With the recent rally in the share market, you would struggle to think that there has or will be any longer-term economic impact to companies or the economy.
To use the logic of Benjamin Graham, the father of value investing, in the short run, the market is like a voting machine--tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine--assessing the worth of a company. One thing is clear: What matters in the long run is a company's actual underlying business performance and not the investing public's opinion about its prospects in the short run.
There is very clear evidence that the real economy is suffering, we think short-term the market is ignoring this, take the chart below that shows that US Manufacturing has been hit in a significant way.
If you just looked at the recent performance of the market, there appears to be very little priced in for any deterioration in companies earnings or their outlook.
Short-term sentiment v Long term fundamentals
In the short run, the market can deviate quite strongly from fundamentals, being driven by fear and greed. This explains some of the most recent market moves. By the same token we have had unprecedented policy stimulus globally, but there is a lag to the benefit from some of this stimulus, more so if you have lost your job, some of those jobs wont come back.
Longer-term fundamentals will prevail. Dividends, cash flow and profits are what will drive share price returns. We are starting to see some trades becoming very crowded at the moment. The S&P500 is trading on its highest forward PE since 2000, partly because there has been a reduction in corporate earnings. Australia is in a similar overvalued territory, having recouped much of the March declines.
Needless to say we continue our high cash exposure, we have built a position in small cap gold producers and we are reducing our exposure to some of the businesses that have overshot fair value.
Have a great weekend
Michael
