Microeconomics for investors
Back on April 14th, we wrote the following column. Once again, it proved prescient.
Having taken some profits in overstretched retail stocks and having avoided mining services and mining completely (other fund managers have not been so fortunate) The Montgomery [Private] Fund has 45% of its portfolio in cash ready to take advantage of opportunities as they arise. Investors are in the fortunate position of having almost half of the portfolio in the safety of cash.
Be sure to SUBSCRIBE FOR FREE and stay tuned for upcoming blog posts about where we see emerging opportunities for you to investigate, and in the meantime read one of the most popular columns from April…
Microeconomics for investors
About a month ago we sold out of more than 20 percent of our portfolio because the prices of the companies we owned surged past our estimates of even the most optimistic intrinsic values. At our last four weekly investment committee meetings we have walked away with virtually nothing new to buy to replace those things that we sold. As a result the cash has been building and stood at 36 per cent in The Montgomery [Private] Fund last week.
Did we predict this latest sell off? No. Can we predict such events? No. Does sensible investing help to preserve and grow the funds you have spent a lifetime accumulating in your SMSF? Yes. Can you do what we do? Yes.
The simple fact is that you must turn the stock market off and instead focus on businesses. Do this and you can achieve equally satisfactory returns over the very long run.
Last week gold fell 6.25 per cent from $US1573.64 on April 8. Then on Monday it promptly declined 10 per cent. Plunging gold was joined by declining prices for silver, base metals and oil too.
According to many commentators, the reason for the fall was institutional investors fleeing bullion in favour of other safe-haven assets amid concerns about central bank sales and souring sentiment.
Imagine investing by trying to predict changes in sentiment?
Eighty years ago, Ben Graham, the intellectual dean of Wall Street, observed, “speculation is largely a matter of A trying to decide what B, C and D are likely to think – with B, C and D trying to do the same”.
If you aren’t losing money, you’re panicking or at least scratching your head. Ben Graham was right when he described the market as manic-depressive, because in the short run, it certainly isn’t efficient.
Now, we are told there is a slowdown in the US economy and this is why we have seen a sharp sell-off in commodities. And the reason for the fears of a slowdown in the US? It’s because China is slowing!
Notwithstanding the fact that China would eventually have to be renamed ‘Earth’ if it continued to grow at 12.5% per annum, we all have known for several years that China would slow the rate at which it is expanding.
One of my overpaid genius US peers was quoted: “We’re due for choppiness, given the run we’ve had,” adding, “we’re moving at a slower pace, and those who got overly excited about GDP growth are probably pulling in their horns a bit”.
Imagine investing by trying to predict when horns would be pulled back?
Markets never go up or down in a nice straight line, so for once and for all time, throw out that notion and zip up your wallet whenever a so-called expert predicts it.
No sooner has the market gone down, because China is “only” growing at seven per cent, will it then rise because seven per cent growth means that interest rates won’t be hiked or because of some other equally unpredictable change in the way market participants view things.
Instead you simply need to think about businesses.
The good portfolio is one built by selectively acquiring, at rational prices, over a lifetime, those businesses whose earnings profile ensure the business will be much larger in the future than it is today.
A better portfolio is one where those same businesses also harbour sustainable competitive advantages. The most valuable of which is an ability to raise the price of the product or service it sells even in the face of excess capacity.
And the very best portfolios are the ones that have removed those businesses that have the worst economics. The worst are those businesses that must do the reverse – lower prices in the face of excess capacity. Producers of iron ore and other commodities rank among the worst kinds of businesses to own because their customers do not run across the road to pay more for the dirt they sell. Their customers simply go around looking for the cheapest price forcing the vendor to match the lowest rate going. A price taker must by necessity follow the cycles that are experienced by the commodities they sell.
So zip up your wallet if a fund manager comes along, calling himself or herself a value investor, and owning such companies.
Earlier this week, a local stockbroker observed “any company with the ability to raise prices or margins will be rerated. Pricing power, via industry structure, will be the key attribute because that is how you generate organic earnings growth and eventually dividend growth”. To see this trader talk business economics was one for the books – perhaps he had been reading the work of Buffett et. al. from the 1970’s. Whether he holds this line the next time commodities rally will determine whether his mood and his bank balance will eventually find immunity from the market’s short term gyrations.
There are only two things you need to know to take advantage of market highs and lows and see them for exactly what they are; The first is understand business economics and the second is to understand how to estimate value.
DO these two rational things consistently and you will discover Cyprus, China and Japan, and anything else that flies like a black swan from left field, can be used to your advantage rather than being something to run in fear from.
This article was originally posted in April 2013
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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.
