July 27, 2015
It’s been a brutal July. After briefly rallying in the wake of the Greek bandaid, the Dow has declined again, down to 17,402—or 5.2% off its recent high of 18,351.
Cyclical stocks have been washed out, and our energy and steel stocks have seen major declines. The market winners have become very narrow, focused on a few tech names that defy gravity. Some of you may think you’ve seen this movie before. If so, I’m pretty sure you’re right.
I never make market predictions, because that’s best left to charlatans who think they can. But any old hand will tell you that a narrow leadership doesn’t bode well for the overall markets. I would expect things to get worse before they get better. That may appear to be a prediction, but it’s not much more than a lowering of expectations.
At such times, many clients understandably ask: if you think there’s more pain to come, why not sell stocks and sit tight? It’s a very good question with some unsatisfactory answers. Aside from the tax consequences and transaction costs of trading, the following reasons hold sway:
- Markets cannot be timed; the short-term direction of market prices is unknowable. While the next trend might be down, it just as easily might be up. To make shifts based on false notions of market direction is, by definition, to make illogical decisions based on the unknowable.
- If the value is there, you don’t sell. Instead, you buy more when prices go down—even if the short-term view looks bleak. Value among steel, energy and emerging markets is the most compelling I’ve seen since 2009. Price to operating cash flow ratios are less than five, which implies a yield of 20% on the underlying assets. That’s not where you sell—that’s where you buy. If history is any guide, buying quality assets at 20% cash flow yields is a recipe for making a lot of money over the next few years. I’ve never seen otherwise. There are no guarantees in this business, but it’s a reasonable expectation.
- These sectors are providing terrific dividend yields as well. The Steel ETF (SLX) now has a forward-looking yield of over 4% while the emerging market ETF (SCHE) is at 3%. If you sell, you lose the yield. Better to stay put and get paid to wait. The yield itself is a firm indication of value that eventually attracts buyers.
Those of you who’ve been with me a long time have conviction in our value strategy, having seen it work (eventually) time and time again. For those newer clients who have never ridden with me through a market storm—given that stocks have only gone up over the past few years—you may want more clarification. I’m here to provide it.
I welcome all calls and emails from all clients. No concern is too small or too big.