2020 has been a year that will stand out in the history books. Financial markets have seen their own share of history in 2020, including significant inflection points, both those readily apparent, and those that have existed behind the scenes.
In the energy sector, March 9th, 2020 was a significant inflection point, where many energy equities, including Occidental Petroleum (OXY) declined over 50% in a single trading session, and alternatively, leading natural gas equities, including EQT Corp. (EQT), Cabot Oil & Gas (COG), and Southwestern Energy (SWN) actually finished higher amid the energy carnage, as I chronicled and outlined in the following two public articles.
While natural gas equities have shined in the energy complex in 2020, energy stocks, and value stocks have generally continued to be out-of-favor, however, the inflection point might have been reached on November 9th, 2020.
A Record Change In The Relative Performance Of Momentum Stocks Occurred On November 9th, 2020.S&P 500 Equal Weight ETF (RSP) Had Its Best Relative Performance Day Versus SPDR S&P 500 ETF (SPY) Ever On November 9th, 2020!FAANG Stocks Had Worst Relative Performance Day Since Acronym Gained Popularity On November 9th, 2020!
Takeaway Thoughts
Sometimes an inflection point is obvious, hitting an observer over the head, and sometimes it is more discreet, requiring some time to appreciate what has transpired. With energy stocks, which are the fulcrum of the value opportunity, continuing to outperform this past week ending Friday, November 20th, 2020, including the Energy Select SPDR Fund (XLE) rising 5.7%, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) rising 6.6%, and the VanEck Vectors Oil Services ETF (OIH) rising 10.9%, while the SPDR S&P 500 ETF (SPY) declined 0.8%, and the Invesco QQQ Trust (QQQ) declined 0.2%, market participants may look back to November 9th, 2020, and view it as a line of demarcation between the “Have’s” and the “Have Not’s”.
On May 13th, 2016, I wrote a public Seeking Alpha article stating that Apple was trading at its cheapest valuation in a decade.
The total return for AAPL shares since that articles publication was close to 400%, with the S&P 500 Index up roughly 60% over this time frame.
In 2020, I have been more bearish on AAPL shares, securing a 221% gain on AAPL puts, with a February 28th, 2020 closing transaction.
That first sale of the put options was too early, given the melt-down the broader equity markets suffered over the course of March of 2020.
Today is a perfect time to use Apple as a market hedge on the short side, again, as its enormous market capitalization and elevated price-to-sales-ratio will make it hard for shares to move higher going forward.
“I will go to my grave… believing that really loose monetary policy greatly contributed to the Financial Crisis. There were obviously problems with regulation, but when we had a 1% Fed Funds rate in 2003 after, to me, it was pretty obvious that the economy had turned (up) and I think the economy was growing at 7% to 9% nominal in the fourth quarter of 2003 and that wasn’t enough for the Fed. They had this little thing called ‘considerable period’ on top of the 1% rate just so we would make sure that their meaning was clear. And it was all wrapped around this concept of an insurance cut… I’ve made some money predicting boom-bust cycles. It’s what I do. Sometimes I am right. Sometimes I am wrong, but every bust I had ever seen was proceeded by an asset bubble generally set up by too loose policy…”– Stanley Druckenmiller
(Source: Image From Author’s May 2016 Seeking Alpha Apple Article)
Introduction
On May 13th, 2016, I wrote a public Seeking Alpha article stating that Apple (AAPL) was trading at its cheapest valuation in a decade. The total return for AAPL shares since that article’s publication was close to 400%, with the S&P 500 Index up roughly 60% over this time frame.
(Source: Author, Seeking Alpha)
More recently, I have turned somewhat bearish on AAPL shares, especially as the company has continued its climb towards the $2 trillion market capitalization mark.
In fact, earlier this year, I purchased January 2021 puts on Apple shares, and then on February 28th, 2020, I cashed these puts in for a 221% gain, which was too early with the benefit of hindsight, even though I wrote publicly about the risks of COVID-19, including this article, titled “Two Black Swans“, which was published on Seeking Alpha on February 25th, 2020.
Alternatively, you could say I cashed in at a decent time, given the broader stock markets seemingly parabolic rise from its March 23rd, 2020 lows, which has been led by the largest market capitalizations stocks, including Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOGL), (GOOG), Facebook (FB), and of course, Apple.
Whatever logic you subscribe to, I think it is a perfect juncture to take a bite out of Apple shares on the short side again.
Why?
I feel this way for three reasons. First, the company’s sheer size and elevated price-to-sales ratio is going to make it hard to grow robustly going forward, secondly, on a broader valuation basis, shares are no longer cheap, like they were in May of 2016, and third, market participants are using the leading growth stocks as a bet on continued disinflationary pressures amdist the COVID-19 pandemic, yet some combination of a vaccine, treatments, or herd immunity is likely to usher in a historic capital rotation towards value equities and economically sensitive equities.
