This market might be in a bubble, so profit by it!

January 20, 202111 Comments

Lately, I’ve seen plenty of market commentary espousing the potential for the markets to be in “bubble territory”. CNN, the internet and (worst of all) the news flow on peoples smart phones have been spewing talk of a market crash. Headlines designed to attract eyeballs, and thus advertising, are geared to grab our attention. Now that “The Donald” won’t be around to provide topical news, the media needs something else to talk about.  A market bubble is a catchy topic, given the past 6 month returns.

Interestingly, Investors who normally pay little attention to market valuations (and/or have little financial analytical background to understand them) are suddenly becoming market timers. Why the change in investor behavior? Perhaps the explanation for this sudden interest in predicting markets is boredom. With the stay-at-home orders across North America, its no wonder that arm-chair investment quarterbacks are appearing out of the woodwork. After all, with so much time on our hands, and access to the plethora of financial commentary available, why not add to the neurosis that we call the stock market? There is a problem with this armchair analysis, however. As is often noted, a little knowledge can be a dangerous thing!

So…are we in a bubble, as the nice man on the TV says we are?

The answer is YES….and NO! My view is that the market looks quite a bit like a barbell at the moment. Let me explain…

YES:

On one side of the barbell, stocks are ridiculously overvalued, and in many cases, technically overbought. Its pretty hard to argue that Tesla is fairly priced at 350 time forward earnings. It sits at 100% ahead of its 200 day moving average. Its also pretty hard to make a case for buying solar and green energy stocks with 100x PE ratios and equally overbought technical indicators. I blogged on these sectors recently.

Its also optimistic to imagine FAANG names like Amazon (chart below) or Netflix as cheap. This, when they trade at over 80 time forward earnings. Thankfully, some of these stocks have been consolidating in a sideways trend. This is constructive, but these stocks have a history of moving in range-bound patterns for many months at a time (eg.: Amazon from 2018 to 2020) – leaving me to think that the market is biding time while the earnings catch up to the price as they consolidate.

Then, we have the “stay inside” stocks. Even after its 35% decline, Zoom is still overpriced at 135x forward earnings. Peloton trades at over 400 times forward earnings, and is about 50% ahead of its 200 day moving average.

Overbought stocks like the FAANGs, Tesla, and stay-inside stocks have significant influence on the major stock indices. That’s why the S&P 500 has a trailing PE of 38 – which is it’s third highest in history. So, yes, some market indices are expensive, because they are overweight expensive stocks. Like the S&P 500 index. Chart below, courtesy www.multipl.com.

 

NO:

On the other side of the barbell are the cheap stocks like we hold in the ValueTrend Equity Platform. Some of the sectors we’ve been buying recently include: Utility holdings range in the 18-23 times forward earnings range, and pay substantial dividends to boot. Many, like BCE (which we recently added) are just moving off of major support zones. Stocks in the material sector trade at less than 30 times earnings. Infrastructure holdings such as Brookfield Infrastructure (which we also hold) are quite cheap and are nowhere near overbought.

We’ve also located stocks from the technology sector that are cheap when compared to the astronomical valuations of the stocks discussed above. Although we recently sold Intel in the high-$50’s, that stock was cheap when we bought it in the mid-$40’s.  There are value stocks out there, you just have to look for them. Even some of the country indices, on a relative basis to the US markets, are cheap. I noted on my last blog that Canada’s TSX 300 weighting in materials and energy puts it in a superior position to many world indices. Emerging Markets and some European markets are also in our portfolio.

So, yes, some overpriced stocks make the market indices expensive. But… not ALL stocks, not ALL sectors, and certainly not ALL indices, are expensive. In fact, many are downright cheap!

 

A final argument for owning well chosen stocks

Have you looked at interest rates on bonds, GIC’s and bank accounts lately? TINA (“there is no alternative to stocks”) will continue to drive the markets. The absence of a fixed-income yield of any significance influences investor behavior like no other time in history. Low borrowing costs and mortgages continue driving capital into equities. TINA, low rates, COVID-related stimulus, a vaccine rollout and a reopening of the old-world economy will drive equities in 2021.

