Hello Everybody,
This week a milestone was reached with the Nasdaq crossing 5,000 for the first time since the Tech Bubble busted in 2000. Any credible analyst would have told you that the Nasdaq was in a bubble at that time. The problem is that they also would have said that starting in 1996, so if you’d have gotten out of stocks you might have missed several good years of rallies. In fact, many value managers lost a huge portion of their assets and prominent news magazines proclaimed that Buffett had lost it in this “new era.” While you may or may not have gotten caught up in the hoopla of the era, it is very likely that you didn’t fully escape the carnage as most mutual funds, index funds etc. were pummeled in the years that followed. The pain was especially severe in 401K plans where most investors have very limited options, so it was very difficult to avoid the destruction.
This brings us to today. The Nasdaq trades at about 23 times trailing twelve month earnings. This equates to an earnings yield of 4.3%, which is not very attractive. When you consider that stocks such as Apple, Microsoft, and Cisco constitute large portions of that index and trade at below average multiples, you begin seeing that many of the other stocks are quite pricey. Despite this, I don’t believe that the Nasdaq is in a bubble. Instead, there is a much worse area of the market that will likely lead to tens of billions, if not hundreds of billions, of dollars of losses.
The biggest bubble is in fixed income; created through Central Bank policies that are taking any steps possible to lower interest rates to stimulate growth. Currently, depositors in Europe are paying banks in countries such as Germany and Switzerland. Think about that, there are negative interest rates on deposits! Companies from all over the globe are issuing debt at levels that would have been considered impossible just years ago, just like the valuations on those technology stocks in the late 90’s reached levels nobody believed could occur. Actavis (ACT) is a very aggressive drug company that for years had been a mid-tier generic company, before embarking on an acquisition spree for the ages that culminated in 2014 with the $66 billion acquisition of Allergan (AGN), the maker of Botox. To pay for the acquisition, Actavis issued $21 billion in bonds with different expirations. Actavis is a BBB- credit so very average, yet the rate on the 10-year that investors are receiving is a paltry 3.6%. That has historically been an incredibly cheap rate for Treasuries let alone a BBB- company.
You might be thinking, “well I don’t own those bonds so why do I care.” These rates aren’t commensurate with the risks, and are indicative of an incredible bubble in fixed income. A huge portion of investors have significant stakes in bonds through mutual funds and index funds. When interest rates go up, or if spreads widen considerably, which seems quite likely, these funds can take very large losses! It can take several years just to get back to even on only a 1% increase in interest rates, let alone anything more significant than that. For you “baby boomers” counting on fixed income to pay the bills, this is a massive problem that needs to be avoided.
Unfortunately, fixed income isn’t the only problem. Many investors are smart and because they know bonds are a joke right now, they pile into “blue chip” dividend paying stocks. We are talking Procter & Gamble, Exxon, Coca Cola, Boeing, 3M, and Campbell’s Soup. We are also talking REITS and utilities. REITS are the most expensive that I’ve ever seen them; in many cases trading 40-50% higher than their historical averages. So, if you own a real estate fund, good luck!
These formerly high-yielding stocks pay out large dividends because they are growing slowly, if they are growing at all. The valuation ratios have all been jacked up, because of this surge of fund flows into these types of stocks. Most of these blue chips are priced 25-50% higher than they should be in a more normal environment. With a simple regression to the mean, these equities can sell off quite considerably, creating huge losses in your portfolio. Once again, if you own mutual funds or index funds, you are very likely to be sitting on these time bombs. This is not new. In the 1960’s the “Nifty Fifty” were blue chip stocks that caused a 2000-esque bubble that eventually blew up. The problem is, nobody can accurately forecast the timing of the blow up. You just have to either decide to try and play musical chairs and not be the last one standing, like former Citigroup CEO Chuck Prince proclaimed right before the Financial Crisis, or you have to decide not play that game.
At T&T Capital Management (TTCM), we are focused on maximizing long-term risk-adjusted returns. We don’t play stupid games just to be similar to most companies. This puts us at odds with most market participants on many occasions, and now this is certainly the case. We are very much focused on industries that are hugely out of favor such as financials and to a smaller extent energy. Almost every stock we own trades at a discount to book value and single-digit normalized P/E ratios. Going even further, we utilize strategies such as cash-secured puts and covered calls, which can generate considerable income, while reducing portfolio risk. Very few funds employ these strategies, for a variety of reasons. I expect our portfolio to diverge from the overall market by a considerable margin over the next several years. On any one given year we might underperform or outperform, but I believe over the long-term we are likely to beat the indices by a considerable margin given the way our portfolios are structured. Now is the time to make a change. If you have 401Ks with limited options or exposure to mutual and index funds, don’t try and best the last man standing in the game of musical chairs. Protect your capital and let’s focus on value. Some of the best returns for value investors came in the years after 2000, when the indices and technology companies were getting killed. I believe a similar story could play out in the very near future.
Obviously there are no guarantees, but I am just communicating with investors as I’d want to be communicated with if our roles were reversed. If you have any questions, give me a call directly and let’s chat. 805-886-8140