It has been pretty much a sideways week for the stock market. In spite of worsening situations in Iraq and Ukraine and a huge negative revision to GDP stocks just keep chugging along. There is not a lot of excitement about stocks right now as much as a sort of a mildly positive complacency. As long as the Fed and other global central banks say and do the right thing from the markets perspective and jeep interest rates at rock bottom, most are content to hold the stocks they have and buy more with any cash they get in the door. The only things that matter this week are The Fed and World Cup
To a guy who lives on valuations and favors baseball over all this is a very confusing world. Stocks are being purchased at fairly crazy valuations and no one cares about the Orioles two walk off wins against the White Sox or the feel good story of the red hot Milwaukee Brewers and Hank the wonder dog. It all zero rates and backbiting futballers. I am told the US lost today but moved on to the next round anyway. I am not even going to attempt the fancy World Cup math that created that situation any more than I will ponder the Feds next move. All I know is that rates will be low well into next year at least and I have to put up with all the soccer chatter for another week minimum.
BY any measure the stock market is on the high side of fair. The Tobin Q ratio, Value Line Median Appreciation Index, market cap to GDP ratio and the Schiller PE all tells us that valuations are a little stretched right now. Sam Zell, Seth Klarman and other smart folks have told us that the market is at dangerous levels and that the disconnect between Main Street and Wall Street is setting up a potentially ugly situation for the stock market. Howard Marks tells us that we are not cheap but not yet egregiously overpriced either so we should move forward with caution. According to the Wall Street Journal, Michael O’Rourke of Jones Institutional Trading recently told clients “Each reading and subsequent revision has disappointed. The complacency within markets is at an extreme where only the positive implications are priced in. The problem is there were no positives.” I agree with all of that. The problem is that the stock market doesn’t care what any of us think and is content to just grind its way higher on the tailwinds of global monetary policy.
So what does an investor do in this environment? You really have a couple of choices. You can join the rest of world , totally ignoring John Templeton’s suggestion that doing what everyone else does leads to average results, buy stock and hope nothing bad happens. With a bit of luck stocks ignore Mr. O”Rourkes suggestion that “ there is a reckless optimism bidding the market higher indicating there is little doubt we are in the greed phase. Should the data disappoint or even if we have a simple reality check, this episode is likely to prove to be a major missed selling opportunity” and just keep pushing higher.
Or we could learn to think more like Hetty Green , the woman they called the Witch of Wall Street. As I wrote in my Benzinga.Com article earlier this week “The Grandmother of Value Investing” she was a mean old biddy but she was also a very rich one. Her approach was pretty simple. She made loans with strong collateral and strict covenants with some of her money and would buy select bonds while holding huge cash reserves. When there was a crash in stocks or real estate she would swoop into buy and then hold until it reached a price she thought was on the high side of fair and would sell to overly enthusiastic buyers. A simple strategy but one that made Hetty Green the richest woman in the world at the time.
Wilbur Ross has used a similar strategy to become a billionaire. Sam Zell used it to accumulate several a billion dollars’ worth of real estate. Seth Klarman has used the strategy of being a buyer of last resort to become one of the most successful hedge fund managers of all time. It has been a big part of Warren Buffett’s success over the years. Of course our good friend Mr. Womack used this strategy to make sure he never had a losing year in the stock market.
You don’t have to use it just for stock market crashes either. In the past year alone we have seen silver miners, North American oil and gas drillers, small cap REITs, shippers and commodity related companies fall out of favor and sink to ridiculously low valuations. Looking out five, or even ten years if necessary, there is virtually no scenario under which these stocks do become popular and overpriced again giving us a chance to sell asset bought cheap for inflated prices.
There is another sector that can allow investors to buy very cheap today with the expectation of selling dear in the long run. Yes, I am climbing back up on my small bank soapbox. When you look at the Banking on Profits Portfolio here is what you find. Our current buy rated stocks trade at just 86% of book value on average. The 5 cheapest list last week traded on average at just 70% of book value. The current price to book value average of bank takeover offers is about 130%. That number will go up as the consolidation trend continues and if history is any guide top out above 200% of book value in the future. Even at today’s level the potential gain in a takeover offer is greater than 50% for the average Banking on Profit stock and 85% for out cheapest stocks and that’s at today’s low takeover multiples.
Our banks have solid and improving balance sheets and loan portfolios. Most of them have a strong activist investor that owns a significant number of shares and is pushing for changes leading to a higher stock price or the outright sale of the bank. A lot of portfolio banks are buying back stock below book value. Many have seen insider buying by officers and directors in the past year as the people running the bank know the price of their stock is just too cheap and should appreciate substantially in the years ahead.
I have no idea what the economy will do and how the fed will react. I have no earthly idea how the markets will react to the Feds reaction. I don’t care who wins the World Cup. I know that if I buy things when they are out of favor and cheap and hold them until they are popular and expensive I will make a lot of money over my investing lifetime and I know that if the Orioles pitching continues to improve we have a real shot at this division. Of course I am much surer of the former than the latter!
Song of the week
Almost the weekend and time for the song of the week:
Special offer on Banking on Profits