Monthly Letter February 2013

We get to hear all sorts of strategies when listening to sell side analysts. The quality of those pitches varies quite drama cally. At a CIO-dinner in London recently yours truly and the other par cipants were presented with the follow- ing strategy: buy stocks where earnings go up and sell stocks where earnings go down. Intui vely this sounds like a great strategy. Who wouldn’t want to own stocks that have increasing earnings and be short the decreasing ones? Wish it was that simple. All of us would love to nd the stock that has steady growth, no cyclicality, great market posi on and “low” valua on. If the market was totally unaware of the fairly important di erence between earnings going up or going down it would indeed be simple. Madrague’s assump on though is that the market is correctly priced. There is a reason for a stock to trade at a certain valua on.

There is a ra onale for the prices and valua ons that we can observe. We nd that the hurdle for investment becomes much higher if we have to disprove the market rather than assume that the market is com- prised of ignorant investors trying to lose money. The avor of the day changes though, depending on where we are in the economic cycle, what happens to regula on or how risk averse the investment community, to name but a few reasons. Right now we can see that there is a clear trend that investors have a faiblesse for yield and stability again. This was at its high last summer, normal- ized during the fall and has recently started to outperform again. We think that the market is paying too much for these types of stocks, but we can see the a rac on given the low return environment outside of the equity world. It is all rela ve. When the bond-like investors come to the equity market they have di erent glasses on than your typical equity investor.

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