The market is neither expensive nor cheap

There has been a lot of noise about “high” valuations in the equity space for some time. But credit looks good, and David Fingold of MI 1832 Asset Management sees a green light for the economy – which matters more than P / E ratios, he says.

Since the March 2020 low, the benchmark MSCI All Country World Index C $ is up about 75% and some experts have noted that the market would appear expensive. Still, Fingold, a value-driven stock picker who oversees the $ 1.2 billion Dynamic Global Discovery Series F, continues to see the upside while saying the market is neither expensive nor cheap.

“I don’t think you can get any information about the investment environment by looking at the so-called market valuation,” says Fingold, vice president of 1832 Asset Management LP in Toronto and senior portfolio manager who oversees a group of eight global, US and international equity funds with a total value of approximately $ 13 billion. “This is an area where some are obsessed with valuing capitalization-weighted indices. Some people say that they can derive some informative power by looking at the “value” of the market. I don’t think you can. For example, there were as many opportunities in March 2000 as there were dangers. Many people don’t know that the average stock was doing badly for two years before March 2000. But they did well for the next two years after March 2000, although there was a correction for the average stock in 2002. .

Putting the PER in perspective

Too much attention is being paid to whether the markets are expensive or cheap, says Fingold, who joined the company in 2002, after working for 14 years in an investment banking organization and graduating with a bachelor’s degree. BSc from Babson College in 1988. He notes that Myles Zyblock, the company’s investment strategist, looked at the price-earnings ratios of different benchmarks and whether those ratios can predict future returns. “The answer is, basically, they don’t. What is important is whether or not there will be a recession. The recessions of the past 70 to 80 years have been accompanied by a bear market of around 30%. How reasonable is it for there to be a recession in the next 12 months? “

The yield curve is on an upward slope and “it would be unprecedented to have a recession in the next 12 months”. However, Fingold admits that there are exceptions to the rule. This was the case in the late 1940s and early 1950s when the Federal Reserve applied what is known as the yield curve control and the Bureau of National Economic Research declared a recession, although the the yield curve itself has not inverted. “The Fed is not currently using yield curve control. In fact, it is about tapering. The yield curve is therefore increasingly determined by the market and its slope is ascending. “

Large market says go

Is there a risk, Fingold thinks, of a market correction? This requires destabilizing the credit markets, he notes, and yet the conditions are quite healthy. “There has been a slight widening in credit spreads since the end of August, but they remain incredibly low. There is no reason to believe that the market is short of credit, ”says Fingold. “We don’t get a yellow light or a red light. We get the green light. To sum up: the curve is looking good, credit is looking good and we have to be optimistic. There is no reason to be pessimistic. This is a radical departure from when we raised a bunch of liquidity in March 2020. The yield curve has inverted and credit spreads have exploded. The current circumstances are constructive, ”Fingold said, adding that based on current data, a recession is not likely in the next 12 months.

Yellow flag on oil

“The only thing flashing yellow is the rate of change in gasoline futures which is up 100% year over year. There have been a number of recessions over the past 80 years. preceded by a doubling of gas prices in the 12 months leading up to the recession. But it did not predict the recession of 2020 because energy was in bad shape before 2020 “, explains Fingold.” That indicator is there. But there is also a very strong employment environment, which works against the rate of change in gas futures. ”

Despite being a bottom-up investor, Fingold emphasizes that he and his team are keen on managing macroeconomic risks. “Every company we invest in is exposed to macroeconomic risks. We have to worry about what could, in the words of Charlie Munger [vice-chairman of Berkshire Hathaway Inc. (BRK.A)] reverse our investment assumption. From a risk management perspective, we see amber lights at worst. But we see a lot of green lights when we look at the economy as a whole. “

Since the start of the year (October 26), the Dynamic Global Discovery Series F has generated a return of 8.55%, compared to 12.93% for the Global Equity category. But over the longer term, the fund outperformed the category. Over the past five and 10 years, the fund has generated an annualized return of 13.81% and 13.61%. In contrast, the peer group returned 10.74% and 11.54% respectively at an annualized rate. Fingold has managed the fund since 2004.

Advantage all caps, all periods

Managing a portfolio of 25 stocks, the fund is an all cap product, with a mix of small, mid and large cap stocks, with varying holding periods. “It depends on why we acquired a stock and whether it turned out as we hoped,” he says, noting that holdings such as Switzerland-based Schweiter Technologies AG (SWTQ) date back to 2005 and others, such as Israel – defense electronics company based at Elbit Systems Ltd. (ESLT), dates back to 2013.

“If you’re talking about a small or mid-cap company that has a controlling block and we think it has a sustainable competitive advantage and not many people have heard of it, but we think it has the ability to be a long term business. long-distance runner, we’ll hold it for a very long time, ”says Fingold, noting that small businesses are owned for several years to weather the business cycle.

However, since part of the portfolio is held for relatively short periods of time, the portfolio turnover rate has been skewed, which reached 311.34% for the 12 months ended June 30, 2021. are timely. If we don’t think so, we’ll sell them. They are different from another part of the portfolio which is part of a buy and hold philosophy. “

Geographically, 40.9% of the portfolio is made up of US equities, followed by 18.4% from Switzerland, 18% from the UK, 10% from Israel, 5% from France, 4, 8% from Sweden and 3.4% from Japan. On a sector basis, the fund is dominated by a 26% weighting in information technology, followed by 20.5% industries, 15.1% financials, 13.5% materials and more weightings. weak in areas such as consumer discretionary and healthcare.

Attractive returns in rentals

One of the main holdings is Ashtead Group PLC (AHT), an industrial equipment rental company based in London, England. The company derives about 85% of its revenue from the United States, through a subsidiary called Sunbelt Rentals which has 388 locations. “We like it because the equipment rental industry is so poorly understood. Many companies that traditionally owned equipment have instead taken advantage of leasing. To be frank, why own equipment that you rarely use if you can get it really quickly, when you need it, and return it to the rental company. Then you can invest your own capital in something that can generate a higher return, ”says Fingold. “If you have the right fleet with the right locations, you can get very high utilization of your equipment and get good returns. It is a network-based business that requires expertise in logistics and customer support. This allows customers to focus on running their business, instead of worrying, “We need to change the front loader oil filter. “

Ashtead Group, which has a market capitalization of 26 billion pounds sterling (43.9 billion Canadian dollars), generates operating margins of 28.9%. The stock is trading at 22 times its price compared to estimated earnings in 2022. Acquired in 2020, the stock is (Sterling) 60 (CA $ 101.4), which is double the purchase price.

Returned to Israel

Another favorite is Mizrahi Tefahot Bank Ltd. (MZTF), based in Tel Aviv, Israel’s third largest bank and one of the largest mortgage providers. “We are drawn to the quality of management, which we have known for a very long time. This bank has built the leading position in the mortgage market in Israel and merged in 2020 with the Union Bank of Israel. There are important synergies from this merger. I’ve been following them for a long time and they were able to generate significant returns, ”Fingold explains, adding that the bank has a return on equity of 13%.

Mizrahi Tefahot Bank has a market capitalization of 29.4 billion Israeli shekels (C $ 11.5 billion) and its shares are trading at 10 times the estimated profits of 2022. “Like many banks, in 2020 they owed restricting oneself to returns to shareholders. We believe there is a significant benefit for dividends as regulators allow more normal returns on capital. The dividend yield is 1.7%, but the market expects a significantly higher dividend. “

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