No longer cheap Market Outlook August 2017

With good quality shares having been re-rated, it's a lot harder to find compelling stock ideas. We might have to be content paying 'fair' prices, rather than 'great' prices.

 Market Outlook August 2017

 

Capital returns to July 26th AIM FTSE small FTSE mid250 FTSE 100
1 month +1.0 +1.0 -0.2 +0.1
1 year +31.5 +20.9 +14.9 +10.8
3 years +26.6 +28.5 +25.2 +9.5

 

A quiet month for equity markets, but as we can see from the returns table, AIM and the FTSE small caps are generally having a better time of it than their larger counterparts. This has caused their valuations to rise, which  is causing me concern. I’ll expand on this theme in a moment.

Solid momentum

Meanwhile it’s important to recognise that markets have continued to perform pretty solidly. In the US the S&P 500 has just recorded another all-time high, as has the tech-heavy NASDAQ index. This is unequivocally bullish and should not be ignored. Which makes me uncomfortable about the caution I’ve been expressing in recent months. Admittedly I haven’t been outright bearish, just wary of what looks like complacency in the face of several potential threats. Accordingly I’m carrying 10 per cent cash in the GCI Portfolio, rather than being fully invested. A proper bearish stance would warrant a 30-50 per cent cash position. So we’re benefiting from the decent market while keeping some powder dry.

Re-rating

As well as nervousness about the ‘big picture’, I also have increasing problems with the bottom-up view of the market. The GCI Portfolio has performed very well by choosing good quality companies which have delivered better than expected growth. This has led to a re-rating, with a higher p/e on higher earnings leading to excellent share price returns. When I find stocks with these characteristics I like to say on board for as long as possible and ride with their momentum: when you’re onto a winner it makes sense to stick with it (which is why I respect those new highs on Wall Street).      

However, the re-rating of many small cap winners is making it much harder to find that winning combination of value and growth.

Less compelling

I’ve included a table below which shows a selection of our GCI favourites with their prospective p/e multiples at the time of recommendation and the equivalent today. As we can see, they’ve all been re-rated to some extent. Now I’m happy to pay up if I’m traveling in the first class compartment with a terrific growth company – so I can live with the IG Design and Dotdigital ratings; but there’s no getting round the fact that Tristel now looks rich. The other stocks in the table trade at good prices and the list at least demonstrates that valuations aren’t systemically crazy. They are just less attractive than they were.

Patience required

This phenomenon makes finding great stocks all the harder. We might have to be content with paying fair or good prices for them, rather than my preferred great prices! Which means returns over the next couple of years could well be less interesting than those of the recent past. Hence the need to be patient and wait for the right opportunities to deploy our cash.      

 

Stock p/e when tipped p/e now
Tristel 19 32
IG Design 13 17
Dotdigital 21 25
Somero 8 12
Empresaria 8 10
Conviviality 11 14

 

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