Apple’s Sheer Size Is A Headwind
Apple’s market capitalization at Friday, July 31st, 2020’s closing price of $425.04 is a remarkable $1.84 trillion. In fact, with a 10.47% share price gain during Friday’s trading session, Apple shares added over $174 billion dollars in market capitalization.
Breaking this down further, that $174 billion gain in market capitalization, if ascribed to one company, would make that hypothetical company roughly the 35th largest company in the SPDR S&P 500 ETF (SPY).
For perspective, the market capitalization of Pepsico (PEP) is $191 billion, the market capitalization of Abbot Laboratories (ABT) is $178 billion, the market capitalization of Saleforce.com (CRM) is $176 billion, the market capitalization of Oracle Corporation (ORCL) is $170 billion, and the market capitalization of AbbVie (ABBV) is $167 billion.
Again, for perspective, Apple gained roughly the amount of market capitalization in a single day, that some of the largest companies in the S&P 500 Index have taken lifetimes to build.
Overall, AAPL shares now compromise roughly 6% of the S&P 500 Index (SP500), and with Friday’s move, they should surpass Microsoft as the venerable index’s largest holding, which will be mirrored in State Street Corporations (STT) SPY product.
The problem with being this enormous, is that Apple is going to have a hard time growing revenues, profits, and cash flows at a rate that make a material impact on the overall size of the enterprise.
Building on this narrative, at a trailing-twelve-month revenue run rate of $274 billion, Apple is selling at an almost 7x revenue multiple for the past twelve months, and revenue has not really grown at all from 2018’s annual levels ($266 billion).
On this note, given this price-to-sales multiple, we have to remember what Scott McNealy, the former CEO of Sun Microsystems said about his company trading at a 10x revenue multiple at the peak of the dot-com bubble era.
‘At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?’
Now Apple is not Tesla (TSLA), which sports a price-to-sales ratio over 10 (though to be fair to Tesla, revenues could surge higher on higher vehicle volumes), however, with Apple’s revenue growth already slowing to a crawl, and the sheer size of Apple’s revenues being so large, it is going to be hard to grow revenues and profits to simply maintain the company’s stock price anywhere near today’s levels, let alone grow it, at least in my opinion.
Apple’s Valuation Ratios Today Are Head & Shoulders Above Where They Were In May Of 2016
Remember, we just established that Apple shares are trading for almost a 7x price-to-sales multiple, with very little revenue growth the past two years. Building on this narrative, the valuation table image below, with underlying data from Morningstar (MORN), is taken directly from my May of 2016 public article.
(Source: Author’s May 2016 Article, Seeking Alpha, Morningstar)
Notice that back in May of 2016, Apple shares were trading at 2.3 times price-to-sales multiple, a 10.3 times price-to-earnings ratio, and a 3.9 times price-to-book ratio.
Today, those valuation multiples for Apple are 6.9 for the price-to-sales multiple, 32.2 times for the price-to-earnings multiple, and 25.2 times for the price-to-book multiple.
(Source: Morningstar)
Given these extended valuation ratios, it should be no surprise that Morningstar had a $285 fair value target on AAPL shares as of July 31st, 2020, which is a tidy 32.9% below Apple’s recent closing price.
Growth Stocks Could Be Hurt In A Capital Rotation
It has already been established that Apple is a growth stock without revenue growth, as their trailing-twelve-month revenues of $274 billion are only modestly above their 2018 fiscal year revenues of $266 billion and their 2019 fiscal year revenues of $260 billion.
This flat-line in growth is decidedly different than their large-cap growth peers. On that note, an analyst can say whatever they want about Alphabet, Amazon, Facebook, and Microsoft, and some of these companies are ridiculously overvalued too, in my opinion, however, at least these companies are firmly growing revenues.
Building on this narrative further, we know that growth stocks have outperformed their value counterparts for the better part of 13 years now.
(Source: Nomura)
This outperformance has grown amidst the COVID-19 outbreak, with growth stocks actually less sensitive to asset manager’s modeled COVID factors than their value peers.
(Source: Los Angeles Capital Management)
This makes sense as many of the leading growth stocks like Amazon, Netflix (NFLX), and Shopify (SHOP) have actually benefited, on both a relative and absolute basis, from the lifestyle changes that COVID-19 has engendered.
Apple has fit firmly into this camp, with shares making new all-time highs, as they have gotten a revenue boost from more employees working from home, and the resulting technology spending.
The fly in the ointment here is that Apple is really not a growth stock these days, even with their recent quarterly earnings that came in better than expectations, so it has been lumped in with the positive leading growth stock beneficiaries of the COVID-19 pandemic, yet Apple has not yet seen a commiserate, sustainable boost in their business, at least on the same percentage terms as some of their peers.
