Mid-Year Review: Staying on the Value Side of Market Swings
Price Counts in Up and Down Markets
If there’s one important lesson investors may have learned from the market swings of the last five years, it could be this: Both declining and rising markets present risks and opportunities. As our experience has shown, short-term oriented investors have a tendency to view the market as risky when prices decline, while long-term focused investors tend to view this as an opportunity to invest at potentially attractive prices.
Since we are now just over five years removed from market lows of 2009, we thought it would be useful to review certain aspects of investor behavior in the U.S. market during this period, which has been particularly interesting as it was characterized by very high volatility, significant intervention by government authorities and extreme swings in sentiment. These factors may have led to the wrong interpretations of risk among short-term oriented investors, and by the same token, opportunities.
During the last five years, we note the following observations:
•Extreme market sentiment has led many investors to focus only on volatility and to confuse risk with opportunity.
•Their pre-occupation with market activity ignores individual company valuations, where we believe opportunity can be found.
As shown in Exhibit 1, many investors added to equities when prices were rising and reduced equity exposure during periods of market declines, when many seemed to view the environment as risky.
Of course, with the benefit of hindsight it is easy to see that investors should have been doing the opposite in 2009. However, at the time, opportunities were not so obvious and there were many big and legitimate worries. Our view—then and now—is that these market swings can be more easily navigated by staying focused on company fundamentals and the power of companies to generate earnings and free cash flow over decades (not the next year or two).
Here are our underlying principles, which we think are critical to long-term success:
1. Price Always Matters: Amid declining and rising markets, the price you pay for an investment can be a significant determinant of long-term returns.
2. Time in the Market Has Trumped Timing the Market: A recently updated study by Dalbar highlights the benefits of adhering to a long-term investment discipline in all market conditions.
3. Allocations in Brandes Strategies Reflect Our Focus on Long-Term Business Valuations: The price paid must be related to a careful assessment of long-term value, and near-term uncertainties in profits are often not very important to long-term owners. Current allocations in Brandes equity strategies mirror our commitment to a focus on long-term fundamental business valuations.
Price Always Matters: Market Participants Who Saw Risk Likely Missed the Opportunity
When global markets hit multi-year lows just over five years ago, many investors focused on recent negative performance and high levels of share price volatility, and concluded that equity investing was extremely risky at the time. The financial media was peppered with quotes from prominent organizations and investors pointing to how dire the investing environment seemed. On April 8, 2009, for example, an International Monetary Fund representative commented that the U.S. mortgage crisis had “spiralled into the largest financial shock since the Great Depression” and there was a one-in-four chance that it would cause a full-blown global recession, according to an article in The Guardian. The crisis also gave rise to expectations of a new normal, a prolonged period of low economic growth and low returns from equities in an era of deleveraging and reregulation globally. These expectations helped exacerbate the negative investor sentiment at that time.
Amid the negative news, Brandes focused on valuations and fundamentals and viewed 2009 as an opportunity to buy attractively valued companies with high margins of safety and the potential to generate above-market gains over the long term. In March 2009, while a number of market indices had hit their lowest points in over 10 years, attractive valuations then vs. long-term averages signaled opportunity, as shown in Exhibit 2.
