Valuations in the equity market are currently at the second highest level they’ve ever been at. That S&P 500 is currently almost 39 times the inflation adjusted profit for the index over the past 10 years. The all time high of 44 was reached in the year 2000 and we are not far off that mark. Traditional investors expect low to even negative returns over the next 10 years given these valuations.
If you are one of those investors that are kicking yourself for not investing in Bitcoin, NFT’s or even just Google shares, don’t fear because those returns are all backwards looking, the key to being a part of returns like these is to constantly be looking forward not backward. The downside of this is that in order to take chances on what will be next, you have to be prepared for some weak returns or even losses. I have been touting the good valuations in emerging markets for some time now but my investments in that sector have yielded weaker returns compared to those of the Nasdaq or tech in general.
Yet don’t have a short memory. The current rally in tech only started to pick up steam in 2015. Does anyone remember when the narrative around Apple was that it was doomed to a slow decline since Steve Jobs wasn’t at the helm to spur the next whizzy innovation? As recently as 2016, Apple was trading at only 10 times earnings, now it’s trading at 40 times. Nothing fundamental changes about the company in that time, it’s just the market changed it’s mind and decided big tech was the future.
Examples like this should give every investor pause and remind them to take a minute to step back. Much of the hype you are touting a particular stock or a particular market are from people looking to make a fast buck. Fast money is nice, but it usually isn’t sustainable. That’s why long term investors like myself, are constantly scouring the market for the next deal and the next opportunity.
With that being said, you usually can pick out opportunities better in an area where you have some knowledge or expertise. In my case, I worked in emerging markets as well as with financial institutions for many years. Unfortunately these have been losers as of late but eventually these sectors may come back into vogue. Yet it also means that you may want to have exposure to other areas where you don’t have expertise as well. Even with valuations high, there is an opportunity cost to not investing in tech at the moment so through ETF’s I can achieve this and make up for my lack of expertise in that particular space. Just know that eventually, if you wait long enough, other sectors and other areas do tend to have their day in the sun. So for the investor looking towards the future, I have picked out 3 areas I think could offer investors decent returns compared to the S&P 500 over the next 5-10 years.
Value – Value has severely underperformed growth since the financial crisis as can be seen below.
Yet when there are periods of heightened market volatility or when valuations get too high for investors to bare in the tech sector, there is then a natural rotation to the stocks that are more reasonably priced. This is the mai argument to remain in value shares for the time being. We all know that the shoe is going to drop one day and these tech valuations will come back to earth. No one knows exactly when that is no matter how much they like to speculate about it. Yet when it does happen, you can expect value to outperform other sectors handily.
Although we didn’t see this phenomenon in the last crisis, all shares fell at that time, during the last bursting of the tech bubble we did and those who held value shares were able to weather the storm through ugly investing years of 200-2003.
There is also a tech angle to argue for value as well. The sectors overweighted in value indexes are most often financial, industrials and healthcare. Financials are considered a slow and stodgy industry at the moment but the potential for the tech sector, through fintechs, to make it flashy again is compelling. For all the crypto bashing I do, it is a financial innovation at the end of the day that may lay the groundwork for the next big innovation in finance.
Industrials and healthcare should also benefit from all the innovation that is currently going on. The IT advantages could allow these sectors to become more efficient be it through boring cloud computing for established industrial companies or or through robotic surgeries for the healthcare sector. Just because it doesn’t have tech in the sector name doesn’t mean it can’t start to benefit from the current environment and the greater efficiencies that can be captured.
Emerging Markets – Here it is just a simple long term valuation argument. Compared to the current valuations of the US, the developing world is looking like a steal. This isn’t an argument for going overweight the sector however. The valuations here have been reasonable for a number of years but returns have still not shown up. The crackdown on certain sectors in China which I wrote about a few weeks ago highlights the political risk of emerging markets but the valuations there remain compelling.
The below chart from The Emerging Market Investor site, shows that even in markets that are considered hot right now such as Taiwan, valuations are not exceedingly high when compared to the US. This is one reason I am long not only the EM index but also the EM index ex-China to be able to capture the opportunities in smaller market valuation as well.
Although these markets tend to be more old economy (commodities and financials) heavy, which is not fashionable at the moment, the green revolution as well as simple interest rates could change their attractiveness to investors.
With shortages fueling inflation of imported goods and with less reliance on dollar debt, which makes it easier to endure a stronger local currency, emerging market central banks have been able to actually raise rates post pandemic as opposed to many advanced economy governments. The search for yield as well as the current state of risk appetite may drive investors to embrace emerging currencies once again.
Particular stocks I am watching include Credicorp (BAP) which owns the largest bank in Peru and a third of all banking assets in the country. Although there is significant political risk in the country, the shares of BAP were recently trading at a 10 year low and have rallied almost 17% in the past 2 weeks as investors moved back into emerging market stocks.
Meme and Tech Stocks – This is not in the way you think. I am not saying to go long on meme stocks or tech stocks, but I know many of them are overvalued at the moment and I know that won’t last forever.
The most glaring example I have written about on this topic is the saga of AMC. These shares are worth no more than $1 a share if anything. Yet the Reddit crowd or “Apes” as they refer to themselves, have bid the shares up to $44 a share recently. I have been wrong on calls of the timing of a drop in the past but it was my timing that was wrong, not the fundamentals. This is a long term short play that I have my eye on. Market volatility, a prolonged slide in tech shares or any other event that were to produce big retail outflows from the market would likely drop this stock like a stone. The timing of this is debatable but it is almost sure to happen.
When it does happen I am positioning myself to buy puts on shares of this name and others like it, anticipating a prolonged fall in price and high volatility. This is probably my riskiest call but as a stable and patient long term investor, it won’t be something I will be devoting large proportions of my savings to, just a riskier portion which can hopefully give me some profits while the rest of the market is down trending.
Others – These are pretty simple and broad opportunities I have laid out. I’m sure there are other sectors or particular investments which will have fantastic returns which I haven’t mentioned at all. If you are convinced you know what those are then I encourage you to take a chance and take a position, taking risk and taking a stance on the next opportunity is part of investing. Like many, I will be sticking to what I know and playing my long term game so when the market does turn on a dime and another sector becomes hot, I will have been there ready to ride the wave.
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