For example, Amazon is Apple’s closest peer in terms of market capitalization, and Amazon reported earnings on the same day as Apple, and the company topped their consensus revenue estimates by roughly 10% for the second quarter of 2020, showing overall revenue growth of 40% year-over-year that dwarfed their larger capitalization rival, with Apple reporting 11% revenue growth year-over-year.
Closing Thoughts – Apple Is A Terrific Company That Is Significantly Overvalued
Back in May of 2016, I could not say enough good things about Apple’s stock from a value perspective. Today, with Apple’s price-to-sales, price-to-earnings, and price-to-book multiples all significantly higher than they were in 2016, and with the company showing a lack of revenue growth the past three years, I am much more skeptical on shares.
So skeptical, in fact, that I purchased Apple January 2021 puts on January 24th, 2020, and then took a 221% gain on these a few weeks later.
(Source: The Contrarian)
With Apple shares climbing even higher in the summer of 2020 than they were earlier in the spring of 2020 before the COVID-19 outbreak, I think now is the ideal time to use a short position again in Apple shares as a hedge against a broader market decline. This hedge serves dual purposes for me personally, which are protecting my long positions, and guarding against a capital rotation where in-favor stock like Apple are sold, and out-of-favor stocks that are undervalued, like Antero Resources (AR) that I profiled recently here, appreciate.
Given how overvalued Apple shares are today compared to where they were in 2016, it is also possible that Apple’s common stock underperforms the market, and even declines on an absolute basis, irrespective of the broader markets overall direction.
The possibility of outright declines in Apple’s common shares seems farfetched now, with the afterglow of Apple’s recent multi-year bullish performance fresh in investors’ minds, however, we only have to look back to the first half of 2016 to see an environment where Apple’s stock was out-of-favor.
Shares do not have to go all the way back to their May 2016 levels of $90 per share for current Apple investors to suffer, as simply going back to Morningstar’s fair value target of $285 would imply an outright decline of roughly 33% below Apple’s closing price on Friday, July 31st, 2020.
Wrapping up, without a doubt, Apple has been one of the most remarkable growth stories in U.S. business, particularly over the past two decades. Personally, over the last decade, I have owned Mac’s, iPod’s, iPad’s, iPhone’s, and Apple common shares, so you could even say I am a connoisseur of Apple’s products.
Common shares have appreciated by roughly 500x from their 2000-2002 lows, propelling Apple to become the largest market capitalization stock in the world. Whether you own Apple shares outright or not, most investors have an implicit stake in the company, because Apple has a roughly 6% weighting in the S&P 500 Index and a roughly 12% weighting in the Invesco QQQ Trust (QQQ).
The significant weightings in benchmark indexes are a result of historic run of growth, and many traders front running valuation insensitive and price insensitive index/ETF buying, however, Apple’s revenue growth has slowed and stalled, and its once formidable free cash flow yield (the company generated over $66 billion in FCF in the past twelve months) has shrunk to under 4% as its market capitalization has ballooned. Apple remains a fine company, just an expensive one on a valuation basis, and this poor valuation starting point is a recipe for poor future stock returns.
Disclosure: I am/we are short SPY in a long/short portfolio, I plan on shorting AAPL shares again via put options in the next 72 hours, and I am long AR.
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication and are subject to change without notice.
Earlier today, a public article I posted about Antero Resources (AR) was published on Seeking Alpha. You can find it under this title & link, “Antero Resources Is A Generational Buy: Dispelling The Myth Of Antero As A High-Cost Producer“. While writing this article, and spending a lot of time researching commodity equities, and more specifically energy equities the past 5 years, really the past 7 years, that has snowballed to an almost obsession now, due to the inherent undervaluations, I have slowly worked to the conclusion that most market participants have become over obsessed with quality and/or perceived quality.
What do I mean by this?
In the case of Antero, almost all long/short fund managers I know, are long Cabot Oil & Gas, and short Antero. The relentless price action in favor of this trade, has essentially eradicated valuation sensitive and price sensitive money out the door.
Building on this narrative, the Darwinian survival funnel of the markets, has led almost all investors to the same securities the past decade, a ending place where quality and dividends are praised above all, and the perceived quality, and sustainability of dividend growth, and/or yield is worshiped.
The end result of this process is a bubble that is bigger than the late 1990’s bubble, more pervasive, and more driven by longer-term sovereign interest rates than anything else.
Looking back to 2018, GMO laid out a path for a classic bubble for the S&P 500 Index (SPY), and we are there, as the following graphic illustrates.
Looking at the above, once we peak, and roll-over, the path is frightening, something many market participants have some how forgotten following 2007-2009, and 2000-2002.
Really, though, it is worse than that, as yield-oriented investors have been pushed out the risk curve, and the perceived quality equities, namely the dividend payers, have become essentially the longest duration bonds.
Jumping straight to the punch line, what happens when almost all market participants embrace quality, perceived quality, and are piled into essentially the longest duration assets, chasing yield, when longer-term interest rates rise?
Who is prepared for this?
