This June, we observe the 10th anniversary of the beginning of the Financial Crisis. It was ten years ago when two Bears Stearns hedge funds went bust due to subprime mortgage bets, and the situation got progressively worse from there. If you don’t know your history, you are doomed to repeat it. I remember that period of time very well. I was living in Orange County, Ca, which was considered the mecca of subprime mortgage lending, when the consensus was that “housing prices can only go up.” As Mark Twain is purported to have said,
“History doesn’t repeat itself, but it often rhymes.”
Now it is June of 2017, housing is once again incredibly expensive, although not anything like it was back then. Much more concerning to me are prices for bonds and many sectors of the equity market. Junk bonds excluding the somewhat distressed energy sector, are yielding a paltry 5.2%. Still that spread is more than 300 basis over the 10-year Treasury yield. If junk bonds are yielding, just over 5%, how do you get the 8-9% returns that most market participants expect in things like mutual funds or ETF’s? Well, perhaps the answer is in equities. I mean, market performance since 2009 has been exceptional, right?
The inflation-adjusted P/E of the S&P 500 is 30.1, 79.2% higher than the historical mean of 16.8. The P/E of the S&P 500 is 25.79, which is 64% higher than the historical mean of 15.66. It has been 8 years since our last recession and while I don’t believe one is imminent, if we go five years withoutfacing one from this point in time, I’d be quite surprised. This has already been one of the longest economic expansions in American history, although far from the fastest of course.
Many commodities such as oil and iron ore are down dramatically over the first half of this year, yet the stock market has been very stable. To this market observer, the optimism has gotten far too pervasive. It isn’t just the obviously speculative glamour stocks such as a Tesla or a Salesforce.com, which lead me to this conclusion. If you look at the valuations of blue chips such as Boeing, Procter & Gamble, and McDonalds, it is tough to find a rationale that would justify the prices being paid.
To me the stage is set for permanent losses of capital for most market participants. Those seemingly innocuous allocations to that ETF or index fund where zero attention is paid to price, ends up being that large mistake which sets you back a few years on your retirement goals.
If we at T&T Capital Management were only limited to indices or mutual funds, I’d strongly consider a very large cash position. Knowing that we might miss out on short-term gains if the market continues to rally.
Fortunately, as deep value investors, we are able to identify those underappreciated opportunities where the stocks trade at deep discounts to intrinsic value.
Of course these opportunities often come in the form of highly out of favor industries and companies. In my career it has not been uncommonfor people to cringe at or chastise my investment recommendations, because we tend to gravitate to the areas of the market that have either been left for dead, or are hated based on terrible recent trends. If you look at the stocks we have made a lot of money on, you won’t find any of the glamour companies yet I’m proud to say, we have one of the best track records in the business: Tim Travis on TipRanks.com
Despite my overall concerns about the market, I can tell you that we have some incredible opportunities. They are not as obvious as they were last year when we saw so much volatility, particularly in financials, but they are there.
There are at least 7 stocks that I believe should return 50-100% over the next 5 years.
Now keep in mind that I research and follow hundreds, so that percentage isn’t that great when it comes to good opportunities, but that is all we need. I’m adding money as aggressively as I can to my personal and family accounts, given my long-term outlook on these opportunities. We have a major advantage to most market participants in the way that we use options.
Being able to sell cash-secured puts allows us to acquire stock at much lower prices, or generate a very attractive income return, far greater than what you can get in junk bonds. It is often more than double what junk bonds are yielding and sometimes, can be more than 20% annualized.
Many market participants just look at their fund choices in their 401k or other retirement plans, and choose the best ones based on the last 5 or maybe 10 years, without much emphasis on strategy or future prospects. Given this proclivity who wouldn’t want to buy index funds in year 8 of a bull market if you don’t care about valuations? This is why market participants in general tend to buy at the highs and sell at the lows.
The great thing about investing is that we will find out if we are right or wrong and it should be quite conclusive, although the timing is anybody’s guess.
If you have any questions or would like to add to your account, there are some specific opportunities right now that I’d be happy to discuss, so give me a ring at 805-886-8140.
All of these ideas are for long-term investors though, as we put little to no emphasis on chasing short-term profits based on speculation, at the risk of incurring permanent losses of capital. I hope you enjoy the article.