This month’s comment begins with another excerpt from Howard Marks, suggesting future market returns will be depressed as a result of low interest rates.
While agreeing with Marks in principle, we are also aware that high quality companies have been commanding much higher valuations – a subset of the low interest rate environment. That has resulted in many experts and forecasters hollering about a “rotation to value” (and cyclical) stocks. The question long-term investors such as Laurus should ask is, how long can this consensus trade hold out?
No one would be surprised to hear economic growth will struggle in the months/years to come, and that a debt overhang is looming. As we exit the pandemic sometime next year, companies that are levered, at a technological disadvantage, or simply unable to compete will be digested or simply disappear. And with the “boomers” average age now in the mid-60s, the big days of commercialism are coming to an end and government pension finances are in trouble.
From the moment we climbed out of the Great Recession in 2009, easy investment returns could be gained by staying passive. Not so looking forward. With multiples at historical highs, interest rates at historical lows, a debt overhang and benign economic growth ahead of us, company profitability will be scarce. Which is an active manager’s – and, more specifically, small cap active manager’s – nirvana. The ability for high quality smaller companies to nimbly react to changing economic conditions will likely result in a continued resurgence in the small cap portfolio outperformance that we’ve experienced over the past six months.