We like market routs because we can buy more for less. This week our friend Rob Armstrong, former editor of Lex, launched a new investment column in the Financial Times and we could not avoid getting into an argument on day one.
We thought the view that valuations are high as expressed in Rob’s very first column is simply wrong, at least as far as our stocks are concerned. Yes, average market price to earnings (P/E) ratios for indices like the S&P 500 appear to be at the higher end of historical ranges, but they are not that high if they are capitalized at current and likely future interest rates, and there is great dispersion between stocks. There are many companies that are at low multiples in absolute terms and relative to their earnings and cash flow growth. Alphabet is an example: even we were surprised by the strength of their results this month. We said at the beginning of the year that stocks were cheap. Knowing what we know now means that we were buying Alphabet at 16.5x 2022 P/E, or rather owning it since we first bought it in 2012… No wonder it is up 35% this year. You can see our exchange in the FT here and we look forward to more robust discussion.
We continue to believe that we will see a strong recovery from the pandemic even as it continues to have a significant social, economic and political impact. As vaccines are rolled out in the US, Europe and other wealthier countries throughout the summer, the discussion will move on to providing doses for less wealthy countries that are in desperate need. It is in all of our interests to vaccinate as many people as possible to avoid the proliferation of variants that could impact the fight against the disease. The pandemic is far from over but as with other issues, the further we look ahead the clearer the picture becomes.
Economically the discussion is also moving on, from the recovery to its consequences. As the global economy recovers from the pandemic, the shortest, sharpest of economic externalities, we are seeing shortages everywhere. Demand is strong, incomes have been resilient and supported by governments, services have been closed, manufacturing has been idled, and supply chains have been disrupted. It is entirely obvious and expected that that we should see shortages in labour, inputs and finished goods, and it is equally obvious and expected that this should lead to a spike in short-term inflation. Just as in 2003 and 2009, we have to recall that this is because of good news, not bad, and that these temporary issues will resolve as economic activity resumes and supply improves.
To us the next obvious and expected question is the slowdown that will follow the recovery. Not even the US economy can grow at 7% two years in a row, and so the next six to twelve months of strong growth will be followed by lower rates of growth, stability or even declines. It is a question of if, not when, just as in any other recovery, it will require companies, governments, and central banks to manage it, and it could lead to volatility as numbers over- or undershoot. However, the slowdown will be among the most anticipated of all time, and it will be supported by government and central bank action. We think in particular that the Biden administration’s insistence on providing stimulus and infrastructure investment should be seen as a prudent provision of cushion for the slowdown rather than fuel for the recovery, in particular because many measures will only take hold over the next several years. It is a fact that the US mid-term elections in 2022 will come right after the period of the most challenging comparisons and the Biden administration will be highly sensitive to employment, growth, and other indicators.
