Why they’re pessimistic about this market

Editor's Pick, Market commentary | Comments (36)

Why they’re pessimistic about this market

You may be surprised to know that our largest position by far is cash.  And that’s because we’re not finding value among the quality businesses we like to own. In value investing, patience can be a virtue, and we think holding cash will pay off handsomely.  But, of course, not everyone will agree with us.

The Montgomery Fund holds 27 percent cash.  The Montgomery Global Fund holds 27 percent cash, and The Montgomery [Private] Fund holds 43 percent cash (the fund can hold up to 100 percent cash).

Such high levels of cash, earning miniscule rates of interest, are going to drag performance in a rising market. Our direct investing clients value the preservation of capital above earning the last few percentage points of a market’s gain, especially when market valuations are stretched as they are now.

While we have not lost money recently, we haven’t made much either, and while the optimists are winning, our high cash weightings produce embarrassing relative returns.

Because nobody knows how long it will be before value emerges broadly, it might be worth examining a selection of comments made by central bankers and fund managers, while we wait.

Dividing sentiment into two camps, those currently in the lead are the bullish investors who are backing an acceleration of global economic growth favouring higher resource prices including copper and iron ore.  This is the ‘global reflation’ trade and supporters look to recent hawkish comments by central bankers to support their case;

Australia’s RBA Governor Phillip Lowe (Feb-17) was the first to highlight that inflation targeting was no longer dictating the bank’s rates setting. He commented that while colleagues were arguing the bank should be doing more to get inflation back to its target, by cutting rates further, he was concerned about “how much extra fragility would that create in the economy” by encouraging further growth in household debt.

US Fed Chair Janet Yellen (16-Jun-17) stated: “And, you know, I continue to believe though that with job growth running well in excess even with the moderation of the level that’s needed to provide for new entrance in the labor market, we do have a strengthening economy with policy accommodative, all that we’re doing in raising rates is moving — removing a bit of accommodation heading toward a neutral pace.”

ECB President Mario Draghi (27-Jun-17) delivered a bullish assessment of the region’s economic prospects, saying that reflationary pressures have replaced deflationary ones as the Eurozone’s recovery progresses.

BOC Governor Stephen Poloz (28-Jun-17) stated: “It does look as though those (rate) cuts have done their job.”

BOE Chief Economist Clive Haldane (20-June-17) stated: “Having weighed the evidence, I think that the balance of risks associated with tightening ‘too early’, on the one hand, and ‘too late’, on the other, has swung materially towards the latter in the past six to nine months… Certainly, I think [such] a tightening is likely to be needed well ahead of current market expectations.”

In the other camp are those lauded and legendary fund managers who believe stretched equity valuations, record low levels of volatility, stretched prices more broadly across all assets, the concentration of funds flowing into a narrowing group of tech stocks and speculative fervour amid buyers of non income-producing collectibles are all signs that raised cash levels are sensible.

Ray Dalio, founder of Bridgewater Associates LP, the world’s largest hedge fund with more than $150 billion under management, believes the “magnitude” of the next downturn will be epic. “We fear that whatever the magnitude of the downturn that eventually comes, whenever it eventually comes, it will likely produce much greater social and political conflict than currently exists,” he recently said.

Bill Gross, founder of PIMCO LLC and now portfolio manager at Janus Henderson, cites the highest risk levels since 2008: “investors are paying a high price for the chances they’re taking.”

CEO of DoubleLine Capital Jeff Gundlach advised, “moving toward the exits.” Gundlach is reducing his positions in junk bonds, emerging-market debt, and lower-quality investments, because he believes investor sentiment will turn negative, telling Bloomberg: “If you’re waiting for the catalyst to show itself, you’re going to be selling at lower prices.”

Carl Icahn, who regularly loads up on stocks and hits it out of the park, warned on CNBC in June that he isn’t seeing opportunities; “I really think now, I look at this market and you just say, ‘look at some of these values,’ and you have to wonder.”

