Value stocks as a driver of performance

We consistently discuss the benefits of “buying low and selling high”.  We are not alone in this regard as many successful investors, including Warren Buffett, tout the advantages of “value” investing.  While value is primarily defined as an investment trading below intrinsic value, there is significant debate about the proper way to measure value for a stock.  In addition, recent research suggests that valuation has little to do with short term future returns, but is very important for long term returns.

In regard to determining value, the price to book value metric has been a widely used valuation measurement.  Book value measures the amount of tangible assets on the balance sheet, and includes things like inventory, cash, and real estate.  Historically, a lower price relative to the book value per share indicates a value stock. Recently, there has been debate on how accurate book value represents stocks in an economy that is heavily reliant on services rather than tangible goods (such as the U.S. economy).  According to Barron’s, service oriented stocks have large percentages of their values in intangible assets like brand name, intellectual property, or customer loyalty.  These assets don’t show up on the balance sheet and would not be included in price to book value calculations.  Therefore, are we excluding investments as “value” stocks simply because the usual measurement system does not properly calculate their value?

With regard to valuation and the influence on future returns, analysis has shown that valuations don’t have a significant impact on returns in the short term, but have been shown to have a large impact on longer term returns.  The JPMorgan Guide to the Markets reflected this in the below charts.  On the left, you see that 1 year returns are relatively random across the valuation spectrum, but over 5 years (the chart on the right) returns are heavily influenced by how much you pay for the investment.

What this means for investors is that assessment of value is not a one-metric analysis.  Factors like price to earnings, cash flow, and the future outlook of the business are all worthwhile metrics to assess a stock’s value.  Second, in the short term, many different drivers can supersede valuations when it comes to returns.  However, as the time period expands, paying attention to company value and “buying low” and “selling high” tends to reward investors over time.

Sources:

  • The Reformed Broker
  • Pension Partners
  • Barron’s
  • JPM Guide to the Markets

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on August 28, 2018 Read More

What’s Going on in Turkey?

The Turkish economy has been strong the past decade so one would inherently believe this is a positive for the country. But recently a combination of issues are pointing towards a potential economic crisis in the country. The economic growth in Turkey has been fueled by too much debt, which is causing:

  • Inflation levels above 15%
  • Rising interest rates; Turkish 10-year government bonds have a 20%+ yield
  • High trade deficits; they import more than they export

The overheated economy in Turkey has also resulted in a currency crash. The Turkish lira has collapsed versus the US dollar as investors are concerned about Turkey’s debt obligations (both government and corporate) to other countries. As the lira collapses, foreign debt becomes increasingly difficult to service and manage. See the chart below illustrating the weakness in the lira:

Also, relations between the US and Turkey are at a low point. Turkey has detained a US pastor accused of supporting a 2016 failed coup in against Turkish President Erdogan. In reaction, President Trump recently announced increasing sanctions and a doubling of tariffs on Turkish steel and aluminum.  This has added to the panic around Turkey, and the world watches and worries about contagion to other regions of the world, particularly The European financial markets.

But let’s put some perspective on Turkey’s economic crisis. On a macro scale, Turkish debt levels are smaller than what Greece was during their crisis several years ago. Outside of a handful of banks, there is not a lot of Turkish bond exposure in the global financial markets. Further, Turkey’s GDP is roughly only 6% of the Eurozone. Yes the Turkish stock market has fallen a lot, but it has become extremely cheap now possibly enticing investors. What global markets are really looking for is an internal Turkish economic plan to battle rising interest rates and inflation.

As of now, the crisis in Turkey is hurting emerging markets around the world, mostly due to US dollar strength versus global currencies. The GTR (EELV only has a 1% exposure to Turkey), G40i (no Turkish holdings), and Endowment (D and E) have international stock market exposure and have been negatively affected as a result. The crisis in Turkey could last awhile longer, but we feel the financial damage to international currency and stock markets has already occurred.

The MSCI EM Index is currently trading at 11.3 times forward earnings. This is a 26% discount to developed markets.  Based on price-to-book EM stocks look even cheaper. Following a nice 2017, returns in EM are weak in 2018 and we think hold value. There are still political and currency risks in emerging market investing, but for those with longer time horizons the risk/reward ratio looks favorable.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

Posted on August 15, 2018 Read More

Two Steps Forward – One Step Back

The choppy markets of 2018 continued to move higher in July as investors reacted to the news of the day.  The headwinds were generally self-induced as Washington rolled out more tariffs in an effort to deliver a world with fewer tariffs.  The final answer here is unknown, but any long-term improvement to free and fair trade will not come without some short-term pain.  The market is handicapping this on the fly, and the days when we saw corrections seemed to correlate with escalating fears of expanding the trade wars.  The tailwinds pushing the market upward, on the other hand, have been a result of strong corporate earnings or positive economic data.

This ebb and flow of positive and negative information is evident as the second quarter earnings season hit full stride in late July.  Two of the FANG stocks were severely punished when earnings and outlooks for Netflix and Facebook fell well short of expectations. As a group, the FANG stocks are down 10% from their June highs.  On the flip side, other companies like Coca Cola, Caterpillar, Pfizer, Apple and Datawatch posted great financial results and shareholders were rewarded.  On the economic front, the U.S. generated a 4.1% GDP growth number in the second quarter which is beginning to reflect the positive effects on our economy of tax cuts, reduced regulations and a confident consumer.

Stocks had their best month since January.  International stocks, emerging markets and the U.S. stock markets all posted healthy gains for the month. The two major international indices (MSCI Emerging Markets and MSCI EAFE) were up 2.20% and 2.46%, respectively, in July.  The much followed S&P 500 gained 3.72% while the Dow Jones Industrial Average posted an impressive 4.83% return for the month.  The technology and biotechnology focused NASDAQ Composite added 2.19% as the FANG correction weighed on the index.

In the bond market, prices fell slightly after the benchmark 10-Year U.S. Treasury yield began a move back up toward the magic 3.0% point.  The benchmark 10-Year U.S. Treasury yield moved up 11 basis points to yield 2.96%. The yield curve continued to flatten: the 2-Year Treasury rose by 15 basis points to end the month yielding 2.67%, and the 30-Year Treasury rose 10 basis point to 2.98%.  While interest rates on longer term bonds are still low by historical standards, the short end of the yield curve is beginning to offer value as the 2-Year Treasury approaches 3.00%.  We still believe owning fixed income securities in your portfolio will not hurt you, nor will they help your assets grow. Their value will either be an insurance policy against a stock market correction or a source of liquidity, income or price stability.

Expect heightened volatility to continue as we move down the road on trade and into the heat of the mid-term elections.  Politics, elections, tweets and rhetoric are background noise which needs to be toned down.  Earnings, valuation and economic results will shape the degree of volatility and the direction of the market.  The latter are fundamentals which we monitor closely and ultimately drive long-term price movements.  Our current market optimism comes from the solid fundamentals of strong earnings and economic growth.  Stay invested and focus on the fundamentals, not the noise.

MARKETS BY THE NUMBERS:

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Posted on August 6, 2018 Read More
 
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