Will this lead to the historic bifurcation between the “Have’s” and the “Have Not’s” being closed?
After rising for 24 of the past 33 weeks, and 12 of the past 16 weeks, the iShares 20+Year Treasury Bond ETF (TLT) made a new all-time, intraday high, before closing lower on Friday during the past week (and actually closing lower by a fraction for the week).
Bigger picture, TLT has been on a remarkable run, rising concurrently with the broader U.S. stock market (SPY), as inflation expectations have been in free fall.
Is this rise in the bond market overdone?
Yes, is the unequivocal answer, as there has been an amazing deterioration in both business confidence, and investor confidence.
Closing Thoughts – What Happens If Economic Data Turns Up
With four interest rates cuts priced into the fed fund futures market, including the growing probability of a 50 basis point cut at the July FOMC meeting, what happens if economic data strengthens, and both business confidence and investor confidence improve?
In this scenario, the bond market may have already priced in a future that is different from what actually happens, and this could be the trigger for a capital rotation bigger than the one that occurred from 2000-2002.
For a look at a different research approach, I am offering a 20% discount to membership to “The Contrarian“, the lowest price point since the founding members price, where we have a live documented history dating back to late 2015, including an updated valuation and price target list for over 103 targeted companies, including several companies that offer upside appreciation potential that rivals the best opportunities of late 2008/early 2009, in my opinion.
Additionally, I am offering a limited time 50% discount to a host of research options through this site, including a lower price point option. To get this offer, go here, and enter coupon code “june 22”.
Reach out with any questions via direct message (for members here, I have a couple articles that I will post later this weekend).
Via my research services, or another avenue, please do your due diligence, and take advantage of what I believe is a historic inflection point,
WTK
P.S. Heading out to Costco (COST) with family/kids, and then some errands, so if you sign up or message, I will get back to you later this afternoon/evening.
Investors are crowded into the same investment strategies, sectors, and individual equities, prodded & encouraged by central banks since the GFC.
Almost all investors are positioned for the same outcome, which is either an eventual recession, or the lower for longer narrative prevailing.
These anticipated certainties are why there are so many historic price dislocations today.
At the height of the prevailing bearishness in December of 2018, I was very bullish, writing privately for members of my research services, and publicly with articles such as, “Is Everyone Bearish“, and “2019 Is Going To Be A Banner Year For Value Equities“, which were both published on December 21st, 2018.
Looking back, this bullish stance was partially correct thus far, with the S&P 500 Index, as measured by the SPDR S&P 500 ETF (SPY), up 17.8% year-to-date in 2019 through April 29th, 2019, and targeted undervalued equities, like Chesapeake Energy (CHK), up 40% YTD in 2019, even after its recent pullback.
However, my bigger picture investment thesis, which has focused on the equities that are unloved, under-owned, and out-of-favor, articulated in articles like this one, “Everyone Owns The Same Stocks“, and with “Economic Growth Has Already Bottomed“, has only partially been embraced, as almost all investors expect either a recession over the next 2 years, or a continuation of the “lower for longer” narrative that currently has a python grip around the financial markets.
The surprise first quarter 2019 U.S. GDP reading of 3.2%, which came in far above consensus expectations, and the recent stronger economic data out of China, have done little to change the prevailing sentiment.
Put simply, almost everyone remains skeptical that any cyclical upturn in global growth expectations will have any staying power.
This sentiment, and the tendency of market participants to embrace what is working, has caused some historic price dislocations, such as the relative performance of commodities versus the S&P 500 Index.
Look at that chart above!
If you thought commodities were undervalued in the late 1990’s, the dislocation since 2011 has resulted in 100-year relative valuation levels being tested.
In summary, if you, like me, wish you could go back a decade ago in time(members of The Contrarian can read this last link), similar to Disneys’ (DIS) new Avenger’s movie, and buy the disruptive growth businesses like Amazon (AMZN), Apple (AAPL), Alphabet (GOOGL), Netflix (NFLX), even Microsoft (MSFT), and reap compounding returns that turned out to be hard to believe, I think a similar sized opportunity exists today.
This time, from my perspective, the opportunity is in economically sensitive equities, some of which own tier 1, irreplaceable assets.
Sign Up For A Limited Opportunity
I am very excited about the year ahead, and I want to recruit as many members to my investment research services as possible.
To provide incentive, I have enabled a 20% price discount on memberships to The Contrarian, (founding members still have a lower price, but this is the lowest price offered in a long time) where we have a live history that actually captured the past significant inflection point in 2016.
I am also offering a very well received more traditional research newsletter, a stepping stone to The Contrarian, featuring direct email reports, with an introductory price of $250 for the first 10 subscribers that use the coupon code “half off”, which is 50% off the current annual rate, which will rise at the end of 2019. For access to that, sign up here.
Wrapping up, looking forward, instead of looking in the rear view mirror, is very important in life, and in the investment markets.
