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(Un)Following The Herd

Updated: Mar 15, 2022

Synchronized global recovery? To quote the great American philosopher, Lee Corso, “NOT SO FAST, MY FRIEND!”

No matter where you turn, someone is telling you that <insert asset class here> is the cheapest it’s been in years. I have news for everyone out there: Just because something is cheap relative to something else, DOES NOT MEAN IT CAN’T GET CHEAPER. Moreover, there is normally a reason that it became cheap. Oddly enough, the people calling a particular asset class cheap are the same yahoos that probably told you to buy it in the first place!

Rant over.

If you are wondering which asset classes and sectors I am referring to…I am going to make you wait a little longer. Hopefully the suspense will force you to read this all the way to the end.

The fact of the matter is most people do not have the ability, tools, wherewithal, or resources to reliably trade speculative securities in global markets. If you know someone who says they do, they are probably lying to you. The most brilliant minds in investing have long preached much more vanilla management strategies that revolve around high quality fixed income and core stocks.

This idea was most notably introduced in 1949 by Benjamin Graham. He opined, “the proportion held in bonds should never be less than 25% or more than 75%, with the converse being necessarily true for the common-stock component; that his simplest choice would be to maintain a 50–50 proportion between the two, with adjustments to restore the equality when market developments had disturbed it by as much as, say, 5%.”

Of course, in 2019 this is somewhat oversimplified given the various investment options we have at our disposal. Moreover, many alternative investments help us manage correlation and overall volatility. While this may be true, the core philosophy Graham recommended in his book, The Intelligent Investor, still rings true today: Diversify a portfolio, rebalance said portfolio, and don’t chase returns.

Even though we have more investment choices, the general idea is still the same. Unless someone is speculating with a very high-risk tolerance, every portfolio should have some form of fixed income or cash alternatives. The percentage should vary depending on conditions, but one should never blatantly try to time the market with their allocations.

Now that you all know where I stand on general asset allocation, let’s talk about what Mr. Market is telling us and which direction a handful of important economies are going. (For a more in depth look at the overall market conditions, watch my latest Market Recap).

The United States is slowing. The dramatic drop in domestic equity markets in the 4th quarter should be enough to prove that point, but most economists from leading firms have already called a bottom and are expecting a major turnaround. I would argue that they might be jumping the gun. They all hopped on the “bottoming process” bandwagon as the market went up for 5 straight days and recovered a decent amount of what it has lost from its highs.

Oddly enough, nothing has fundamentally changed. This is especially true in the tech sector.

Tech is one of those sectors I don’t necessarily think is as cheap as it could or potentially will be. Of course, this is all my opinion; however, I have some interesting data to back this up. According to Bloomberg, tech sector earnings peaked in Q2 of 2018. Being a cyclical industry, it is important to watch the rate of change here: Q1 earnings saw growth of 29% YoY, up to 32% in Q2, and slowing to 26% in Q3. The wild multiples some of the household names had, and in most cases, still have, demand massive growth to support them. If growth is not accelerating, then it is decelerating. That means that multiples MUST compress, not expand.

Please note, I am not telling you to go out and sell all of your tech stocks. Rather, I’m putting some important data on your radar screen. Take a look at what you are trying to accomplish in your portfolio. If you are out there buying NFLX and FB because you think they are great long-term investments, and you understand they are inherently more volatile than the broad indices, then good for you. If you are buying them to try to make a bunch of money because they are cheaper then they once were, you may want to take a more pointed look at your investing strategy.

Not so coincidentally, the rate of change in US GDP has tracked closely with the profit growth of tech companies. Surprisingly, companies with excellent cash flow and generally solid balance sheets have still been left behind. I would argue high quality consumer staples and other bond proxies may actually provide a better relative value – IF you are in agreement that the US economy is slowing.

Please note, a broad diversification of equities is always recommended, but certain styles are more attractive at different points in the economic cycle. While this may seem like common sense, exactly where we are in the economic cycle is apparently up for debate. Many of our clients have been asking the million-dollar question “Why are almost all the economic big wigs acting like the global economy is not slowing down?”

To me, it’s pretty frickin’ obvious! But I guess it’s only obvious if you bother to look at data that shows what is happening in the global economy. Analysts at many large brokers are all saying the same thing (or a version of the same thing), “Buy emerging markets and international because they are as cheap as they have ever been.”

To this I must quote another timeless American intellectual, Pepper Brooks, “That’s a bold strategy, Cotton, let’s see if it pays off for them.”

This is my second asset class/sector to raise a red flag on. Yes, emerging markets has a cheap valuation. Same goes for most developed international.

But there is a reason for this in both cases.

EM is cheap because of currency headwinds and general global growth lethargy. Developed international/Europe is cheap(ish) because of continuing policy dumpster fires and serious recession risks.

Here’s a no BS fact people need to take note of: EM and Europe have been cheaper and spreads on forward p/e have been wider. This has happened as recently as the end of 2017, and we all saw what happened to EM and developed international in 2018. (For those that missed it, it was NOT good).

My stance on the whole thing is pretty simple. If you are interested in managing risk and volatility in your portfolio, you need to understand what both terms not only mean by definition, but what they potentially mean to your long-term goals. Next, you need to align your core holdings with those beliefs, but as Ben Graham alludes to, allocate your portfolio based on rules and maintain your diversification.

Final Thought: Portfolio management should be an activity one participates in thoughtfully and humbly. Don’t be afraid to go against the grain if you are convicted and have research to back it up. Not every investment you make is going to work out, but if you stick to a sound set of rules and maintain adequate diversification, you will be alright!



Any opinions are those of the author and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance may not be indicative of future results. Diversification and asset allocation do not ensure a profit or protect against a loss. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing involves risk and investors may incur a profit or a loss. Investing in certain sectors may involve additional risks and may not be appropriate for all investors.

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