Oaktree Capital’s founder Howard Marks in his latest letter to investors, stated: “The uncertainties are unusual in terms of number, scale and insolubility in areas including secular economic growth; the impact of central banks; interest rates and inflation; political dysfunction; geopolitical trouble spots; and the long-term impact of technology.

In the vast majority of asset classes, prospective returns are just about the lowest they’ve ever been.

Asset prices are high across the board.  Almost nothing can be bought below its intrinsic value, and there are few bargains. In general, the best we can do is look for things that are less over-priced than others.

Pro-risk behavior is commonplace, as the majority of investors embrace increased risk as the route to the returns they want or need.”

George Soros is reported to have recently sold stocks and bought gold… after a near 10-year hiatus.

Appaloosa Management’s David Tepper warns investors to stockpile some cash and says he’s “on guard”.

It’s fair to say there are those who also believe in other scenarios such as a continuation of slow growth requiring no change to current interest rates settings.

Irrespective of what camp we might personally believe in, our process is being strictly adhered to and that process isn’t finding large amounts of value among the quality names we like.  But we aren’t going to change our process.  As a result, cash is the safest alternative and for as long as it remains Montgomery’s largest portfolio position, a rising market – especially the Australian market which is 17 percent weighted to materials (compared to 2.9 percent in the US) – will snub its nose at our apparent conservatism and make our process look dumb. As Howard Marks noted, currently the optimists are winning.

So which camp are you in?  I’d be delighted to hear your thoughts.  Leave your comments below.

INVEST WITH MONTGOMERY

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.

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36 Comments

  1. peter latham
    :

    Roger,
    I respect your views (after all, I do have funds invested with you) but as an alternative to a pure cash position, isnt there a dull boring but reliable stock paying good dividends that would be relatively “bulletproof” in the case of a correction ? This may be a fairly simplistic approach to holding (say) less cash than you do ?
    Or have you already (to a degree) adopted this concept ?

    • Roger Montgomery
      :

      a stock that is relatively “bullet proof in a correction”? Peter, we know that correlations are very high during a dislocation. There will however be companies whose shares will recover more quickly…

  2. john volf
    :

    I tend to agree with you Roger. I don’t have funds invested with you, although I want to, but fear paying these high multiples. I like your philosophy, and I do invest directly in the ASX, but I too am heavily in cash to the tune of 75%. A good entry may be once some of the excess has seeped out of asset prices. Keep doing what you do. Whilst it sucks when you make an error, or act too early or too late, I’m still with you and your team.

    • Roger Montgomery
      :

      Thanks James. We cannot validate your email address (which bounces from Macquarie Bank as an “unknown address”) and while your Linkedin profile says you work at Macquarie our contacts cannot find you on the bank’s intranet. Happy to respond to your message if you supply valid credentials.

      • James Cork
        :

        Thanks Roger – i’ve updated my profile to my personal email address, as opposed to my now-defunct former work email address. Regards.

  5. Kelvin Ng
    :

    Hi Roger, I think stock market valuations in the US are fair to expensive. Its not a bubble, given where interest rates are at the moment. My best guess is that a 10 to 20% correction can happen at any time, at which point if it happens I’m guessing you would buy more stocks. I think its more likely than not that this bull market will only end with full blown euphoria and bubble valuations and full retail participation, but I would expect the Montgomery Funds will not participate in the bubble and I’m perfectly ok with that.
    Kelvin

