July 12, 2021
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Today, we’re sharing this fantastic essay from contributor Dan Ferris, previously published in the Stansberry Digest on July 2.
The daily Digest takes you “inside the room” at Stansberry, detailing the latest finance news and investing opportunities seven days a week. It’s usually only available to paid-up Stansberry Research subscribers, but American Consequences readers can sign up for free here.
Dan Ferris, the Bearish Guy, Channels His Inner Market Bull
If you’re an optimist at heart, you’ll love today’s Digest…
Unlike many of my typical weekly missives, this essay one will not be filled with 10 different reasons to be bearish… with five different examples of speculative excess… or with yet another recommendation to hold a “truly diversified portfolio” (stocks and bonds, cash, gold and silver, and a little bit of bitcoin)…
Instead, this week, I’m channeling my inner market bull to bring you something fresh…
I’ll show you a whole group of stocks that even a market bear can own today. I’ll even tell you it’s time to “buy the dip” in these stocks. How much more bullish could anyone be?
Yes, this really is me, Dan Ferris, the bearish guy. And no, I’m not writing under duress (though I can’t help but think my editors and everybody else at Stansberry Research are at least a little bit relieved that this won’t be another bearish story).
Today, instead of my usual fare, I’ll recommend a trade that I’ve liked off and on for the past couple of years. This trade has already performed well since last fall… And right now, it’s more attractive than it has been at any time in history – going back to at least 1928.
But before I give away all the specifics, we must learn about different types of stocks…
As you likely know, the stock market can be split many different ways…
You can divide stocks into different groups by market cap, specific sector, current momentum, and much more. And as a dyed-in-the-wool value investor, one particular split always catches my attention – two broad groups of value stocks and growth stocks.
Value-stock indexes generally contain the cheapest stocks (above a certain market cap) based on simple metrics like the ratios of price to book value, price to earnings, and price to cash flow. On the other hand, growth-stock indexes generally contain companies whose revenues are growing faster than the rest of the market at any given time.
The fact that some pairs of value and growth indexes contain some of the same stocks is a topic for another Digest. But just know this today… Any overlap doesn’t stop the indexes from performing differently – sometimes very differently – for many years at a time.
What do I mean by differently?
Well, over the past few decades, when growth stocks have performed well, value stocks have tended to perform less well… and vice versa.
I call it the “tick tock” of stock market history because it resembles the swing of a pendulum in a big grandfather clock. The pendulum swings toward value stocks for a while… then back toward growth stocks… then back toward value… then growth… then value… etc.
If you’re wondering why this happens, it’s just a function of human nature… People tend to get excited about one group of stocks, then they get bored and switch to another group.
Generally speaking, value stocks are seen as stodgy and conservative. So when investors are super optimistic and excited about speculating on new technologies and other growth stocks, they tend to leave the stodgier, more conservative stuff behind. (Oil and financial stocks are two good examples of the stodgier, value-type stocks today.) And when investors then feel like they’ve gotten burned by believing too deeply that a “new era” was dawning due to new technologies, they turn back to the stodgy, conservative, old value stocks.
Now, let’s look at how value and growth stocks have exchanged market roles over the past two decades…
We’ll use the Russell 3000 Value and Growth Indexes to track the two groups of stocks. And we’ll start with the most recent period, then go backward in time to the start of the 21st century.
Since the bottom of the financial crisis in March 2009, growth stocks have outperformed value stocks. From March 1, 2009, through today, the Russell 3000 Growth Index is up roughly 675%, while the Russell 3000 Value Index has risen only about 295%…
To understand why investors turned to growth stocks when they did, try to remember what was happening back in 2009…
All stocks were down as fear and uncertainty reigned. But the worst performers were the banks, homebuilders, subprime mortgage lenders (all stodgier, value-type businesses)… and any other business tied directly to the housing bubble. That’s because when the housing bubble burst, investors lost huge amounts of money and soured on those sectors.
More than 100 banks failed in the bust – including large ones like Wall Street stalwart Lehman Brothers and savings and loan Washington Mutual. Home prices kept falling and didn’t bottom until 2012, scaring investors away from any businesses connected to housing.
When investors turned away from banks, homebuilders, and other value stocks, they sought opportunities elsewhere… They turned back to technology and other growth-related stocks.
Of course, right now, you might be wondering why investors abandoned growth stocks to begin with. To answer that question and understand why value dominated in the run-up to the housing bubble peak, we must go back to late 2002 – the bottom of the dot-com bust.
And as you can see in the following chart, value stocks trumped growth stocks in the aftermath of that bust. From the bottom of the dot-com crash in October 2002 until the peak of the housing bubble in October 2007, the Russell 3000 Value Index rose 112%, compared with a 90% gain in the Russell 3000 Growth Index over the same period…
After technology, telecommunications, Internet, and other growth stocks crashed at the end of the dot-com bust, the Federal Reserve lowered interest rates. Lower interest rates meant lower mortgage payments… That made buying houses more feasible for many Americans.
