After years of life circumstances preventing me from adding to my brokerage account, today is the big day I get to add new investments to it. I take a mostly passive approach to investing with the rationale that over the long term, very few managers or lone investors will beat the market return. I think of the return that long term investors earn over others who buy and sell as a “hold” premium that becomes higher the longer that you hold stocks. I am willing to make sector bets however, and this post will look at some of the sector bets I’m making based on my macro view and why. These will span both direct real estate as well as foreign markets.
Seeds Planted
This good fortune was bestowed on me by patient investing that started over a decade ago. I had purchased a home in NYC and a few years later, purchased a property in California to rent to a friend to go into business together. I later got out of that business venture handing it over to my friend and keeping the home with him as a tenant. Losses were made and I moved on. The same with my marriage and my divorce. The sunk costs of divorce as well as its ongoing costs have to be just taken as a loss. I can’t cry over them or dwell on them, I just have to move on. This is all we can do when we make a bad investing and life decisions. As long as you have your health, determination, skills and a willingness to learn, you can always get back up.
In regards to my direct real estate, the lowest interest rates ever, a steep appreciation in particular segments of the housing market and the finalization of my divorce, freed up new equity in my properties at a price that couldn’t be beat. I look at these new proceeds as inflows from private equity: they were locked up for many years, used leverage and earned a liquidity premium. While maintaining my current property, I am able to use the proceeds to redeploy cash and pivot it towards my macro views on the global economy and markets.
My Macro View
Investing when the market sees a sudden drop is easy. It is said that the market takes the elevator down and the stairs up. The advantage investors can glean from this simple observation are that when there is a sudden drop, it’s a great time to rebalance your portfolio towards equities and away from bonds and cash.
Yet the past year since the pandemic induced drop has seen equity markets in the US jump a staggering 22% in the case of the S&P 500 in 2020 and 45% since this time last year. Share prices in tech and small caps as seen through the Nasdaq 100 and the Russell 2000 were through the roof in 2020, having returned 43.8% and 41% respectively.
Tech was a logical play once everyone was locked inside and relied on Netflix and cloud computing to get by. The rally in small company shares was less intuitive and more surprising. Clearly the market was betting that with quantitative easing in full swing and 2 rounds of stimulus working their way through the economy, small domestic firms are going to be big winners.
Yet now comes the hard part. Other sectors have started to catch up. Financials and energy have been some of the best performing sectors this year. The cyclicals, having been beaten down for longer, are finally getting noticed by investors as tech shares are looking very richly priced. It won’t be as easy to just ride the tech wave from here on out, skill and experience are going to matter more for what remains of 2021. My view of the market going forward is broken down into the following segments:
Cyclicals – When broad rallies like this happen there are sectors that lead and sectors that lag, but when the rally is indeed broad, those lagging sectors tend to pick up later with the “tailwind” of the upswing. This includes beaten down sectors such as the energy and financials sectors I mentioned as well as industrials. These investments can be captured through the sector funds offered by iShares such a as IYF and IXC.
Value – Value has been much maligned for some time now but it may finally have its long awaited day in the sun. I like both small cap as well as large cap value. The rationale is that we are in a market with very inflated prices. Investors would rather pick up a company at a good deal as opposed to pay 30 times revenue for a tech company. The Vanguard Value ETF (VTV) for large cap as well as for small caps (VBR) are good plus for this.
Emerging Markets – I have been speaking about the rotation into emerging markets for some time now and for the first time in many years, last year the Emerging Markets Index was competitive with the S&P 500 at around 18%. There are two factors favoring this sector right now: the weakness of the dollar and the upswing in tech and commodities. Tech in the emerging tech companies in Asia, driven mainly by China. Commodities being important to markets such as Russia, South Africa and Latin America. The pricing is also reasonable at a forward P/E around 15 compared to around 30 for the US market. Within this, I would even single out emerging Asia to outperform overall. I hold VWO and EMXC to capture these opportunities.
Foreign Value – Similar to my logic above, I am looking for non-US stocks to do well in the weak dollar environment. As developed markets have also done well over the past year, those value stocks could also see an inflow in these markets. Keep in mind that there is some overlap here. Much of the foreign value indexes are now heavy with financial and energy shares that were beaten down last year. This can be captured through an ETF like the MSCI EAFE Value ETF (EFV).
Muni Bonds – I am staying away from taxable long term bonds as they will fall in value as yields rise but muni bonds have the right amount of yield to still remain attractive. For New York, there hasn’t been a year when the sector lost money since the Taper Tantrum of 2013. Although they are not as sexy as stocks, muni bonds will make up a good portion my my current investments given the volatility and uncertainty of the equity markets going forward.
Country Plays – Certain countries I like just for their value play. The UK in particular is looking attractive here. The UK equity market is currently trading at a forward P/E of 13.6 compared to 21.9 for the US and 17 for the EU. As mentioned, value plays have usually not worked out well in the recent past but with so many markets so richly valued, I sleep better at night know I at least owned something priced at a bit of a discount and with room to rise. South Africa, although beset with problems is in the value category in this respect and could be an attractive play with the upswing in commodities, which leads us to….
Commodities – There is a broad deflation play going on. Will the US be able to buck the low growth and low inflation trap that has plagued Japan and the EU for the past 10 years? We are in the midst of a massive experiment to see if massive fiscal stimulus, quantitative easing which result in huge deficits can push growth up without setting off runaway inflation. In the chance that inflation does tick up or worse yet, takes hold for some time, commodities are going to be an even more important component of returns going forward. This sector can be captured through the Invesco Commodity Index Tracking Fund (DBC).
Housing – Much of my focus is on equity but I remain an active direct real estate investor. The pandemic and shift to work from home is going to benefit places in the south where warmer weather, lower taxes and cheap houses are the norm. Texas is where I will make my play here, partly helped by the fact that my sister in the military also owns a home there and will be able to assist the coordination and outsourced management that comes with being an absentee landlord. I see Texas today very similar to California in the 70’s and 80’s. California was not always the land of liberal values and expensive homes. The 1970’s and 1980’s saw a massive influx of people and a largely laissez fairer attitude towards housing and business. Remember this is the state that produced Richard Nixon and Ronald Reagan. As people flooded in, building exploded and home prices grew as zoning became more restrictive. My next direct real estate investment will be in Texas to take advantage of the demographics of population growth there which I expect to keep up for the coming years.
Keep in mind with all of this I will still purchase my funds that track the overall market, both US and world based. This will help keep me honest a year from now if certain investments don’t pan out. Opportunity cost can be just as painful as losing actual money so comparing my returns to the index annually is an important exercise.
Did I miss anything you think will be an important theme in the coming years? Feel free to leave a comment and share your thoughts.
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