“In the short run the stock market in a popularity contest, but in the long run it is a weighing machine.”
With the performance dichotomy of different asset classes and stock market sectors we are currently
witnessing, that adage by Warren Buffet’s mentor, Benjamin Graham, is particularly relevant.
It has been an extremely turbulent last few months since the last update we sent out. Throughout most
of the summer we had the continuation of the fear that the Federal Reserve would taper (slowly reduce)
its quantitative easing bond buying program. That led to severe disruptions in the bond markets and
also in pretty much anything with a dividend. Then in late August we had Syria intervention fears,
followed on closely by more Fed related consternation. Finally, to cap it all off, we had the wonderful
fiasco of the government shutdown and debt ceiling debate.
On a side note, a spokesperson for Robert Pittenger, the House rep. of North Carolina’s 9th district,
addressed my rotary club recently. One of our members asked him if our Congressional leaders truly
realize how lowly they are thought of right now. His response was that: “At least they still score higher
in the polls than cockroaches!” Sigh….that is about all I can say on that one.
U.S. markets have been strong this year, but other asset classes have performed much more poorly. The
U.S., Japanese (best if you also hedged against their currency drop), and to a lesser extent some of the
European markets have been the only investment areas that have worked. Actions in the bond markets
and other income based investments have been horrendous. The action in other overseas markets have
been very mixed and we have many major markets flat or down on the year such as China, Canada,
Brazil, Russia, and Australia. Additionally, most commodities of all stripes have been sharply down
including silver and gold.
While U.S. equity markets are doing well, it also means that the more diversified an investor has been
across asset classes, the poorer their overall returns have looked on a relative basis. Thus, this has led
to investors of all sizes plowing money into the U.S. markets at the expense of other investment types.
Tapering fears have also lead to strong divergences within the U.S. equity markets themselves. Anything
viewed as having slower growth rates or even remotely linked to being impacted by rising bond yields
(the likely result of tapering) has been shunned. On the other side of the performance spectrum,
traditional metrics of valuation and asset allocation have been thrown out the window as speculative
“hot” money chases growth and momentum.
Some 2013 examples are below:
1) Stocks with the highest price to earnings ratios (P/E) have performed the best (they historically
have done the worst). The stocks that have done the best for us over the last 5 years,
fundamentally solid investments with well covered dividends, have lagged while the herd chases
after the momentum.
a. Stocks like Tesla sport a valuation that is ½ of GM’s but with only about 1/100 of GM’s
sales volume
b. Netflix (NFLX) P/E ratio approached 440 (10-20 would be considered normal for most
blue chips—high growth companies are often given higher ones but this is absurd) until
their CEO even came out and said his stock is in a bubble
c. Some other high flyers: LinkedIn P/E 650.16 Facebook P/E 218.17
2) Stocks with the lowest or zero dividends have done the best (historically they have done the
worst). Over 50% of the return for the S+P 500 since post WWII has been from dividends alone!
a. In a frenzy to buy stocks with growth-- a dividend is currently viewed as a drag on
potential expansion
3) Margin debt (borrowing money to buy more investments) is at the highest amount it ever has
been as investors leverage up for expected returns.
I’m in no way saying that the whole market is dramatically overvalued or that we are back to 2000 type
levels, I’m just pointing out that it is prudent to be cautious here. While a correction could happen at
any time, I don’t currently foresee a major drop on the near horizon. Unlike past peaks in the market,
the overall valuations of U.S. indices are pretty much “fairly valued” at the moment and we are also in
the seasonally strongest time of year for the market (Nov-Jan).
I have chosen some momentum names for many of you so far this year, but it is with a clear
understanding of what I’m getting into and with the viewpoint that it is a trade. However, I do see the
momentum names as very vulnerable to a major drop. That drop will also likely be the canary in the
coal mine that leads to a broader short term correction. Once the rocket ship stocks run out of fuel, I
believe we will see money rotate from those high fliers into other more undervalued asset classes and
areas.
For those of you whom we employ short term trading strategies and are currently riding some of the
momentum names, just recognize that the party won’t last forever. I would surmise that many of these
names along with the overall market will continue to run into the year end and possibly into Jan. But,
we are nearing the end of the game for these plays and we may likely want to look at them from the
short side in the New Year. For those with longer term focuses or with more conservative income
accounts, there are plenty of attractive investments still out there and we will continue to focus on
buying or adding to positions in attractively priced companies that are best able to increase their
earnings and dividends. These investments are also the ones that will hold up the best over time and
will go down the least when the momentum subsides.
