Our weighted average return in November was -0.96%. Since 2015, we have generated a net return of +38.73%.
In terms of investment strategy performance, our weighted average net returns for November were (a) +0.15% for conservative strategies, (b) -0.09% for balanced strategies, and (c) -2.11% for aggressive strategies.
Markets continued to be extremely volatile in November. The S&P 500 index traded all over the place, giving up -3.83% in the third week of the month, before jumping +4.71% the very next week. By month end, the S&P 500 had gained +2%. Emerging market stocks (+5.07%) finally managed to rally on the back of lower US bond yields, and US investment grade bonds ended the month +0.64%.
Politically speaking, the US mid-term elections played out as expected with the Republicans gaining seats in the Senate, and the Democrats claiming a majority in the House of Representatives. A Democrat majority in the House will now be able to curtail Republican attempts to expand fiscal stimulus to ingratiate themselves to voters before the Presidential elections in 2020. Party politics aside, the overwhelming political issue in the world today remains US-China trade tensions and the continued uncertainty as to whether a deal will be able to be reached or not. Uncertainty abounds in Europe as well due to Italy’s budget issues and Brexit.
As such, we are in an environment where companies are recording record earnings, but their future ability to generate profits are being heavily discounted due to political uncertainty. This is evident in the price action that we are seeing in certain sectors of the market.
For old school portfolio managers with an equity mandate, volatile markets mean moving assets into defensive sectors such as consumer staples and utilities. As a result, these sectors have performed very well since the summer, whereas growth sectors such as information technology and biotech have sold off heavily. Conceptually, this makes a lot of sense, but in actuality, this is purest form of trying to ‘time markets’ and intuitively speaks to why most portfolio managers fail to beat their benchmark indices in the long-run. How so? Because most often this means chasing returns and ignoring fundamental valuation principles that are the foundation of long term outperformance.
For example, let us take a look at a classic consumer staple stock: Proctor & Gamble. P&G has a number of different brands that households use every day, from skin care (‘Olay’), to laundry detergent (‘Tide’), to diapers (‘Pampers’), to dish soap (‘Fairy’). The ‘every day’ use of these products is the critical component of why P&G is considered consumer staple company. P&G is great company, but it faces massive challenges on a daily basis to stay relevant to its consumers who are constantly tempted by new, upstart brands with product descriptions that say things like “small batch” or “artisanal”. P&G’s sales have been flat to negative over the past four years and they pay high multiples to acquire new brands (their last acquisition was done on a 5x price to sales valuation…). All of this would be fine if not for the fact that P&G shares trade at a steep 23 times next year’s earnings, with no intrinsic growth in sight.
Now, let us take a look at Apple. Apple makes the most successful and possibly most technologically advanced consumer product in history: the iPhone. With the exception of infants wearing ‘Pampers’, anyone with an iPhone spends considerably more time on this device on a daily basis than they do with every single possible combination of P&G products, and, from anecdotal evidence, even infants would rather use an iPhone than a diaper. However, since Apple became the first company to exceed 1 trillion in market capitalization this summer, Apple shares have lost around 30% from their highs – or 365 billion USD in valuation. This equates to 1.5x the current market capitalization of P&G. A practically unfathomable amount.
Although Apple’s sales have also slowed in the past couple of years, they remain astoundingly high. From a valuation perspective, after removing the net cash component from their market capitalization, Apple currently trades at a 10.72 next year’s earnings – which means that the market values every dollar in earnings that P&G generates as twice as valuable as a dollar earned by Apple. Yes, I understand that we are comparing apples to ‘tide pods’, but I welcome any and all arguments that attempt to justify this dynamic above and beyond short term price movement.
We have not owned Apple shares for quite some time. This was due to the fact that we saw more compelling growth opportunities or relative value elsewhere in the market. However, at these valuations, Apple is once again a screaming buy and we have initiated large positions in Apple over the past couple of weeks. By the way, the last two times Apple shares traded at a P/E multiple this low, they rallied over 130%… Overall, this sell off – although fraught with much near term negative price action and flat out stress – has given us the chance to buy back shares of companies that we deem to be the consumer staples of the future at significant discounts to where they had been trading for a long period of time. It is hard to be thankful when you are in the second month of negative returns, but this is a battle won with sound rationale and patience.
A year from now we will be talking with prospective clients that ‘knew’ that they should have been buying Apple shares ‘at the end of 2018’ but found some reason not to. They will say something to the effect of ‘yes, Apple @ 170, that was easy money’. We will smile and agree. Not because it was easy, but because we actually did it.
On behalf of our Client Portfolio Management team, I thank you for your continued trust and support!
FULL DISCLOSURE: Please note that the opinions expressed in this blog should in no way be considered as investment advice or a solicitation to buy or sell securities.