At RVP, we believe the best investors are the most disciplined investors, and that a well-defined financial plan — often codified in a formal investment policy statement — is the foundation of a good strategic asset allocation plan. Experience has shown us that a good strategic asset allocation is the key to prudent decision-making, which can, in turn, support performance over the long run.
Today’s market presents unique challenges
Markets are complicated, and the current level of uncertainty within the market feels as high as ever. In recent years, there has been unprecedented central bank intervention and fiscal support benefiting risk assets. In addition to an accommodating Fed, fiscal stimulus as a percent of U.S. GDP has been in excess of 10% the last two years. Even though the Fed has indicated that it will remain accommodating into the near future, questions remain about exactly when and how this support will wane. Additionally, even if the proposed $3.5 trillion Reconciliation Bill passes, fiscal stimulus will likely be reduced to roughly 3.7% of GDP in 2022,[1] significantly less than the prior two years. This concern is especially timely, considering the market is valued at 20-plus times next year’s earnings[2] and market capitalization at its highest point in history relative to GDP.[3]
Considering the valuations of the market and the uncertainty around stimulus, investors may feel inclined to reduce their equity exposure or even sit on the sidelines altogether.
Assessing the positive and negative factors in the market
We understand investor’s concerns, and we agree that there are risks on the horizon. By weighing these negatives against the positive forces within the market, we can gain a more complete understanding of where the market is today.
- As mentioned previously, today we see 20-plus forward price-to-earnings multiples, which is expensive by all historical measures.[4]
- While the Central Bank has been accommodative, there have been periods of taper talk, a general withdraw of some Fed support, and uncertainty as to Fed chair Powell’s reappointment.
- Inflation is currently spiking, and we see a slowing rate of growth, bringing about concerns of stagflation.
- The potential for higher corporate and individual tax rates has been proposed in Washington D.C. and may come to fruition.
- Individual investors have their highest equity weighting in 20 years, at 70%.[5]
- Washington D.C. will need to navigate another debt ceiling impasse in October.
- There are concerns that the debt-laden Chinese developer, Evergrande, will go bankrupt, which poses a contagion risk.
- We have not seen a market correction of 10% in 18 months.[6]
- The COVID-19 pandemic is still front and center.
Despite these concerns, we have to remain balanced and objective in our views, however, and acknowledge the positive fundamentals that are supportive of stock valuations:
- Yields on stocks and bonds point to equities being relatively cheap compared to bonds by historical measures.
- We have seen an impressive rate of earnings-per-share growth, which may justify lofty price-to-earnings valuations.
- We have seen a 5% to 10% selloff in every subsector over the past year, including 10% in small caps and the value and growth sleeves of the market, so there has been some rationalization within the stock market.
- Perhaps we are experiencing the peak of COVID-19, and there is light at the end of the tunnel.
- The Fed has indicated their intention to hold rates near zero for the next year or longer.
- The credit markets appear solid, as indicated by high yields and a positively sloped yield curve.
When we weigh all these positive and negative forces together, our assessment is that the long-term bull market is likely intact — but we should be prepared to weather a correction of at least 10% or more. After all, we have had one correction of at least 10% every 17 months on average over the past 70 years.[7]
What the exact catalyst will be for a correction is unknown, but several of the negatives referenced earlier are possibilities. It’s the positive drivers in the market — such as expected Fed policy, the state of the credit markets, the yield curve, and earnings yields and growth — that make us more comfortable over the long term.
How RVP is navigating the uncertainty
Year-to-date performance has been strong both on an absolute basis and relative to benchmarks across nearly all RVP strategies. Several factors have contributed to this performance, most notably investor-friendly actions in the closed-end fund market, such as tenders and fund liquidations at net asset value (NAV).
RVP began the year with a significant quantity of yield-oriented holdings across all strategies and have been using the current market demand to realize some solid gains. This focus on floating-rate assets and the overall demand for yield in the market has also contributed to performance.
Given the valuation concerns discussed earlier, we favor value over growth, and today we are sticking with the overweight toward value which includes financials, healthcare, and industrials.
There is also opportunity in non-US developed markets. This large swath of the global economy has traded at a 30% discount on a valuation basis verse the U.S. over the past decade, and Japanese equities have risen only half as much as the U.S., while in the U.K., they are only up a quarter as much. However, annualized GDP growth over that past decade has been in the same ballpark as that of the U.S. The primary difference is that the U.S. has experienced significant multiple expansions as expressed in our price-to-earnings levels, and therefore, we believe it holds less forward return opportunity.
We are clearly in a low-yield environment where we must work harder to find compelling risk-adjusted assets. This has always been a strength of RVP, and we continue to find value in unique securities across all of our strategies.
In our Durable Opportunity strategy, we are buying Pennant Park (PNNT). This business development company (BDC) is trading at a 31% discount to net asset value and yields 7.25%.[8] Today, the average BDC is trading at full value relative to NAV. And while there is a lot of interest from investors in private credit, we think our focus on under-appreciated holdings (as measured by NAV) presents a better pathway to capturing yield and seeing capital appreciation if we make prudent investment decisions.