Disclosure: I am/we are long CHK, positions in the contrarian portfolios, and short spy as a market hedge.
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
Growth investing has dominated value investing for the past decade.
The pendulum has swung to a rarely reached extreme.
As it swings back the other way, which I believe it has started to do with the price action in October, there should be significant opportunity.
There is an old saying that a picture says a thousand words, so with that in mind, take a look at these two charts, the first from Ned Davis Research, and the second from Chuck Mikolajczak, by way of Alastair Williamson.
Looking at the charts, two conclusions should be abundantly clear.
1. The U.S. equity market has been in a bubble, and this bubble has exceeded the epic 1999/early 2000 peak valuations in certain areas.
2. Growth companies, led by the infamous quintet of Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOGL), and carried along by many others, including NVIDIA (NVDA), and more recently, before its even more recent decline, Advanced Micro Devices (AMD), have been in-favor to the extreme excesses of the late 1990’s, while value stocks have rarely been this out-of-favor historically, on a relative basis.
The price action in October was a wake-up call, with AMZN, perhaps the leading flag carrier for the markets broader price action the past decade, down -20.2%, and cast aside, forgotten companies like Southwestern Energy (SWN), which is one of my favorite buy-and-hold investments today for the next decade, up 4.5% for the month, even with the S&P 500 Index (SPY), which is dominated by the large-cap technology growth stocks, down -6.9% for the month.
In an irony of ironies, Southwestern Energy was actually the worst performing S&P 500 Index component from the U.S. equity bull market starting point of March 9th, 2009, through its exclusion from the venerable index in 2017, due to its lower market capitalization, which was caused by its share price decline and severe under-performance.
I would bet almost anything, that Southwestern Energy, which has undergone a very dramatic transformation the past three years that we cover in depth in The Contrarian, outperforms the S&P 500 Index over the next decade.
There are whole studies that cover how unpopular companies outperform, particularly those booted from popular indices like the Dow Jones Industrial Average (DIA), and that is the place to look for opportunity today, in my opinion.
After all, there is a reason that Ibbotson data, now part of Morningstar (MORN), shows small-cap value as the best performing asset class in the market over the long-term.
Sure, this has not been the case for the past decade, but as we showed above, the U.S. equity market has been in a historic bubble, and value equities have been historically out-of-favor.
For a first-look at the forgotten companies that I will be covering in-depth, and have been covering in-depth, please consider joining The Contrarian, which is my premium research service platform on Seeking Alpha.
I am biased, of course, but I think we have the best group of investors and traders anywhere, seasoned by nearly three years of experience together, positive and negative, and commentary for some members, with many members actively contributing their unique perspectives to a robust Live Chat discussion on a daily basis, particularly when volatility surfaces.
Right now, we have an open free trial at The Contrarian, so if you have ever had an interest in test driving our group, now is a good time.
From my perspective, as I said in my blog posts the past two weeks, it would be worth taking a look, simply to view the Live Chat dialogue.
I do recognize that the price point of The Contrarian is a little steep, coming in as one of the more expensive services in SA’s Marketplace.
Over the years, I have had quite a few requests for a lower-priced, more streamlined research product, and over the last several months, I have slowly put together a more traditional research newsletter.
To celebrate this official soft launch, which includes a deep-dive research report on what I believe is an extremely timely equity (delivered via email upon membership), I am offering a limited time $299 annual membershipfor the first 100 members. To get this discounted price, simply use the coupon code “first100”. (WTK’s Note: There are a few slots left remaining at this introductory price).
Ultimately, I think we are now at a major inflection point in the financial markets, highlighted by the price action in October of 2018, which has been ongoing in slow motion for three years, but which could suddenly accelerate. Being different, being contrarian, has been extremely painful for a long time now, however, resilience and persistence, two necessary qualities for success in contrarian investing, in my opinion, are leading to what I believe is an upcoming golden age for active investors.
If you have any questions, send me a direct message at any time,
William “Travis” Koldus
Disclosure: I am/we are long SWN and short SPY as a market hedge.
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
Passive index investing has dominated fund flows for a long time, accelerating over the past decade.
Once vaunted value investors have been left behind, as have a whole group of out-of-favor, forgotten equities.
The pendulum has swung too far to one extreme, and appears to be starting its move in the other direction, offering historic opportunity for forgotten equities.
I grew up, and have spent almost all my life in the great state of Indiana, though I have traveled across the United States, and a little bit of the world (I want to travel more) in my career, and for pleasure.
Growing up in Northwest Indiana, which was really an extended connection to Chicago, referred affectionately to those from this area as “The Region” (I actually used to tell people that it was really like growing up on the South Side of Chicago, but true South Siders take offense to that), I went to college for undergrad studies at Ball State, in Muncie, Indiana, then moved to various suburbs around Indianapolis, working first in a suburb, then in downtown Indianapolis, then in a suburb again, before starting my own boutique investment research firm.
