In July, we interviewed Larry Pitkowsky and Keith Trauner of the high-flying GoodHaven Fund. The mutual fund managers acknowledged at the time how well index funds had been performing during the seven-year bull market in stocks. Yet, they said passive investing might stumble over the next several years as stock valuations soar.
The GoodHaven Fund GOODX, -0.12% had risen 16% from the start of the year until July 20, when the interview took place. The mutual fund has about $ 271 million in assets and is now up 23% for the year, more than double the benchmark S&P 500 Index’s SPX, +0.59% return of 10.5%.
In a follow-up interview this week, Pitkowsky admitted he and Trauner had “enlightened self-interest” when arguing in favor of active management, because they run a mutual fund of which they believe they are the largest individual shareholders.
“But the question is, when should an investor be putting their foot on the gas?” Pitkowsky said. “In March 2009 [when the S&P 500 bottomed, in the wake of the financial crisis], it would have been time to put your foot on the gas and go from cash to anything.”
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Trauner said: “Indexing is a perfectly valid strategy. The problem is when market pricing becomes high and you are in a situation where it is almost impossible to earn high returns because of high valuations.”
Here are two charts showing just how high the index is trading compared with previous periods:
The S&P 500 Index is trading for 18.6 times the past 12 months’ earnings, the highest level since February 2004.
The index hasn’t traded this high — relative to earnings — in nearly 13 years.
And the S&P 500 trades for 1.9 times the past 12 months’ sales, nearly a 16-year high.
The current market “reminds us in a way of 1999 to early 2000, when people poured money into tech at an inflated pace,” said Trauner. “You could have said to someone, ‘The market is expensive; don’t know how you make money from here,’ and if you were buying the indices, it was true.”
“But if you ignored the latter stages of technology, you had a wonderful next decade, as the indices earned next to no return,” he added.
Even though the valuations appear high relative to earnings and sales, the charts make clear just how much more frothy the stock market was in early 2000. Trauner pointed out that in early 1999, “tech stocks were absurd, even though the boom went on for a year and a half” longer.
So nobody can predict which way the wind will blow for the market as a whole, but Pitkowsky and Trauner argue that in an expensive market, it’s better to be careful and selective.
The fund’s top holdings
Here are the top 10 holdings of the GoodHaven Fund as of Aug. 31:
|Company||Ticker||Industry||Share of portfolio||Total return – 2016 through Dec. 6|
|WPX Energy Inc. Class A||WPX, -0.54%||Oil and gas production||11.9%||164%|
|Barrick Gold Corp.||ABX, -2.95%||Precious metals||11.2%||111%|
|Birchcliff Energy Ltd.||BIR, +2.02%||Oil and gas production||4.2%||138%|
|White Mountains Insurance Group Ltd.||WTM, -0.32%||Property/Casualty Insurance||4.1%||17%|
|Spectrum Brands Holdings Inc.||SPB, +1.37%||Electrical Products||3.7%||18%|
|Federated Investors Inc. Class B||FII, -0.03%||Investment Managers||3.5%||7%|
|Hewlett Packard Enterprise Co.||HPE, -0.53%||Computer Processing Hardware||3.5%||59%|
|Leucadia National Corp.||LUK, +0.38%||Investment Banks/ Brokers||3.4%||34%|
|Alphabet Inc. Class C||GOOG, +1.66%||Internet Software/ Services||3.3%||0%|
|Alleghany Corp.||Y, +0.31%||Property/Casualty Insurance||3.1%||22%|
|Sources: Morningstar, FactSet|
Pitkowsky and Trauner emphasize that they make long-term stock picks, focusing on companies with low valuations, including turnaround plays with new management teams. Pitkowsky said: “We’re just starting to possibly see a sea change in how [many portfolio holdings] are valued.”
Pitkowsky repeatedly emphasized how he and Trauner don’t try to guess which way commodity or stock prices will go, as they focus on individual companies. But he did say that the recent OPEC deal to cut oil production could “provide a tailwind and a floor” for oil stocks. He also said WPX Energy Inc.’s WPX, -0.54% turnaround had been “executed as well as you could ask for.”
When discussing Barrick Gold Corp. ABX, -2.95% Pitkowsky emphasized that after a major reorganization by executive chairman John Thornton, the copper and gold miner is now “in a position to play offense in their universe.” He said the price of gold “hasn’t done very much,” but also said central banks’ rapid balance-sheet growth added inflationary pressure.
“If this is the trend, wouldn’t you like to have some exposure? You might see real inflation across the board,” Pitkowsky said.
The managers also touted Leucadia National Corp. LUK, +0.38% which tends to be overlooked by investors because it operates in so many different industries. The company’s main subsidiary is Jefferies, an investment bank and broker, which Trauner said “on its own, has the best track record for any firm on Wall Street.” The company also has subsidiaries in the meat-packing, auto-dealership, real-estate, manufacturing and telecommunications industries.
A stock the managers discussed that isn’t on the top 10 holdings list, above, is Verizon Communications Inc. VZ, +0.70% which made up 2.5% of the fund’s portfolio as of Aug. 31.
“What is fascinating about Verizon, is that over the past few years, a lot of ‘steady Eddie’ businesses have taken on high valuations. Those businesses started to sell at 25, 30 times earnings,” Trauner said. Verizon trades for just 14.6 times trailing earnings and 12.5 times the consensus 2017 earnings-per-share estimate, among analysts polled by FactSet, and the stock features a dividend yield of 4.59%.
“The world is coming in Verizon’s direction in a big way,” Pitkowsky said, because of the move from cable services to mobile-entertainment services, “which should be helpful to pricing.”