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Investing in the Most Undervalued Sector Editor’s Note: Today, we have another article from Chris Mayer. He brings you an argument for how the market constantly over inflates certain sectors. He points out the extreme valuations in the financial sector, which we all know is starting to contract. Enjoy… The Market’s Tree Rings
He had a lot of success managing money in the happy market before things turned ugly in 1973-74. “Stocks we had went from 10 times earnings to six times earnings,” Sosnoff reflects. “There I was, Ahab, tangled in my own harpoon whale lines and being carried down to the depths by the malevolent great white whale. Of what did it avail that all my earnings projections were uncannily accurate? We were buried just the same.” All of which is to say there is nothing quite like the right stock at the right time. One interesting guidepost to look at is the longer-term market cycles of what’s in fashion and what’s not. Which brings me to one of my favorite charts. It is a conceptual portrait of market history — stretching back to 1977. Take a look at “The Tree Rings of Markets Past.” This chart marks off the booms and busts of various sectors. You see fat eras of plenty, bulging like swollen rivers after a rain, and you see thin areas of hardship, like parched desert sands:
It shows you the market capitalization share of the S&P 500 by sector. The S&P 500 Index, a popular stock market index made up of 500 stocks, is broken down into 10 sectors, as you can see. Market capitalization is the value of the sector in the marketplace. As stocks rise, market caps swell. ************************************ Imagine Gains of 1,567%, 3,685%, 8,500% — in Just Days or Weeks “Orphan Stocks” are your ticket to these option-sized gains. For the first time ever, you can get the hottest info on these orphan stocks delivered to you before the opening bell... Check it out here before it’s too late… ************************************ Looking at the chart, you can see what’s been popular. In 1980, the energy sector was hot and grew to represent nearly one-third of the S&P 500. It collapsed thereafter, and energy sector investors took a beating. In the 2000 bubble, you can see how technology stocks came to represent an even greater share of the stock market, nearly 35%. I’m sure I don’t need to recall how badly mauled investors in technology were as the bubble popped. The folks who make the S&P 500 Index are always adding and subtracting names from it, so it’s not a true representation of what these sectors did. But the Index still manages to capture the spirit of the past rather well. I love this chart for all that perspective it gives in one glance. And because it shows how great tides shift in the market. Now unfolding is another great shift. You can see how financials have come to represent a sizable piece of the S&P 500. Today, they make up over 21% of the whole. Financials have enjoyed a long stretch of prosperity. If the past is any guide, you want to avoid the dominant sector. Even if you didn’t know anything about the market’s tree rings, you’d want to avoid most financials now. With cracks in the mortgage business giving way, the financials are under significant pressure for the first time in a while. As John Hussman of Hussman Funds shows, financial stocks have many marks against them, generally speaking. Bank reserves against loan losses sit at a 32-year low. Yet overall net charge-offs are up 50% from a year ago. “Given the thin coverage of the banking system for such losses, rising charge-offs and loan loss reserves are likely to bite deeply into earnings,” writes Hussman. Historically, the best time to buy financial stocks is when the group trades for about book value. Yes, as Hussman point out: “Currently, the typical multiples are two and often three times that level.” Most financials, he says, “are only ‘cheap’ based on comparisons with very recent norms and on the assumption that the high profitability levels of recent years will be sustained indefinitely.” ************************************ Two Stocks You’ll Never Hear About from the Major Media The press has scared the U.S. government witless over global warming. In fact, the Supreme Court just opened the door to another round of panicked legislation. But even if you don’t have to believe in global warming, you still have a chance to cash in. Discover two under-$5 companies poised to ride the hysteria to triple-digit heights. ************************************ But let’s get back to that chart for a minute… The energy sector — even after taking a much larger part of the pie — is far from danger levels. As recently as July 2004, energy was sitting there at only six and change. It has expanded since by a sizable margin. Yet even today, it’s less than 10% of the S&P 500 — far from bubble levels. If avoiding the fattest sectors proved helpful, then perhaps giving the skinny sectors a good look might be a good idea. In that vein, note the squeezing of basic materials so tightly it barely registers on the chart. What is the basic materials sector? It’s all the companies that do the dirty work and bring up metals like copper, nickel and zinc. It’s all the stuff that we need to build pipelines and power grids and more. Nothing lasts forever. Things won’t always stay bad and can’t possibly stay good. This is some of the most elementary investment thinking but is painfully true. If you can keep an open mind and remain patient, the goldmine you missed years ago may be right in front of your face before you know it. Sincerely, P.S.: This basic materials sector should be pretty familiar to you. We’ve talked many times here in the Sleuth about the importance of these materials to our growing infrastructure needs. I truly believe that this theme will be here to stay for quite a while. I’m so sure, I even wrote up this report on one specific type of infrastructure play… Check it out here… |
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Chris Mayer, the editor of Capital & Crisis, began his career in banking, specifically, corporate lending, after earning an MBA with a concentration in finance, He later started writing Capital & Crisis, a monthly newsletter that gave Chris' unique brand of financial commentary a more regular and expanded format. With an unusual fondness for old books, old investors and old ideas, Chris fits perfectly into the Fleet Street mold. |
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