More recently, my life, which is a story on its own accord, for a book that would make interesting, perhaps even good reading, even for those not financially inclined, and my career to an extent, has taken me to various small towns across Indiana (and some of the bigger cities too…which outside of Indianapolis are really pretty small on a national scale, with the possible exception of Ft. Wayne), and even though I love geography, and enjoy driving, it is amazing to me the number of different small towns that I was unaware of, and stories behind them, which I am sure is true in a number of states, however, I have not traveled them nearly as much.
Many of these small towns, dotted in-between the never ending corn and soybean fields, which can be a beautiful backdrop driving, especially in the changing seasons, are forgotten by those in the bigger cities in Indiana, which really, again, there are not many of, let alone on a national scale. Summarizing, I have spent virtually my whole life in Indiana, and I come across new towns and places on a regular occasion, with their own interesting backstory and history.
Building on the narrative, even though Indiana is home to a number of Fortune 500 companies, including Eli Lilly (LLY), Cummins (CMI), Steel Dynamics (STLD), Zimmer Biomet Holdings (ZBH), Berry Global Group (BERY), which honestly I had not heard of before today and I have spent my past 25 years actively research and investing, and Simon Property Group (SPG), and a number of S&P 500 Index (SPY) companies have significant operations located in Indiana, which is a list too big to show in its entirety, including somewhat surprisingly Salesforce.com (CRM), on this note Indianapolis is also a finalist for Amazon’s (AMZN) second headquarters search, and a number of global industry leading companies have significant operations in Indiana including ArcelorMittal (MT), and Roche Holding Ltd (OTCQX:RHHBY), (OTCQX:RHHBF), Indiana is an overlooked state, in my opinion, on a national profile.
Sure, we in Indiana have globally recognized institutions with significant fan followings, including Notre Dame football in South Bend, Indiana basketball in Bloomington (though they have been in a down cycle, they are still a sleeping giant with a level of national success that only a few other programs can match), heck even the much maligned NCAA headquarters is located in Indianapolis.
The college programs and towns in Indiana are terrific from Purdue in West Lafayette, to Indiana University in Bloomington, to Notre Dame in South Bend, to Butler and IUPUI, both in Indianapolis, to Indiana State in Terre Haute, and Rose-Hulman Institute of Technology in Terre Haute (Rose-Hulman, which I go to on a regular basis, and Purdue are two of the finest engineering schools in the country), and right on down through the smaller colleges such as the University of Indianapolis, DePauw University in Greencastle, Indiana, (the only time I ever ran of gas driving, which occurred recently, was near Greencastle, where a nice man, resembling a younger version of my deceased for seven year father, and having his same first name, picked me up and helped me on my way), and Wabash College in Crawfordsville, Indiana.
Speaking of my deceased father, who I wrote about more here, we used to travel the state together for a couple reasons. First, he was an athletic director, and coached a bunch of sports, so by default their was regional and statewide traveling. Second, we both loved Indiana high school basketball, particularly before the winner-take-all tournament was changed, and third, my dad had a love for track-and-field, which he coached at the high school level too, and followed with interest around the state.
Interestingly, the professional sports teams in Indiana, including the Indiana Pacers, which I had tickets too for some time, including when they collided with the Miami Heat team four consecutive finals team, led by LeBron James and Dwyane Wade, and the Indianapolis Colts, probably have less state and national followings that Notre Dame football or Indiana basketball.
In summary, Indiana offers a rich fabric of nationally recognized colleges, and internationally recognized companies, yet while parts of Indiana thrive, there has certainly been a number of small towns, companies, and industries that have been left behind.
On this note, both of my parents were raised in Gary, Indiana, which was once, long ago, one of the most thriving cities in America, yet today, the southern Lake Michigan industrial coast line, from East Chicago to Hammond to Gary, is a shell of its former glory.
Jobs were cut, and industrial production centers centered in the Midwestern United States lost their place in the global supply chains.
Even though the fortunes of many of these companies have been revitalized since commodity prices bottomed early in 2016 (alongside a bottom in global growth), followed by a bottom in sovereign bond yields (with a corresponding top in bond prices), the broader U.S. equity market, which has been dominated by a handful of winning companies, and winning sectors since the current bull market began in March of 2009, has overlooked a small, but significant group of companies, overrun by the passive flow driven rally.
Additionally, many stock markets outside the United States, and associated targeted companies have been left behind too, as global capital fund flows have been recycled to the United States this past decade, driving up the U.S. Dollar Index, and combining with domestic fund flows to passive and ETF passive strategies, to narrow the global equity bull market, led by U.S. equities, to a significantly smaller group of winning companies that one would expect, given the magnitude of the equity rally.
Collectively, the left behind companies and their associated equities, both domestically, and internationally, where there is a greater number of these mis-priced companies, in my opinion, are theforgotten companies.
