Earnings still matter

Indicators worldwide continue to reflect the damaging effects of the coronavirus pandemic and associated restrictions on economic activity and business profits. Yet puzzlingly equity markets have continued to rise. This suggests that the equity market does not seem to care about earnings – yet. History shows that in the long run earnings will still matter.

In a recent interview with the Economic Club of New York, Stanley Druckenmiller said “in the intermediate term liquidity moves markets more than earnings.” Druckenmiller, known as one of the world’s greatest investors, pointed to the massive liquidity injection by the Federal Reserve Bank as the main reason for a rebound in stocks.

In the past two months the Federal Reserve’s has expanded from a little over $4 trillion at the beginning of this year to almost $7 trillion, as the US central bank has spent up to $75 billion daily purchasing US government bonds.

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Source: Federal Reserve

Druckenmiller explained that drastic cuts to earnings projections have not mattered as the Fed’s multi-trillion-dollar bond-buying program has leaked into risk assets like equities. As investors sell these low risk assets to the Fed they have likely redeployed funds into higher risk assets, including high yield bonds and equities, regardless of the outlook for company earnings.

This has meant that US stock prices have been able to rise more than 30 per cent since the end of March, even as earnings forecasts for US corporates have fallen by almost 20 per cent. Moreover, the correlation between stock prices and earnings forecasts has been close to negative one – an almost perfectly inverse relationship.

US stock prices and earnings forecasts since the end of March 2020

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Just as Druckenmiller cautioned that the liquidity effect dominates in the “intermediate” term, a study over the last two decades shows that in the long run the direction of corporate profitability is highly likely to dictate the direction of stock prices. In fact, the correlation between share prices and earnings forecasts since 2000 has been almost positive one – an almost perfectly direct link, and a stark contrast to the relationship over the short run.

US stock prices and earnings forecasts since 2000

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The divergence between stock market prices and company earnings in the past two months should warrant near-term caution from long-term investors, who seek to compound wealth over decades. Many such investors are clients in the Montaka and Montgomery Global strategies. They can take comfort in the defensive positioning of these funds, with low net market exposure and high cash holdings, respectively. Rather than chase short-term liquidity-fuelled bounces, we are focussed on protecting capital at a time when fundamentals have diverged significantly from prices and the possibility of substantial downside has risen.

Our Funds

The Montgomery Fund

  • AUSTRALIA/NZ
  • Concentrated high conviction equities
  • From $25,000
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Montgomery Global Fund

  • GLOBAL
  • Concentrated high conviction equities
  • From $25,000
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Montaka Global Access Fund

  • GLOBAL
  • Access long/short global equity portfolio
  • From $50,000
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Montgomery Global Equities Fund (ASX:MOGL)

  • GLOBAL
  • Concentrated high conviction equities
  • No minimum investment - see your broker limits
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Montgomery Small Companies Fund

  • AUSTRALIA/NZ
  • Concentrated high conviction equities
  • From $25,000
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Our Funds

Concentrated High Conviction Equities

Listed

Montgomery Global Equities Fund (ASX:MOGL)

Global
Available on the ASX as an Exchange Traded Managed Fund, invests in 15 to 30 quality global businesses for long-term capital growth with a target distribution yield of 4.5% per annum. Mirrors the strategy of the Montgomery Global Fund.
Unlisted From $25,000

Montgomery Global Fund

Global
Invests in 15 to 30 quality global businesses for long-term capital growth. Priced daily. Mirrors the strategy of the Montgomery Global Equities Fund (ASX:MOGL).
Unlisted from $25,000

The Montgomery Fund

Australia/NZ
Aims to provide long-term growth and income by investing in 20 to 40 high-quality Australian and New Zealand businesses trading at attractive valuations. Priced daily.
UNLISTED FROM $25,000

Montgomery Small Companies Fund

Australia/NZ
Aims to provide long-term growth by investing in 30 to 50 high quality, undervalued, Australian and NZ small and emerging companies with strong growth potential. Priced daily.
Unlisted from $1 Million

The Montgomery [Private] Fund

Australia/NZ
Seeks to deliver absolute returns from a portfolio of high-quality Australian and New Zealand businesses. Capital preservation is paramount. By invitation only.

Alternate Equity Strategies

New Fund

Montaka Global Extension Fund (ASX: MKAX)

GLOBAL
An ASX-quoted managed fund, typically, the Fund seeks to hold 15 to 30 long positions and partially offsets these with 10 to 40 short positions, operating with 130% exposure to its long portfolio and 30% exposure to its short portfolio, resulting in a net market exposure of around 100%. Features a target distribution yield of 5% per annum.
Unlisted from $50,000

Montaka Global Access Fund

Global
Aims to generate materially higher risk-adjusted returns, net of fees, than is generally available in the equities market over the medium term. Priced monthly. Provides retail investors access to the Montaka Global Fund.
Unlisted from $1million

Montaka Global 130/30 Fund

Global
Provides the opportunity to benefit from both the gains of extraordinary businesses and the declines of deteriorating businesses through a global equity active extension strategy, which has the potential to significantly outperform the broader equities market over time. Seeks to generate double-digit annual average returns, net of fees. Daily priced.
Unlisted From $1 Million

Montaka Global Fund

Global
Aims to generate materially higher risk-adjusted returns, net of fees, than is generally available in the equities market over the medium term. By invitation only.