Looking for value? You’re unlikely to find it in stocks
Western markets are jammed with expensive stocks, says Merryn Somerset Webb. Maybe it‘s time to retreat to cash.
Some charming people from Vietnam came in to see me this week. I'm not going to tell you much about them and their business (SSI Asset Management) for the simple reason that they don't yet have a fund open to ordinary investors.
Bitter experience has taught me that if there is anything that drives a reader to distraction it is being told about a fabulous investment opportunity to which they have no access. So we will come back to SSIAM in January when it will have a fund for us.
What I do want to tell you about is the page of their presentation that compared stockmarket valuations in Vietnam to those in the markets in which the likes of you and me are likely to be mostly invested. In Vietnam, the proportion of listed stocks trade on a price/earnings (p/e) ratio of under ten times is nearly 60%; in the US and the UK it is around 15%. In Vietnam, well under 20% of the stocks trade on p/e ratios of over 20 (that, by the way, is expensive). In the UK and US, about 45% are on ratios above 20.
Then there's price-to-book ratios. In Vietnam, nearly 50% of listed stocks trade on price-to-books below 1 (so less than the value of their assets). In the US and UK, again, it is more like 15%. The point is not that Vietnam is stupidly cheap (although it is pretty cheap), but that other markets are jammed with expensive stocks.
This was something brought home to me by a page in a presentation from another lot of managers this week. It compared the (low) valuations of stocks in their fund to those in three of the most popular and most promoted funds in the UK a p/e ratio of 23 times and a price-to-book ratio of 8.9 times (that, by the way, is insanely expensive).
The manager with the comparison chart was a little shy about telling me which funds he was referring to. So I looked up the average p/e for nine of the top ten shares in the CF Woodford Equity Income Fund (it fits the criteria, but one stock is unlisted). The average p/e of the mostly big UK blue-chips in the fund came out at 24.7. If anyone knows what they are doing when it comes to investing, we have to assume it is Neil Woodford. But 24.7? Gosh.
Managers running portfolios priced like this will all have perfectly justifiable reasons for doing so. They will point to individual stocks in their portfolio and note that special cases skew the numbers (the Woodford top stock average is skewed by one very high p/e, for example). They will say that in a world of zero interest-rate policies you have to pay for income. They will point out that large companies with a global remit or brand and the pricing power to combat both inflation and deflation should be seen as safe havens in turbulent financial times such as ours. When times are tough, any price is the right price for safety. Maybe they are right.
But here are a few of the things that I worry about. First would be profits and dividends. The big companies of the world have had things remarkably easy for the last few decades. Interest rates have fallen steadily; labour costs have fallen; tax has been easy to avoid; and there has always been growth to tap into in somewhere when the West tripped up, the emerging markets picked up the slack.
This is all on the turn. Interest rates will rise. Labour costs are rising (wages in the UK were up 2.9% year-on-year in the three months to July). Corporate tax avoidance is a hot political topic. And global growth has vanished. All this matters: Socit Gnrale's Andrew Lapthorne notes that "US profits growth has never been this weak outside of a recession".
On to dividend cover. For the FTSE All Share as a whole this is now at a 20-year low, with some of the biggest dividend payers out there looking pretty ropey. Take GlaxoSmithKline: it yields just over 6%, but to maintain its dividend it will have to pay out every penny of profit to its shareholders. There's no wiggle room: if its profits fall, it will be paying shareholders income out of their own capital. That's something we should all thoroughly disapprove of.
Other things to worry about include the credit bubble in emerging markets. The International Monetary Fund (IMF) reckons that emerging-market companies now hold some $18trn worth of debt. That's a lot of debt which will be tough to service in a low-growth environment. There will be blow-ups.
To all that, I would add the longer-term problems I wrote about last week the issues of who really controls companies and of incentives. When it is easy to get share prices to rise it's easy for chief executives to get rich. If the markets get tougher and it gets harder for them to hit their targets and make their millions, might more of them do a VW? Of course.
Some sectors have already cracked under all this commodities/mining is the obvious one, but the biotech boom is on its way out too, and the markets have just seen their worst quarter since 2011. Will it get worse? Veteran analyst Peter Bennett of Walker Crips thinks so. He describes the market like this: "Propped up by unparalleled monetary hot air, with credit piled high, valuations in the stratosphere in so many asset classes, world macro a bit rubbishy and deteriorating for the first time in my life this has a nearly existential feel about it."
Mr Bennett's largest position at the moment is in cash. Most fund managers can't hold much cash. Ordinary investors can. Perhaps we should sell off some of the more expensive stuff in our portfolios the stuff that isn't pricing in all this risk and do just that.
This article was first published in the Financial Times