Finding Opportunity in an Uncertain Market

by Bill Nasgovitz of Heartland Advisors, 7/10/19

“No one cares about value.”
— Milwaukee-based, 40-year veteran wealth manager

A dizzying combination of trade wars, escalating tensions in the Middle East, and domestic political gamesmanship left investors struggling for direction during the period. While the markets alternated between defensive and offensive leadership, the underlying focus was on mitigating perceived risks.

The approach favored large companies over small, low volatility over high, and investors sought safe havens with predictable revenue. Valuations remained an afterthought, as the S&P 500 finished the quarter trading at price-to-earnings multiple of over 20x.

A spike in volatility also reflected the skittish tone during the period. The performance swings of the broad indices provided opportunities for active managers to exploit pricing inefficiencies that resulted from emotional responses driven by a short-term outlook.

Growth at What Cost?

A glance at the valuations of some recent IPOs in the chart below confirms why our wealth manager friend declared value just doesn’t matter in today’s markets. But as long-term investors, that outlook strikes us as foolhardy.

By chasing dubious growth projections from the latest and greatest story stock, investors are setting the stage for potential pain if promised revenues fail to materialize to support sky-high multiples.

Opportunities Persist

For investors willing to look beyond daily headlines or the latest earnings releases, however, uncertainty during the first half of the year has created opportunities. During this period, we’ve sought to maintain a balanced approach rooted in valuations while also taking a clear view of the risk/reward profile of each business. As such, we aren’t making market calls, and are instead focused, as always, on capitalizing on the opportunities presented.

Our efforts have resulted in each of our strategies trading at the end of the second quarter at a discount on a price-to-earnings basis ranging from 13% to 40% compared to the S&P 500. These valuations, we believe provide a margin of safety for investors in what is an expensive market. Additionally, each of the four portfolios has a lower debt-to-capital ratio than its respective benchmark.

Looking forward, we believe it’s important to avoid jumping into positions that have only recently come under pressure, even if their valuations have improved. In our view, the prudent course is to get past a fear of missing out on upside potential and stay focused on company-specific factors.