Davis Advisors Streetwide Conference Call: part 1
On 29 September 2015, Davis Advisors hosted a conference call with a group of US-based financial advisers. From Davis Advisors were Chris Davis (CD), Chairman, Portfolio Manager and Research Analyst and Danton Goei (DG) – Portfolio Manager and Research Analyst. This is the first of a three-part series.
The economic environment and markets
CD: The first goal of the call is to provide some perspective and context on the market. There’s been an enormous amount of turmoil. There’s a lot of anxiety. We also want to talk about the risks and our outlook for the market.
I want to start with a general thought: we all want lower prices. When prices are high, everybody says, “Gee, I would buy that company if only it were 20 percent lower,” or, “I had my chance and I passed. I wish I could get that chance again.”
We all want lower prices, but we do not want the uncertainty that creates lower prices. We all know that the most difficult clients that you have are those whose conviction is correlated with market prices.
These clients become more optimistic the higher prices go. They’re more pessimistic the lower prices go. They’re difficult clients because the tendency will constantly be to buy high and sell low.
We’re in an environment now where the lower prices go, the more uncertainties seem to grip us, often driven by the trumpets of the media.
In terms of the longer-term perspective, uncertainty is the constant. What varies is our perception about it.
When we went into this year, the market had a five-year return of about 16 percent. That was an incredible run and was one of the longest periods without a correction in market history. We all knew there had been a significant recovery and as such, people expected this to be a more difficult year.
I remember I really started in business around 1987 and we all remember the crash of ’87. Crash, the market down. However, we forget that the market was up slightly that year. What we remember is the decline from the peak.
However: what really matters isn’t the prices or what prices have done. What matters is value.
What are the underlying values of the businesses that make up the market? In today’s prices, current year earnings are about 16 times trailing earnings.
This equates to a six percent earnings yield. I think it’s important to realise that this is a perfectly reasonable starting point for investors. It certainly doesn’t ring the bell for market lows. It’s certainly not anywhere near bubble territory and it’s very attractive given the alternatives.
That doesn’t mean the correction can’t continue. It just means that we aren’t standing on the edge of what we would call a fundamental abyss when we look at the longer-term perspective of what expectations should have been going into this year.
DG: There’s always something to worry about, but we really try to parse it out and figure out what’s going to impact the economy and what’s going to impact the earnings of companies.
The list of things that we are focusing on at the moment include:
- The dysfunction in Washington, DC.
- Immigration reform – a lot of our knowledge-based companies can’t get the workers they need.
- Corporate tax reform is long overdue – the US has one of the highest corporate tax rates in the world. We have a strange system that incentivises companies to park money abroad and not invest to the US.
- The international slowdown, specifically in the emerging markets. There are some dramatic examples such as Brazil, where the slowdown was dramatic one year to the next, and where the outlook is pretty dismal.
- China is very topical; it’s such a big part of the world economy that we feel it’s very important for us to be on top of it.
- Commodities and the drop in those prices.
- International stability or instability.
- Geopolitics in the Middle East and in the Euro Zone.
- What’s happening with the Fed and interest rates?
There’s a long list of things that we do as a group and as a research team and importantly, we constantly talk to management teams to understand how these factors are impacting their businesses.
CD: Where you see a lot of risk in the world is often where we want start looking. But the opposite is also true and this is a key point for clients; usually the greatest risk is where people feel the safest.
That is a point we always want to bring home. We have to look at businesses, take risks into account. But we also want to look for risks where people feel safe.
I always like to mention that a one percent move in interest rates wipes out 21 percent the value of a 30-year bond at today’s rates. That same one percent move wipes out almost nine percent of the value of a 10-year government bond.
That’s a lot of risk where people don’t think they’re taking risks…and usually that’s where risk lurks.
The most important macroeconomic factor to consider is what can happen in the world that reduces the earnings of the companies that you own. Because it’s those earnings that drive value.
The prices can swing around, perception about earnings can create volatility, but really what matters is the cash produced by the businesses that we own.
We believe we are in an environment that is increasingly separating out stock pickers.
We want to invest in high-quality companies with strong corporate governance, a competitive advantage, strong balance sheets, and strong free cash flow generation.
At Davis we have two key goals in managing money. Firstly, we want to grow the value of the savings that investors have entrusted to our care. Secondly, of course, we want to beat the market over time after fees.
We have to reorient that mindset to that old saying of my grandfather’s, that you make most of your money in a bear market. You just don’t realise it at the time.