Will your portfolio weather the coming storm?
By Dan Ferris
Since the birth of today’s bull market in 2009, investors have been pouring money into the market… And yet, most folks don’t seem to care at all about the inevitable storm on the horizon.
Take a look at the so-called “FANG” stocks: Facebook, Apple, Netflix, and Google’s parent company Alphabet. Microsoft, Nvidia, and Amazon are frequently included in this group of market bellwethers, too.
They’ve outperformed most stocks over the past decade. They’re often discussed as “no brainer” stocks to hold for the long term because their businesses are viewed as unbeatable. But if you look at these companies’ numbers, you’ll see something else…
For example, Amazon is viewed as a company that can never do anything wrong. When it announces plans to enter a new business, the other stocks in that industry instantly sell off.
However, the future might not be as rosy as it appears for Amazon…
Value guru Murray Stahl – CEO of investment adviser Horizon Kinetics – recently discussed the company in his quarterly investor letter. He noted that current Wall Street estimates assume Amazon’s profit per share will triple by 2022. And since its sales aren’t expected to even double in that time, Stahl explained that Amazon’s profit margins would have to rise from the current net margin of 4.34% to 10.22% to meet that mark. As he concluded…
Even if the company manages to do all this, the share price would not advance unless the shares trade, in 2022, at a [price-to-earnings (P/E)] ratio above 21.45 [times]. If, instead, the P/E ratio is 25 [times], and Amazon achieves all of this margin expansion and all this profit growth, the return to shareholders would be 5.23% per [year]. Again, this makes the unlikely assumption that the company issues no more shares. It does seem like a great deal of risk for a rather unexciting rate of return.
Stahl went through a similar exercise for Netflix… It resulted in a similar conclusion. Starting in late 2017, I sounded similar alarms about Facebook… and the stock lost 19% of its value in a single day last July.
These are all great businesses, but here’s the thing…
Even owning the best businesses won’t save you during the next financial disaster.
In early 2000, most investors viewed tech giant Cisco as the “no brainer”…
But then the dot-com bubble burst, and the stock plummeted nearly 90% in the ensuing bear market. Almost two decades later, Cisco still hasn’t recovered to its dot-com high.
And it isn’t just the big, favored tech companies… Investors also love to scoop up shares of so-called “wide moat” brand-name companies, planning to hold them for the long term.
Stahl reviewed consumer-goods giants Kellogg and PepsiCo in his letter…
He wondered how they’ll maintain their moats as advertising spending and other investment metrics decline. (For example, Kellogg’s ad spending fell 33% from 2010 to 2018.) Neither stock looks expensive at around 14-15 times earnings today, but if Stahl is right and growth fails to materialize as expected, they could actually be overvalued at these levels.
Even owning the best businesses won’t save you during the next financial disaster.
And Stahl isn’t the only one questioning the sustainability of some big-name brands today…
In 2013, investing legend Warren Buffett worked with Brazilian investment firm 3G Capital to buy ketchup maker H.J. Heinz and form packaged-foods company Kraft Heinz.
But in a recent Financial Times interview, Buffett did not disagree that 3G Capital likely sacrificed the long-term health of the business for short-term profits by adding leverage and cutting costs sharply. He denied the problem was underinvestment in the brand, but admitted with potentially worse consequences over the long term: “overestimating the strength of the Kraft Heinz brands and their power with retailers.”
And 3G Capital’s leader, Jorge Lemann, publicly admitted that sentiment last year. As he explained to the crowd during the 2018 Milken Institute Global Conference in April 2018…
I’ve been living in this cozy world of old brands and big volumes. We bought brands that we thought could last forever. You could just focus on being very efficient… All of a sudden we are being disrupted.
The brands owned by Kraft Heinz – a supposedly powerful brand-name company – simply aren’t as strong nowadays as they were in years past, just like Buffett and Lemann said. So it shouldn’t be surprising that Kraft-Heinz’s stock tumbled 27% in a single day in February after the company reported disappointing results. Today, it’s about 30% off its recent high.
