Risk on

I had previously commented that the markets had taken something of a risk-on attitude. Just how much that something is surprised me when I looked at it just now.

YTD, the Footsie is up 6.5%.

Here’s the YTD performance of some of the "dull as dishwater" stocks: AZN -5.9%, BATS +2.3%, RB. +7.6%, TSCO -21.4%, VOD -4.0%. As you can see, generally quite weak. RB. (Reckitt Benkciser) is the only one to beat the Footise. On Friday it was down 2.5% – quite a large drop for such a stable company. RB. is looking cheap on a historical basis, BTW. BATS is, I think, a little toppy in terms of its valuation. AZN continues to surprise me – down 5.9% on the year, despite being very cheap; patent cliffs or no. And look at Tesco! Down over 20% on a slightly disappointing set of figures.

Compare and contrast that with riskier outfits: AFF (Afferro Mining) +46.7%, DPH (Dechra Pharma) +7.6%, LLOY (Lloyds) +44.3%, PIC (Pace) + 24.3%, SHG (Shanta Gold) +78.5%.

Even companies that I consider good and pretty safe – just not considered blue chips – have had a good run: DPLM (Diploma) +18.9%, DNO (Domino Printing Sciences) +30.9%. Actually, DNO is another one that looks a bit toppy in terms of its valuation.

In amongst the riskier stuff, the banks look historically cheap as a whole. PIC, not without its difficulties, that’s true, still looks very undervalued. AFF and SHG can’t really be judged by what happened in the past, but by what is likely to happen. These companies look to have enormous potential.

In terms of how I think valuations are: the blue chips are mixed, with some cheap (some even absurdly so), some expensive, most middling. For the riskier companies, it looks like there is plenty of value to be found.

It seems that a big component of investor return is sentiment. If you get the sentiment wrong, then you’re going to get slaugtered, no matter good your analysis is. In 2011, it seems that the market really became risk-averse. Investors who stood in the way of market sentiment were quickly trampled, no matter how good their analysis was. During 2012, we’ve seen the fundamentals in AFF and SHG shift a little, with less risks than we might have guages in 2011. However, they were still good (and still of above-aberage risk) companies in 2011, and their falls seem unjustified by the facts.

This presents something of a conundrum to investors. Misvaluation can be a two-edged sword. You can be right on valuation, but then suffer a mediocre performance as you fall during the downturn and rebound on the upturn. It also brings me back to my ongoing contention that it’s not shares that matter, it’s sentiment. It’s like, you want to see mass shifts in sentiment, and then try to guage when that trend has exhausted itself. It is then, and only then, that you want to buy what is discarded. At that point, use crude valuation to scoop up bargains. The good news is that you don’t have to be particularly insightful. You don’t have to be a Peter Lynch, Warren Buffett, Joel Greenblatt, or Mike Burry. All you have to be able to do it avoid the utter garbage, and apply simple valuation criteria. It reminds me of some very profound words by Howard Marks: asset classes outperform when they are priced to do so.

This leads me to think: it’s how you partition shares into classes, and determine the attractiveness of each class, that is likely to be the strongest determinant in performance.

It’s all so very easy, and yet all so very hard. You never know just when market sentiment will shift. If I had to guess, I would say that the market will be higher at the end of the year than it is now. Why? Because 2011 was a down year, the defensives are so-so, but the cyclicals still look very cheap, despite the run-up they’ve had so far this year. I think the odds favour a dash for trash. Having said that, Greece could default tomorrow and it we’ll be back to risk aversion.

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About mcturra2000

Computer programmer living in Scotland.
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