Continued pressure on bond yields and bad economic data out of China and Europe scared the market today, causing a 3% selloff.  While it is a large point drop, it would only qualify as the 342nd largest percentage drop in history.  Stocks got off to a torrid start to the year and it shouldn’t be shocking to see increased volatility as this year progresses. The global economy has definitely slowed down quite a bit.  There are trade concerns hurting everyone, and in the U.S., we have idiosyncratic issues like Boeing’s 737 problem, that really takes a bite out of our largest manufacturer.  Experiencing a technical recession of negative GDP for 2 quarters, would not be a startling result, nor would it be something that would particularly worry me.

Similar to what we have been saying all year, stocks as a whole are expensive.  However, there are pockets of opportunity that offer a strong margin of safety and highly attractive returns.  There is a reason we are relatively heavy in financial, as is Warren Buffett.  In this sector, we are able to buy stocks at huge discounts to liquidation value, despite the highest capital ratios in history.  These stocks have good dividend yields, which are growing, and most have buyback plans that allow them to take advantage of discounted prices.

In a world where the 10-year Treasury is under 1.6% and there are 15 trillion dollars in bonds with negative rates, what alternative is better than value stocks?  Most of the stocks we own have double-digit earnings yields.  Even if earnings are flat, returns overall should be good.  Naturally volatility jacks up options premiums, so it is an amazing environment for new positions.

If the market were to continue to struggle a bit and we ended up getting exercised on some more puts, we would have the opportunity to make 50-100% on many of these investments over the next 3-5 years, in an environment where I expect very little from the overall S&P 500.  From a macro perspective, we are overdue for a recession, but I also think if we get one it would be much more of a run-of-the-mill type recession, than a 2008.  The sure-fire way to lose in any selloff is to panic. The way to win is to look at ways to take advantage of disconnects in price and opportunity. A few weeks ago, we locked-in a great deal of profits on many of our huge bank and insurance positions such as ALLY, AIG, and Citigroup.  Now we have the opportunity to either buy the stocks or sell puts again at cheaper levels and with higher premiums.  On our long-stock positions, we have covered calls on many to enhance our income generation.

Europe has been getting killed and we see more opportunity there than most other markets.  Under anything other than the worst scenarios imaginable, returns should be good.  If the economy gets a bit better and maybe the outlook improves after Brexit etc., you could see returns on some of those stocks of 100% or more, that is how cheap they are.  Stocks like Barclays and BNPQY are valued as though they will never grow profits again.  I’m much more optimistic.

Here is our latest research reports on BNPQY and AGO for you to enjoy: