“I am even more defensive than when we last met,” says Sebastian Lyon, founder of Troy Asset Management and manager of the multi-asset Troy Trojan fund.
“The portfolio has less than 40% in equities, we just cannot find value in the market. Any purchases are made on a rifle shot, not scattergun, basis. Any investor buying equities now is taking a big risk – the more the market climbs the more vulnerable you are to a correction, and it could be as much as 50%.”
Lyon is not famed for his bullish attitude towards stock markets. He invests for capital preservation, aiming to beat the stock market over the long term – but this is done mainly though losing less money in the downturns.
In 2011, following a volatile period in the FTSE All Share, Lyon sold out of equities, predicting a market correction, reducing the portfolio position from around 70% equities to less than 40%, and upping exposure to cash, gold and index-linked bonds. Instead, the FTSE All Share – and the S&P 500 – continued to rise, and the portfolio lagged.
“I talk to our shareholders. We are investing irreplaceable capital for them, many are reatired and no longer working, they cannot suffer an 50% drawdown,” he explains.
The All Share is nearly 2000 points higher than it was when Lyon pulled the cautious switch in his portfolio, but this time he is confident that his positioning is the right one.
He continues: “I did call the correction too early, and there is an argument that the market could continue to climb from here, but what worries me about some fund manager’s attitudes is they are encouraging investors to put new money in now. There is a complacency about the fact that at this point in the cycle the risks are higher and the returns will be lower. Investing in equities now is a big risk.”
Valuations at All Time Highs
Examining 19 of the largest stock holdings across Troy Trojan and the Gold Rated Personal Assets Trust (PNL) – a closed end fund run by Lyon – almost every single one is trading at a near all-time valuation high, as measured by cyclically adjusted P/E. Coca-Cola, Colgate, Diageo, Microsoft, Nestle, and Reynolds American are all at a 10-year high, while P&G and Unilever are almost at peak.
“You never know how long a stock market rally will last,” says Lyon. “But we are close to the record for the longest stock market rally in history. The market is so overinflated that even bad news is good news; Nestle and Colgate reported disappointing results in recent weeks but their share prices still climbed.
“Nestle was on 11 times earnings when I bought it, and there was significant upside to the share price. Today? Nestle is on 23 times – the upside is minimal.”
Lyon is also concerned by the amount of leverage companies are taking on, either to make an acquisition or to pay dividends. He has been reducing holdings if they choose to take on more debt.
“Rates may be low now, but they will not be low forever,” he warns. “The raising of rates may well be the trigger that causes the stock market correction. It might not take much, just a small bank rate rise. We are now eight years into the cycle… I would be very surprised if a correction did not happen in the next couple of years.”
Instead, Lyon is keeping his powder dry, with large amounts of liquidity in the portfolio in the form of gold, cash and index-linked bonds.
"Yields cannot fall further, there are no pockets of value in equities or bonds," he said. "It is not like during the tech bubble where you could buy stocks unrelated to tech, everything looks expensive. Gold should succeed in an inflationary or deflationary environment, although I expect deflation is a more likely scenario."