Kraft Heinz won’t be the only victim… The same thing will likely surprise the hell out of shareholders of other big brands. That’s why I’ve been cautious about recommending such stocks to my Extreme Value subscribers lately.
Time will tell if I’m right, but the S&P 500 Consumer Discretionary Index currently trades at 24 times earnings, and the S&P 500 Consumer Staples Index trades at 20 times earnings. Those aren’t cheap. They’re the kind of prices you pay when you aren’t worried about anything.
You can also see investors’ complete lack of concern in another place right now…
Gold and related stocks.
As longtime readers know, gold is the longest-tenured financial asset on Earth. It has been around for thousands and thousands of years. Ancient Egyptians used electrum (an alloy of gold and silver) 6,000 years ago. And yet, it’s still around as a real store of wealth today.
Since President Richard Nixon killed the last vestiges of the gold standard in 1971, the metal has risen roughly 36-fold in price. That more than adjusts for the 96% decrease in the U.S. dollar’s value since the Federal Reserve began managing the currency in 1913.
Since Nixon killed the last vestiges of the gold standard in 1971, the metal has risen 36-fold in price.
Which one sounds like the best form of money and the best insurance against monetary or economic catastrophe? Would you rather have a fiat paper currency that lost 96% of its value in a little more than a century? Or would you rather have the most consistently sought-after financial asset that has maintained its value for the past 6,000 years?
Despite that, gold is languishing. And so is the leveraged way of buying it – gold stocks…
Today, gold trades for around $1,280 per ounce, down about 30% from its 2011 highs. Meanwhile, the VanEck Vectors Gold Miners Fund – an exchange-traded fund that contains a basket of gold stocks – is down roughly 70% from its 2011 highs.
If gold were as popular as it should be given its history and the fact that stocks are more expensive than they’ve ever been, there’s no way I’d be able to pound the table like this.
But most investors just don’t seem to be concerned today…
The Volatility Index (“VIX”) – the market’s “fear gauge” – is around 14 today. When investors are panicking, the VIX quickly soars…
We saw that in early 2018, when the VIX soared to around 37 as the markets sold off. And it happened again at the end of the year… The VIX spiked from around 12 in early October to about 37 by late December. The VIX’s highest mark ever was 80 in November 2008. Until then, it had never breached 50. But as you can see, it spikes quickly if investors get fearful.
Since May 2017, I’ve urged investors to be cautious…
Last October, I encouraged folks to buy put options right before the market fell 19% through the end of the year. Of course, as we know, stocks rebounded and the market is higher now. But it hasn’t been a smooth ride.
With the extremely high valuation of the market and low level of investor concern, I believe we’ll see plenty more bumps along the way – even if the bull market keeps chugging along.
And the thing is, you don’t have to know exactly when the next crash is coming… You just have to see all the signs around you and realize that it’s coming at some point soon.
Some folks started becoming bearish in 1996 and 1997. Although the market didn’t bottom for another five or six years, when it did, it was right back to where it had been in 1997.
The same thing happened in the last financial crisis in 2009. But that time, the ensuing devastation was much worse… The market went all the way back down to 1995 levels.
There has never been a better time to think about market cycles. There has never been a better time to question your underlying assumptions about stocks, bonds, and gold.
And there has never been a better time to start preparing for the storm that’s approaching…
When you look back two or three years from now, you’ll wish you’d taken this advice. If you think you can simply jump into any stock between now and then, just remember that Kraft Heinz and Facebook each lost at least a fifth of their values in a single day in recent months.
If that can happen to popular, large-cap stocks, it can happen to any stock on the planet.
Editor’s note: Last week, investing legend Jim Rogers cohosted the FREE online Bear Market Survival Event where he talked to investors about protecting their portfolios from the coming storm…
Event attendees learned why the next bear market will be the worst in our lifetimes… how to know when it’s arriving… how to grow your wealth while others are wrestling with disaster… and much more.
Is your portfolio prepared? Click here to find out.
Dan Ferris is the editor of Extreme Value, a monthly investment advisory that focuses on some of the safest and yet most profitable stocks in the market: great businesses trading at steep discounts. His work has been covered extensively in Barron’s and other respected news outlets.