  6. Pete M
    :

    Hi Roger,
    Whilst you may receive criticism in the short term I think that the opportunities that will become available soon will place you in an opportune position to pick up all the bargains at the coming sale. History doesn’t repeat but to be fully invested now would not allow many value investors a good night sleep. There is a reason that interest rates worldwide are so low and it’s not because everything is travelling well. I have read some of the comments that we are mid cycle and that one should be fully invested because this bull will run until it is the most expensive market ever. I think this is very misconceived given that on some metrics we are now in the midst of the most expensive market ever (median cape PE or price /sales in the US markets). I read somewhere that over the last 100 years there has never not been a US recession following a two president. I would be very cautious overnight the next couple of months – the US is currently experiencing tech bubble 2.0 & Australia is home to some of the most overpriced realestate in the world – both courtesy of the greatest debt levels ever experienced. When confidence disappears – and it will for any number of macro economic or geo political reasons – the many factors that together have combined to form this once in a li

  7. Justin Smith
    :

    Hi Roger,

    Does The Montgomery Fund still have a holding in HSO? Any comment on the latest results? You have always spruiked this as a great business that the market had been too harsh with.

      • Roger Montgomery
        :

        Justin and Peter,

        At this stage our thesis has not changed. The company’s fixed asset turnover is under some pressure as the company continues to build supply ahead of demand but we are in little doubt about the long term prospects for private hospitals in Oz. As we have also noted (but ignored in your “spruiking” comment), private hospitals are under pressure from declining PHI subscriptions, double dipping by public hospitals and in HSO’s case a loss of share in Victoria. We ‘currently’ believe these to be temporary in nature but keep in mind our view can change at any time and because we cannot control shares prices, they could fall further.

  8. Andre
    :

    Roger, sometimes I question myself whether the amount of information in regards to markets make us more pessimistic about the markets than we should be. We have been hearing about economic meltdowns in all types of markets for a number of years now and yet economies and markets climb ever higher.
    It’s a bit like the thermal coal market. For years, commentary has been made of the impending doom of this industry and yet energy coal is above US$100/mt and growth prospects for traditional export markets grow ever stronger as alternative energy sources have proven ineffective for these markets. Whilst I am sure that at some point technology will catch up but it certainly won’t happen in 10 years. Like those who have investments in thermal coal businesses, are we better off investing knowing that on the balance of probabilities that equity markets will continue to climb higher on the back of continued growth, fed by stimulus provided by governments and central banks from all over the world. Clearly you have flagged your intention to bunker down prepared to strike in the event that markets turn, regardless of the time frame. Timing is always, everything.

  9. Luke Joseph
    :

    With respect I think you and they are wrong about where we are in the cycle and note that you have been cautious since late 2012 (remember the Bubble Watch series of blog posts?). Valuations are high but I would say that they are right where they should be given the interest rate environment.

    Valuations are the third highest they’ve ever been, behind the dotcom boom and right before the great depression. But my view is that this won’t be over until the market gets to the highest valuation its ever been and the bull market is the longest bull market ever. Why shouldn’t those two outcomes occur, with all the money that’s been printed over the last decade?

    Of course valuations would contract if interest rates went up alot, but why would that happen, given what is happening with the structural deflation caused by the internet (and soon AI)? I just can’t see a major correction happening with US rates at or near 1%. I think we’re still mid-cycle, and people are so terrified of a major sell-off that it is preventing the sort of hubris that accompanies a market top.

  10. Chris
    :

    Is it wise to be greedy when others are? I think not!!! Banks are changing there policies every day tightening at every step. I was at a conference the other day and a banker that I respect and has been in the industry for many years made the comment that it has the feeling of pre GFC. This made me step back and think that capital preservation will be king. Time will tell but I’d rather be wrong on the other side of the fence All the best to everyone

  11. peter latham
    :