This is a term, the forgotten companies, that I am going to use over-and-over in the next several weeks and months, to describe the group of undervalued companies that offer rare opportunity, in their equity prices.
For a first-look at the forgotten companies that I will be covering in-depth, and have been covering in-depth, please consider joining The Contrarian, which is my premium research service platform on Seeking Alpha.
I am biased, of course, but I think we have the best group of investors and traders anywhere, seasoned by nearly three years of experience together, positive and negative, and commentary for some members, with many members actively contributing their unique perspectives to a robust Live Chat discussion on a daily basis, particularly when volatility surfaces.
Right now, we have an open free trial at The Contrarian, so if you have ever had an interest in test driving our group, now is a good time.
From my perspective, as I said in my blog posts the past week, it would be worth taking a look, simply to view the Live Chat dialogue.
The price point of The Contrarian is a little steep, coming in as one of the more expensive services in SA’s Marketplace.
Over the years, I have had quite a few requests for a lower-priced, more streamlined research product, and over the last several months, I have slowly put together a more traditional research newsletter.
Ultimately, I think we are now at a major inflection point in the financial markets, which has been ongoing in slow motion for three years, but which could suddenly accelerate. Being different, being contrarian, has been extremely painful for a long time now, however, resilience and persistence, two necessary qualities for success in contrarian investing, in my opinion, are leading to what I believe is an upcoming golden age for active investors.
Disclosure: I am/we are long CLF, MT, X, and short SPY as a market hedge.
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
However, if you look at the chart above, it is interesting that the U.S. Dollar Index has not made a new high this year, even with all of the recent tailwinds, including a sharp downturn in U.S. equities, shown by the SPDR S&P 500 ETF (SPY) below.
Additionally, looking at the bigger picture, the U.S. Dollar Index, even with its recent rally, remains substantially below its 2015-2017 highs, as the longer-term chart shows in the following frame.
Interesting, to say the least.
If the Dollar cannot make new 2018 highs with all the recent tailwinds, and remains materially below its 2015-2017 highs, what does that mean?
Is this a positive leading indicator for equities that would rally on Dollar weakness, including emerging market equities (EEM), developed international equities (EFA), international financials (EUFN), commodities, and commodity equities?
(Travis’s Note: This post was originally written on March 8th, 2018, and I encourage readers to go to the original post to view the comments. The central theme of this article, which essentially boils down to buying-and-holding compounding equities, is a central theme of mine, from an investment philosophy standpoint. Additionally, as part of the discussion, I talk about the “Punch Card Portfolio” in this post, and you will see multiple references to that in reading my research. One last thing, the ground floor of the future sector that I think will thrive is commodity equities, specifically natural gas equities, and more specifically Appalachia natural gas producers, which members of WTKTheContrarian have already received one-deep dive report on Southwestern Energy (SWN), which I believe is the best-buy-and-hold stock in the U.S. market today, with more reports on these companies, and this sector, to be delivered in the future.)
Buying and holding quality stocks is a surefire path to investment success.
This is harder to do in practice than in theory.
Ground floor of a future sector that I believe will thrive.
Wednesday night, and Thursday morning, I worked on, and published, an article for members of The Contrarian that highlighted, what I believe, is one of the brightest future long-term growth opportunities in the United States.
As I was wrapping up this article, and the revisions to the article, it occurred to me, that the best way to participate in this sector is just to buy and hold a select group of companies for the foreseeable future.
Building on this narrative, we all look at the Dividend Champions or Dividend Aristocrats of today, and wish that we could have gone back in time and “bought in” on the ground floor of these company’s eventual successes, like eponymous Seeking Alpha author Buyandhold 2012, who is one of my favorite investors & commentators in SA’s community, and who many investors, including myself, at the tender age of 40, could learn from.
Aside from both being paper boys in our youth (do they even have paper routes for kids today?), our investment paths been very different, and I have learned (often the hard way) that buying and holding quality companies is the best way to get the most out of your investments.
In fact, the more I think about it, there is a compelling case that can be made for buying, and never selling, as this would make investors think about their investments in a different light, and ease the burden of what to do, and when to do it.
Buffett commented about this investment approach, and had a name for it, which he called the “Punch Card” Portfolio, meaning that if you had a punch card, and could only make 20 investments in your life, and that was it, it would make most investors better investors.
Think about that for a minute, as I am sure almost all of us as investors would have run through our 20 “Punches”, as the electronic world of investing is conducive to over trading, and over analysis.
I wrote about the “Punch Card” Portfolio, and John Hempton’s take on this type of Portfolio in an October 20th, 2016 article for members. If you are a member of The Contrarian, click on the above link, and it will take you to this article.
Looking back, most of my biggest investment mistakes in life have involved selling companies too early, as there is no limit to how much a quality company can compound wealth, given time.
