Mackenzie Minute: December 8, 2017
Hovig Moushian, Portfolio Manager on the Mackenzie North American Equities Team (formerly known as Mackenzie All Cap Value Team), says his team looks for valuation gaps between stocks to find opportunities when equity valuations are so elevated.
HOVIG MOUSHIAN: As we approach the end of 2017, Canadian and US equity markets are deep into the eighth year of their bull market runs. This is the second longest bull market we've seen in history. And this has led to valuations levels that are elevated across the marketplace, with stocks trading well above their fair-market value levels. In some cases, where earnings growth has been more rapid, valuation levels are even higher still.
In the context of the current environment, we have focused increasingly on relative value opportunities, or situations where the valuation gap between two stocks has become unjustifiably wide in our view. For example, this summer we observed a one and a half multiple point valuation gap between CN Rail and CP Rail, the widest that it has been in the last eight years, particularly for two railways that are highly correlated. As a result, we eliminated our holding in CN and diverted all of our rail exposure into CP on the expectation that that valuation would converge and we would benefit as a result, and this turned out to be the case.
As value investors, we get most excited about stocks that trade at low absolute valuation levels. In the current environment, with valuations generally elevated for stocks, we're particularly cautious of stocks that have downright inexpensive valuations. These may turn out to be value traps or situations where there has been a permanent negative change in these businesses and that low valuation can persist or get even worse. Our experience has shown that it's next to impossible to completely avoid value traps but we manage the negative potential impact on our funds by maintaining more modest exposures in these types of names, during this kind of environment.