Garage Sale
Summer is usually a good time for homeowners to engage in the time-honoured purge commonly known as 'the garage sale'. Global stock markets are currently going through just such a winnowing process. GMO (get me out!) investors, shell-shocked from the multiplying headline risks, are taking the junk out to the curb - to be sold at any price. These stocks have not been giving them any joy, I guess.
Now savvy investors, cruising the investing curbside in their Ford F150 sized funds, are starting to load up on some bargains.
As risk asset prices continue to compress, succumbing to the panoply of negative events, the sharks running private pools of capital are beginning to smell blood in the water. In the new world order of negative risk-free rates, everything risky looks cheap by comparison to bonds. That's what the world's central bankers want you to believe as they continue to push the economic rock up the cyclical hill, inflating the bond bubble in the process. The resultant force feeding in our collective risk appetites stemming from these historically low discount rates has created enormous opportunity for deal-making. I think it is just getting started.
Three highly cyclical companies listed on the beleaguered TSX, Transat, Canfor and MICC, have been snapped up in as many weeks. Obviously the public markets, now a shrunken head as compared to their halcyon days of twenty years ago, are no place for a company with even a hint of cyclicality. In a world of hyper vigilant investors, ready to purge any asset with the mere hint of volatility, cyclical and industrial stocks have become portfolio pariahs.
But I seem to recall that value investing usually wins in the long run, or so the CFA textbooks told us 30 years ago.
You remember back in 1989 BI, - Before Internet.
Trouble is, the long run has gotten veeerrry long lately. Non-cyclical Growth stocks have been a one-way bet for 10 years. Playing "The Cycle" is now a forgotten relic, shunned by all but the brave. But there is a glimmer of hope.
The common element of the above listed companies is a high sensitivity to the economic cycle. Their earnings are uncomfortably unpredictable, but with good reason. Swings in consumer confidence and the omnipresent risk of a jobs killing recession are tricky variables to forecast. No wonder they are cheap. As long as fear-mongering pundits can grab airtime on CNBC, they will remain cheap.
But the deep pocketed among us, like Jimmy Pattison, Bruce Flatt and believe it or not, Calin Rovinescu of Air Canada, know value when they see it. Having the luxury of the long view, and unencumbered by the tyranny of short term performance measurement by pesky consultants, they are free to cast their minds forward to a future payday that looks increasingly distant. Especially with this week's headlines loudly screaming 'Recession"!
Meanwhile, back in the trenches, active portfolio managers, benchmarked to the sad sack TSX, continue their Sisyphian tasks of providing investment advice to dwindling number of paying customers. Punch-drunk from repeated cyclical stock collapses and chronic under-performance, these clients continue to bolt from Canadian index investing towards the private equity markets. There, finding comfort from the mirage of low volatility and long term performance, they can sleep comfortably, while avoiding any market turbulence.
But what's this? My PE manager, stuffed with uninvested cash, says all the defensive, stable earnings plays are picked over? They are trading at 20x EBITDA and there isn't enough room on the balance sheet to financially engineer an exit strategy? And now he wants to bottom fish a cyclical? Over my dead investment mandate cowboy!
Does anyone else see the irony? Fire the index guy, give the money to a pe gal, and she buys underperforming cyclicals in the public market.
I'm shaking my increasingly wrinkled head over this lunacy.
I don't want to keep beating a dead horse, but the value trade is digging in its heels here - big time. The corollary to my piece last week - "Show's Over"- the Netflix short sale - is the impending decine in the Growth/Value ratio. Is now the time to buy the Industrials for a bounce?
The last three years have seen similar mean-reversion trades, always centered on the fourth quarter of the year. Tarnished by fears, mostly imagined, of an imminent China economic collapse, these stocks are beat up and cheap. I'm looking to stick in the pin soon.
INDUSTRIAL/TECHNOLOGY ETF Ratio
The key to getting this trade right is patience. There is value here to be sure, as evidenced by the take-over wave that has begun to hit the public markets. Jumping the gun can get you slapped upside the head though. The bottoming process has not even played out yet. We probably need to test the 1.37% 10 year bond yield lows and revisit the 200 dma on the S&P 500 before this is all over. Cash is still king and fear usually gets overdone. Escalators are followed by elevators.
Marie Kondo would be proud of investors getting rid of stocks that do not 'bring you joy" There isn't much joy in this market, but, to some investors there is value.
Risk Model : 1/5 - Risk Off
Last week, in a stunning reversal, fully 25% of AAII Investors surveyed jumped on board the "Bearish" band wagon. It was one of the largest swings on record. It can be easily blamed on the Trump tariff tweet bombshell of two weeks ago, as the survey kicks in with a one week lag to prevailing news. But - wow - what a collapse of confidence. I almost didn't believe the numbers until I clicked on the AAII site.
AAII Bull/Bear Ratio
Can this many investors be simultaneously right? Shouldn't we look for some babies in this bath water? The take-over potential in segments of this beat-down market is compelling evidence of a fundamentally oversold condition. With the stock market once again yielding more that the bond market, asset allocation is favouring stocks over bonds. If only we could get Trump to tweet something positive for a change. Oh, wait a minute, isn't he running for some kind of office next year???