Read my previous posting for some context. I mention that things I expected to happen last summer (while touring on the bike and writing A Maverick Investor’s Guidebook) have transpired. Good earnings releases preceded improving economic data and markets rebounded (as they always do) from what seemed like an abyss. For example a ‘resources’ fund I launched and managed (with help of junior PM over the latest few years) until May of 2010 rocketed 193.06% in 2009. Even though the fund and track record belong to someone else now, the point is that over the past three months alone the return for it is 48.25%.
As an aside, even though the rate of return for this fund since its inception is a respectable 18% per year, note that I was receiving lots of hate mail during the financial crisis in 2008 to 2009 (from folks who bought the fund at the worst time – this is a phenomenon that takes up a chapter of my new book). Anyhow, most stock markets have enjoyed (like the Toronto Stock Exchange) a healthy rebound in recent months based on improving global happiness, which in turn is caused by a shift in investor expectations. So why the angst?
What’s been happening doesn’t matter, and many investors are now buying into gold stocks, oil stocks (hence the stellar rebound in resource sectors) and the like based on this ‘past’ performance. Firstly, the momentum in gold stocks and the oil price has pretty much stalled. Gold because interest rates are creeping higher (no rate of interest on bullion) and oil is holding up with a crisis in Egypt, but demand at these levels must wane – looking at the cost of filling up my own gas tank makes me want to puke.
Let’s look at some charts (courtesy of J. Aitken, a strategist I respect) for kicks. First, the P/E ratio on trailing operating earnings (a common measure of value – greenhorns can look it up – for stocks and markets) for the TSX has about doubled.
What this means is that investors expect earnings to get better, and are betting on it by bidding up the prices of stocks. The question is not whether earnings are improving, because they certainly are, but are they improving enough to justify today’s stock prices? This is unknown, and the Return on Equity (ROE – again, you might have to do some of your own research if you’re not familiar with this metric) for stocks in the index hasn’t really gotten any better just yet.
So the proof isn’t yet in the pudding. Expectations have a tendency to be either too pessimistic (like they were last summer) or too optimistic. It’s impossible to tell if they’re too optimistic right now, but there are warning signs that cause me some concern. One worry is the (too) sudden bullishness of journalists and TV personalities. Another is the complete lack of concern that the skyrocketing costs of high prices for oil, copper and other inputs may dampen profitability for some economic sectors. Yet another is that rising interest rates, which can be an okay thing if it’s because economic growth is robust at the same time, will nevertheless create downward pressure on profits and valuations for Financials and other financially leveraged businesses. Many investors piled into bonds a bit late into the game, and will suffer some as rates rise (and the value of their bonds declines).
So what do I like? Starting to avoid banks and insurance companies (own lots of bonds you know) and prefer natural gas stocks (demand driven, golly geewiz its cold everywhere) over oil stocks (vulnerable if the uprising in Egypt fizzles). I do believe fundamentally that corporations have much capital spending/upgrading to do after the recession (hence my favouring CISCO and productivity bolstering technology stocks) and there are still some good values (selected Forest Products companies that have restructured drastically as their world collapsed around them over the past few years, Coals, Railways, and such) to be found out there. Love those stocks that haven’t gone up much, and are so out of favour they really can’t go down much since nobody owns them anymore (no sellers).
If I’m right (and I’m no smarter than you) then the cash I have on hand (from reducing holdings in golds, oils, mining stocks) will go right back into these same sectors/stocks if and when the market settles down some – maybe next week, next month or in the seasonally depressed summer months.