Is the market currently expensive?
This is something we hear a lot from investors, and see a lot in the mainstream papers.
But is it really the correct question to be asking?
It can be easy to forget we do not own the market – rather, we own a portfolio of stocks.
While individual stocks operate within the broader stock market, too much anxiety over whether the market is expensive or not is a bit like owning a property in St Kilda and worrying about national housing values – national values provide little insight into an individual property’s performance.
There are four main reasons we don’t like to become too worried about the market’s valuation:
1) Predicting the macro is risky: We have a philosophy of not trying to predict the macro, because it’s fraught with risk – consider those big macro calls around Brexit and Trump, which surprised everyone last year. It’s highly risky to build investment cases from these predictions.
2) We have a go-anywhere mandate: Being able to invest in “all caps” provides a broader set of opportunities than large or small caps – as we invest far and away from the top 20 stocks, the index is even less relevant.
3) We simply don’t own the market as most people perceive it: A concentrated portfolio invests actively, which means much of the price movement in our portfolio is not explained by the index’s price movement. Our results look substantially different than the market over a given period with our goal to generate positive returns significantly over the long term.
4) Portfolio and index volatility are two different things: We see the market as quite volatile. But we believe our portfolio has potentially less relative risk than the market. This is because we hold a portfolio of companies with greater upside than the market generally – it’s a by-product of sifting through an index to find quality. Remember, every index includes poor performers which you would never consider investing in, because they are likely to fall heavily during any downturn.
By ST Wong, August 2017