There are opportunities amid the uncertainty.
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Alessandro Valentini, Portfolio Manager, Causeway Capital Management.
Risk aversion dominated security markets the year end of 2018. And 2019 promises to be another year with several macro political happenings possibly leading to continued volatility in the market. Given the uncertainties in the global markets, our attention is concentrated on companies that are delivering or restructuring and should benefit from these operational improvements.
Take Brexit as an example. There’s been a lot of commotion and worrying about the outcome of the exit negotiation, and U.K. stocks have been impacted by this uncertainty. We strongly believe common sense will prevail and the U.K. will not exit the union without an agreement or at least will make sure that a series of agreements happen rapidly after the official exit day. But the bottom line for us is that you have had companies in the portfolio, like Prudential or Aviva, being greatly impacted. These are diversified insurance companies. And Pru is actually mostly active outside of the U.K. and the only real impact from Brexit is if we were to see massive credit default in the U.K. And this is an unlikely scenario even in the most disastrous of outcomes.
At the same time, these are companies that are taking actions to improve their businesses: Prudential, by separating the U.K. operations to emphasize more attractive U.S. and Asian businesses, and Aviva by fixing an over-levered balance sheet and refocusing the business. So this sentiment really of weakness in the fourth quarter of 2018 has provided us with great opportunities to increase our position and drive our performance for 2019.
In terms of industries we are following, we are bottom-up investors, so we really focus on individual companies. But one interesting characteristic in the current market situation is that valuation gap between defensives and cyclicals. EAFE markets contain the highest valuation gap between defensive and cyclicals right now. And this is not only relative to the geographies, but even on a soft relative basis. The current defensive premium is nearly at the level that occurred during the height of the great financial crisis.
At year end 2018, UK beverages traded at all time high valuations while UK banks languished at discounts to book value at a single digit PE multiples. This situation allows us to invest in cyclical businesses of high quality at valuation levels that we haven’t seen in the recent past and that go back to crisis period.