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Strategies for long-term investing in a short-term market
11/20/2013 2:40 pm EST
And, more importantly, should there be?
I think the answer to both questions is “Yes.” Long-term investing has a place even in this macro driven, let’s-all-follow-the-central-banks market. There are big, readily identifiable long-term trends to back with your money.
But…and I think this is crucial…long-term investing not only isn’t easy right now when all the profits seem to be going to the momentum players, but also making money from this strategy requires some rethinking of how to play the long-term game.
I put together some thoughts on this topic for a workshop I gave on November 15 at the American Association of Individual Investors conference in Orlando. This post is a version of that presentation.
It’s pretty easy to spell out why this market is so difficult for long-term investors. We seem to be in a period of repeated booms and busts beginning in 1999 with the Dot com/technology boom and bear and concluding (maybe but I don’t think so) with the Lehman/global financial boom and bust. The current market is one dominated by macro forces, and particularly by cheap money from global central banks. To take just one example, the Federal Reserve’s balance sheet had ballooned to $3.84 trillion as of mid October. That’s up from “just” $488 billion in January 2011. As all that money sloshes around the world in search of opportunities and hot markets, it produces extraordinary short-term volatility. My favorite example of that is August 2011 when from July 6 to August 10 the Standard & Poor’s 500 dropped 16.3%; only to climb 7.4% from August 10 to August 15; before falling 7.1% from August 15 to August 19; before climbing 7.9% from August 19 to August 30. Quite a ride for a year when the total net S&P 500 return for the year came to only 2.1%.
I could advise, as some dedicated long-term investors do, patience—if I thought this kind of market was only going to last for a few more months.
But it’s not. This market is likely to be with us for quite a while.
Why? Let me give you some of my reasons.
We’re witnessing the end of the 30-year bull market in bonds as interest rate drop from the double-digit 1980s. That drop in interest rates has to stop—unless we go to some form of electronic money that lets us set negative interest rates--at 0%. From here on out, stocks don’t have the fuel of falling rates that makes them look ever better versus bonds and that helps increase company profits by lowering corporate interest payments.
We can’t expect the world’s central banks to withdraw the cash they’ve pumped into the global economy any time soon. As I wrote in my November 4 post http://jubakpicks.com/2013/11/04/look-everybody-the-federal-reserve-has-no-end-game-for-getting-its-balance-sheet-back-to-normal/ the Federal Reserve has no end game. It will take the Fed more than a decade to reduce Fed balance sheet to “normal.” Same goes for the Bank of Japan. And, if the global and/or regional economy breaks the wrong way, for the People’s Bank of China and the European Central Bank.
And, finally, I think a number of the trends that pushed up global growth rates are now breaking in the other direction. An aging world grows more slowly. We’re seeing the end of cheap rural labor in China. We’re seeing the beginning of an age of competition for global capital.
With those long-term trends in place, I just don’t think “Be patient” cuts it.
But, fortunately, not all of the long-term trends are negative.
For example, globalization really is raising incomes in developing economies to create new classes of consumers. An aging world may grow more slowly in the aggregate, but aging does create big new markets. Food demand really is growing both in “volume” and for more “up-market” products.
And then there are lots of more “local” long-term opportunities. Just in energy, for example, there are long-term trends pushing toward technologies such as turbo chargers and carbon fiber that raise automobile mileage, toward big profitable investments in moving new sources of energy (U.S. natural gas) to new markets, and toward breakthroughs in battery technology that will “revolutionize” already revolutionary technologies in fields from electric cars to wind and solar power generation.
So what kinds of long-term investing strategy will work best in a short-term world? (Other than getting adopted by Warren Buffett or having your 12-year old daughter write the next “Angry Birds.”)
My suggestion? To create a limited number of narrow long-term opportunity silos holding limited numbers of stocks.
What’s that mean? And why am I suggesting this strategy?
For successful long-term investing in the current market, you’ll have to avoid overpaying and be prepared to buy on weakness.
Which means you’ll need to do the work—lots of work—to know what a stock is worth. This amount of work is more than is really possible to do on very many stocks and companies for anyone to do who doesn’t do this as a full time job.
