Where Are the Opportunities Today?
It’s sort of bizarre for me to hear how so many are planning to just “sell everything” or may have already done so. Investors only seem to consider two options with their money – all in (index funds) or all out. Contrary to the last post which covered the somewhat bearish view of the markets from SIC 2018, I’m going to offer a round of relief for investors with this update on current and future opportunities. Remember, it’s a market of stocks, not a stock market.
Review of the BIG THREE OPPORTUNITIES
At the end of last year, we covered three big opportunities for investors in a three-part series. They are as follows, and these are all still very valid and working quite well in terms of providing risk-adjusted portfolio returns. Risk-adjusted is a code word for returns with limited downside risk.
- Overweight Emerging Markets, Japan, Asia and Europe
- Rebuild Commodities and Inflation Hedge positions for a trade
- Avoid the next bear market in US stocks (and buy aggressively at the lows)
Just that easy, right?
Actually, it’s not really that hard once your free yourself from the shackles of what everyone says you should own in your portfolio. I’m talking about a willingness to own an unconventional portfolio of investments with heavy positions in things like Commodities, Inflation Hedges, and Emerging Markets. I see hundreds of investment portfolios every year (not-managed by ASFA). They own the same thing 100{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of the time. 60{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in stock index funds, which include about 10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} internationals, 30{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in Treasury bond index funds of some sort, and 10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash or real estate. I NEVER see a portfolio with any commodities or emerging market exposure. Larger portfolios tend to own more individual names but here again, they are mostly Dow Jones Industrial Average stocks + Facebook and few banks.
We are repeatedly taught, told, and or guided by industry experts/ managers that you should just keep it simple, own a few index funds, “set it and forget it”. There are indeed long periods of time, where this works well and a basic blend of index funds is hard to beat. The last 5 years has been exactly that period of time. But the next 5 years will not provide the same experience unless you believe that stocks and bonds go up forever in uninterrupted bliss.
Just NOT that easy, right?
In our shop, our clients pay us to manage market risk and purposely adopt unconventional portfolio holdings when market conditions tell us to do so. Sometimes, that means we should just own indexes as we have done largely for most of this bull market. But sometimes, that means we need to own big positions in Emerging Markets, Asia, Commodities, carry higher cash and go lighter on US equities as we are now. In summary, the landscape of where opportunities lie is pretty obvious, but the hard part is getting yourself to act on that information when it’s a bit unconventional. Remember that avoiding a big loss by systematically moving to cash is also an opportunity – to buy low with your capital intact!
Other Opportunities
In this section, I’m speaking specifically to opportunities within the US market at the sector and individual company level. One could conceivably hate the US stock market as a whole, own zero index funds or even short the market, while still accumulating longer-term positions with far greater upside potential. Let’s dive into those.
Real Estate
We like real estate at this level as a bit of a contrarian play on the mass consensus view that interest rates will go vertically higher from here. We are not going to see a vertical move in rates at any time soon but rather a long slog higher over years; just like the last 6 years honestly. Rates will drop periodically especially as stocks run into trouble and we seem to be approaching that situation now. I doctored up this chart of real estate using the IYR ETF in red and compared it to the S&P 500 index shown in Green. Obviously, the two have been tracking each other nicely since 2010, until the end of 2017 when real estate fell out of favor.
Here’s why we like real estate now as an addition to our “alternative” baskets:
- Real estate does not typically have a high correlation to rising interest rates. In fact, real estate as a sector is often the beneficiary of some inflationary pressure, which we’re seeing now.
- The supply/ demand equation for real estate and homebuilders is still very attractive, nowhere near the situation we had in 2006.
- This particular ETF (IYR) also pays about 4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in annual yield and is still annualizing over 9{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}/ year.
- It is currently trading at the bottom of a multi-year, well-defined price channel, which offers us a technical entry point.
- Real estate is an “unconventional” holding (see above).
Next-Generation Opportunities
Students of cycles know that innovation moves in an upward sloping S-curve as it goes from early adopters to mass acceptance to maturity. Today, I see a lot of technology companies that I would put on the “mature” side of the curve where upside growth is probably limited. Apple and Netflix come to mind. Conversely, we are far more interesting in the near tidal wave of companies on the very early adopter side of the curve. These are the “disruptors” that we all have heard of but might not have used them ourselves. These are the very companies that we invest in via our New Power Fund (Innovators, Facilitators, Game Changers, Integrators, Disruptors). There are a ton of them, some just coming to market as IPOs, others are being bought by incumbent IT companies. These are the type of companies on the front edge of the S-curve with enormous opportunities. Please do your own homework on specific companies. This is not a recommendation to buy any specific company at this time.
- 3D printing
- Cyber Security
- Cloud Based Enterprise Software
- Automation and Robotics in products and service
- Blockchain technologies and applications – Oh my this is big
- Energy Storage/Transmission Solutions
- Smart Home / Smart City/ Smart Car
- The Internet of Things
As we heard from the SIC speaker notes in the last update, this is a critical time for the markets. We believe that conditions have changed toward an environment where the trends of the past may be reverting on a different path. In some areas, that might be a new surge of strength and in others, the opposite. What appears obvious is the reality that what has worked well last year or since elections, is not going to be very productive in the months, quarters (years) ahead. It is time to adapt to the new environment, respecting opportunities and new risks where they are today, not where they were in the past.
Stay tuned
Sam Jones