    I don’t know whether to feel guilty/ unwise/ ignorant (or all of the above), as the SMSF of 7 figures that I am a trustee in, has comparatively little cash (Just under 10%). The fund is in pension mode, but both my wife and myself do not need to draw down on the Tax Free earnings; as we both receive State and Commonwealth Pensions. To that end we can afford to be a little objective. Most of the SMSF is in equities and Listed Investment Companies, and a few funds (including one with Roger). The SMSF also owns 50% of a residential property in Regional NSW. The biggest segment of my fund is still the banks, but wait……. they have been since prior to the GFC !. CBA was last bought for $26.00 during a shareholder offer in about 2009. So should I sell the likes of CBA or Ramsay or BWP (bought at $1.00) or AGL (purchased for $2.71) simply to raise cash because the “expert” advice is somewhat pessimistic ? I guess the answer as it almost inevitably is, is that it comes down to each and every investors personal situation (unless you’re a fund manager). My investing mood could be described as cautious or guarded and there are no stocks on the horizon that I would be falling over myself to buy. Whilst the SMSF has no debt, I am guarded about selling shares which for the most part are providing a reasonable tax-free dividend and have good prospects (eg. BAP). One of the benefits of investing with Roger is that you get both good advice and a different perspective included as part of your fund management; and I did buy BAP after listening to Roger on ABC Radio……. To summarize, I am not a buy and hold at any cost, nor am I aggressively looking to buy; but with the market bumping along at the moment producing reasonable dividends with franking credits, I would be hesitant in raising cash levels by selling shares simply because it more closely matched Warren Buffet’s cash buffer. To each their own; and only time will tell if I have been “guilty/ unwise/ ignorant (or all of the above)”

  12. Allan
    :

    I guess from a portfolio construction perspective, I would personally position myself for multiple outcomes, i.e staying invested and cautiously dollar cost average into the market but also having some cash/alternative strategies as a form of risk management that would benefit if markets go south.

  13. Ian Hammond
    :

    Not sure if I am in any camp as I focus on looking for good companies and a good chance to buy them and don’t look much as the overall economic news.

    For share investing I have a line of credit that allows me to borrow up to about 15% of the value of my current portfolio. Presently this line of credit is not used and I hold extra cash in may account allocated to buy shares.

    The last time my line of credit was unused and I held extra cash for share investing was before the GFC and that proved to be a great time to buy giving me some really good returns.

    Not sure if it is coincidence or not that I am holding cash again.

    Thanks for your articles they are often thought provoking and often provide a different perspective to the mainstream.

  14. Chris
    :

    I think that I would believe the fund managers, rather than the bankers, especially since the former are the ones at the coal face and the latter appear to be more insulated and removed from it. The fund managers can see what is happening before their eyes, the bankers cannot until it’s too late.

    To me, it feels like a game where the fund managers are the ones playing on the field, the bankers are the ones who direct the rules of play from on high. This influences the style of play (e.g. investors reacting to monetary policy) and seems to be that it is done without any real certainty of how this will affect things in play…it’s an inexact science / exercise in control.

    Trading Economics’ forcast is interesting in that it is predicting a trade balance of -$3910 million by 2020, the ASX to be at 4920 points and the AUD to be at 0.65 USD, but all with no explanation as to ‘why’.

  15. simon
    :

    Roger instead of sitting on so much cash you could have bought a great business like WTC like i did a year ago and made 50% instead of 2% !!

  16. simon
    :

    BRK – mkt cap is $445bil /cash of $90bil = 20% cash and hes not bragging (like some others) about holding so much cash….

    “I hate cash,” says the Berkshire Hathaway chairman and CEO. “But it’s a holding position until you find something else.”
    Buffett says he thought Berkshire was doing OK with $90 billion cash until he saw Apple’s war chest.

    Warren Buffett told CNBC that Berkshire Hathaway has $90 billion in cash, and he’s looking to “buy a big business.”

    The billionaire investor has been talking for a while now about wanting to make a large-scale acquisition but said he does not have anything on his radar now.

    “I hate cash,” Buffett said in an interview that aired Friday on “Squawk Box,” one day before Berkshire’s annual meeting in Omaha, Nebraska.

    “I mean we are investing,” he said. “But [cash] is a holding position until you find something else. But the very fact that interest rates are that low makes it hard for us to buy other things because other people buy things with borrowed money, and borrowed money is so cheap.”

