The Writing Is on the Wall, by Brian Nelson, CFA
“The stock market is a no-called-strike game. You don’t have to swing at everything—you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, ‘Swing, you bum!’” – Warren Buffett, 1999
If there is an environment more difficult to hit a pitch out of the park, I don’t think I’ve seen one. Valuations have been shooting to the upside for some time, making it difficult for investors to hit that proverbial home run. The market is climbing a wall of worry—and now, the wall has writing on it. Janet Yellen at the Fed had something to say about valuations in its Monetary Policy Report (1), released July 15:
“…valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year. Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid-1990s and mid-2000s, reflecting improved market sentiment and, perhaps, the influence of “reach for yield” behavior by some investors.”
It’s somewhat unusual for the Fed to make sector valuation calls, which is why we think the Fed wants to say more, but doesn’t want to spook investors in doing so. Small cap managers, for example, have been saying for some time that stocks are as “expensive as ‘they’ve’ ever seen them” (2). Many pure value investors have already stepped to the sidelines.
We credit the Valuentum methodology—which prefers stocks with strong valuation and pricing support—for letting the portfolio’s winners run to keep the outperformance gap moving in the right direction. The Best Ideas portfolio (see page 8) added 70 basis points of outperformance since the last update, and at the time of this writing, Best Ideas portfolio holding Intel (INTC) posted a strong quarter and outlook—it’s up a few points in after-hours trading.
Today, you are at the plate. The crowd is loud. But you don’t have to swing at every (stock) pitch. The Best Ideas portfolio on page 8, for example, is a list of ideas that we think will continue to outperform. Importantly, if you’re chasing overpriced social media and biotechs or reaching for unsupported dividend yields, you’re likely going to strike out. I simply don’t want that to happen.
(1) http://www.federalreserve.gov/monetarypolicy/files/20140715_mprfullreport.pdf
(2) http://blogs.wsj.com/moneybeat/2014/07/07/why-cash-is-king-for-this-small-cap-investor/
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INSIDE THIS ISSUE
1 The Writing Is on the Wall
2 There’s No Space Like Aerospace
5 Ford’s China Sales Continue to Impress (ticker: F, GM)
6 eBay is One of the Cheapest Stocks on the Market (EBAY)
7 Nelson on Bogle, Part I
8 Our Best Ideas Portfolio (see article for tickers)
13 What Causes Fair Value Estimates to Change?
16 How Members Use Our Investment Services
18 The Watch List
20 Featured Reports: NCR, SAVE, WU
23 Our Stock-Selection Methodology
30 How We Use the Valuentum Buying Index in the Best Ideas Newsletter Portfolio