Don't Take a Big Position Before Jackson Hole!

Recently, we pointed out the disconnection between robust corporate earnings, strong balance sheets and sovereign debt issues. The negative sovereign debt issues were the only thing being aired in the press and the resulting bearishness offered numerous opportunities. We also took a swipe at the unreliability of economic data (particularly when used to predict the future*) as a guide to investment strategy.

With the recent volatility and focus on the market expectations of pieces of economic data it is worth stepping back a little and looking at what we are trying to do. The title above was a trader’s comment quoted in the Financial Times; we think it encapsulates beautifully a flawed approach which focuses on the short-term and announcement driven market.

As a long-term investor, the current volatility throws up many opportunities. The results companies are currently reporting are great cause for optimism.

One of the reasons we are optimistic is company earnings have grown at a steady rate over extremely long periods of time. Certainly they decline at times of economic stress, but they have always rebounded and gone on to higher levels relatively quickly.

Further, the earnings among different industries can behave very differently to economic trends. For instance, earnings of online based companies (eg Realestate.com.au or Rightmove) did not decline during the GFC; rather they continued to grow strongly.

The graph below shows the growth in earnings per share of the S&P500 over the last 50 years. One could look at this figure as if all the companies in the index were a giant conglomerate and reported a single earnings per share figure.

The point we’d make is that while the S&P500 is pretty much were it was 10 years ago the earnings of the S&P500 have gone from $47 per share to $92.00 per share. There is real value in stocks particularly when compared to bond yields of near zero for short dated issues and only 3.5% for 30 year terms.

At current prices, stocks are trading at below 13 times earnings and one is not paying for upside. We don’t like trying to predict the direction of the market but we do like buying when stocks are cheap.

* The economist J.K. Galbraith said that he'd predicted 9 of the last 5 recessions.

Hugh MacNally, September 2011

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