Tiger Cub Snoddy Says Investors Wrong on Priciest Ever Equitiesby
Negative rates change the picture for valuations, he says
Says defensive stocks with good dividends should cost more now
Tiger cub David Snoddy says investors and analysts who view the world’s safest stocks as too expensive are wrong.
Companies with strong cash flows and steady dividends deserve higher valuations in a world where low or negative interest rates have created a wasteland for bond yields, according to the head of the $2 billion hedge fund firm Nezu Asia Capital Management. A measure of global equities with low volatility rose last month to the priciest level ever compared with company earnings. For Snoddy, that’s no reason to sell.
“The guys that have been tooting the horn about defensive, high-yield stocks globally for the last two years, I think they’re missing that point,” Snoddy, 48, who ran the Tokyo office of Julian Robertson’s Tiger Management before setting up Nezu Asia, said in an interview last week. “It becomes more important how much yield I can get from this thing, because I can’t get it anywhere else.”
The inflows have come from two directions: bond refugees seeking higher returns amid quantitative easing and Europe and Japan’s minus-rate policies, and stock investors retreating from riskier parts of their market on fears about global economic growth. Snoddy’s views contrast with those of Norm Boersma, president of Templeton Global Advisors Ltd., who sees the potential for a crash in such equities.
Snoddy uses Japan, a market he’s worked in for decades, to illustrate his point. He’s invested in Nippon Telegraph & Telephone Corp., the former monopoly carrier that still counts the state as its largest shareholder with a 35 percent stake. The company has an projected equity dividend yield of 2.5 percent, according to data compiled by Bloomberg. That compares with about 0.31 percent for Japan’s 30-year government bonds, while more than 70 percent of the nation’s sovereign debt trades at yields below zero.
“How different is your NTT credit risk relative to the Japanese government?” Snoddy said. But “it would take me about eight years of JGB 30-year yield to get one year of NTT yield. I think that’s a big difference.”
The phone company’s stock slipped 0.5 percent this year through Thursday, compared with a 13 percent decline for the Topix index. NTT rose 0.1 percent on Friday in Tokyo, while the Topix added 0.5 percent. Most of Nezu Asia’s funds are "down single digits" in 2016, Snoddy said. The firm invests across the region, and its Nezu Asia Fund posted a compound annualized return of 9.9 percent from inception in October 2000 through April 29. Former employees of Robertson who establish their own hedge funds are known in the industry as tiger cubs.
Snoddy’s comments illustrate the predicament facing investors after years of stimulus by the world’s most powerful central banks inflated asset prices. For hedge fund managers who typically charge higher fees, the challenge is even greater. The industry lost $15.1 billion to net withdrawals in the three months ended March, the highest outflows since the second quarter of 2009, according to Chicago-based Hedge Fund Research Inc.
Snoddy favors an investing approach called growth at a reasonable price, with a focus on companies that generate cash flow to finance their own expansion, and says that attribute has become more important in the era of minus rates.
He talks of Japan’s “cash machines,” including Daito Trust Construction Co., which develops rental properties, and Kao Corp., a maker of household goods and cosmetics. Snoddy owns Daito Trust shares.
Daito Trust posted 60.5 billion yen ($551 million) in free cash flow in the year ended March, while the figure for Kao in its last fiscal year was 116.8 billion yen. While Daito Trust rose to a record 5.2 times book value this month, its valuation compared to free cash flow is about 27 percent lower than in 2008. Daito Trust shares slid 0.7 percent on Friday, while Kao lost 0.1 percent.
Many people “have been saying consumer defensives and quality companies are more expensive versus the market than they’ve ever been,” Snoddy said. “But that’s on a price-to-earnings or price-to-book basis. On a cash-flow basis I don’t know that’s necessarily true.”
Snoddy is positive on the prospects for Japan’s stocks. Moves under Prime Minister Shinzo Abe to make companies more shareholder-friendly, coupled with pension funds’ need for yield amid the negative-rate policy, will drive a shift into equities as the only liquid instruments other than bonds, he said.
He says the Mothers Index of smaller shares, which aren’t as influenced by exchange-rate fluctuations and slower global economic output, suggests negative rates are having some effect. The Mothers gauge has risen more than 30 percent since Jan. 29, the day Bank of Japan Governor Haruhiko Kuroda announced the policy. The measure added 0.3 percent on Friday.
Bond defectors seeking better returns have pushed up valuations in global stocks less sensitive to the economy, creating the potential for a “sharp correction,” Templeton’s Boersma said in an interview in April. It’s driven by a need to be in the equity markets but a fear of the more volatile areas, he said.
The MSCI All-Country World Minimum Volatility Index traded at 20.7 times earnings on Thursday after rising to an all-time high of 21.1 times on April 19.
For Snoddy, valuing companies against their profits doesn’t capture the whole picture. In the era of negative interest rates, defensives and other quality stocks with good dividends naturally have more worth, so measuring against cash flow is also important.
“If you think about what a global low-interest-rate environment does to the value of cash machines, then it makes sense that they would be more expensive,” he said.