A Stock Picker's Market and Market Cycles

This is part three of Capital International Asset Management's Advisor Due Diligence presentations from their Fall 2010 conference.

View Part One here, Why Luxury Cars are Selling Like Hotcakes in Beijing,
and Part Two here,  Challenging Canadian Notions of Portfolio Construction.

A stock-picker’s market environment
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Rob Lovelace: From my own personal investment standpoint, I think what's really struck me in this environment, and I think it came out a little bit in what Carl and Jeremy said, is it's not a very theme-based investment market, it's not a very top-down market. Now that may surprise you, because everyone right now is thinking, wow, if you don't get the macro right -- If there's one lesson we learned in the last three years, if you don't get the macro right, forget it, right? Macro dominates everything.

And yet, when you cut through it, what the markets are saying right now is, are we in an inflationary world or are we in a deflationary world. And in the course of the last calendar year or the last 12 months, it's gone back and forth two or three times. We were in an inflationary world, and then Europe had its crisis, Greece, and everyone said, wait, wait, wait, this is a deflationary cycle. We're in a deflationary world, and now with quantitative easing in the United States, well, we're back in an inflationary world. And so how do you construct a portfolio in that environment? You either have to be trading on such a short-term basis that fundamentals don't matter, which I would argue you can do but it's extremely difficult to do on a consistent, long-term basis, or you step back from it and look through to the underlying companies and find those companies that know how to do business in multiple environments and know how to survive.

For example, a lot of consumer products and other companies that Carl knows extremely well, have operated in deflationary environments in Japan for more than a decade and inflationary environments in Latin America and other places. They've got internally-trained people that know how to deal with all those markets. They know how to deal with places where they have no pricing power and where they have extreme pricing power. And so what you see in our portfolios tends to be a gravitation towards companies that know how to deal with volatile environments, that have balance sheets that are prepared for it, they're, they've got CFOs often from places like Brazil, so they know how to deal with rapidly changing currency and interest rate environments. This is why we take the time to get out and get to know them and see their subsidiaries in other countries, 'cause it really tells you how they're structured, how flexible they are and how much they're learning and trading across.

So the global footprint, finding the best company and wherever it's based, with managements that know how to deal with these multiple environments and will take advantage of them, with products that people want, these are the types of things that we're out there trying to uncover. I really think it's a very, very good stock picker's market environment right now without much theme.

What threats are there in the market right now?
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Rob Lovelace: Well, there's the four- to six-year cycle, and then there's also the 30-year cycle. And I think what everyone's really shocked about right now is we just got hit by the 30- to 40-year cycle, which is, which is the big one, right? So got to go back to the '70s to really find something similar in North American context. Obviously, Japan had it, you know, sort of mid cycle for us.

But it was interesting. We went back as a firm and we often pull out a speech that was given by one of our, the president of the company in the 1970s when total mutual fund sales for the year, I think, was less than what we sell in one day now as a company. I mean, that's how, it was very tough in the 1970s. And he gave a speech talking about how 30 years prior, how tough things were and how well we had done in the 1940s when we were losing the war and how grim things were in the market. And then you go back to the 1940s, back to the 1920s.

So, first of all, there aren't that many firms that can actually pull out documents from people you knew that actually worked at the place, and, actually, I would argue, I don't think any of the firms that were managing funds that were created in the Depression period. I mean, really the roots of Capital Group go back to the Depression.

So the roots of our company, in fact, think about this issue all the time. The four-year cycle, the six-year cycle, the 30-year cycle, and how do we get through it. I wish that I could say that we have a formula that would guarantee that when we get to the 40-year cycles there's something you can do about it, but you know the math as well as I do, unless you own treasury bonds. I mean, Canada again did much better, but in the U.S. context, if you didn't own treasury bonds, you were kind of out of luck. So it is why we keep, you know, more than a billion dollars on our balance sheet as a company and have no debt. So that from a business standpoint we don't have anything that makes our investment professionals worry about the ongoing strength of the firm as we go through these cycles.

On the shorter term cycles, in terms of what you're specifically asking about, it's part of the reason why we've always had a one- and a four-year bonus, because we wanted to be able to recognize the cycles and the investment styles as we try to match up the different styles. But because the cycles have gotten a bit longer, which was exemplified in your question, we recently added an eight-year bonus. So we're actually measuring our associates on how they do over a full eight years in terms of the bonus that they receive. Again, I challenge you to find anyone out there that's thinking -- I mean, I mentioned earlier the firms that are doing quarterly judgments of their associates. How many are really thinking about eight years.