The single biggest threat facing equity markets is the fact profits around the world are slowing at their fastest pace since 2009, according to Alastair Mundy, who says this “inescapable truth” is the major reason he is bearish at this point in time. 
2016 has certainly been somewhat of a rollercoaster ride for equity markets with 2015’s volatility and hefty falls carrying on into the first six months of the year.
Indeed, over the past 12 months all major regional and global indices are sitting on a loss with the likes of the FTSE All Share, MSCI Europe ex UK and the MSCI Emerging Markets indices down more than 5 per cent.
Performance of indices over 1yr
Source: FE Analytics
While some see this as a natural phenomenon given risk assets have delivered almost uninterrupted gains for most of the seven years since the global financial crisis, other believe this is due to growing macroeconomic uncertainty.
Certainly, there has been greater newsflow surrounding the future of China, the potential of recession in the US, a Brexit-induced break-up of the EU and the concerns that central bankers are running out of firepower.
Mundy, on the other hand, has been bearish on equities for a prolonged period of time thanks to his contrarian investment style. In his most recent note to shareholders in his Temple Bar Investment Trust, he says the major reason for being cautious has little to do with central bank intervention, macroeconomic uncertainty or potential political troubles.
“While the debate rages as to whether or not the US may or may not be in recession, or if the eurozone economy is finally recovering, equity investors cannot get away from the inescapable fact that profits are declining the world over,” Mundy (pictured) said.
“Earnings per share [EPS] for companies within the MSCI World index are now declining at the fastest pace since 2009, losing 4 per cent in the past couple of months alone (this despite stronger oil prices).”
“Global earnings are now 14 per cent off the peak set in August 2014 and back to where they stood five years ago. Equity prices on the other hand are 25 per cent higher. Gravity beckons.”
Of course, Mundy has held these bearish views for a number of years now – a period which has seen decent returns from global equities – and his trust (as well as his open-ended Investec UK Special Situations fund) have struggled from a relative basis as a result.
Performance of index over 5yrs
Source: FE Analytics
Many also believe that without the euphoria that normally comes before a market crash, a severe decline in equity prices is unlikely. However, Mundy says the best way of describing the current market backdrop is using recently released films as analogies.
In his most recent update to investors, he starts of by noting how many within in the industry have spoke at great length about ‘The Big Short’ – the story of a select number of US traders who created credit default swaps (CDS) to use extensively to bet against the US housing market and the rise of dodgy collateralized debt obligations (CDO).
Though he says the film and the book it was based on tell an interesting story of boom market euphoria, he says the current market backdrop has greater comparisons to a scene in the biographical sports comedy ‘Eddie the Eagle’ about how Eddie Edwards, played by Taron Egerton, attempts to break into the British downhill skiing team.
“At one point the British Olympic Association introduces the whole team to potential sponsors at a dry ski slope. The team ski down one at a time before coming to a stop in front of the would-be sponsors,” Mundy said.
“Eddie is the last skier to come down, joins the rest of the team at the bottom, loses his balance and knocks into his colleagues who fall over one at a time, leaving the whole squad on their backsides in the snow.”
He says this scene sums up the precarious nature of the current financial system perfectly.
“The relevance? In an equity market trading above its long-term average valuation, with declining earnings – probably as a result of sluggish revenue growth and margins under pressure – and a host of uncertainties (Brexit, euro-crisis, China, Trump, etc.) it would seem that the most important factor holding it up is the very low level of government bond yields,” he said.
“If these yields were to reverse, for whatever reason, the Eddie domino effect could have very significant implications for a number of different asset classes.”
Performance of gilt yields of over 3yrs
Source: FE Analytics
FE data shows, for example, that though many believed bonds were heading for a painful bear market around this time three years ago as the US Federal Reserve warned the market was going to start ‘tapering’ quantitative easing and generally tighten monetary policy, yields on the likes of 10-year gilts have fallen considerably over that time – a trend which has only accelerated in recent months.
Mundy also uses a film reference to explain his recent underperformance.
The manager takes a strict contrarian approach to equity investing, whereby he will usually only hold shares which are 50 per cent off their peak over the past seven years. If there are a lack of opportunities, his cash weighting will increase.
This approach has worked well over the longer term, with Temple Bar having returned 293.33 per cent since he took charge in October 2002 – beating the IT UK Equity Income sector and the FTSE All Share by 50 and 90 percentage points, respectively, in the process.
However, value investing has significantly underperformed other styles in recent years as there has been a general sense of nervousness in markets and companies displaying growth in a low growth world have been favoured.
As such, and as Mundy has held a high cash weighting and shorted the rallying US market on valuation grounds, Temple Bar is now significantly underperforming its sector and benchmark over the shorter term.
Performance of trust versus sector and index over 3yrs
Source: FE Analytics
Mundy says this performance, his investment philosophy and his future plans are best summed up by an old Clint Eastwood movie (he forgets which one) he saw recently.
“Clint is sitting in a bar minding his own business while a huge fight breaks out in the background. Clint is completely unmoved until one of the protagonists accidentally knocks his beer. This shakes Clint into action and soon he is knee deep in victims. Rather like Clint, we do not go looking for trouble, but trouble has a habit of finding us,” Mundy said.
“Currently, the good news is that there is more trouble finding us than there has been for some time – probably a consequence of a broader spread of stocks being downgraded and increasing shareholder nervousness.”
“This certainly makes our roles more interesting, but we must be careful. We are as strict as we can be that we wait for shares to significantly underperform before we even consider buying them. This demands great patience, but just as importantly sometimes demands great ongoing discipline to turn stocks away even as supply increases.”
Temple Bar is currently trading on a 7.3 per cent discount due to its recent underperformance, has a dividend yield of 3.8 per cent, is geared at 3 per cent and has ongoing charges of 0.49 per cent.