It is my strong belief that money has NO ALTERNATIVE to stocks. The returns available to investors are negligible within fixed income securities. Money will continue to seek a home in securities that can offer some growth and inflation protection. It will eventually punish the overvalued sectors on the one side of the barbell, which may indeed harm some market indices. But it still needs a home. That home, we believe, resides at the other end of the barbell. It resides in the sectors we focus on within the ValueTrend Equity Platform. It resides in the sectors I mentioned above: Utilities, reflation names, and overlooked value stocks like infrastructure and old-economy names. It resides in international markets, selectively chosen.

All you need to do is apply some logic to this market to take advantage of the continued rotations that are occurring within the indices. Its my strong conviction that the investors who profit over the next few years will be those who are willing to adapt to the cycles and trends that occur in the final stages of a growth cycle. If you worry that your portfolio isn’t positioned to deal with those challenges, perhaps its time to take a look at ValueTrend. We’re happy to set up a  Zoom meeting or phone call to discuss your personal situation, and how we might help you align it to meet your objectives. Just hit the contact us button at the top of this page, and we can arrange a discussion to see if we can help. You may rest assured that we will shoot straight with you, and we pride ourselves in our friendly, ethical and no-pressure way of doing business.

 

11 Comments

  • Hi Keith,
    Awhile ago, you recommended Loblaw.
    Do you think it is still a good value trade? I was wondering with the stock price in the $63 range, and their Shoppers component underperforming, that it might be a good value pick? Or is it too defensive a pick at this point with a dividend that is not attractive enough?

    Reply
    • Wendy–it broke support, we waited a few weeks to see if it would revive, it didn’t so we sold. We moved into better pastures. This is the discipline behind effective trading, and it paid off by moving into something better. I do not like the chart and have no plans on re-entering at this moment.

      Reply
  • Well, Keith, Yes I have looked at rates on bonds–all types today. Wince. Borrowers are in the green. No reason for me to lend other than short term and insured. So, yah, I added to some stock positions today. Noted–tech overvalued, utils not so much. I’m relieved to hear that you’re adding old faithfuls for now.

    Reply
  • You mention buying utilities sector.
    I don’t appreciate the value of buying this sector for a growth portfolio.
    Yes they have stable business environment and good dividend yield, but I would not expect very much capital appreciation. Sure if you get 4% div and only 3% appreciation you have achieved 7% which is a decent annual return. But in your growth portfolio are you not looking for higher appreciation?
    Cheers

    Reply
    • Daddyo–sometimes portfolio management is as much about risk-adjusted returns as it is about raw returns. If a big chunk of the market (per the blog) is way overvalued and easily subject to, say, 20% correction, why be in those stocks just because they are more appropriate to the growth mandate? Meanwhile, many of the utilities, per your example (and not an overweight position to us, BTW) represent very good trading opportunities with minimal risk. BCE, which we own, was bought near $54. It has a target of $58-$60. It has a div yield of 6%. If we hold it for 6 months waiting for the target, we make near 10% capital appreciation and 3% of the dividend payout. Not so bad, and the downside is low… our stop point would be a break of $52 by more than a couple of weeks. That’s about 5% downside, and we may have earned a bit of dividend between buying and then having to stop-loss sell if that did occur.
      This is a low risk trade, as are many of the utilities.
      Meanwhile, do you really want to buy into a market where almost every growth stock out there is at risk?
      That’s our logic.

      Reply
  • Keith, you mention BIP above. Did you add the BIP.U or .C shares? And why one vs the other? I ask because I have held BIP.U shares for a couple of years and switched into the C shares when they were offered a few months ago. Happy that I did as the C shares have appreciated better than the U. But, I’m not really sure what the advantage is of one vs the other, other than the tax issues for a Canadian account. Thanks

    Reply
    • We, too have owned it for a few years and got the C shares. We didn’t do any further swapping and ended up keeping both. I believe there are tax advantages for the C shares–do an internet search and there are a few articles on the subject. The Globe & Mail covered the differences quite well – you need a G&M subscription to access the articles

      Reply

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