For investors who choose to focus on the ever-changing daily macroeconomic news flow, it becomes a challenge to identify what is really important in forming their investment decisions:
What is the appropriate response to swings in market sentiment around concerns for the global cycle and the issues facing China? What about the effects of reflationary policies of Abenomics? Are QE and economic reforms on the right path, and how should we position for the future?
Too often we observe significant weight being applied to almost irrelevant information in decision making.
We would argue it is almost impossible to consistently forecast the effects of short-term news flow on markets. Forecasting also relies on an ability to ‘time the market’ in a world that holds an uncertain future.
So why bother trying to follow themes or time markets?
Instead we choose to let share prices lead us to the most attractive investment opportunities, and be patient.
One of the latest themes is the market’s narrow focus around defensive stocks.
This appears to be a response being driven by the market’s aversion to rising volatility. These kinds of stocks appear to offer comfort to investors due to a perception of certainty around the delivery of shorter term earnings.
Examples of these names can be commonly found in Consumer Staples; Pharmaceuticals; Railways; and Utilities.
The main problem with this investment thesis is that many market participants were willing to handsomely over pay for this comfort from perceived earnings certainty.
This is something we avoid at all costs.
Overpaying for shorter term certainty can give way to longer term underperformance, and a herd-like focus on shorter-term macroeconomic news flow often serves to harm investors’ longer term returns.
Where is the value in this?
On the other hand, the market’s narrow focus on themes can leave behind a long tail of unloved, out-of-favour and very cheap names for contrarian investors seeking out value to exploit.
These opportunities are best identified on a stock by stock basis. History shows that investors willing to exploit shorter term market anomalies by applying a disciplined long term valuation approach, will be more than compensated for their patience.
Where then should contrarian value investors look?
Start by focusing on the extremes of valuation and there are plenty of opportunities to exploit.