Across most of our other accounts, we own Virtus Dividend (NFJ). This covered-call and dividend-focused fund still trades at a near 10% discount and yields 6%.[9] Our view is that this fund still has the potential to perform well relative to its peers moving forward.
Finally, another fund we own very broadly is the Vertical Capital Income Fund (VCIF). This mortgage fund trades at a 10% discount and distributes a yield near 9%.[10] RVP currently owns 18% of the outstanding shares and filed a 13d in 2020, meaning we are engaging with management as an activist. We are hopeful that our actions will lead to investors realizing the full net asset value from this fund in the coming year.
Closing thoughts
As mentioned earlier, we can never predict or time near-term market moves. As a result, and to reiterate our earlier comments, it is important to have a balanced plan that you can stick to in good times and bad times — participating when markets are rising and then rebalancing, taking advantage of volatility when corrections occur. If you’d like to discuss your investment strategy, we invite you to connect with our team.
ABOUT THE AUTHORS:
ROBERT HUFFMAN III
Bob Huffman co-founded Relative Value Partners in 2004 with Maury Fertig. As Chief Executive Officer, he oversees the management of RVP’s investment strategies, in addition to being responsible for the business development and strategic growth of the firm.
An industry veteran with more than 30 years of experience, Bob’s investment acumen began in Fixed Income. He spent two decades at Salomon Brothers/Citigroup, serving in various roles within corporate bond sales to eventually become the Head of Midwest Institutional Fixed Income Sales. At Salomon Brothers/Citigroup, he worked closely with chief investment officers and senior portfolio managers at many major financial institutions across the country. His experiences and learnings there helped form the initial vision behind RVP.
Bob currently serves as a member of the Board of Directors for Northwestern Mutual Series Fund, overseeing and evaluating the money manager selection process for the 25 funds in the Northwestern Mutual Series Fund. Bob also is a board member of One Chance Illinois and is a finance committee member of the Chicago Jesuit Academy. Previously, he was a member of the Board of Trustees for both Loyola Academy (Finance Chair) and The Cove School.
Bob earned a Master of Business Administration from Washington University in St. Louis and a Bachelor of Science in Business Administration from Marquette University.
MAURY FERTIG
Maury Fertig co-founded Relative Value Partners (RVP) in 2004 with Bob Huffman. Maury serves as the firm’s Chief Investment Officer, overseeing all investment strategies and client relationships, including institutional clients.
Prior to starting RVP, Maury spent 17 years at Salomon Brothers/Citigroup working in Institutional Fixed Income and eventually as Head of Midwest Corporate Bond Sales. He started his career at KPMG Peat Marwick, as a Senior Accountant.
Ingrained in the Chicagoland community, Maury serves as a Vice Chairman of the Board of Directors for the Jewish United Fund of Metropolitan Chicago and is the Immediate Past Chairman of the Pooled Endowment Portfolio Committee. He also held the role of Hillel Board President at the University of Illinois at Urbana-Champaign and is a former member of the international Board of Directors of Hillel: The Foundation for Jewish Campus Life. In 2004, Maury was named an Exemplar of Excellence, an award recognizing individuals whose work for Hillel sets a standard for others to emulate. He also earned special alumni recognition by the Pi Lambda Phi National Fraternity.
Maury is the author of The Seven Deadly Sins of Investing: How to Conquer your Worst Impulses and Save your Financial Future (AMACOM). He has been quoted extensively in business media such as Barron’s, The Wall Street Journal, Bloomberg, Dow Jones and Investment News. He has also appeared on CNBC, Bloomberg Television and Morningstar.com. Additionally, Maury authors a column about income strategies for Forbes.com. Maury earned a Bachelor of Science in Accountancy from the University of Illinois and a Master of Business Administration from Northwestern University’s Kellogg School of Management. He is also a Certified Public Accountant.
[1] Rhodium Group, 2020 Green Stimulus Spending in the World’s Major Economies. (Link)
[2] Multpl, S&P 500 PE Ratio by Year. (Link)
[3] Longtermtrends, Market Cap to GDP: The Buffet Indicator (link)
[4] Corporate Finance Institute, Forward P/E Ratio. (Link)
[5] Wall Street Journal, Americans Can’t Get Enough of the Stock Market. (Link)
[6] Investors Business Daily, Stock Market Correction Averted? Putting This Reversal In Context. (Link)
[7] MarketWatch, Here’s a reminder that stock-market corrections don’t always become bear markets. (Link)
[8] The securities data within this article was current as of 10/8/2021
[9] The securities data within this article was current as of 10/8/2021
[10] The securities data within this article was current as of 10/8/2021
Relative Value Partners merged with Kovitz Investment Group Partners, LLC as of August 2024. All Insights are opinions of the author as of the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete, and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Past performance is not indicative of future results, which may vary.