White swans, revulsion and value

James Montier
Global Strategist
+44 207 762 5872
james.montier@sgcib.com

February 2009
Volatility: not unprecedented nor unpredictable

1
Not a Black Swan

Black Swans Predictable Surprise

Unpredictable
At least some were aware of

the problem

Massive Impact

The problem gets worse over

Ex-post rationalization time

Eventually explodes into crisis

Five impediments to recognising predictable surprises:

(i) Over-optimism
(ii) The illusion of control
(iii) Self-serving bias
(iv) Myopia
(v) Change blindness

2
Minsky/Kindleberger framework for bubbles

Displacement

Credit Creation

Euphoria

Critical Stage/Financial Distress

Revulsion

3
 0
1
2
3
4
5
6
7
8
Jan-25
Jan-28
Jan-31
Jan-34

Jan-37
Jan-40

Jan-43
Jan-46

Jan-49
Jan-52
Jan-55
Jan-58

Jan-61
Jan-64
Jan-67
Jan-70
Jan-73

Jan-76
Jan-79
Jan-82
Jan-85
Debt is closer to revulsion (BAA spread)

Jan-88

Jan-91
Jan-94
Jan-97
Jan-00
Jan-03
Jan-06
4

Jan-09
 10
20
30
40
50
60

0
1881
1885
1889
1894
1898
1903
1907
1911
1916
1920
1925
1929
1934
1938
1942
1947
1951
1956
1960
1964
Valuation - Graham and Dodd PE (US)

1969
1973
1978
1982
1987
1991
1995
2000
Source: SG Equity Research

2004
5

2009
 Valuations determine long run returns (% p.a. real)
9

33-18.5 18.5-15.7 15.7-12 12-5

PE Range

6
 10
15
20
25
30
35

0
5
Jan-37

Jan-40

Jan-43

Jan-46

Jan-49

Jan-52

Jan-55

Jan-58

Jan-61

Jan-64

Jan-67

Jan-70
UK Graham and Dodd PE

Jan-73

Jan-76

Jan-79

Jan-82

Jan-85

Jan-88

Jan-91

Jan-94

Jan-97

Jan-00

Jan-03

Jan-06

Jan-09
7
What would Ben think? (% passing)

Criteria US Europe UK Japan Asia

EY>(2*AAA) 46 59 58 82 66

PE < 40% of Peak PE 8 10 15 4 10

DY>2/3 of AAA 37 72 69 82 60

Price < 2/3 TBV 1 3 9 15 10

Price < 2/3 NCA 0 0.4 3 0 0

Total debt < 2/3 of TBV 38 38 43 70 72

Current ratio >2 27 16 20 24 26

Total debt <= 2*NCA 20 17 24 35 26

CAGR >=7% over 10y 54 48 29 55 41

2 or fewer earnings 5 8 14 6 9
declines of -5%

1,3,6 and G&D PE <16 3 9 8 22 17

8
 Number of Stocks passing our Short criteria
(P/S>2, C score =5)
45

40 US

35

30

25

20

15

Europe
10

current
2005

2008
2003

2004
2002

2006

2007
2000

2001
1994

1995

1997

1998

1999
1996

9
 Shareholder’s equity as % of total liabilities
70

60

50

40

30

20

10

0
Non-financials Banks

10
 0.5
1.5
2.5
3.5

0
1
2
3
1927
1930
1933
1936
1939

1942
1945
1948

1951
1954
1957
1960
1963
1966
1969
1972

1975
1978
1981
Long-term US financials price to book

1984
1987
1990
1993

1996
1999
2002
2005

2008
11
 Beware book value

1400

1200
Book value halved

1000

800

600

400

200

0
1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937

12
A bias against value? Does expensive wine taste better?

13
 0.5
1.5
2.5
3.5
4.5

1
2
3
4
5

0
1950

1952

1955

1957

1960

1962

1965

1968

1970

1973

1975

1978

1981
The earnings cycle – S&P500

1983

1986

1988

1991

1993

1996

1999

2001

2004

2006
14
 10
20
30
40
50
60
70
80
90
1997

1998

1998

1999

1999

2000

2001

2001

2002

2002

2003

2003

2004

2005

2005
What if the 1930’s repeated? (S&P500)

2006

2006

2007

2008

2009

2009

2009

2010
was to

2010
hold today
experience
If the 1930s

2011
15
Why buy value? Protection against error and poor
outcomes

16
 Indiscriminate selling – Performance across G&D PE
deciles (%) 2008
Value 2 3 4 5 6 7 8 9 Glamour
0

-5

-10

-15

-20

-25

-30

-35

-40

-45

-50

17
 Value in the Great Depression (% p.a.)
Value Growth Market

0.0

-5.0

-10.0

-15.0

-20.0

-25.0

-30.0

-35.0

-40.0 B/P

D/Y
-45.0

18
 The dark side of emotion: the psychology of bear markets
90

80

70

60

50

40

30

20

10

0
No invest Invest and lost Invest and won

Target patients Normal players Patient controls

19
 No sign of learning: the longer it lasts, the worse we get
90

85

80

75

70

65

60

55

50

45

40

1st 5 2nd 5 3rd 5 4th 5

Target patients Normals Patient controls

20
 Equities are a long duration asset – contribution to value
from… (%)
80

70

60

50

40

30

20

10

1st 3 years Next 5 years Long term

21
 ADHD and stock holding periods
10

1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Source: NYSE

22
 Contributions to total real returns

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%
1 year time horizon 5 year time horizon

Dividend Yield Growth in real dividends Change in valuations

Source: SG Equity Research

23
 0
0.5
1.5
2.5
3.5
4.5

1
2
3
4
Sep-00

Jan-01

May-01

Sep-01

Jan-02

May-02

Sep-02

Jan-03

May-03

Sep-03

Jan-04

May-04

Sep-04

Jan-05

May-05

Sep-05

Jan-06

May-06

Sep-06

Jan-07

May-07

Sep-07
Sources of cheap insurance (Index linked yields TIPS)

Jan-08

May-08

Sep-08

Jan-09
24
 Gold
1050

1000

950

900

850

800

750

700

650

600
F M A M J J A S O N D J F M A M J J A S O N D J

25
 Dividend swaps
World dividends discounts- 2008 = basis 100

100

90

80

70

60

50

40

30

20
STOX5E_X SP500 US great depression

10

0
2011

2012

2014
2013
2010

2015
2008

2009

Year

26
 Top decile fund managers – Performance in...
0

-2

-4

-6

-8

-10

-12

-14

-16

-18

-20
Worst 1 year Worst 3-years
Source: Brandes Institute

27
 Percentage of long-term top performers in lower
performance deciles
100

80

60

40

20

0
Decile 6 Decile 7 Decile 8 Decile 9 Decile 10

Quarterly 1-year 3-year

Source: Brandes Institute

28
 Performance around hiring and firing decisions
15
(%)

10 Hired

Fired

-5

-10 -3 to 0 -2 to 0 -1 to 0 0 0 to 1 0 to 2 0 to 3

Source: Goyal and Wahler

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