Focus: Whitney George – Value in Volatility

By Remy Blaire

Volatility and velocity are two words that are now an integral part of the market watcher’s vocabulary. February is a short month but wild swings in the market have been fast and furious. With so many swift moves in such a short period of time the passive investor has more than one reason to come out of hibernation.

As we take a look ahead, inflation and economic growth will be closely monitored amid global monetary policy shifts. Whitney George is Chairman of Sprott U.S. Holdings. Inc. and Senior Portfolio Manager at Sprott Asset Management USA. Take a closer look at Whitney’s insights on recent market volatility and why opportunities abound for value investors.

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Remy Blaire: Recent volatility has everyone asking about the trajectory for the broader market. Recent swings have also awoken those who have been passive investors. Now, there’s no doubt that the recent roller coaster ride for global equities/bourses has raised questions about fundamentals and the greater economy. But what are the concerns you have at this moment in time?

Whitney George: It is less of a concern than you would think, Remy. My job is picking stocks bottom up and finding great values regardless of what markets or economies are doing. Of course, the environment like the one we are in now tends to create more of these value opportunities. But I do think that this time, just watching it unfold, there has been a dramatic shift that is somewhat more profound than just increased volatility and big point moves every day.

We entered the year with a very strong January. It was classic: People that had been on the sidelines, in what has been a very mistrusted bull market for coming up on nine years, were finally looking like they were capitulating in, only to be slapped in the face at the end of January – early February with extreme volatility, the likes of which we have not seen in several years.

In terms of the February correction in the market, a 10-11% correction actually is nothing out of the ordinary. Historically, it happens at least once a year and it is just part of the way the market works. What’s different this time was the velocity. The fact that the market rout was done in 10 days was a big surprise, as opposed to taking a month or more as it has done historically.

I think this has caused people to take a step back and rethink their positioning. What I think triggered the downturn was the one-two combination punch of the new tax bill and the $1.5 trillion that it will add to the existing U.S. deficit over the next 10 years. On top of that, the budget compromise adds another $300 billion over the next two years.

Suddenly, we’re staring at trillion dollar plus deficits per year as far as the eye can see. Ironically, as the last deficit hawk went silent in Congress, suddenly, deficits and debt have become a major feature in the narrative on a daily basis and something that we hadn’t worried about. To paraphrase Warren Buffett: “debt doesn’t matter until the day it does. And then that’s all that matters.”

Remy: You just highlighted debt and deficits. No one has a crystal ball, but there are a few certainties that always accompany market cycles. So for value investors such as yourself, where do you see the opportunities?

Whitney: I think there are a variety of opportunities. One: I think real or hard assets is a category to watch. Precious metals, farmland, real estate, for example, have all become vastly underweighted in most investor’s portfolios. Not so much because hard assets have done poorly but because they have just not kept pace with the equity and the bond markets over the last few years.

I think investors have found themselves out of balance or may find themselves out of balance, once they look more closely at their portfolio allocations. I think it is beneficial to re-allocate to those under-owned categories, maybe at the expense of equities and fixed income.

Certainly, the focus is now shifting toward inflation. We had a slightly higher reading today than people were expecting, as opposed to the fight against deflationary forces that had been going on really since the bottom in 2009. There is a shifting narrative out there, and it is likely to cause repositioning.

I think we very well could have seen the lows on the market from this correction. But I think it’s going to take a lot longer than some might like to achieve new highs because of the kind of psychological punishment that investors have taken and the roller coaster ride they’ve been on since the beginning of the year.

Value investors love this stuff. This kind of volatility and again, the individual stock volatility has been there for the last year or so. It’s not uncommon for individual stocks to go up or down 10% on no news. And on news, a 20% move in a day became quite common.

What I think was going on is that the vast majority of money invested in the market has been in the passive strategies that tend to pile into the highest weighted stocks or the biggest companies, while beneath the surface there has been a lot of volatility and activity that has created some great values.

And when you get a 10% correction in the market, that’s the whole market. There are some stocks that don’t go up, some that go up a little bit, and then there might be stocks that are down 20 or 30%. Not all companies are treated equally when they go through these corrections, and of course that creates some valuation opportunities for stock pickers like myself.

Remy: It seems that when the good times end that’s one of the hard questions asked. The same thing, there are plenty of people in the marketplace who were plenty spooked when we saw that velocity and volatility in the beginning of this month.

But some people also started asking where are the cracks that could lead to real crisis down the road. And there were headlines earlier this week about the concern regarding manipulation of the VIX. So what are you focusing on as we head into the rest of this month?

Whitney: I am always on the lookout for opportunities. I think whenever you turn an index like volatility into an asset class, like the VIX [CBOE Volatility Index], there is bound to be some growing pains along the way. There are a whole bunch of new innovations that have been popularized in the market whether it be volatility strategies, or ETFs where the underlying securities may not be as liquid as the ETF would give them the appearance of being, or just algorithmic trading where computers take over and they don’t really care about what a business is worth.

I think we’re going to continue to test a bunch of these things. We’ve seen some strains in ETFs. For example, going back to 2013 during the Taper Tantrum, you had the Flash Crash in August of ‘15 where you had some dislocations, trading halts and things like that in some of these ETFs that were thought to be the very liquid.

So again, what I continue to focus on: low P/E, high-quality companies. I am particularly interested in adding to positions where valuations are attractive, the companies have significant cash, buybacks in place because in fact, they may be the only buyers of stock on those kinds of days. But I do think rising interest rates and higher inflation are going to be detrimental to P/E multiples. Our economy could do very well but that doesn’t necessarily mean the stock market will continue going up the way it has in the last few years.

This will be the challenge. You’re going to have good economic activity. You don’t see a recession coming at this stage. But again, the market itself can cause people to slow down on spending and things like that because of the wealth effect. So it sometimes can be self-fulfilling. But we’re not seeing the kinds of credit issues out there in Corporate America that would foreshadow an imminent recession, and therefore a bear market, at this point.

On the other hand, the national debt [ceiling discussion] … has been suspended until next year, March of ’19, if it’s ever addressed again. It is going to be something that gives people a pause and just going to be something that creates some rotation. I do think some of the biggest, most highly valued stocks potentially are vulnerable. I do think passive investing works great when the market is going up all the time. And being average is an excellent outcome. But in declining markets, negative returns even if they’re average aren’t so much fun for individuals.

Remy: Okay Whitney… you’ve been through several market cycles so I know that you have experienced plenty and you know what you’re talking about. So it sounds like this is a good time for those who haven’t thought about re-examining their portfolios to do so. Thank you very much for your insights today.

Whitney: You’re most welcome. And it is a delight and thank you, Remy.