February 5, 2020
Eagle, Colorado
Last month, I said:
“Only 6 days into the year and our country is all but on the brink of a new war in the middle east, this time with Iran directly. The market (so far) seems to not care all that much.”
I did not make one single mention of the coronavirus.
It wasn’t really on anyone’s radar at all – certainly not as a well-known risk to the market. I am not clear on how directly a virus actually impacts market returns, but the major indexes ended up finishing January with a slight loss. The S&P 500 (SPX) was down 0.16%.
For example, on Nomura’s “Event Risk Radar” out on 1/2/20, you will not find “coronavirus”.
All our standard model portfolios finished January with gains. So, I am very pleased to report that. Making money when everyone else is losing is fantastic, and certainly involves some degree of luck. In many respects, I’d rather be lucky than good – but it has also been said that luck is where preparation meets opportunity – and Elevate has prepared well for 2020.
I mentioned the price of oil last month, too. Which was as high as $64.72/barrel in the immediate aftermath of the Iran situation. Today, a barrel of oil trades for $51.50. Oil is down 20% in a month. Oil companies are down more. Exxon Mobil (XOM) trades for the same price you could have bought it for in 2010 – that means 10 years of no returns. And if you bought in 2014 at $104, you are now down 40% in 6 years.
Meanwhile, Tesla (TSLA) shares went up 60% in January. Which is really just a mania. There is no fundamental valuation method that would imply such a price. TSLA started the year trading for around $425/share – which I think was grossly overvalued based on their earnings and revenues – but last night it hit a high of $968… (it is subsequently down 14% today, trading around $765 as of this writing).
I point all this out because it appears to be a referendum on investing in companies that depend on fossil fuels for revenue. The market would rather buy very little in the way of earnings than be forced to deal with the public optics of investing in companies with earnings that are deemed by society to be environmentally unfriendly. For example, over the past 12 months, Exxon made $14 Billion in earnings, and sent $14 Billion worth of dividends to shareholders while TSLA lost $827 Million and sold $848 Million of newly issued shares to investors – thus diluting existing shareholders. TSLA basically financed their losses by selling more shares.
Of course, none of this makes any sense. Any rational person based on fundamental valuations would probably rather invest in XOM. However, the “bigger fool” theory is beginning to take hold. The bigger fool theory basically says that even if it is foolish to overpay for a stock today, we can still make a lot of money selling our shares to a bigger fool later, for an even higher price.
We don’t necessarily subscribe to this method of investing, but at the same time we know that this sort of irrational behavior can go on for a lot longer than anyone thinks possible. And so, we continue to hold positions across the board that are very much overvalued by any fundamental standard. As we watch them become even more detached from reality, we continue to hold on and our trailing stop-loss price automatically increases with each new high set by the shares we own.
If we were to limit ourselves to only buying stocks that trade at rational fundamental values – we’d be stuck investing in things like XOM, which wouldn’t be doing us any favors. Sometimes, all we can do is buy what is going up and hold on (while always minding our stops, of course) even if we know we are buying things that are grossly expensive.
To be clear, we do not have positions in either XOM or TSLA, and we don’t recommend either now.
Last month I also said:
“I am starting to feel euphoria creep back into the market, though. It seems like no matter how bad the news gets about trade wars, real wars, negative yields, massive homelessness, the market just keeps going up. As irrational as it may be to pay double or triple for the same (or even lower) earnings as 10 years ago, the markets can stay irrational for a lot longer than any rational person thinks possible.”
As of today, we can add the coronavirus to the list of negatives that the market doesn’t really care about (at least not really, yet).
Even though it looks like some folks used the virus to take some money off the table in January, the market has bounced right back so far (it’s early) in February.
Our strategies have not changed. We still hold some cash, we still hold our best positions, we still have all our stops in place, we still have some hedges (like gold) in place and we still see no reason to make any material changes to our strategy.
This biggest risk I see ahead is the Fed stepping away from the liquidity table. Right now, the fed is injecting massive amounts of capital into the short-term cash markets, and history says that when they stop – the markets could see some downside pressure. See chart below.
So, this is the biggest near-term risk I see, today. I also understand that like the coronavirus, a meaningful drop in stocks will probably be caused by something that nobody sees coming.
I will leave you with a couple of charts I look at every month. These are produced by JP Morgan Asset Management and are available to the public at this link.
The first chart shows that we are in “uncharted territory” for the most part based on price – and have been for years. The second chart shows that stocks aren’t actually that expensive when compared to the dotcom bubble, or when compared to bonds (look at forward P/E in 2000 and EY Spread ).
With that, I thank you very much for reading.
Until next time,
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisors
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