The problem today, is that almost everything is overpriced, including many of the stalwart companies in the in S&P 500 Index (SPY), and many of the Dow Jones Industrial (DIA) components, so it is hard to find a quality company that is attractively priced.
This leaves an investor with two primary choices, including building cash to wait for future opportunities, and spending time looking for undervalued companies in out-of-favor sectors.
Instead of purchasing the broader stock market at all-time valuation highs, would it not be much better to buy a sector, or a group of companies, that was selling at multi-decade lows in terms of valuations?
Do these type of companies even exist in today’s hyper valued stock market?
Said another way, are there any “Punch Card” investment opportunities today?
The answer is a resounding yes.
To find them, though, as an investor, you have to look forward, not backward, and this is hard to do too, as almost all of us want to extrapolate the past into the future.
This is human nature, and it causes us to miss opportunities as the investment markets are non-linear in structure.
What if I said that there is a group of companies as undervalued as the best opportunities at 2009’s market bottom hiding in plain sight, with the wind at their back for the foreseeable future?
Clearly this does not describe the broader stock market today, but there are a group of company’s, much like REITs, or small-cap equities in 2000, that are extremely out-of-favor, while the market is extremely in-favor.
Would it help to know that these companies are profitable today, even at the bottom of a nearly decade long bear market in their industry, and just beginning to pay dividends and return cash flow to shareholders?
Would it help to know that these companies own emerging Tier 1 assets in a world that has largely already been discovered and owned?
Over the next several months, I am going to write several public articles on these companies to get commentary and feedback from fellow investors.
For now though, particularly over the next several weeks, I am going to double my efforts for members of The Contrarian, as after a lot of blood, sweat, and tears, I am increasingly coming to the realization that a huge opportunity is right in front of us as investors.
To read my recent article and get a preview of what I think could be long-term quality companies early in their life-cycle, in an emerging out-of-favor sector, consider taking a two-week free trial to “The Contrarian“.
If it is not for you, there are no hurt feelings.
I am willing to face rejections, as I try to put together a unique group of investors, traders, and speculators.
In fact, we would welcome a few qualified dissenters to the group to take the other side of the thesis, and to flush out these investment ideas further, so if that could be your role, send me a message and I will respond.
Best of luck to everybody, and have an enjoyable end to the week,
WTK
P.S. If you have a “Punch Card” stock idea today, meaning a stock that you would buy and hold forever, share it in the comments section, and we could probably get a good discussion going.
Disclosure: I am/we are short SPY In A Hedged Portfolio..
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
(Travis’s Note: This article was originally published on January 22nd, 2018, which, with the benefit of hindsight, ended up being near the peak in the global equity market. Much like 2000, though, when the NASDAQ peaked in March, then rolled over, however, the S&P 500 Index attempted to make a new high in the Fall of 2000, this time something similar happened, with global equities peaking in January, and then the U.S. stock market, specifically the S&P 500 Index, making new highs in the Fall of 2018).
There is no parallel for today’s price action.
Extremes are beyond extreme.
There will be a price to pay when overcrowded trades unwind.
One of my favorite authors is Malcolm Gladwell.
One of my favorite short stories is Gladwell’s 2002 New Yorker article “Blowing Up“, about Nassim Taleb & Victor Niederhoffer.
One of my favorite passages (I have many) from this article is the following:
Physical events, whether death rates or poker games, are the predictable function of a limited and stable set of factors, and tend to follow what statisticians call a “normal distribution,” a bell curve. But do the ups and downs of the market follow a bell curve? The economist Eugene Fama once studied stock prices and pointed out that if they followed a normal distribution you’d expect a really big jump, what he specified as a movement five standard deviations from the mean, once every seven thousand years. In fact, jumps of that magnitude happen in the stock market every three or four years, because investors don’t behave with any kind of statistical orderliness. They change their mind. They do stupid things. They copy each other. They panic. Fama concluded that if you charted the ups and downs of the stock market the graph would have a “fat tail,”meaning that at the upper and lower ends of the distribution there would be many more outlying events than statisticians used to modelling the physical world would have imagined.
Reflecting on a personal level, I have characteristics of both Taleb and Niederhoffer, and I have endured and caused a lot of pain in 2017, both daily , and on a cumulative basis.
Reflecting on the markets, we remain in an unnatural state, where the S&P 500 (SPY) has risen 15 straight months on a total return basis.
It is a melt-up of epic proportions, which comes after an already epic bull market, and the consistency of the advance for the broader market, and for the “Have” stocks (the “Have Not’s” have been left behind in an equally historic move) has removed any objectivity from analysts, speculators, and investors.
To close, we have to chronicle the magnitude and the extremes of the price action, and realize that when crowded trades unwind, there will be nobody else to take the other side of the trades.
Disclosure: I am/we are short SPY As A MARKET Hedge.
Additional disclosure: Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.
(Source: Author’s May 2016 Article, Seeking Alpha, Morningstar)
Interesting, to say the least.
