An Interview with Sheldon Lieberman, Portfolio Manager
Recently, Sheldon Lieberman, Portfolio Manager and 20-year member of the firm, shared his thoughts on the current equity markets and the Hotchkis & Wiley Large Cap Value Fund.
Q1: How do current large cap equity valuations compare to history?
Overall, current equity valuations are consistent with historic levels. The S&P 500 trades at about 15x next years’ consensus earnings, which is in line with the 20-year median.
Over the past five years, the S&P 500 total return has increased by 40%, or about 7% compounded annually.1 Some believe that the market has moved ahead of itself and this formidable rally has been overdone; however, fundamentals would suggest otherwise. Over the same five year period, earnings for the S&P 500 have increased at the same rate that the market has appreciated (i.e., 40% cumulative, or 7% compounded annually). Stock prices have been considerably more volatile than earnings which created valuation dislocations that astute active managers were able to exploit.
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While over the last few years the number of extraordinary valuation opportunities have diminished somewhat, we continue to identify compelling prospects on a risk-adjusted basis. The primary difference between equity markets today versus five years ago is that the risk/return profile is much more appealing today. Companies have deleveraged their balance sheets in an unprecedented fashion and in many cases have built substantial net cash positions.
Q2: Until recently, mutual fund flows have favored fixed income at the expense of equities. What do you expect going forward?
According to a Deutsche Bank study, fixed income fund flows are about $1 trillion above trend and equity fund flows are about $1 trillion below trend.1 To say this is “off trend” is a colossal understatement. This deviation is more than eight times the previous largest. The good news for equity investors is that a reversion back to more “normal” fund flow patterns has already begun to emerge. Low bond yields and the threat of rising rates do not bode well for high-grade fixed income. Going forward, we believe that a further reversion toward the long-term trend is likely and this should lend support to equity prices.
Q3: In the wake of the Great Recession U.S. companies have shown a reluctance to spend, instead preferring a build-up of cash reserves. Can you please comment on future capital deployment strategies?
Balance sheet strengthening has been the most constructive byproduct of the financial crisis. Many companies now boast fortress-like balance sheets making further cash stockpiling unnecessary and therefore less likely. Company management teams must decide between increasing capital expenditures, making acquisitions, or returning capital to shareholders. We expect each of these to rise. When executed prudently, capex and acquisitions can be accretive to earnings per share. When executed foolishly, these can destroy value. Consequently, we most often prefer that companies increase their dividends or boost their share repurchases. Capital deployment strategy is the most critical topic we discuss during our meetings with management teams.
Q4: Have there been any shifts in equity market dynamics that have influenced your approach to research?
Corporate globalization has definitely influenced our research approach. Compared to 20 years ago, companies have a much greater international presence—particularly large cap companies. Accordingly, it has become essential to analyze the competitive environment globally when researching a U.S.-based company. Research on General Motors, for example, would not be complete without assessing its competitive position relative to Toyota, Daimler, and others based outside U.S. borders. We have expanded our research team over the past 10 to 15 years which has deepened our coverage both inside and outside the U.S. In fact, we launched a global equity strategy more than two years ago to take advantage of our enhanced global research capabilities.