“The market is expensive.”
“No, no, you’re wrong. The market is cheap now.”
We all like to talk about the market in absolute terms.
Hell, we’re guilty of this ourselves at Livewire. In our coverage of the reporting season that just ended, we ended each wire by asking our funders to give us a unique number to rate market value.
This blanket treatment of the market is, in many ways, nonsense. Sure, the market can be sold or make big profits as a whole, but that tells us little about how expensive or cheap the market is at the stock level. Unless you’re investing in passive index ETFs, individual stocks and sectors are where the rubber meets the road.
Ask Dr. Philipp Hofflin from Lazard, the guest at the latest The Rules of Investing podcast.
In this cable, I summarize Hofflin’s comments on market-wide valuations versus stock-level valuations, as well as where he sees the best value in the market right now.
The absolute value of the markets.
To illustrate the point of market valuations as a whole versus stock and sector levels, let’s look at the absolute value of markets.
“A long time ago, almost 30 years ago, I was taught by a colleague who was one of the first full-time analysts,” says Hofflin.
“Markets get more expensive when people put maximum profits on maximum multiples,” adds Hofflin.
Today, the United States market sees any measure as very expensive.
“If you look at the headline multiples, it might not sound too bad, but you have to take into account the fact that they have record margins, record low taxes and very low interest bills.”
We can draw a parallel between the United States today and Australia in 2007.
“When that market peaked, we’re basically still at that level 15 years later. The multiple back then wasn’t that high, or earnings were at cyclical highs because of the mining boom.”
“We’re in a similar situation for the US. Earnings are at cyclical highs and sitting at high multiples.”
So there are a lot of downsides to the US.
Australia’s valuations are more dovish by comparison, in Hofflin’s view.
“I don’t think Australia is that bad, our market is a bit overvalued. Markets do mean-revert, but they do so over long periods of time.”
The dynamics of the internal market is the most important
Internally we still have a very distorted market.
Starting in 2018 we had a boom in growth stocks, which in COVID 2021 turned into a huge multiple bubble.
“And the multiples bubble we had in Australia was bigger than the peak in March 2000; bigger than the tech boom. Multiples for the top quintile of stocks were higher than they were back then.”
Since the end of 2016, the information technology sector has had the second worst cumulative EPS growth in the stock market.
“That has, at best, only been half reversed.”
“So you’re in a position where high-multiple stocks are heavily discounted compared to their normal premiums and low-multiple stocks are heavily discounted compared to their normal discounts.”
Hofflin thinks there will be a lot more pain to come for stocks that have historically traded at high multiples, there is more pain.
“In many ways, we’re one year into a multi-year mean reversion internally. From that two-tier market where there was a lot of hype about technology and innovation and BNPL, and people were avoiding the more established companies.”
“So we’re back in 2001 in the sense that speculative stocks have fallen very hard, people are starting to question the bubble narrative, but there are still a lot of companies, perfectly good companies, that are still priced too high.
Domestically, there are still a couple of years to go before relative prices return to normal.
So which sectors does Phil think are attractively priced?
Despite the bullish energy market, Lazard owns a few producers, including Woodside (ASX: WDS), Santos (ASX: STO) and Whitehaven Coal (ASX: WHC).
“We own energy stocks because they are not pricing in high energy prices.”
Similarly, Hofflin believes that financials are also trading at attractive valuations.
“Banks are not that expensive except for CommBank, and all of our fund management stocks have very low multiples.”
Lazard also owns so-called “picks and shovels” stocks like Worley (ASX: WOR).
In insurance, “the largest share is in QBE…which we originally bought for the premium rate cycle.”
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