We strive to see the world as it is, and act accordingly. Going by the textbook and implementing conventional wisdom without testing it against actual conditions is not in our playbook. What we see today is nothing short of astonishing—for two reasons.
“Safe” has become the new dangerous. We are astonished at how the investment world appears to be upside down in some respects. And we are astonished that so few of us seem to have noticed.
During the year 2000, the technology-heavy Nasdaq Composite index fell over 39%1. This crushing of technology and growth stocks at the start of the millennium and the financial crisis that arose just seven years later drove fear of the stock market deep into the psyche of some investors. Consequently, we believe there has been a flight to safety that has created some real anomalies.
Yields on long term government bonds and high yield corporate bonds have fallen to near historical lows not seen in over 50 years2. It isn’t just in bonds, either. Supposedly safe stocks appear to be the most expensive part of the market.
Standard & Poors reports that the market average price to earnings (P/E) ratio is about 18. Food companies, shampoo makers, toothpaste sellers, medical supply companies and utilities are priced at a premium because those lines of business are assumed to be recession-proof…you know, safe. In an 18 P/E market, these companies are priced at 22, 25, 30, or 34 times earnings3.
We have owned many of these companies in the past at P/E’s of 10 or 12 or 14. Why anyone would own an electric utility when solar plus battery technology is bound to turn them upside down is beyond us. (We wrote about the coming change here.)
Consequently, we believe that allegedly “safe” stocks have become so expensive they are dangerous. The textbook says utility stocks are safe. We look at the world and say, “Not really.” Safe is the new dangerous.
Meanwhile, there are market sectors and companies priced below the market average P/E, including some with dynamic prospects in the years ahead. We believe the stocks we own are bargains. That’s an opinion, not a guarantee. You know we don’t offer guarantees, except that values will fluctuate.
Clients, if you would like a longer conversation about this upside down situation or any other topic, please email us or call.
2Federal Reserve Economic Data, Federal Reserve Bank of St. Louis
3Standard & Poor’s, Inc.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Stock investing involves risk including loss of principal.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Floating rate bank loans are loans issues by below investment grade companies for short term funding purposes with higher yield than short term debt and involve risk.
High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.
Government bonds are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.