The challenge: everyone’s onboard the same train
The most crowded trades in the recent bull market have been:
- US stock market in general
- US growth, in particular
- US dollars
- US Treasuries
- Large-caps & tech giants.
Larry McDonald of Beartraps suggests that the deflationary environment over the past decade has helped all these trades. He suggests that an inflationary environment would bring a much different outcome. He is not alone:
“The next 3-5 years are going to be very, very challenging… for the first time in a long, long time I’m actually worried about inflation,” says legendary investor Stanley Druckenmiller on the Fed. “I think we could easily see 5-10% inflation in the next 4 or 5 years.”. Here’s a link to his outlook.
One possible solution to an inflationary environment:
Commodities like base metals, gold, and even some off the radar commodities like agriculture can be a good diversification against an overbought stock market. Also – Keep an eye on oil for a setup. Its got support at $35. Technical short termed indicators like stochastics and Chalkins moneyflow momentum (top pane) are rounding over – suggesting a bit more volatility ahead. That might let us see $35 soon. Longer termed outlook indicators like MACD and cumulative moneyflow (A/D) are bullish. We’re not in oil yet, beyond one position in a pipeline. But we’re watching. Meanwhile, we do have exposure to base metals and gold producers, and even an agriculture stock. Plus, some emerging markets who benefit from commodity price strength.
The challenge: US large cap stocks are overbought
Druckenmiller, quoted above, is also concerned about the potential for a market bubble (in the US markets):
“Right now, we’re in an absolute raging mania. We’ve got commentators encouraging companies to do stock splits. Companies then go up 50%, 30%, 40% on stock splits. That brings no value, but the stocks go up.”
Which brings us to now. As noted in my prior blog, over the past 3 months it was lonely be an investor concerned about market valuations and technical overbought status, particularly the NASDAQ. Everyone was wondering if the NASDAQ average would ever correct. Now that it is in correction, some investors suggest that it isn’t a real correction. Its a blip. Some thoughts to consider, again from Larry McDonald: “If market participants are in denial, that means they haven’t capitulated. It’s a high risk move to buy in a correction without a capitulation. It can work out, but it’s not the safest of bets.”
Possible solutions in an overbought tech/large capped environment:
I noted above that commodities are an interesting place to consider as an inflation hedge. As an added bonus, they are also non-correlated to large-capped stocks. They march to their own drum. As noted above – that drum (inflation) may become louder over time, especially with the Fed announcing they no longer peg to a 2% inflation rate. MMT (Modern Monetary Theory), here we come! Free money forever! But they are also a diversification away from an overbought equity market. Beyond gold, silver, and lumber (which are neartermed overbought) its pretty hard to suggest that most other commodities are overbought.
Beyond commodities, keep an eye on international markets. Emerging markets are moving. While we do have exposure to a broad EM ETF, we are also buying bits of individual EM country ETF’s. The problem with the broad market play is the China-concentration. That’s been fine so far. But its the other countries like Chile and Brazil that may offer better value, given their sensitivity to commodities. We own the Chile ETF, and continue to look for entry opportunities in a number of other country-specific ETF’s.
Same goes for Europe. Sure, Brexit is back in the news. But where there is uncertainty, there also lies opportunity. We have a small exposure to a broad Europe ETF, and will look to add to it, or buy individual country ETF’s over time.
Finally, there’s value. I’ve been talking about value for some time now. Below is the chart for the US Value index (iShares ETF: JKF). Notice the nice progressive base move, with no overbought parabolic silliness built into this chart:
There’s also the Canadian value side, as illustrated by the iShares ETF: XCV. There’s not a lot of depth here in Canadian stock picking world, so this ETF is somewhat focused on banks and insurance. Still, that does appear to be a cheap part of the market.
Canadian dividend stocks are also looking cheap. Here’s the iShares ETF XDV:
The above charts are illustrations of the concepts of where I am looking. I don’t own any of those ETF’s and don’t necessarily endorse them. However, they are good starting places to consider. At ValueTrend, we like buying a few ETF’s – particularly when it comes to international themes or neartermed sector trading strategies (aka seasonal swaps, broad sector thesis trades like gold, etc). But when it comes to home soil, we tend to focus more on individual stock selection. As such, if you like the look of any of the above charts, consider going to the company website and getting a breakdown of the holdings. There, you may find an excellent shopping list of individual names that may outperform the group. As you may know, an ETF is really just a mixture of the good, the bad, and the ugly within a stock sector or mandate. Its often best to buy the individual names if you are thinking beyond a neartermed trade.