Saturday, November 18th, 2017

Some perspective from the Cundill team

Dear Investor:
It’s painful in the markets, but bargain-priced stocks beckon.
Sincerely,
James Morton

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The Cundill Funds are a group of funds within the Mackenzie family of funds.  Many of you own the Cundill Value Fund, their flagship global equity fund.  Cundill team member James Morton specializes in emerging markets and turnaround situations and offers some valuable perspective in a recent letter.

The world seems to have taken a turn for the worse over the last few weeks. Markets are in risk off mode. The search for nominal preservation of capital has reached such an extreme that people are now paying the German government to hold Euros for them while Swiss banks discuss charging foreigners for the privilege of depositing francs. Government yields in the UK are at levels last seen in 1688. Equity yields in almost every country, (with Greece a glaring exception) including Spain, are higher than 10 year bond yields across the developed world as well as parts of the emerging world. I believe this is due to the very high level of uncertainty where no one cares about making money only about holding on to what they have. The Parable of the Talents springs to mind as an object lesson in what happens to those who settle for zero return.

As value investors, we both loathe and love periods such as the second quarter of 2012. We love them because they throw up attractive values that only occur occasionally and provide opportunities to purchase equities that go on to deliver superior long term rates of return; sometimes even exceptional returns for anyone able to stomach the short term pain. Of course the reason we loathe them is the short term pain. That seems unbearable, and it is almost always at the most painful point when bargains abound. And right now we are spoilt for choice.

The best time to buy equities is when you are scared. The most difficult decisions to invest almost always deliver the highest rates of return. When fear is greatest try to do the exact opposite of what you feel you want to do. The time of greatest danger is when things are going well, markets are rising and everything seems easy. That is when mistakes are made and capital is destroyed. As of June 2012 we are in many ways at such a moment. No one has a nice word to say about equities. Valuation multiples are starting to signal doomsday once again, yet once again most companies owned in your funds continue to increase the value of their business.

In this portion of the letter, Morton is reminding investors of one of the most important lessons – that wealth is gained by those who own the shares of great businesses acquired at attractive prices and held therough periods of short-term worry.  This is the same lesson spoken so many times and so eloquently by Warren Buffett, John Templeton, Peter Cundill and others of their kind.  Morton goes on to say:

The names may have changed but the script remains the same. Pain always precedes pleasure. Greece is Europe’s dot com. That feckless politicians in a small country cooked the books for decades does without question require a severe downward adjustment of asset values in that country; but whatever occurs in a short-term cycle of creative destruction does not have to translate to lower values elsewhere except in that short term.

Now that message will resonate with most of us who remember the extremely high valuations of technology stocks in early 2000 while solid, consistent and strong businesses continued to strengthen even as their share prices languished.  In the years that followed money managers of funds such as Cundill Value, Trimark Select Growth, Ivy Foreign Equity and AGF Global Value enjoyed decent returns while broad market indices declined by almost 50% and tech indices fell about 80%.  Morton goes on toexpand his scope:

Yes, the Greeks and the Germans appear to be playing Russian roulette. But in some ways, this is a side show. Let us turn to China. Here is a country that while dysfunctional in many respects is a serious economy with over $3 trillion of net foreign reserves. Even assuming hidden bad debts and NPLs, China should have $2 trillion to play with as well as a decent internal balance sheet and continuing external surpluses. So I would argue that what matters more is how China acts not who wins the Greek election on June 17th.

While the funds you own will have little or no direct investment in China and other emerging markets, they will have a very significant exposure to these areas through the great international businesses they own that are based in more free countries with better legal protections for investors.  With their depth of experience and global reach, they are able to compete very well against or cooperate with younger companies in developing markets.  Morton concludes with an interesting perspective based on many years of real investing experience.  I am heeding his advice and, as usual, am encouraging all clients to do likewise.

Lastly, I cannot resist pointing out that Directional Sentiment indices for equities almost everywhere are now below 10%, a reading historically considered extreme, with the Euro STOXX recording a mere 5% of bulls. From such low levels, rallies have emerged 90% of the time. I expect that one will occur once again and usually it happens when you least expect it and most investors will once again miss out.

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