April 2015 Investor Letter

Active Asset Allocator Performance

Executive Summary

Market anomalies exist everywhere we look. Today, US stocks trade at two standard deviations above their long-term average valuation, while European stocks have now closed their valuation gap versus US equities on a price/free cash flow basis. We are in the third longest streak in history since the last 10% correction in the stock market and 40-60% of core Eurozone government debt now trades with a negative yield. Meanwhile, central banks are stepping up their gold purchases and have increased their buying from 409 tonnes in 2013 to 477 tonnes last year. Amidst all the noise, the Active Asset Allocator continues to perform +10% YTD, despite being defensively positioned 20% equities / 30% bonds / 30% gold / 20% cash.

Stock Market Update

The equity bull market rumbles on, now in its seventh year, and stock market valuations are stretching once again. As investors reach for yield, they are bidding up stock prices and valuations above pre-2007 levels. When you compare the value of US equities to corporate net worth, for example, the ratio (Tobin's Q) indicates US stocks are more expensive today than at any other time in history with the exception of 2000. The market capitalization of US corporate equities relative to US GDP tells a similar tale. US equities remain approximately 2 standard deviations above their long-term average valuation. Valuation alone is not a timing tool but we continue to advise caution and do not recommend carrying an overweight position in stocks at the present time.

European stock markets are off to a strong start in 2015 with many regions posting double-digit gains YTD, assisted by central bank money printing on a record scale and the subsequent and linked plunge in the euro.  Is the rally justified? There are some reasons for cautious optimism. For example, we continue to see a steady improvement in new car registrations and solid retail sales growth ex autos +3.7% year/year in January 2015 across the EU

Credit demand is also picking up with capital becoming more easily accessible as bank lending standards loosen. The ECB of course is playing a key role as liquidity provider of last resort and assisting in the slow but steady repair of European bank balance sheets.

However, stock market valuations have already discounted much of this improvement in our view. A cursory glance at price/earnings multiples in both the US and European markets suggests stocks are trading at rich multiples today.

If we take a closer look at the valuation differential between US and EU stocks in the following table, we can see that US stocks were valued on a price to free cash flow of 11.4 times in December 2014 versus just 8.7 times for the EU stock market, so EU stocks appeared cheap on a relative basis. However, when examining the make up of each regional stock market index on a sectoral basis, we note that EU stock indices have a higher allocation to the cheaper sectors of the market including automotive, telecom, utility and financial stocks.  If US sector weightings are applied instead to the EU stock market, the valuation discount closes.


Roll forward to today, and the relative valuation discount has disappeared. Banking, financial services and insurance sectors in Europe look cheap versus their US peers but probably for good reason, while active stock pickers may still find some opportunity in the automotive, oil and gas, construction, machinery and retail sectors. However, European stocks are now trading at 11 times free cash flow or 13 times when US sector weightings are applied to the EU Index. These are premium valuations to pay for long-term investments.


In addition to stretched valuations,  we are also on day 1,292 since the last 10% stock market correction. This is the third longest streak in history (data from Stock Traders Almanac). Now is not the time to be swinging for the fences.

 We remain defensively positioned for now in the Active Asset Allocator, holding 20% equities, 30% bonds, 30% precious metals and 20% cash.

For more information on our analysis, please get in touch. You can reach Brian Delaney at brian.delaney@secureinvest.ie or 086 821 5911.

Bond Market Update

Government bonds re-priced in 2014 to reflect a broader reluctance from global central bankers to tighten monetary policy. This trend has continued in 2015 to such an extent that between 40% and 60% of core Eurozone government debt now trades with negative yields. 

Despite negative yields, central banks, insurance companies, pension funds and passive fixed income funds could potentially continue buying bonds with a negative yield in the future as a combination of QE, regulation, mandate guidelines and liability management force their hands. The ECB for example is mandated to buy €1 trillion in bonds over the next 12 months, which is significantly more than the annual supply of new issuance in the region and 50% of the global net issuance of all debt in 2015. Also, if the Eurozone experiences a prolonged period of deflation, bond investors could experience a positive real yield. 

However, this trend towards negative long-term yields is not sustainable over time. At some point, valuation concerns should deter investment flows into bonds. We continue to assess our bond allocation in the Active Asset Allocator and will likely make some changes in the months ahead if the trend towards negative yields (and continued rising bond prices) persists. For now, we continue to be happy with the performance and allocation of our various bond investments.

For more information on our bond market analysis, please contact Brian Delaney at 086 821 5911 or brian.delaney@secureinvest.ie.

Gold Market Update

Gold in euros has gained +15% YTD and +20% since we increased our allocation in the Active Asset Allocator from 20% to 30%. Gold has done a great job protecting Euroland investors from the recent -25% drop in the EUR versus the USD. We can see on the following chart that a gap has opened for the first time in almost a decade between the EUR and USD gold price, indicating we are either about to experience a rally in EUR or the USD gold price in the near future, or potentially a combination of both.

The Euro certainly has room to appreciate and is oversold on just about every indicator we follow. A relief rally may be just around the corner. 

We continue to monitor our overweight position in gold in the Active Asset Allocator and will hold it as long as the position continues to work. Longer-term, we need to see gold trade back above its 20 month moving average to have confidence that the secular bull market has returned. An analysis of the various components of the demand for gold each quarter may provide some clues. 

According to data from the World Gold Council, ETF investors, concerned about the first significant price decline in gold in over a decade, sold 880 tonnes of the metal in 2013, while central banks purchased 409 tonnes. ETF selling moderated in 2014 to just 159 tonnes , while central banks stepped up their purchases buying 477 tonnes of gold. 

So, according to the World Gold Council, investment demand is potentially stabilizing around 900 tonnes pa and $1,200/oz. Gold ETF selling declined significantly last year and central banks are becoming more active in the market. Central bank actions speak louder than words and central bankers are well aware that printing money in the trillions of euros and dollars and yen each year is not a risk free solution to our problems. At some stage, investors are going to connect the dots and then the price of gold will trade substantially higher than where it is today. Until then, we have to be patient.

For more information on our gold market analysis, please contact Brian Delaney at 086 821 5911 or brian.delaney@secureinvest.ie.