Investors felt burned by the popping of the Internet bubble. Even a cash-gushing, stalwart like router and switch maker Cisco Systems (CSCO) fell nearly 90% from peak to trough.
Folks were fed up with losing money… so they switched to stodgier fare – like the then-cheaper homebuilders, banks, mining companies, and other similar stocks that had been neglected during the dot-com bubble. They also started to invest directly in houses… and TV shows about house flipping began to appear.
That’s really all the history we need…
When the dot-com bubble blew up, investors switched from growth to value. Then, they switched back to growth after the housing bubble popped and triggered the Great Financial Crisis. And for the past decade-plus since then, growth stocks have been in charge.
Growth… value… growth. You can guess what comes next.
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And even better, it looks like the latest transition from growth to value is well underway…
Investors remained in love with growth stocks as the COVID-induced bear market of March 2020 passed and the rebound began. The Russell 3000 Growth Index rose 75% from its bottom on March 23, 2020 through the end of August, while the Value Index climbed 44%…
But by September, the “stay at home” trade in fast-growing technology companies had largely played out. Talk of inflation began to pick up around this time… That’s generally thought to be bullish for some of the more traditional value-stock industries – like oil companies (which might benefit from higher oil prices) and banks (which might benefit from larger interest-rate spreads).
While growth stocks had outperformed their value counterparts most of the time since 2009, a potentially big change started happening at that point… Value took charge again.
Since September 1, 2020, the Russell 3000 Value Index is up 33%. In comparison, the Growth Index has only climbed 20% over the same period.
Now, I must note that the latest trend favoring value recently reversed… Since June 4, the Russell 3000 Growth Index is up 8%. Meanwhile, the Value Index has fallen 1%.
So with that said, you might be wondering if this is really the start of the latest shift from growth to value. My call might seem premature, given the reversal over the past month.
But I believe the past month is merely a dip in the ‘go long value stocks’ trade. Here’s why…
According to our friend Jason Goepfert at SentimenTrader.com, the correlation between value and growth stocks has never been lower going back to 1928. That means investors have never cared about the difference between value and growth more than right now.
So right around the time that value is taking a breather for a few weeks and letting growth stocks catch up a little bit… value has never been more attractive compared with growth – going back nearly 100 years.
In other words, the combination of a one-month dip in value’s recent outperformance over growth and the biggest difference in investors’ appetite between the two groups of stocks looks like the perfect moment to go long value stocks if you haven’t already.
So after more than a decade of you being told to buy every dip in growth stocks, in today’s Digest, I’d like to be the first person to tell you to…
Buy the dip in value stocks right now!
Now, you might be wondering exactly how to execute this trade…
It’s easy… A bunch of publicly traded exchange-traded funds (“ETFs”) exist for this purpose.
The Vanguard Value Index Fund (VTV) is the biggest value-focused ETF that I know…
It tracks the CRSP U.S. Large Cap Value Index, which as its name implies, measures the return of hundreds of U.S. large-cap value stocks. VTV’s roughly 335 holdings include Berkshire Hathaway (BRK-B), the ETF’s largest position, and ExxonMobil (XOM), which is a top 10 position. As of the end of May, financial stocks made up roughly 22% of the ETF’s total holdings. And it’s a Vanguard fund, so the expense ratio is microscopic (0.04%).
It’s large and liquid. And even better, it has performed similarly to the Russell 3000 Value Index… so it should work well for investors seeking to buy the recent dip in value stocks.
(Full disclosure: I currently own a value-focused ETF in my 401(k) account. It’s not the one that I’ve mentioned today… But I don’t want to get in trouble with any lawyers.)
How much will you make if you make this trade today?
I can’t possibly know that… But it’s a good bet that you’ll make more than you would by holding all the stocks that have been “no brainers” for more than a decade.
Nothing outperforms forever. And the sun appears to be setting on the growth-stock hyperbull market.
By going long value stocks right now, I’m trying to reduce risk by buying stocks that are out of favor and have generally performed well for the past 10 months.
And let’s get this straight… Right now, almost nothing in the stock market is out of favor on an absolute basis. Nothing is absolutely cheap. The best thing you can find today is a stock (or group of stocks) that’s relatively cheap in comparison with other stocks.
That’s exactly what this trade is… Value is cheap relative to growth these days, and it’s more out of favor relative to growth than it has been in nearly 100 years. So it has excellent potential to become a great long-term trade.
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If a bear market develops, most long positions in stocks will suffer – and value ETFs are no different…
But given the enormous popularity of growth stocks over the past 12 years, it’s possible that value stocks wouldn’t perform as poorly as growth stocks as the broad market falls.
