It’s time to stop running with the herd
With low interest rates prompting so many investors to stampede into high dividend-paying stocks, it appears we are re-living the exuberance of the dotcom era. But ultra-low rates aren’t normal, and as rational investors we need to avoid the pitfalls of herd mentality.
Perhaps unwittingly, one of our clients wrote to me on the subject of what is now accepted as ‘the new normal’ a long period ahead of very low returns. He asked, “If I have to accept very low returns for a very long time, why bother taking the risk?”
It’s a reasonable point and if his stance were widely adopted a correction in asset prices would be a given.
What then do we make of the famed investor, Howard Mark’s former colleague and founder of the $100bn Doubleline Capital, Jeffrey Gundlach, who a week or two ago said “Sell everything. Nothing here looks good.”? What do we make of bond king Bill Gross who said in July “I don’t like bonds; I don’t like most stocks; I don’t like private equity…The obvious answer is to reduce risk.”?
I remember the tech boom. I was at Merrill Lynch at the time, and the average first day listing gain of an IPO was 90 per cent on the NASDAQ. Anything with a ‘.com’ in its name soared and Warren Buffett was deemed a ‘has been’ – his value investing mantra and reinvestment into boring manufacturing businesses evidence of a washed-up strategy that was no longer relevant. Of course we all know what happened.
Today it’s the ‘same same but different’. What’s the same? Rational, experienced and intelligent investors have broadly adopted another theme. Back in the late 1990s the theme was: ‘pay almost any price for a company with .com because it will change the world’. Today it is: ‘the world has changed (and interest rates are zero), you can pay any price’.
Back then investors stampeded into stocks with massive growth aspirations and high levels of retained earnings (or reinvested for no earnings at all!) and they migrated out of stocks that paid dividends.
In my book Value.able I describe a company called Professional Recovery Systems trading at 50 cents that changed its name to NetBanx.com, had US$989.00 in assets and noted in its SEC filing that “The company does not presently engage in any substantial activity of any description and has no plans to engage in any such activity in the foreseeable future…” At the peak of the internet bubble Netbanx shares traded at $8.00 each!
Today investors are stampeding into stocks that pay big dividends and retain little or nothing for growth.
Back in 1999 it was unbridled optimism that fuelled new highs in stock markets, particularly in the US. Today it is the precise opposite – unmitigated pessimism – that is doing exactly the same thing. The logic goes like this: earnings are weak, the economy is doing poorly, central banks will therefore keep interest rates low…buy stocks!
Mark Twain once observed that when you find yourself on the side of the majority, it’s time to pause and reflect.
But who is the majority? The majority is not represented by the rising chorus of commentators and fund managers warning you to be careful. Rather, the majority is reflected in the prices of assets like Auckland International Airport and Sydney Airport, which for some reason, unbeknownst to your author, are the two most expensive listed airports in the world.
The majority is paying very high prices for assets believing they are justified by discounting future cash flows back to today using ultra low rates. But ultra low rates aren’t normal. All my time in investing tells me the pendulum always swings back and sometimes violently. Back in 2000, the tech boomers were proven wrong when the .com revenues and profits didn’t eventuate. This time, the advocates of ‘lower-for-longer’ will be wrong too.
We look back on the tech boom and the willingness of investors to pay extraordinary multiples for business with no earnings with astonishment. We will also look back on this period, with more than 30 per cent of global bonds paying negative yields, and 80 per cent offering returns of less than 1 per cent, with equal astonishment.
Some things just never change.
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.
John
:
Hi Roger, you mention that you currently have approx. 33% cash in your Private Fund and 26% in your The Montgomery Fund. I imaging you have shares in both of these funds bought at much lower costs than today’s prices. Therefore you are holding gains in much of these funds at present.
My question is, if you had no stocks at all purchased at present and you were going to invest $1Million “today”, what % of that would you hold in cash?
(Given the uncertainty of investing at the moment as you rightly highlight).
