In the markets and in life, we face bullish and bearish periods. Some days are good and some days are bad. But even on bad days, good things can and do happen, which may explain our sometimes Pollyanna-sounding persistence on the existence of a bright side even in the face of somber-sounding issues like fiscal cliffs and austerity measures.
Sir John Templeton famously described the progression of market cycles thusly: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Today, global equity investors may be described as largely in the pessimism phase of Sir John’s scenario, but Ed Jamieson, CIO of Franklin Equity Group®, and Peter Langerman, CEO of Mutual Series®, are viewing this pessimism as a harbinger of buying opportunity.
Peter Langerman on how market headwinds can create opportunities for value investors, and why he thinks European valuations look attractive right now.
- In the third quarter we did see some signs of light and, overall, we are seeing companies adapting to slow growth and doing things like buying back stock, which we think are largely shareholder-friendly.
- This leads us to feel that now may actually be a nice time for value investors.
- After several one-step-forward/one-step-back movements, recent shifts in the European markets seem to indicate that people are again becoming convinced that European leaders will take positive action to address economic issues in the region.
- Negative sentiment for European companies has led, in some cases, to what we see as attractive valuations.
“When the macroeconomic environment is such that it overwhelms the microeconomic environment and overwhelms stock picking, that’s challenging, particularly for value investors like ourselves looking for specific stock stories, restructuring stories, catalysts for change. It’s very hard to pull off a restructuring or a real change in a severe macro downturn. We’ve got enough headwinds here that anybody who expects optimism probably gets thrown out of the room. But, there’s not total doom and gloom. I think we have seen a rebound in the market – some light. Overall we are seeing companies adapting to slow growth, doing things that we think are by and large shareholder-friendly—strengthening their balance sheets, buying back stock, spinning off some assets, doing some strategically intelligent M&A. Those are all positive things for value investors. So again from our perspective, I think this actually is a nice time for value investors.
Europe certainly has been an interesting situation; it’s been a bit of one-step-forward, one-step-back dynamic. Sometimes it seems like one step forward and one-and-a-half steps back. Last year around this time, we had a very negative inflection point. People were thinking Europe was about to implode. Earlier this year, with the Long-Term Refinancing Operations (LTRO) program, we saw a positive inflection point. We saw a big run in the European markets in particular, and in some of the financials. Then there was a step back again. People seem to be again becoming convinced that European leaders will take positive action, although it still remains to be seen what the time frames are.
We’ve been longtime investors in Europe, but starting last year, we had pared back our direct financial exposure in some of the European institutions where we felt there were some serious issues. But we are still quite active in Europe, and we are looking at companies that are by and large global in nature; they may be domiciled in Europe, but have significant operations in some of the emerging market countries, in the U.S., etc., so they’re not necessarily specifically Eurocentric. And even with the companies that are Eurocentric, it’s really all a matter of valuation. Given all the negative sentiment, there are many companies we think are trading at very attractive valuations. If we see a company at a very attractive valuation, at a single-digit multiple of earnings with strong cash flows and a strong balance sheet, that’s a very attractive investment proposition to us.”
Ed Jamieson sees “Five Points of Light” in the U.S. economy: Housing, bank lending, household debt burdens, the trade-weighted value of the U.S. dollar, and job growth. And he shares his thoughts on finding growth opportunities.
- Housing is beginning to come back. It’s been absent from our economy since the downturn began (in 2008-2009), after having been a significant contributor to our economy for decades. Housing sales and permits have recently ticked up, and home prices have started rising for the first time since the recovery from the 2008-2009 financial crisis began.
- Bank lending has been rising steadily for about a year, after having been absent from our economy for about four years.
- The U.S. household debt burden has dropped significantly and is now back to near levels seen in the 1980-90s1 so the process of deleveraging may be nearing an end. You can see it reflected in auto sales, which have risen from about 12 million annual rate a year ago to about a 14 million annual rate today.2
- The trade-weighted value of the U.S. dollar (adjusted for inflation) is near a 40-year low,3 which has really helped the competitiveness of U.S. manufacturing and other products and services. And as a result, this has been reflected in improvement in our trade figures for the past two years.
- Finally, net job growth over the past six months has been as strong as any six-month period since the recovery from the financial crisis began in 2009. And I know there’s a lot of talk about very anemic job growth but we have had steady job growth now for a while and that has a compounding effect, positive effect.
“From our perspective, growth refers to a company’s ability to grow its earnings sustainably. In the current economic environment where we have only modest economic growth, we can’t really rely on companies leveraged to the economic cycle. We have to look for product or industry niches that are exhibiting secular growth trends or companies with competitive advantages enabling them to take market share. I’ll give you a couple of examples. One is this shift to a healthy lifestyle. It’s really benefited athletic apparel companies that have led in product design and innovation, enabling them to take market share in a growing product category; really the best of both worlds for a growth investor. We are also finding market share gainers in U.S. chemical companies that have a new competitive advantage derived from low-priced and abundant natural gas in the U.S. There are a lot of secular growth trends going on.
Projections for earnings growth next year for the S&P 500 are all over the map, ranging from 3% to 13% among the major prognosticators. I guess only time will tell, but I think we are still seeing earnings growth. We are not seeing earnings declines.”
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What Are the Risks?
All investments involve risk, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Growth stock prices reflect projections of future earnings or revenues, and can, therefore, fall dramatically if the company fails to meet those projections. Value securities may not increase in price as anticipated or may decline further in value. Special risks are associated with foreign investing, including currency fluctuations, economic instability, and political developments. Investments in developing markets involve heightened risks related to these same factors. To the extent a fund focuses on companies in a specific region, it is subject to greater risks of adverse developments in that region than a more broadly diversified fund. Current political uncertainty surrounding the European Union (EU) and its membership may increase market volatility. The financial instability of some countries in the EU, including Greece, Italy and Spain, together with the risk of that impacting other more stable countries may increase the economic risk of investing in companies in Europe.
1. Source: Federal Reserve Household Debt Service and Financial Obligations Ratios.
2. Source: WardsAuto, “August U.S. Light Vehicle Sales Record Best SARR,” September 2012.