Tidal Wave Investing
The stock market has run ahead of underlying fundamentals and we believe this rally has very little upside remaining. When the S&P 500 reached its all time high in October 2007, it was an unusual time. The market was at peak profit margins and lofty P/E multiples – a scenario that is unlikely we will see anytime soon. Furthermore, with the exception of the financial sector, most stocks are beginning to trade near the same prices they were during that peak. This may not seem correct because the March 31st close of $1,169 still has a seemingly 34% upside to return to the prior S&P 500 speculative high of $1,565. However, the financial sector used to make up over 20% of the index, comprised of stocks in which there were implosions, such as Freddie Mac, Fannie Mae, AIG, and Citigroup. If you were to account for these permanent losses of capital, the prior peak of $1,565 really equates to a level of about $1,325 today, which would only amount to a 13% gain, instead of 34%. In other words, the losses in the financial sector have created a false illusion that the stock market still has plenty of upside to return to prior peaks.
We believe that what we are currently experiencing is what we affectionately refer to as “tidal wave investing.” This is where “investors” (perhaps “speculators” is a better term) attempt to ride the wave in hopes of getting out before it comes crashing down. Tidal wave investors overlook the obvious oncoming problems simply for the sake of riding the wave because whenever there is a wave to ride, they want a piece of the action. True, riding the wave can be exhilarating in the moment, but not when they get tossed and turned in the aftermath. Things can turn on a dime, and picking that moment has never been easy. There were no newspaper headlines in March 2009 saying “Buy, Buy!” nor will there be any now saying “Sell, Sell!”
History has shown trying to time the market is, on average, a loser’s game. For example, there are studies which show mutual fund investors have had significantly lower returns than the mutual funds experienced themselves due to their poor timing of jumping in and out of these funds. In a vigorously overbought stock market, putting the financial security of our clients at high risk for a little upside is not a sport we are anxious to play. Instead, we are concerned with outperforming over the full cycle.
Thus, rather than picking stocks based on expectations of market directions, we take the more prudent and sensible approach. We focus on what will make stock prices of individual companies perform well over the full cycle by objectively analyzing the future cash flows the shareholder will receive from the business.
In the face of a rising market, our cautiousness may not be exuding credibility, but the more the broad market rises, the firmer we become in our stance. Overvalued markets do not run away forever because they simply cannot go up forever. In the interim we are willing to leave some money on the table to avoid a potentially devastating fall into the undertow. We are pleased that during this speculative advance, thus far, we have been keeping pace with the market while keeping high amounts of cash in the portfolio.
Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.