Being sent on a “fool’s errand” means being asked to do something again that did not work at least once before. The financial press and Wall Street are suggesting that US investors look to Europe and the world to diversify and prosper.[1] One author’s vehicle of choice is the MSCI-World Index. Funds that mimic this index own 1,320 stocks and, by weight, are 72% US companies. Four other countries—Japan, the UK, Canada and France—make up 15%, leaving 13% for the rest of the world. However, the real problem is what the rest of the world’s indexes are made up of. In the US S&P 500, the finance sector makes up 13% of the index. For the MSCI World Index, the finance sector makes up 17%, which means that for the world ex the US, the finance sector is approximately 29 percent. This approaches 40% in some country indexes. In the heavily regulated US, the old-line bank and finance companies carry very high leverage and are considered, at Woodstock, risky. Imagine that sector in the world ex US with less regulation. It is a problem waiting to happen.
Besides the issue of investment vehicles, how about Europe itself? “Many of our most important European allies are contending with three decades of economic, political and strategic failure.”[2] A British historian asks, “What was the status quo? The Americans provided our security, the Russians provided our energy, and the Chinese provided our export market. Guess what? It’s all gone.”[3]
The structural problems in Europe are not just related to large welfare state obligations. “Europeans hold $12 trillion of their savings, or about 70%, in bank accounts that typically have low yields. Unlike in the US, which cultivated widespread stock ownership through 401(k)s, they often rely on state pensions paid out through government budgets, in retirement.”[4] Even Europeans recognize this problem: “The (future) wealth creation will happen to Texas teachers and California public-sector employees, not to European pensioners.”[5]
At Woodstock, we focus on individual companies, which is also a good approach to investing outside the US. However, the environment those companies have to live in affects their valuations. “S&P 500 constituents have a forward price earnings ratio of 22, compared with 13 for the FTSE 100 (UK) and 15 for Germany’s DAX.”[6] We at Woodstock are very selective about which non-US companies we invest in because we believe these multiples reflect reality, not just an opportunity.
A Trio of Concerning Topics
On other matters, around the periphery of the investment world there are three topics to comment on.
The first topic is gold, an asset without any earnings and for which investment requires the expense of keeping it safe. It seems to trade around perceptions of the US dollar, the so-called “debasement trade.”[7] “The US dollar is the best currency in the world. Defending it takes growth policies (fiscal) and rate-setting models (monetary) that take it into account.”[8] A coordinated, bipartisan US government approach to keep the dollar a safe haven would be appropriate.
The second topic is the progression of private equity investments into US retirement plans. The macro view is that fee structures are getting creative. To enter the target date fund market, the actively managed alternative asset funds’ asset-weighted average fee of 1.51% needs to come closer to the average passive fund fee of 0.11 percent.[9] Large asset managers are working on that.
At the micro level, private credit may be facing some headwinds. “Lenders have shifted their focus from simply closing liability-management escape routes to securing high levels of lien-subordination protection—the term that governs who gets paid first when everything falls apart.”[10] Whether private equity or private credit, our view is that when too much money is chasing too few good deals, this does not turn out well.
The third topic worthy of comment is President Trump’s suggestion that the requirement for US publicly traded companies to report results every three months (quarterly earnings reports) should be changed to every six months. The US Securities and Exchange Commission has required the submission of quarterly earnings reports since 1970. It coincides with managements’ quarterly reporting to their own boards of directors and is a highly stylized but useful requirement for investment managers looking for transparency.[11] Publicly traded companies in Europe and the UK “are no longer required to report earnings on a quarterly basis…but many still choose to do so.”[12] This is probably because of pressure and expectations from US markets. This seems like an advantage to US markets and investors that may be given away.
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