In fact, a recent Bloomberg Opinion article highlighted the notion that avoiding the most popular momentum plays is all you really need to do to survive a bursting bubble…
Analyst Richard Bernstein called the housing bubble before turning (and staying) bullish in its aftermath. So he’s no perma-bear. And he’s also experienced at spotting bubbles…
Bernstein uses five criteria for identifying a bubble – and right now, all five say we’re in one.
Four of those criteria are increases in liquidity, leverage, initial public offerings, and trading activity. The fifth one is “democratization of the market”… something that has occurred recently through “meme stock” short squeezes and rising speculative call-option buying.
Bernstein’s advice is very simple and overlaps with my own trade idea today…
A policy of avoiding the most bubble-icious sectors would again have limited the damage nicely.
As actor Tom Cruise said in the 1993 movie The Firm, “It’s not sexy, but it’s got teeth.” He wasn’t talking about the markets, of course. But the general point is still valid…
It might not seem sexy now, but I promise you’ll fall in love with the strategy of avoiding damage to your portfolio when the bear market hits (and they always do sooner or later). Investors holding the biggest bubble stocks will soil themselves… and you’ll sleep well.
According to Bernstein, the current bubble is more concentrated in three S&P 500 sectors…
- Communication Services
- Consumer Discretionary
Avoiding these sectors today – which include names as diverse as Amazon (AMZN), Tesla (TSLA), Home Depot (HD), and McDonald’s (MCD) – might feel wrong to most investors.
But I’m sure most folks felt similarly about avoiding Cisco Systems and Microsoft (MSFT) at the peak of the dot-com bubble in the early 2000s… or about avoiding big, well-known banks like Lehman Brothers, Bear Stearns, and Washington Mutual (all three of which blew up and ceased to exist) at the peak of the housing bubble before the last financial crisis.
I believe my trade is ultimately easier than Bernstein’s idea for profiting from this current setup, though neither is especially difficult.
You can do mine in a single step by buying a value ETF. To execute Bernstein’s idea, you would need to look up the individual components of those three S&P 500 sectors and find a way to buy the rest of the index without including them. That sounds like a lot of work… and I’m willing to bet that you’ll get a similar (or better) result by just buying a value ETF.
To be fair, some of the stocks that Bernstein says to avoid are in those big value ETFs. But it won’t matter… because those ETFs will have more of the sectors that are outperforming – like financials. It’s a portfolio constructed by a value-oriented algorithm… It will always lean toward the cheaper large-cap stocks in the market. So it’ll always perform like a value fund.
And that’s what matters most of all right now… The cyclical shift from value to growth is well underway. As long as I’m right about that, the Vanguard Value Index Fund and other value ETFs will continue to attract capital and outperform their growth counterparts.
Since being bullish on something feels so good, let’s add a bonus idea into the mix…
Bernstein also recommends investing in foreign markets today…
Like value stocks, foreign markets have underperformed the big U.S. indexes for years.
And when I hear “foreign,” I immediately think of emerging markets rather than developed markets like Japan and Europe. I never expect too much from developed markets. On the other hand, emerging markets usually offer more upside potential than big, developed ones.
Since March 2009, every major U.S. equity index has handily outperformed the iShares MSCI Emerging Markets Fund (EEM), which is up just 120% in that span. In comparison, the worst-performing major U.S. index – the Dow Jones Industrial Average – rose 358% over the same period.
Given the contrarian nature of the value and growth tick-tock trade, owning some emerging-markets exposure makes similar sense…
When you know you’re in a bubble, the market is less likely to make a monkey out of you if you avoid what everyone else has gone absolutely ape over.
(Jeremy Grantham of asset manager GMO has studied 330 bubbles and says we’re in the third “real McCoy” bubble of his career… He also recommends emerging markets today.)
So if you’re looking for something to do and you’ve taken my bubble warnings to heart…
I hope that I’ve emboldened you a little bit today.
Remember, even during my most bearish phases, I’ve always advocated against selling stocks in an attempt to avoid a bear market. That sort of timing is a fool’s errand.
I’ve always recommended continuing to hold your equities… That’s because human progress is relentless – and you simply can’t afford not to have a stake in it.
Plus, as I always say, when you find a good business trading at a reasonable enough price, you should buy it… It doesn’t matter if you think the overall market is expensive or not.
You can’t afford not to be a long-term equity holder. That’s how the big money is made in equities – by buying right and sitting tight.
You can buy a value ETF right now. Relative to the growth stocks everyone has been in love with for more than a decade, value is more attractive than it has been in nearly 100 years.
The late stages of a huge bull market – like what we’re living through right now – are great times to put on contrarian trades… And buying a value ETF (and maybe an emerging-markets one, too) is perhaps the least risky contrarian trade you can make today.
Plus, with interest rates making most bonds unattractive and the equity bubble making many stocks unattractive these days, this is one of the best long opportunities you’ll find.
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Contributing Editor, American Consequences
With Editorial Staff
July 12, 2021