Yesterday I saw what I thought was a bit of an overly dramatic statement from once revered investor Bill Miller, which was that he thought large cap quality American stocks were a once in a lifetime investment opportunity.
Now I’ve discovered that he isn’t the only well known investor beating the drum for large cap quality. Jeremy Grantham is saying basically the same thing, although in a little more subdued manner.
Given that Grantham is one of the most pessimistic (and most intelligent) investors you will ever find, it is certainly noteworthy when he is bullish on anything.
Here are a few of his comments on the sector:
I understand the general direction of the performance of quality stocks: down in 2005, 2006, and 2007, which were speculative years; up a lot in 2008, which was the year of anti-risk panic; and down in 2009 and 2010, which were also very speculative. But, I’m puzzled by the general value level around which they have been moving. It’s as if there is an extra and unusual force working against them. This type of mispricing always has a reason. It may not be particularly rational, but there is a reason. Let me confess that I have no certain answer, but I’ll offer a couple of candidates.
One is the population profile: there are more new retirees per new worker than there used to be. Retirees are selling stocks to pay the bills and to buy more conservative fixed income investments. And what stocks are they selling? By the time they retire, they probably own blue chips, having sold down most of their speculative stocks in the decade before retirement. This is just a guess; I have no good data to prove it. But it does seem reasonable.
A second candidate, accompanied by stronger circumstantial evidence, is the “Let’s all look like Yale” syndrome. In the last 10 years, institutions and even ultra-rich individuals have, in general, been increasing the share of their portfolios that is invested in private equity and hedge funds, commodities, and real estate. And even within their equities, they have been increasing their share of foreign equities, including emerging markets and small caps. At the second derivative level, hedge funds may feel that they do not get paid to buy Coca-Cola, and private equity firms, particularly now, do not go after many of the great franchise companies. So what is being liquidated to buy all of this new stuff? Old-fashioned blue chip U.S. stocks and U.S. government bonds that used to completely dominate even sophisticated institutional accounts and now no longer do. In the case of U.S. bonds, we have the noble Chinese to step into the breach for a powerful reason: they have no alternative if they want to run trade surpluses. But blue chip stocks are on their own, without any natural offsetting buyers.
Grantham’s opinion carries a lot of weight with me. And his opinion when he is bullish is even more interesting. He has been talking about large cap quality for quite a while now so he has given the issue a considerable amount of thought.
One thing that troubles me though is that if these enormous companies are so extraordinarily cheap I would have thought that the person who would be most excited would be Warren Buffett. Given the huge amount of money that he has to manage, having these large caps at multi-decade bargain prices would be the best thing that could happen to Buffett and Berkshire Hathaway (BRK.A). But Buffett’s equity activity doesn’t really confirm that he is overly excited. His most recent purchase of a significant size was Burlington Northern (BNI) which was at a price that he deemed fair (not a steal). If these large cap quality companies were such great bargains wouldn’t Buffett be passing on a fair price and going for the more undervalued? Given that Buffett has been watching these large companies for decades and sitting on tens of billions that he needs to put to work his lack of aggressive action is also certainly something to consider.
Grantham adds some interesting commentary on how this undervaluation might end:
Supply-demand issues like the two described can be powerful in distorting prices in the short run and even the quite long run, but it is like holding a ping pong ball under water: it needs constant pressure to keep it there. Remove the pressure even for a short while and the normal equilibrium will quickly be restored. In this way, quality stocks might possibly spend much of the next several years underpriced, but from time to time will bounce back to fair value. This is all that patient investors need. It is the converse of the market pattern of the last 20 years: mostly overpriced, but occasionally spiking down to fair value.
Disclosure: No positions