Читать книгу Active Investing in the Age of Disruption - Evan L. Jones - Страница 27

For a fundamental investment manager this is evidence that macro news and events are driving markets, not fundamental business results. In the 2020s, the markets can progress down two different paths. The first is a continuation of the 2010s, which will be a struggle for active investing, as we have discussed. The second path would be more ominous, as investors lose confidence in central banks. There seems to be little indication that a third option of growth and normalcy will arise. The path of global economies rebounding significantly allowing central banks to stop their intervention has little supportive data. Central banks have taken on the incredible responsibility of stabilizing and supporting financial markets for the next decade.

A macro-driven market, as the Fed has created through constant intervention, takes the emphasis away from fundamental investing. At the core of any investment strategy that outperforms the market is investing based on future expectations of cash flows produced by a company. A security selection thesis can be articulated by managers in many different ways. Investing in a business may be based on operating margin growth, entering new markets, facing weaker competition, creating a technological advantage, or having an elite management team, but they equate to expecting stronger cash flows in the future than the market expects today. Central bank intervention has materially lowered the relationship of fundamental company security selection and equity performance. Multiples are more volatile than earnings, so if multiples are going to be driven by outside factors, cash flows will have less explanatory effect.

[In January 2015] Earnings don't move the overall market, it's the Federal Reserve Board… Focus on the central banks and focus on the movement of liquidity… It's liquidity that moves markets.

—Stanley Druckenmiller, investor

Diligently studying a company's operations to understand future growth does not add the same value to future equity performance when a central bank dictates the markets and low rates make all stocks go up due to higher valuation multiples. An additional driver of valuation multiples today is technological disruption. Certain sectors of the S&P 500 have been decimated by actual or perceived future disruption and are trading at historically low multiples balancing the historically high multiples of other rate-sensitive sectors. Retailers' valuations have been destroyed by Amazon's success, energy producers have been destroyed by supply gluts created by fracking disruption, and health care services trade at all-time lows due to regulation concerns and technology company threats to the established industry leaders. This confluence of cheap, easy money and disruption is the challenge pressuring active managers. If we focus on S&P 500 sectors that are rate sensitive and have not seen large-scale technological disruption, we can see the massive effect on valuations from low rates.

When capital is in oversupply, investors compete for deals by accepting low returns and a slender margin for error.

—Howard Marks, investor

Utilities are one of the most rate-sensitive sectors and to date have not been negatively influenced by technological disruption. Figure 2.4 shows price-to-earnings (P/E) multiples in the 2010s. Multiples have grown over 60%. Utilities are historically a cost of capital return sector, where very few investment managers spend much time due to the slow-paced, regulation-influenced business model. Low rates have made it a top-performing sector.

During the same time frame that P/E ratios rose, utilities had incredibly easy access to capital at very low rates due to investor demand for their debt. From 2010 to 2019, the S&P 500 utilities sector created negative-free cash flow every year and increased dividends every year. Figure 2.5 illustrates the upward dividend per share trend and the downward free cash flow trend. All dividends during the last decade were paid for with newly issued debt. The sector now trades at a net debt to cash flow ratio of 6.7 times. This is the highest level of net debt in history, completely supported by low rates and a chase for yield by investors. Utilities are a very stable industry historically, but any disruption caused by renewables and consumers' ability to generate electricity independently to move off the grid will cause a severe down trend given the sector's debt levels.

FIGURE 2.4 S&P 500 utilities sector trailing 12-month P/E ratio (2009 to November 2019)

FIGURE 2.5 S&P 500 utilities sector dividends paid per share and free cash flow per share (2009 to November 2019)

Another rate-sensitive sector driven by margin stability and large established brand-focused business model is the consumer staples sector. Again, technological disruption has not had a huge influence on the sector (yet) and the sector has been primarily influenced by low rates driven by the Fed (and in Europe by the ECB). Investors have bought into the sector as a bond proxy. When bond rates drop to levels that will not provide the necessary return to an institutional investor, there is a move out the risk curve in a search for yield. Investors have decided that the consumer staples sector is an equity safe haven. Figure 2.6 illustrates the significant multiple expansion that has occurred in the sector, as investors pay up to own consumer staples. In a low-rate environment, investors who may generally hold 30% or 40% of their capital in Treasuries or investment-grade corporate bonds must either accept lower returns than they have achieved historically or take on more risk.

If an institutional investment mandate is to achieve 5%–6% real (after inflation) returns and the ten-year Treasury trades at 2.5% with inflation at 2.0% (yielding a 0.5% real return), what are your options?

The first would be to maintain traditional capital-allocation exposures and convince constituents that they should accept lower returns (not usually a readily accepted path). The second would be to sell bonds and buy riskier assets, usually equities. Because allocators know they have taken on more risk in selling safer bonds, they will search for lower risk equity solutions, like utilities, consumer staples, and minimum volatility–factor ETFs, all of which have very extended multiples. These rate-driven investor decisions and valuation increases have nothing to do with fundamental investing and pressure the success of any active manager. Macro concerns and Fed decisions overwhelm business analysis.

FIGURE 2.6 S&P 500 consumer staples sector trailing 12-month P/E ratio (2009 to November 2019)

Some may point to the overall S&P 500 P/E multiple as being in line with historic levels, but that does not tell the entire story. Price is only half of the P/E equation. Revenues and earnings (operating margins) have also been pushed to historic highs by low rates. Net income margins have been heavily influenced by lower interest expense, lower commodity costs, and lower wage inflation. Of course, the Trump administration's 2017 corporate tax reform lowered tax rates and drove net margin growth even further. Looking at the 30-year S&P 500 net income margin in Figure 2.7, you can see that net margins are at or near their 30-year highs. This coincides with the longest expansion in history, now ten years long. Most long-term successful investment managers create a great deal of their outperformance in down markets when security selection driven by strong balance sheets, barriers to entry, and a deep understanding of their businesses can make a major difference. These fundamental issues that become apparent in a down market have not been an important driver of returns for a decade.

The fact is almost anyone can achieve positive absolute returns in a trending up market. Watch TV and listen to market pundits, buy the hot stocks of the day, and ignore valuation. Growth and momentum have been the lessons learned by new portfolio managers in the 2010s.

Only when the tide goes out, do you discover who has been swimming naked.

—Warren Buffett

When the tide goes out, good investors create outperformance. Global central banks have made sure the tide has not gone out for a decade. US equity market drawdowns of more than 10% have occurred only four times in the last decade and each drawdown has lasted less than 60 days.

FIGURE 2.7 S&P 500 net income margin (1990 to November 2019)

FIGURE 2.8 S&P 500 price-to-sales ratio (1990 to November 2019)

Price-to-sales ratio is a good valuation metric to review when thinking about markets from a top-down holistic perspective. High operating margins are evidenced in the multiple more so than other valuation methodologies. You can see in Figure 2.8 that we have surpassed the dot-com era valuation levels using this valuation metric. This combination of net income margin and valuation multiple expansion has created an environment in which even a historically mild recession will cause a large equity market drawdown.

Low rates have also allowed weaker companies to prosper due to the cheap and easily available credit environment. This scenario of high valuations and weak companies prospering creates the worst environment for fundamental investors to create excess returns.