What’s behind the current stock prices, and why does this really matter? As a simple example, we can take a company whose share price is, for example, €100. This price would be the price that constitutes the company’s correct value in relation to future, ultimately realised cash flows. Therefore, this correct price would give the typical annual return on the shares.
A problem arises if the price of the share is significantly higher, for example, €150, because when the company’s future cash flows begin to realise, the price of the share also starts to approach its true value, i.e. €100. In such situation, it’s not worth buying shares at a price of €150 even if they had risen well in the recent years. Rather, you should keep your head cold and invest in alternative investments until, again, there is a situation when stocks (and bonds) are fairly priced to yield a decent return.
By summing up the market value of all companies in the US stock market (Wilshire Total Market) and comparing it with the US Gross Domestic Product (GDP), we get one time series to show price in relation to value (source: https://www.gurufocus.com/stock-market-valuations.php).
A ratio calculated from these two time series shows that pricing fluctuates roughly between 50% and 150%.
Below, the yellow line at its ending point on June 30, 2009 depicts that the realised annual return for the following eight years was 13% when the purchase price was about 50% (graph above). Accordingly, today the pricing is at 134% and the expected annual return between -8% p.a and +3% p.a for the next eight years. So the purchase price is crucially important as regards the expected return! Right now, stocks are not exceptionally cheap but historically expensive. According to this model, with a typical 80% valuation level: “As of 08/07/2017, the stock market is likely to return -1.2% a year in the next 8 years.”
And again I have to repeat that the world is still heavily indebted. Many find this hard to see because, like decay, the problem has formed slowly underneath the surface. This problem is a major headwind for economic growth as the growth of gross domestic product can no longer be achieved by increasing private and corporate debt and investment. What is left is countries that chronically consume and invest with debt in the absence of natural economic growth (more about the subject: How Much Is a Lot of Debt?).
Although the signs are so clear that, with a high probability, we will not be seeing good returns on stocks and bonds in the next twelve years, I don’t expect to see a great rush to investments like HCP Black. The industry is used to selling shares and bonds as investment objects, and most of the customers are accustomed to buying them. And considering today’s sales and marketing, it’s not profitable for many, in the short run, to introduce alternative investments that seem difficult to grasp. Besides, few have the necessary know-how (more about the subject: Talk the Talk – Walk the Walk).
HCP Black’s investments will best unfold by clicking the fund’s pie chart, one sector at a time. The bolded text gives you the main idea of the block in question. After this, there is a slightly longer description of the investment’s risk-return profile. Many of the texts also have a link to additional information.
The review of HCP Black’s investments from the unitholders’ meeting on April 28, 2017 also explains why it is justified to own these investments even though they have not yielded profits in recent months.
As I write this, the HCP Black fund is at a 5% loss year-to-date. As is our custom, we are on the same boat with our customers because all our free equity is invested in this fund. The extremely defensive investment allocation has been nearly stable for over a year now. But to the best of my knowledge, the stock and bond market offer a lot of risk in relation to expected returns with the current pricing. That is why 75% of HCP Black is invested in instruments other than stocks or fixed-income investments.
When we face historic situations, we have to prepare for extreme circumstances. If we lose equity gains in these years, it is justified considering the overall risk and return because the possibility for major shocks is apparent (more about the subject: Beggar Thy Neighbour – the Whole Picture of Over-Indebtedness and Protectionist Trade Policy).
My view of the expected return is exactly the same as in January 2015 after the HCP Black fund had just climbed 14.05% during one year: the fund is expected to be between +15% and -5% 95% of the time after every 12-month period (more about the subject: On Risk and Return).
In between the unitholders’ meetings, I would like to remind you that we are always available for virtual meetings as usual, and you don’t need any software installations or logins. If you became interested in the fund and need additional information, you can book a virtual meeting easily online: https://www.helsinkicapitalpartners.fi/en/contact-us/. In addition, if you are used to following news feeds, I warmly recommend you follow my Twitter feed @hcpgroup. It allows you to get more detailed and fresh information about what I’m working on on the investment front. I will also add the most up-to-date info on our website. And what would be better than to meet over lunch – or a cup of coffee. In the age of new technologies, we must not forget about the traditional good practices that we have. A lot of important, silent information is exchanged when people meet face-to-face.