Large Cap Commentary – November 2012
The market in November was surprisingly resilient, especially given that the clock is ticking as we get closer and closer to the Fiscal Cliff. If nothing is done the Congressional Budget Office (CBO) estimates 4 – 5% of U.S. Gross Domestic Product (GDP) will disappear and our economy will be thrown into a recession by the first quarter of 2013. Oftentimes the actions of politicians are inscrutable, but in the face of the Fiscal Cliff we may be entering a new period of uncertainty. Certainly, falling back into recession cannot be what the preponderance of investors want.
Part of the resilience we are seeing may be explained by the low valuation of the market as a whole. At Argent Capital we have talked about the ‘Rule of Twenty’ as a measure of the market’s fair value. As a refresher, the Rule of Twenty states that the forward price-to-earnings ratio (PE) of the market should be the number 20 minus the yield of the 10 year U.S. Treasury bond. Today, that yield hovers around 1.6%. The simple math then drives a forward earnings multiple for the market of 18.4X. Instead, we are trading closer to 13X, a difference of more than 40%. Clearly, some of the risks within and outside the market are embedded in the current low valuation we are seeing.
Obviously, we do not know what will happen with regard to the Fiscal Cliff. To be sure, we at Argent Capital listen to the talking heads, read newspapers and pour over Wall Street research. We cannot claim, however, to have particular expertise with regard to the Fiscal Cliff. The same can be said for goings on in Europe or how the new government in China will act over the next decade. What we can do, however, is recognize the increased uncertainties these events pose for the market, or for particular companies, and invest accordingly. One of the benefits of running a concentrated portfolio is that we do not have to play in geographies or industries where forces outside of a company’s control are making the doing of business more difficult.
Similarly, because we run a concentrated portfolio, we can embrace areas of improvement. This is especially true today for a couple of reasons. The first reason is that growth in general is slowing across the globe. That makes our job of identifying companies that are executing their business plans – in other words, those companies that are growing – easier. The second reason, again from our discussion on the Rule of Twenty, is that many of those companies that are successfully executing are favorably valued, like the rest of the market. As a result, we are not being forced to pay a premium for those few, successful companies. It is in this kind of environment we would expect our selective investment process to shine.
Remember, there will always be issues and concerns affecting the market. Our job at Argent Capital is to find those select companies that are able to plow through the concerns of the day, and reward shareholders over the long-term. As always, we appreciate your interest in Argent Capital Management.
Senior Portfolio Manager
Views expressed herein represent the opinion of the portfolio manager as of the date above and are subject to change. Argent portfolio managers may recommend the purchase or sale of these and other securities for their client’s accounts. A list of all stocks recommended by Argent during the past year is available upon request. Past performance is no guarantee of future results.