said, can you give me some pointers to use in running the right ruler over whether today’s price represents an attractive entry point. Is it all about running a DCF over 10 years of projected earnings, relative to where interest rates are at… and if it’s this easy – why, don’t brokers analysts makes these sorts of notes more available on the sell side. The safest way I have found to the unearth value within the current market is to pick-off quality EFTs, from quality managers at IPO – eg when they make an initial offer, and generally speaking this is been a very rewarding strategy… none he least with the Shanghai Composite, which was trading at distressed levels over a year ago… Despite Trump and Corona, the value metric there has still emerged. Clearly is this just one example, and you don’t need to be Warren Buffet to pick off the long hanging fruit.
Roger Montgomery
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Hi mark, have you read Value.able? It was written to answer this question; https://shop.rogermontgomery.com/cart.php
Joe
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Hi Roger,
Thank you for the reply & I acknowledge the index funds are predominantly directed towards “know-nothing” investors. Although based on the performance of active funds vs index funds you have to wonder how knowledge a majority of these active investor managers really are.
In any case, given the sentiments of this article and the following article (lots of variations on the internet)
https://pro.portphillippublishing.com.au/p/w1tglcrasha/ETGLW2DV/?a=20&o=40829&s=116571&u=539368&l=1548487&r=MC2&vid=sYZLZC&g=0&h=true
which suggest stock markets are expensive or that a major correction is imminent, how do you reconcile the significant differences among experts on the valuations of markets? i.e. when the market hovers around average PE you can justify saying its expensive or cheap based on the economy, the type of stocks trading @ high valuations etc. But when all the valuations are so high, how do the expert managers justify a recommendation of continuing to buy?
Ultimately, I’m asking a question concerning ethics as much as investment advice. Is it ethical for advisors to recommend stocks even ones as good as CSL when their valuation is so high?
Roger Montgomery
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Hi Joe,
I think it is ethical to say what one believes to be true and to explain that one could be wrong. We have beaten the broad market since inception of our funds and have achieved this with an average of more than 25 per cent in cash in The Montgomery Fund and over 35 per cent on average in cash in The Montgomery [Private] Fund. The monthly changes in our cash balances reflects our belief that the market has been expensive since 2016. Globally however there have been plenty of opportunities and so our global funds have held less cash than our domestic funds. Just because we believe the market is expensive, its not the same as predicting a crash. The stock market may indeed crash and we are well positioned to take advantage of it. It would be beneficial for us if one occurred but we aren’t able to predict it as accurately as the people you linked to. Please note we were one of the funds that entered the GFC with almost three quarters of the portfolio in cash. Our cash levels have risen recently with the takeover of QMS and Healius which we have owned and we aren’t upset about that. But rather than predicting crashes we will try and uncover quality companies at cheap prices and buy them when they meet our criteria. With respect to your question about managers ‘recommending’ buying stocks when ‘valuations’ are so high, you have to remember that many managers aren’t ‘absolute’ managers like us. They are mandated to be fully invested at all times, so that the people who allocate funds to them can decide on the appropriate amount of cash to hold themselves. Further, I don’t believe the market is hovering at an average PE so I can’t comment on whether others are acting ethically or not, but I hope that’s and ethical answer.
andrew ronan
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Hi Roger, do you think the feds intervention in the repo market is a sign of short term rates rising? Because it seems without their intervention which seems to have gone from temporary to permanent intervention, short term rates would be very much higher, as banks obviously don’t trust each other, because of the massive amount of risk building in the debt markets .
It seems the more the fed intervenes, the more they get trapped, eventually they must be called out by the masses who are being punished by the fed, meaning those who don’t hold assets , what was that about “ what cannot go on forever will stop” , I just think that people seem to comfortable with the lower for longer story.
Roger Montgomery
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fads in investing come and go. We could indeed be in one Andrew.
Totalwealth Plan
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Great article Roger. I explain value to my students in a slightly different way. Value is the discounted value of future benefits. When interest rates go down we discount future benefits by a lower discount rate to arrive at a higher value.
Blessings
Shantha
Roger Montgomery
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Thanks Shantha. eloquent
Joe
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The average price of Telstra is ~ $4 over 20+ years. You can trade it & make money but I prefer growth shares like CSL anytime. Having said that, CSL is expensive at the moment, trading @ a P/E of ~ 74 so probably best to hold off buying until it gets cheaper (as per article’s sentiments)
re: prudent active investments – I’d like your thoughts on the following article & comment
https://www.afr.com/wealth/personal-finance/why-investors-are-shunning-active-and-chasing-passive-20190923-p52tyc
In support of the premise of this article, Warren Buffett has been quoted as saying (I’m paraphrasing) to buy low cost index funds. However, I would classify him as a high conviction investor who ACTIVELY prefers to buy companies. In that sense, there appears to be a contradiction between his actions and his advice.
Roger Montgomery
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Apologies for the delay in replying Joe and thanks for your comment. Yes, there’s an incongruity in Buffett’s actions and words. But it is helpful to put his position into context with a couple of his previous utterances;
1) “There is nothing wrong with a ‘know nothing’ investor who realizes it. The problem is when you are a ‘know nothing’ investor, but you think you know something.”
and
2) “By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals. Paradoxically, when ‘dumb’ money acknowledges its limitations, it ceases to be dumb.”
The advice to invest in index funds appears to be directed to the know-nothing investor.