14 May 2010

Keep some powder dry

Following Steven Le Roux’ recent equity overview his colleague, Neels van Schaik also reinforces the points “Despite the bumpy ride we experienced early in 2009, market valuation levels in the market towards the end of the first quarter in 2009 were low enough to arrest the implosion in equity prices that started in mid-2008. As a value investor one therefore should not have had any problems purchasing high quality companies at exceptionally good prices.

Investors have entered 2010 on a completely different tone though with a state of relief and optimism prevalent. The global media is swamped with positive news about the synchronised global recovery and the resultant uplift in earnings - the complete opposite of 2009 when gloom and doom reigned. Not dissimilar to the euphoria that prevailed in early 2008, China is once again leading the way on the commodities front with its almost insatiable demand for raw materials and consequently, commodity currencies and commodity markets are firmly in vogue. By extension, emerging financial markets have continued with their star performances relative to their developed peers as their economies are in much better shape and likely to stay that way for quite some time.

What concerns us this year as against last year, however, are the high valuation levels of various markets across the globe. Companies are no longer priced for Armageddon as was the case in late 2008-early 2009, which made stock selection much easier. Earnings yields of many companies are not looking that attractively priced relative to bond yields and cash yields anymore. In 2008, we found companies that we purchased at or below the value. of their net assets. Now many of these same companies trade at almost double those levels. Our view is that the margin of safety in equities for most of the market has largely disappeared. With this in mind, we firmly believe that once investors start paying for growth, the risk of capital loss increases significantly.

Capital preservation is for us a key component of our investment philosophy and we therefore deem it prudent to take money off the table as the market moves higher.

We are cautious, on the market in general though, as very aggressive growth and recovery expectation are being discounted. With that said, markets can however certainly move higher in 2010. The extreme stimulus measures that have been implemented in recent years by Central Bank across the global are likely to overstay their welcome and will be supportive of equity prices. The more realistic growth paths for individual countries though will unfortunately only be witnessed with hind sight, once there artificial stimuli disappear.

Our objective as always is to own the right stocks for the right reasons and at the right valuations, and to keep some powder dry when mouth watering opportunities come to the fore again; and they will.”