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Bram de Haas
Bram de Haas
Articles (249)  | Author's Website |

Where to Find Value in a Lofty Market

It becomes much easier to find great investments venturing a little further from home

You don't have to take my word for it. I've reported right here on GuruFocus how Bruce Berkowitz (Trades, Portfolio), Murray Stahl (Trades, Portfolio) and Bill Ackman (Trades, Portfolio) are warning about rich markets and the downsides of the investment landscape being shaped by ETFs. It's not just that a number of amazing investors are saying this either. There's more.

The Shiller price-earnings (P/E) ratio is extremely high. It is only surpassed by the '99 record high:

1497277525951.png

The GDP to total market ratio, also known as the Buffett indicator, is also very high.

1497272901768.png

Insiders have slowed down buying. The buy/sell ratio, tracked on GuruFocus, is at 0.3 which is 33% below the average of 0.4. This is a widespread phenomon across industries. Only energy insiders are buying at an above average rate and in some subsets of the financial industry insiders are net buyers.

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Buybacks have dipped so far in 2017, and they are currently being done in large volumes. Reminiscent of 2008 levels.

The BofA Merrill Lynch High Yield index is at a record low of 5.5%. That means people are charging only a couple of hundred basis points above Treasury rates to fund below investment grade debt.

Consumer delinquency rates are at a historical low level.

consumer delinquency rates

The effect is very interesting because when I search for loan rates from Moneybanker it shows SoFi as having the lowest rates in most of the categories. SoFi isn't a traditional financial institution but a private venture-backed startup. From its Web site (emphasis mine):

We look behind just credit scores and debt-to-income ratios to consider factors like estimated cashflow, career and education. So while other leaders charge higher rates to account for the possibility that borrowers won't pay back their loans, our unique underwriting process helps ensure our members have a high likelihood of making their payments.

I'm sure that's going to work out.

At least this time it is much less likely Main Street will have to bail out Wall Street as the losses will be on venture capitalists.

In summary we have a very lofty market, loose credit and a Fed that continues to tighten. To me the signals are loud and clear: The Standard & Poor's 500 isn't where you want to be.

Enough with the negatives.

Where to find value

Back in January I highlighted gurus switching to emerging markets through the iShares MSCI Emerging Index (EEM) a trade that's still looking very good with valuation ratios significantly below those of the U.S. The Shiller CAPE for emerging markets is just 14.9 compared to the 30 for the U.S. Gurus especially like The Netherlands, Australia, China and Brazil. Even Charlie Munger (Trades, Portfolio) likes it better outside the U.S.

There are also various industries that aren't as highly valued as the rest of the U.S. markets. Energy and asset management both come to mind. The former is down in the dumps due to low oil prices, and the latter is getting killed over the ETF trend. Neither will last and valuations will rebound. It's just not clear when that will happen.

Meanwhile, bargains can be found in both industries like T. Rowe Price Group (NASDAQ:TROW) which got expelled from the S&P 500 and Franklin Resources (NYSE:BEN) for a double whammy as it is both an asset manager and has a lot of exposure to emerging markets through its funds.

Gurus are currently buying biotechnology, REITs and application software. Stocks they like include Shire (NASDAQ:SHPG), Bioverativ (NASDAQ:BIVV) and Gilead Sciences (NASDAQ:GILD) in biotech. QTS (NYSE:QTS) and Vornado Realty Trust (NYSE:VNO) seem to be recurring favorites in REITs. In applications Microsoft (NASDAQ:MSFT), Adobe (NASDAQ:ADBE) and Blizzard Activision (NASDAQ:ATVI) are favorites.

A clear theme here seems to be the defensive nature of their rotation. Biotech has been down since Hillary Clinton started tweeting about price gouging while there's very little reason to expect need for the products to diminish in the near future. Real estate tends to be a more defensive sector and is usually shunned by active managers. Interestingly, it's known to do badly when rates rise. Application software includes many companies with very strong competitive moats and subscription models that are sometimes even mission critical to their clients. These should continue to generate cash flow even in a recession.

The above has led me to focus efforts on finding value outside the ETF universe and pivot away from U.S. stocks toward the continent and emerging markets. There are many unpolished gems to be found; U.S. market valuations in addition to the state of the economy don't lead me to believe it is the best place to look for bargains right now.

Disclosure: Author owns stock in Franklin Resources.

About the author:

Bram de Haas
Bram de Haas is the managing editor of The Black Swan Portfolio

Visit Bram de Haas's Website


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