As Christopher Nolan’s new telling of The Odyssey hits movie screens across Britain, I can’t help thinking of what its hero can teach us about investing at a time of overheating markets.
When some shares are rising seemingly remorselessly it can be very tempting to wade in and buy for fear of missing out.
In the classic Greek legend, Ulysses (the latinised version of Odysseus) is determined to hear the song of the sirens but knows that it will lead him to act irrationally, leading to his doom.
He makes what has become known as a ‘Ulysses pact’ with his crew. They strap him to the ship’s mast and then block their ears with wax. Ulysses is able to hear the sirens’ alluring though deadly singing but they sail to safety – for a short while, anyway!
So how do you resist the siren temptation of markets and psychological biases? I learned a long time ago that the only way was to sign my own Ulysses pact, creating a process that is 80% systematic and 20% subjective override.
The SmartGARP screens on criteria like growth, valuations and changes in profit forecasts. It essentially mimics what most fund managers say they do but that I often find myself questioning. If you give someone two stocks – a fairly fast-growing one and a slow-growing one – they say they'd choose the fast-growing company. If you offer them a cheaper company or a more expensive company, they'd rather buy the cheaper one. And if you say, would you rather have one with good news flow coming out or bad news flow? They'd go for the good news flow.
So why do our funds differ so much from the consensus? Seven out of 10 funds in Europe are still pro quality and underweight value, despite value outperforming for some time now. If you look at news flow over the past five years, many cheap companies have had generally good news flow coming out of them, and many quality companies the reverse.
So, for example, four years ago, everybody thought that LVMH was top of the pile when it comes to quality, and yet over the past three or four years, there's been a steady drip, drip, drip of bad news.
Similarly, the pharma company Novo Nordisk. If you take the period from 2020 to 2024, Novo Nordisk was a hugely popular stock. Every fund manager loved it. We bought it early and enjoyed the benefits. As the earnings went up the stock price went through the roof. The story made a lot of sense: Novo Nordisk had a duopoly on weight loss drugs in an era where obesity levels are rising globally.
In August 2024 the first cracks began appearing in the story. The company cut its earnings forecasts by two per cent as sales of Ozempic missed expectations thanks to competition from US pharmaceutical company Eli Lilly and supply constraints. People said it was a temporary phenomenon, but the numbers told a different story.
The shares were twice the market multiple even with a downgrade. The computer said sell. We did. The share price collapsed and profits continue to fall.
Following the sirens can mean you are blinded to opportunities as well as risks. After the global financial crisis banks were cheap and the earnings kept falling. Fund managers around the world became increasingly negative. When the earnings started to recover after the Covid pandemic, most couldn’t believe that this was a temporary phenomenon and banks remained unloved.
Many still consider them low-quality businesses. They might be, but the earnings are still rising and slowly but surely the share price has been following. Managements seem to be doing sensible things – buying in shares and avoiding crazy acquisitions.
Within this sector are some that SmartGARP scores more heavily than others. Our top 10 holdings feature France’s BNP Paribas and Soc Gen, Spain’s Banco Santander and Banco Bilbao Vizcaya Argentaria, Italy’s BPER Banca and Hungary’s OTP banking group – 21% of the fund.
We have rotated through banks as prices have caught up with the improving story.
That’s a similar story in pharma. We sold the Swiss company, Novartis recently – it’s risen over 30% in the past year – and bought France’s Sanofi. Over the past decade Novartis’ earnings growth has been about 2.5% greater than Sanofi’s, but in the past year Sanofi’s earnings have been better and whereas 15 months ago they were on a similar P/E ratio, today Sanofi’s is about half that of Novartis.
In the past three months oil stocks have had big profit upgrades, but we all know why that is. This is where our ‘20% subjective override’ comes in – applying wider reading to recognise when the numbers you tie yourself to basing decisions on might be temporarily skewed.
In other sectors, travel, airlines, food/beverage and telecom are seeing downgrades – rocks we’d rather sail around.
The call of the sirens is strong. Our impulses and emotions get in the way of smart thinking. If you can focus just on the data – constantly buying stocks that are a bit cheaper than the market, growing a bit faster than the market, and generally under owned by investors, experience has shown me that the odds stack in your favour.
Philip Wolstencroft is manager of the Artemis SmartGARP European Equity Fund and creator of the Artemis SmartGARP process. The views expressed above should not be taken as investment advice.