Back to Fair Value
RJ Steinhoff, CFA Investment Process
In our early February article, “Accounting for Interest Rates,” we noted that lofty earnings growth expectations embedded in stock prices left little margin of safety for investors. At the time, implied earnings growth for the S&P 500 was 4.73%, near peak levels going back to June 2000.
Historically, valuation has not been a reliable market timing tool. Market valuations can stay elevated for prolonged periods of time. However, considering the deteriorating global economic picture that had started to develop, we initiated market hedges for our long/short strategies in January. We also sold several positions that had run up to fair value.
The WHO declared COVID-19 a global health emergency on January 31, but the virus did not factor into our risk management calculus. Towards the end of February it became clear that COVID-19 would have a significant impact on the global economy (see our February article, “Companies Struggling to Quantify COVID-19 Impact”). As the virus hit Iran, Italy and South Korea, investors quickly liquidated equities. The S&P 500 fell over 16% from its peak, one of the fastest corrections in history.
As Chart 1 shows, implied growth expectations have fallen dramatically for the S&P 500, S&P/TSX Composite, and S&P Europe 350 since the beginning of the year. Growth expectations for the S&P 500 and S&P Europe 350 have fallen over 1% since January, the second largest intra-quarter decline for growth expectations since 2000. Investor expectations did not deteriorate this rapidly even during the ’08 Great Recession.
Chart 1. Implied Growth Expectations for the S&P 500, S&P/TSX Composite, and S&P Europe 350.
SOURCE: FACTSET, GENERATION IACP CORP.
The valuation excess we observed just three months ago has been eliminated by the correction. In our view, the broad markets are now fairly valued as implied growth expectations for most major markets have returned to their cycle averages.
Hedges are being kept in place to guard against systemic risk. However, we have bought a number of positions in high quality, undervalued stocks that have corrected down to sufficient discounts to our estimates of their fair market values.
RJ Steinhoff, CFA
Director of Research
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
In our early February article, “Accounting for Interest Rates,” we noted that lofty earnings growth expectations embedded in stock prices left little margin of safety for investors. At the time, implied earnings growth for the S&P 500 was 4.73%, near peak levels going back to June 2000.
Historically, valuation has not been a reliable market timing tool. Market valuations can stay elevated for prolonged periods of time. However, considering the deteriorating global economic picture that had started to develop, we initiated market hedges for our long/short strategies in January. We also sold several positions that had run up to fair value.
The WHO declared COVID-19 a global health emergency on January 31, but the virus did not factor into our risk management calculus. Towards the end of February it became clear that COVID-19 would have a significant impact on the global economy (see our February article, “Companies Struggling to Quantify COVID-19 Impact”). As the virus hit Iran, Italy and South Korea, investors quickly liquidated equities. The S&P 500 fell over 16% from its peak, one of the fastest corrections in history.
As Chart 1 shows, implied growth expectations have fallen dramatically for the S&P 500, S&P/TSX Composite, and S&P Europe 350 since the beginning of the year. Growth expectations for the S&P 500 and S&P Europe 350 have fallen over 1% since January, the second largest intra-quarter decline for growth expectations since 2000. Investor expectations did not deteriorate this rapidly even during the ’08 Great Recession.
Chart 1. Implied Growth Expectations for the S&P 500, S&P/TSX Composite, and S&P Europe 350.
SOURCE: FACTSET, GENERATION IACP CORP.
The valuation excess we observed just three months ago has been eliminated by the correction. In our view, the broad markets are now fairly valued as implied growth expectations for most major markets have returned to their cycle averages.
Hedges are being kept in place to guard against systemic risk. However, we have bought a number of positions in high quality, undervalued stocks that have corrected down to sufficient discounts to our estimates of their fair market values.
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation IACP Inc. may or may not continue to hold any of the securities mentioned. Generation IACP Inc., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation IACP Inc. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation IACP Inc. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
