Although many investors are seeing roses in the future, perhaps due to the combination of anticipated tax cuts and a strong economy, some value investors are a bit cautious. Count Crescat Capital as one of those investors who aren’t full-on bullish, at least according to the fund’s Q3 letter published on November 18.
According to the letter, the fund believes that large cap stocks in the United States are overvalued, at least according to to six comprehensive dimensions (presumably taken as a whole but potentially separate) including price to sales, price to book, enterprise value to sales, enterprise value to EBITDA, price to earnings and enterprise value to free cash flow.
While the fund acknowledges positive factors in the broader economy such as low inflation, low interest rates, or improving earnings growth, the fund believes those factors don’t necessarily justify the market’s valuation levels.
The fund believes that we are currently in the late stages of the business expansion cycle and notes that investor sentiment has been rather bullish. In previous market tops, investor sentiment has also been bullish. In terms of what the fund expects, Crescat Capital views potential catalysts such as the China credit bubble potentially bursting as a potential problem. If that happens, the bursting could be contagious to credit, equities, and real estate. In terms of scale, the fund believes ‘China today is the biggest credit bubble of any country in history’.
The fund notes that China has accounted for around 50% of world GDP growth since 2008, and that if China goes South, other financial securities could be negatively affected. In terms of Crescat Capital’s positioning, the fund is not surprisingly positioned for a potential downturn in China. The fund writes that it isn’t a perma-bear but it strongly believes ‘there is a major cyclical market downturn coming soon that needs to be timed with shorts to generate performance and add substantial alpha’.