You’ll also need to understand the short- and medium-term trends that produce volatility so you can distinguish between bumps in the road (which might actually be buying opportunities) and dangerous shifts in fundamentals with significant long-term consequences. Same comment as above pertains: It’s really, really hard to get this kind of in depth knowledge on more than a handful of trends.
And, you’ll need to track and constantly update the risk/reward of sectors and sub-sectors so that you can differentiate between share price drops (or increases) that are appropriate as risk rises and falls and those that are over-reactions because the market is, at least temporarily, miscalculating risk or reword
The easiest way, actually, for me to explain this strategy is for me to give you a couple of examples.
For instance, you might build a long-term narrow silo in the U.S. energy sector. The International Energy Agency recently said that the U.S. boom in oil and natural gas production should run until 2035. In that period, thanks to that boom, the U.S. will have to lowest energy costs in the world outside of the Middle East. Investing in this long-term boom isn’t quite as easy as falling off an oil derrick. We already know that infrastructure bottlenecks can lead to temporary gluts and falling prices. Of course the U.S. boom hasn’t repealed the energy cycle that moves between global scarcity (and high prices) and global surplus (and low prices.) And the obvious stocks in the obvious sectors (such as producers with big positions in geologies such as the Bakken) are expensive. Pioneer Natural Resources (PXD) trades at 40 times projected 2013 earnings per share and Concho Resources (CXO) trades at 28 times projected 2013 earnings per share.
But I’d still suggest building a long-term silo in this opportunity—it’s real; it is actually long-term; and the risk/reward ratio is extremely attractive for enough stocks. Names I’d suggest include Chesapeake Energy (CHK) at 15 times projected 2013 earnings and with an improving balance sheet for risk/reward stability; Cheniere Energy (LNG) as the first (2015) fully permitted U.S. exporter of liquefied natural gas; and as plays on lower U.S. energy costs for chemical producers DuPont (DD) and LyondellBasell Industries (LYB.) Both Chesapeake and Cheniere are members of my Jubak’s Picks portfolio http://jubakpicks.com/
Or how about this second long-term silo—food. Growing global populations mean more demand; rising incomes in the developing world mean more demand; life style changes that come with higher incomes mean more demand. Again there are short-term problems that you need to track. Weather can produce huge price swings in food commodities and so can shifts in government policy such as we’ve seen with milk in China and as I think we’re seeing gradually develop with corn-based ethanol in the United States. Once again the obvious names can be expensive: I like Nestlé’s positioning in developing economies but at a price to earnings multiple of 19 it’s expensive for a stock with a relatively low earnings growth rate. The PEG ratio (PE to Growth rate) for Nestle is 5.1. But there are certainly a lot of great candidates for building a concentrated long-term silo in this sector: DANONE (BN.FP in Paris and DANOY in New York) on double-digit growth in Asian milk consumption, for example, or Industrias Bachoco (IBA in New York) and BRF (BRFS in New York) on protein exports from Mexico and Brazil, respectively.
I can think of other long-term silos.
How about cell phone chips (Qualcomm (QCOM), ARM Holdings (ARMH), and MediaTek (2454.TT in Taiwan))? (Qualcomm and ARM Holdings are members of my Jubak’s Picks portfolio http://jubakpicks.com/ )
Or automotive energy efficiency (Toray Industries (3402.JP in Tokyo) and BorgWarner (BWA))?
Or aging (Tsukui (2398.JP in Tokyo), DaVita Healthcare Partners (DVA) and Novo Nordisk (NOVOB.DC in Copenhagen or NVO in New York))? (DaVita is a member of my Jubak’s Picks portfolio http://jubakpicks.com/ )
Or developing economy Internet (Tencent (700.HK or through Naspers (NPN.SJ) big stake) and Alibaba (still private but IPO likely in 2014))?
I think you get the idea.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did own shares of Cheniere Energy, Chesapeake Energy, DaVita Healthcare Partners, DANONE, Industrias Bachoco, Naspers, Pioneer Natural Resources, and Toray Industries as of the end of June. For a full list of the stocks in the fund of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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