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How to Ride a Bubble Bath
05/22/2013 8:30 am EST
The market has been riding high and a decline could be steep, says Jack Ablin, who shares a few plays he feels are less likely to explode later this year.
Jack, it's great to have you with us. Tell us where we are in the global recovery, and where you see value or maybe pricey markets today.
Sure. You know, we've come a long way since we've been talking in 2008 and 2009, and the markets have really surged forward, largely on the fact that interest rates are so aggressively low.
When we started the year, I pegged the S&P 500 fair value for year-end 2013 at about 1,520. We pretty much blew past my year-end target by the first week of February, and we haven't looked back. While I think that perhaps the market has probably moved beyond fair value, eventually it's going to be a concern that perhaps we could turn some of this froth into a bubble, if we're not careful.
You think that could happen this year?
It's certainly possible. I mean, here the Fed is hell-bent on keeping aggressively easy monetary policy as long as the unemployment rate is higher than 6.5%. I guess my question to Bernanke and Company is, what happens if the S&P 500 goes over 1,700 and the unemployment rate is still 7%? What do you do then? It's hard to know what they'd do.
Well, they're going to keep dropping money out of helicopters.
That's it. I think they want to err on the side of inflation, even if it means asset inflation and bubbles. Just to get the economy moving forward, and just to guard against the possibility of avoiding deflation.
You're not the only major leading expert who's seen the future for us that sees the increasing likelihood of bubbles in our future, and certainly the vast amount of monetary nymphomania that we've had by some 22 central banks.
It's interesting, because you're looking at this as an investment manager, yet you're considering it somewhat of a risk and something that we should be worried about. What's the investment strategy in a moving-toward-a-bubble-possibility market?
Sure. So you know, in this case, we still want to ride that wave.
Normally, we keep momentum circuit breakers slightly below the 200-day moving average. The problem right now, Charles, is that the market is probably 9% above the 200-day moving average, so for us to hit a circuit breaker, we're going to need a decline in the market of something like 14%. I'm not sure I want to sustain a 14% decline before I start cutting back.
Particularly for new money. If somebody puts $1 million with you and you're going to let them lose $140,000, they are not going to like that.
Right. That's unworkable. So, what we have to do is really put the market on a shorter leash. We are continuing to monitor things.
Like I said, we're not still in bubble territory. I'd call it frothy, but not a bubble yet. But if this market continues higher into the 1,600s towards 1,700, we will likely start taking some risk off the table.
You're the largest ETF investor in the world. Can you give me your top five areas right now?
Sure. Our favorite market still remains US Large-Cap Value. That's going to be the area of the market that we like most.
So what's in that? Still some banks?
That would be banks. It would be, actually, health care has shifted into value because of just the years of underperformance. A lot of levered old...telecoms, those kinds of things.
So there are probably a lot of dividends in that group.
High dividends, high leverage.
You're not worried that dividend stocks themselves are getting overvalued? Some of them probably are, but the ones that are in your value discipline probably aren't...Would you give me an ETF? Is there an ETF that you use?
There is, and unfortunately, I don't recall the ticker on it.
OK, and the four other areas?
Sure. We still like emerging markets, trading at a 25% discount to the US. So it is a value play, but it is levered on global growth, and we're just not seeing that growth come through as quickly as we'd like.
Not yet, but you obviously think that's going to happen.
We think that will continue, especially if monetary policy continues. So that would be an iShares MSCI Emerging Markets (EEM) or something like that.
We like PowerShares Buyback Achievers (PKW). Buybacks are an interesting play right now, because the free cash flow yield on the stock market is higher than the yield on high-yield bonds for the first time consistently in history.
And that's helping companies.
Somewhere in the fours...4.5% or something?
Well, no, it's actually higher than that. High-yield bonds right now are probably trading at around 5% or so on average, and the free cash flow yield on the S&P 500 is 6% or 6.1%. So this makes buybacks a great opportunity. Buyback achievers is an interesting play, again, as long as the markets continue higher.
And then lastly, I'll call it on the yield and sort of cushion side, I would use PowerShares Senior Bank Loans (BKLN). These are floating rate, typically senior, secured, although they are low credit quality. So if rates do eventually go up, this will move up along with it. In the meantime, it's paying probably a 4% or 5% yield right now.