On a personal note, you will notice that I used a lot of I’s in this article rather than we. That is since Dad
is currently recovering from a triple bypass. Thanks for all your concerns and well wishes thus far! He
still has a couple ancillary issues that they are working out so it will be a few weeks yet before he’s back
home and up to snuff.
Finally, I have attached an article below that I found of interest. It is a refreshing viewpoint away from
many of the doom and gloom articles out there right now.
All the best,
Lee
Is Perma-Bearishness a Form of Mental Illness?
Alexander Green, Chief Investment Strategist, The Oxford Club
There was a revealing story in this week's Wall Street Journal...
David Rosenberg, the chief economist and market strategist at Gluskin Sheff & Associates, spent a
decade warning about the health of the U.S. economy and the future of the stock market. That meant
he missed the bull market a decade ago but helped the firm's clients avoid the 2007 to 2008 financial
crisis. Unfortunately, he missed the rebound that followed. (Such is the fate of market timers and other
psychics and clairvoyants.)
However, this past spring the longtime perma-bear changed his tune and became more enthusiastic
about the economic recovery and more bullish on stocks. (Better late than never.) The interesting part
was the reaction of his firm's clients. There was an uprising. One subscriber called him "a turncoat."
Another wrote, "It is too much for me to have another cheerleader." Still another canceled his account
and said, "I don't recognize his work."
This dovetails perfectly with my own experience with longtime stock market bears. They never fail to
see the cloud in every silver lining - and continually seek validation of their view that the country is
broke and going to hell in a handbasket.
There is a problem with this analysis: It is wildly out of touch with reality.
Let's start with the assertion that the country is broke. Corporate profits are at an all-time record - as
they have been for each of the past 13 quarters - and so are profit margins. Corporate balance sheets currently holding more than $2 trillion in cash - have never been healthier.
How about American households? We've been told that families are drowning in debt and saving
nothing. This is true of some families, but not most. Last month the Federal Reserve announced that
household wealth in the U.S. hit an all-time record in the second quarter: $74.8 trillion. Understand this
is assets minus liabilities. Americans as a whole have never been richer.
Bear in mind, it is not my opinion that American businesses and households have never been richer. It is
a well-documented fact.
And Uncle Sam...
How about federal government deficit? Here, indeed, we face a serious problem. But not as serious as
many over-the-top forecasters make it appear. The annual deficit peaked at $1.4 trillion in 2009 and has
been sliding ever since. The Congressional Budget Office projects it will be $642 billion this year - and
will keep falling through 2015.
How about beyond that? That, of course, depends on the level of economic growth, tax revenue and
appropriations. Former Treasury Secretary Larry Summers, the former Federal Reserve chairman
candidate who was apparently too conservative for Democratic lawmakers to confirm, wrote in an
October 14 op-ed piece in The Washington Post that the increase in the federal deficit over the next 25
years could be entirely offset by either a 0.8% decline in spending or growth in GDP by the same
amount.
Personally, I wouldn't bet a nickel that Congress will cut spending, regardless of who is in power. But,
fortunately, we have a good reason to believe the 0.8% increase in GDP will materialize.
Horizontal drilling and hydraulic fracturing (fracking) are creating an energy revolution in this country.
This year the U.S. overtook Russia as the world's largest producer of oil and natural gas, a development
that was unimaginable only a decade ago. America now produces 22 million barrels a day of oil, natural
gas and related fuels. Funny, it seems like only yesterday that we collectively boohooed about our
growing dependence on - indeed, our addiction to - foreign oil.
As my 16-year-old daughter Hannah would say, "That is so yesterday."
You'll notice that gloom-and-doomers on the budget all begin their arguments with the same words, "If
nothing is done, the federal budget deficit... blah, blah, blah."
Yet something will be done. Simpson-Bowles and other bipartisan commissions have already outlined
the steps necessary to reach fiscal sanity. Yes, there is political polarization in Washington and plenty of
heated rhetoric, but entitlement reform is coming.
Why isn't it already here? Because voters let the yahoos in Washington get away with it. I need only
point out the 91% reelection rate for Congressional incumbents in last November's election. Only when
forced to make difficult choices will these blunderers finally act.
This is nothing new, incidentally. As Winston Churchill famously observed, Americans can always be
counted on to do the right thing... after they have exhausted all the other possibilities.
So - to recap - corporate profits have never been greater, corporate balance sheets have never been
healthier, household net worth has never been higher, and the annual budget deficit is going down, not
up.
This doesn't mean the economy can't stumble or the stock market can't fall. They can. But they won't
go down because we are going broke, for one simple reason:
We aren't.
Good investing,
Alex