Roger Montgomery
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It would be about the same or a little higher – provided I could investing in strongly growing businesses. I also just personally invested in our domestic market neutral fund. Similar logic – looks like cash but with explore to high quality companies and hedging the tail risks.
Jim Hasn
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Enjoyed this article very much. If Templeton’s beliefs on bull markets are right, and we are still pessimistic, then we might still have a way to go.
This reporting season in Australia has been highlighted by the impressive share price appreciation that are sustained beyond 1-2 days by companies that have not only demonstrated significant earnings growth, but are suggesting in their guidance that the growth is not likely to slow up. It has also been highlighted by the non-performance of the growth plodders, for want of a better word and the belting of short-comers, even good businesses that haven’t met expectations. Having had some nice appreciations and one or two disappointments, I too am increasing the cash percentage, but only by selling the non-performers and waiting for further opportunities.
Roger Montgomery
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Good points Jim. Great to hear from you again. Hoping you are well.
Nic Arena
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Roger,
You must be pleased with ISD. Lots were writing it off and it has delivered solid results. Just another boring stock doing well.
Roger Montgomery
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Hi Nic,
Our analyst Scott Shuttleworth and I had a good conversation about what we need to keep a close eye on. He also analysed the criticisms levelled at ISD online and dismissed them.
Luke Joseph
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Roger, it was great to hear your thoughts the other night with Ross Greenwood about APN Outdoor Group. Will there be a write-up on that company any time soon?
Roger Montgomery
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Stay tuned. We will put something up after reporting season.
Keith
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As to cash levels, I have felt for a little while the need to get to about 25% – 35% cash, maybe higher. Having made good gains over the last 12-18 months,
The Boral CEO comments about the Reserve Bank inability to manage the economy sound about right. What I find bizarre is that the low interest rates and government ineffectiveness on debt levels are effectively reducing the purchasing power of the one group with money, mature aged people, by the low interest rates. A few years ago the receive 6 – 8% now 2.5% if lucky. Wage earners have not suffered an income fall like that, If deposit interest rates are say 4 – 5% the economy would be in better shape that it is. The rates are causing mature aged people to contain their expenditure, and they will become reliant on the government for pensions soon than would have been the case. Brilliant on the earth of the government, treasury and the reserve bank.
Roger Montgomery
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That’s correct Keith. The low rates are, perversely, acting like a tightening of monetary policy.
Keith
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Roger
I agree with your comments. The real question is when will the pendulum swing back?
What I have noticed is a number of commentators and investment professionals who have been commenting about the extraordinary events – interest rate levels other symptoms of the current situation. The question is when, not if. In the past I have observed things continuing for much longer than one expects.
Is it the election of Trump. There will be some external catalyst. What will the event look like? Will there be some warning signs a short while before a cataclysmic event, or will it be the ‘Black Swan’. event, whatever that is.
I have to say I sold about $100k of stocks in the last few days on the basis that the news was now in the markets from results and it will be a little while before news will drive things much higher particularly after such a good run recently. That brings me back to about 8% cash with the remainder in Australian mid ranking stocks. I think I need to have another look to see if there are another one or two to ‘weed out’.for sale.
Roger Montgomery
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Sounds like you are applying a sensible framework to your investing.
Luke Joseph
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That being the case…
If we were firmly in bubble territory, wouldn’t we expect the funds’ level of cash to be near 50% as opposed to their current 25-30% ?
Roger Montgomery
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There are still companies growing strongly and not overpriced. We would have to sell those to raise cash further.
william-garbett
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Do the funds have a cash cap? (30%?)
Also what % of the funds are cash now?
Roger Montgomery
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Hi William, Yes 100% cap for the Private Fund and a soft cap of 30% for The Montgomery Fund with a remit to be able to go to 50%. Funds are 33% and 26% cash respectively.
john volf
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Thankyou for your article Roger. Thanks also to David Buckland for taking the time to speak with me today.