I am back in the office after a week on the road, so this is a good time for a quick portfolio update.
- With fluctuating markets, we have been able to take advantage of some opportunities but are still holding decent cash positions in the 12-15% range. Some cyclical names, as well as quality interest sensitives (such as Brookfield Infrastructure Partners LP, BIP-UN) have sold off to attractive risk-reward levels. However, we feel that the current market represents fair value at about 15x earnings, so we can still expect solid returns in equities, but not as attractive as in the last few years.
- When you look at equities vs. bonds, we still find value: In 2007, you could get 10% yields on junk bonds and 5% yields on 10-year U.S. Treasuries. Now we have junk yields closer to 5% and treasuries at 2% – a huge expansion of valuations. This exuberance has not spread to equities, as the P/E multiple on the S&P 500 is the same as it was in 2007 – about 15x.
- And this is where we see upside risk to the market: If investors feel better about the current environment, P/E multiples could expand to 18x pretty easily. If this were to happen, we would see 2,000 on the S&P 500 and 20,000 on the Dow in the next year or two. This could also mean a rough ride for bond holders, as money likely would flow from fixed income into equities. Of course, if we saw an 18x multiple on the markets, risk-reward would no longer be attractive and we would likely raise cash.
- Of course, there are always risks. Today, my biggest concern is China – not just the growth rate but how they are achieving it. They are on an unsustainable path and when it unwinds it will be a shock to the global economy and markets. (Watch for a separate blog post on this topic soon.)
- When you are faced with such a wide range of outcomes, it's important to stay nimble. We have reasonable cash levels and have shifted the portfolios to larger-cap, more liquid companies. This way, if the bearish scenario begins to play out, we can quickly raise cash.