NEW YORK (Dow Jones)--Rudolph-Riad Younes wishes you luck if you're buying U.S. stocks today. He thinks you're going to need it.
Many are buying domestic equities thinking they're relatively cheap - trading at 18 times next year's earning. But by his tally, domestic equities are trading at closer to 30 times their expected earnings or about twice their historical average, once you account for stock options and strip out anomalous items like pension-fund gains.
The Lebanon-born co-manager of the Julius Baer International Equity Fund thinks the Nasdaq Composite Index is fairly valued at about 500, which is a comfortable 61% lower than its current level. Riad also sees the potential for an ongoing malaise in the U.S. sapping global economic and profit growth. The self-described "very conservative" guy has much of his personal portfolio in cash, while he rents and waits for New York housing prices to tumble.
But what does he know, right? If Riad's track record didn't sparkle his views wouldn't be so chilling, but it does. Unlike most of their peers, Riad and co-manager Richard Pell often flit among areas where they see value and aren't shy about letting cash pile up. Riad has helped the fund top its benchmark, the MSCI EAFE Index, and the average foreign-stock fund in each of the six years since he took the reins. Over the past five years the fund averages a 9% annualized gain, beating 98% of its peers. . . 1. What's the case for investing overseas today? .
The U.S. economy is only 25% of the world economy and if you believe that the wealth gap (between European and emerging countries and the U.S.) will narrow in coming years, that tells you there will be higher growth overseas. Also, today international companies are less efficient than their U.S. counterparts. In a sense, that's positive because globalization will make them meet the standards of U.S. competitors or at least get closer to it. So, you'll have greater economic growth and structural reform working in your favor overseas.
Another reason for international equities to outperform is that international investors are very much underweight equities. If you look at pension plans or individual accounts, their (equity positions) are a fraction of what you see here. . . 2. What's your take on U.S. equities? .
In the U.S. equity market we had a high (price-to-earnings) multiple and that's come down. But we think the (earnings) part is still 50%-to-70% too high. In the U.S. everyone complains about fraud committed by CEOs and about analysts being mercenaries as opposed to honest advisers, yet everyone still listens to them.
Standard & Poor's, a relatively objective company, or more objective than analysts and CEOs at least, complained about the quality of reported and operating earnings where the numbers often don't account for options and do include gains from pension plans and other things that cloud matters.
So, S&P 500 switched to a more conservative "core earnings" number. If you look at these numbers that adjust reported earnings in a rational way, they come way down.
S&P said something similar back in mid-May. These facts could be a shock for bulls who have been dreaming in the market lately.
Equities were presented as a no-brainer, that they always beat cash and bonds. It was fallacious. What's important is valuation. If equities are trading at almost 30 times earnings and you think owning them will today will help you beat bonds and cash I have two words: Good luck. . . 3. How would a sputtering U.S. market affect the global economy? .
We think you will have U.S. companies finding that they have too much debt, too many employees and not enough money in their pension plans. This will lead to less economic growth, lower earnings and more firings. It's a vicious cycle we could end up in.
Given that the U.S. is 25% of the world economy and might be even more when you consider how much reliance the world has on the U.S. consumer, we think global economic growth will be lower than expected not just for a while but for years to come. . . 4. With that in mind where are you investing today? .
Given that big picture, we are trying to avoid companies that are very exposed to the capital markets. We're also trying to avoid companies with pension issues and an aging labor force. In the U.K., for instance, that means avoiding companies with names that start with "British," like British Petroleum and British Telecommunications.
It's very hard to be sheltered from a slowing global economy though. There are some pockets, but when things get bad you'll always end up with some collateral damage.
We think central European banks are one of the few real opportunities to find companies where whether or not you make money isn't dependent on the world economy. They're making progress in local markets and if they join the European Union the area could become very rewarding.
We own brand-name consumer goods companies like Diageo (which has subsidiaries like Guinness and Seagram). We also think the paper industry is okay, too. It's one of the few industries where they've been disciplined on the supply side after much consolidation in the industry. The sector is trading at trough valuations.
We also like the natural-gas business. It's hard to transport and the supply is declining dramatically. Also, gas consumption is growing in the U.S. due to its efficiency and environmental advantages. So, it's a very interesting industry to be exposed to. We like Canadian natural-gas companies that are relatively cheap. We own Canadian Natural Resources and EnCana (ECA). . . 5. You've been heavier in cash and lighter in technology stocks than most of your peers for some time now. Why? .
Today we are at about 9%-to-10% cash, (about double the average stock fund). Right now we are adjusting tactically because the bulls came in. We're trying to use some money to areas we think are sensible, mostly adding to positions we already had. We feel that might just keep playing the earnings momentum game for a while.
As for technology, we think fair value on the Nasdaq is about 500. The case for this is very simple. The answer is right in front of us if we're willing to see it. Capital expenditures as a percentage of the GDP (or the economy's gross domestic product) is usually about 8% ... Even if you say it's 10%, tech spending is just a subset of that, along with boats, office furniture, tractors, whatever. Tech has been about 50% of cap-ex spending. You ask yourself, in 20 years even if tech spending becomes 100% of cap-ex spending and the economy grows at 5%, tech earnings would only grow about 8% to 9% a year. That would only get a fair value on the Nasdaq of about 800. . . 6. Like many of your peers, you've been underweighting Japan. What's your take on that market? .
We're underweight Japan because after the Nasdaq we think it's the second-most expensive market any way you look at it. They have a lot of structural problems. Some they can fix and some they can't. They have an aging population, for instance, and they have big competitors like China and Korea next door that will eat Japanese companies' lunch.
On the other hand, it does make sense to invest some money in Japan because it's a 21% weighting in our benchmark - (the fund had 9% of its assets in Japanese equities on Sept. 30.) So we try to find some cheaper ideas. I would say Nissan Motor is our best idea in Japan right now. They've had genuine corporate restructuring, not just lip service. (CEO) Carlos Ghosn has exceeded expectations in cutting costs and now he's focusing on the top line. Early indications are that he's ahead of schedule there too. . . 7. Given your strong opinions one wonders what you've done with your own portfolio. .
In my personal portfolio I'm a very bearish, very conservative guy. All of my 401(k) goes to my International Equity Fund. In my IRA I've held Nokia shares for a long time. And I own some Julius Baer shares I get through the company's plan. Those are my three main equity investments and the rest is in cash, which is a big percentage now. I've been looking at a real-estate investment. I've decided to rent for the next two to four years and wait to buy a house I like for 50% of the price today. |