    He added: “If we are competing with equity money against slim equity plus a lot of debt, we’re at a disadvantage.”

    Buffett said he thought Berkshire was doing well with $90 billion cash until he saw this week that Apple’s cash pile swelled to $256.8 billion in its fiscal second-quarter.

    “I’m very jealous,” he laughed. “I thought I was doing OK until I looked at their balance sheet.”

    “On the other hand,” he said. “We’ve got ours here in the United States.” Apple keeps most of its cash outside the U.S. for tax purposes.

    • Roger Montgomery
      :

      Hi Simon, When looking at cash as a percentage of a portfolio, Berkshire’s Market Cap is not its book value so keep that in mind when conducting your comparison.

      Also in Buffett’s interviews with Alice Schroeder:

      “to Mr. Buffett, cash is not just an asset class that is returning next to nothing. It is a call option that can be priced. When he thinks that option is cheap, relative to the ability of cash to buy assets, he is willing to put up with super-low interest rates, said Ms. Schroeder, who followed Mr. Buffett for years before she became his biographer.

      “He thinks of cash differently than conventional investors,” Ms. Schroeder says. “This is one of the most important things I learned from him: the optionality of cash. He thinks of cash as a call option with no expiration date, an option on every asset class, with no strike price.”

      It is a pretty fundamental insight. Because once an investor looks at cash as an option – in essence, the price of being able to scoop up a bargain when it becomes available – it is less tempting to be bothered by the fact that in the short term, it earns almost nothing.

      Suddenly, an investor’s asset allocation decisions are not simply between earning nothing in cash and earning something in bonds or stocks. The key question becomes: How much can the cash earn if I have it when I need it to buy other assets that are cheap, versus the upfront cost of holding it?”

      Read more at https://www.businessinsider.com.au/cash-as-a-call-option-2012-9#BpqcjI4QtHzJHyjR.99

  18. jamie
    :

    What is Warren Buffet saying and doing in the current market? Do we know what % BH is holding in cash and whether that % is higher or lower than normal.

  19. William
    :

    Patience and sticking to your game plan are important parts of the ingredients that make successful investors. Could’nt agree more with your strategy. In my fund have held around 45 percent cash now for some time.

  20. simon
    :

    one of the few people that correctly told people to buy in march 2009 was Marc Faber

    he has been saying the markets will fall 50% for the last 3 years running

    so much for the experts opinion !

  21. Max Zan
    :

    Hi Roger

    Fully agree with you that it’s time to hold increasing amounts of Cash.

    It got me thinking about my own personal situation.

    It stands as follows

    – 4% equally spread across 4 ASX Stocks with defensive characteristics and high levels of management ownership. All have overseas exposure in one form or another and operate in different Industry sectors.

    – 8% in a Balanced Managed Superannuation Fund with both Australian and Overseas exposure

    – 88% in Cash in different structures earning between 2.5% and 3.1% and backed by Australian Government guarantee.

    Don’t see any reason to rush in and buy at present as everything is overvalued. It’s the worst I have seen it since I become a share investor in 1996.

    Cash is King at present and I’m convinced there will be better opportunities to buy ahead.

  22. andrew ronan
    :

    It seems obvious that the smart money has bolted from the markets already but the dumb money through ETFs etc is still piling in. A good sign that the markets are topping I guess .As you say Roger it’s big risk for for pennies in return when you consider the potential losses incurred in a market mean revision event. And if your comfortable being 50/60 % still invested in these conditions that to me even seems bullish unless you have a bullet proof exit strategy, and even though your holdings are of high quality, will they not become much cheaper investments when the mean revision does eventually occur and given that we are already late in the cycle do you think that a much higher cash level is warranted as it can then be redeployed later at a much higher rate of return.
    Thanks for the informative articles. Andrew.

  23. Peter Foot
    :

    Whilst you’re in the mood for sharing, what % of the Alpha Plus fund is currently held in cash?

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