January 29, 2018
Recently Published Articles:
- Ventas Inc (VTR): This Stable High-Yielder is a Buy
- By This Metric, Stocks Have Never Been More Expensive
- How to Make Money from Emerging Markets Volatility
I’m home from a month-long trip in Asia and excited to be back to writing.
Here’s the updated cyclically-adjusted price-to-earnings (CAPE) ratio chart for the S&P 500:
And for those that are not fans of the CAPE metric, here’s the updated ratio of stock market capitalization to GDP:
Just about any way you measure it, the U.S. stock market is the second most expensive it has ever been relative to fundamentals, like earnings or book value.
The recent corporate tax cuts explain only a portion of these high valuations. The other portion is explained by our unusually low period of interest rates and simple overvaluation as we’re 8.5 years into an economic expansion.
The S&P 500 average dividend yield is now down to about 1.7%, and the only time it was lower was at the peak of the Dotcom Bubble.
The price-to-sales ratio is the highest it’s ever been, fueled in part from increasing net profit margins but also due to high valuations.
The price-to-book ratio is up to 3.6, when it was only 2.2 five years ago. Investors are paying over 60% more for each dollar of book value today compared to what they paid in 2012. This is the second highest it’s ever been.
The ratio of net worth to disposable income is also the highest it’s ever been, because of fairly high housing valuations and very high equity valuations compared to actual income.
2017 Review and Updates
The beginning of a new year is a time for reflection, to see what’s working and where we can improve. So before I give my views on the markets as we start 2018, let’s see how 2017 went.
I published seven newsletter issues in 2017; an average of one every 6-8 weeks.
Mostly I focus on updating readers on economic conditions and valuations, but I also highlight some stocks that I think are good values at the moment, and some of them I’m personally going long on.
Overall, the stock picks were quite good. But to me, it’s mainly about picking companies and ETFs I’m comfortable with, focusing on balanced asset allocation in general, and sleeping well at night.
In January last year, I highlighted Ventas at $63/share (and REITs in general), and the UK stock index.
REITs as a group have been relatively flat in 2017 with pressure from rising interest rates. Ventas went as high as $68 but is down to about $56/share, and paid about a 5% dividend yield for the year. More on this below- I think it’s a better buying opportunity now.
The UK index is up about 24% since the issue and paid a nearly 4% dividend yield from the starting price, so that was a good pick.
In February I highlighted VF Corporation (VFC) at around $50/share and Infosys (INFY) at about $14/share as both stocks were experiencing weakness.
Now, VF Corporation is up to about $81.50/share and paid decent dividends (about a 65% total return) while Infosys is around $18.50/share and paid dividends as well (nearly a 35% total return).
In April, I didn’t make any specific stock highlights, and mostly focused on potential tax reform.
In June, I highlighted the iShares Silver Trust (SLV) at around $15.60/share, Target (TGT) at around $52/share (and grocery stocks in general due to the fear-based industry sell-off that occurred when Amazon acquired Whole Foods), and Magellan Midstream Partners (MMP) at $68/unit, for which I also wrote a Seeking Alpha article. I also pointed out that tech stocks had a sudden dip, and for example highlighted Texas Instruments at around $80/share although I felt it was a little pricey.
SLV has been relatively flat, although my option-selling approach has been reasonably profitable on it.
Target is up over $76 and paid a fat dividend during the time (close to a 50% total return in seven months now).
Magellan is nearly at $75/unit and has been paying its 5% yield, so that has been strong.
Texas Instruments is over $113 and paid dividends, well over a 40% total return in seven months. Most of the tech stocks I listed in that issue during the nice dip have outperformed the S&P 500 since that time, and Texas Instruments in particular has shined.
In August, I highlighted Discover Financial Services at about $60/share (and here’s my Seeking Alpha article on it from July). I also highlighted Enterprise Product Partners (EPD) at about $26/share (with another Seeking Alpha article). I also recommended international stocks in general, and singled out the MSCI Brazil ETF at around $38/share and the MSCI Singapore ETF at around $24.50/share in particular.
Discover is already up 35% to about $81/share in five months and paid dividends.
Enterprise is up to over $29 and has been paying about a 6% yield.
The Brazil ETF is up to $37, a 23% gain so far in five months, plus dividends.
The Singapore ETF is up to over $28, a 14% gain in five months plus its fat dividend.
International markets, and particularly emerging markets which I highlighted a number of times in 2017, had a great year and as a whole outperformed U.S. equities.
In October, I re-recommend a bunch of stocks, like Magellan, Enterprise, and Ventas, and emphasized having an international focus.
In November, I re-iterated my recommendation for Discover Financial and Synchrony Financial (at $34/share), and gave a bullish case for Starbucks at a bit under $57/share.
Synchrony is up to about $40 from $34, already a 17% gain in two months.
Starbucks has been choppy and sideways. Their recent quarterly release showed disappointing U.S. results but outstanding results in China.
Because I tend to prefer conservative dividend-paying picks and ETFs, none of my stock highlights in 2017 went very badly, and the majority of them did better than the S&P 500. Buying good companies and out-of-favor country indices during dips was very profitable in 2017. But we had global synchronized growth for the year; it was hard not to make money.
REITs in general were probably the least constructive area that I’ve focused on, although this was more a case of lost opportunity cost rather than big negative swings. REITs were of course solid choices for those living off of investment income, especially if held in tax-free or tax-deferred accounts. I’m still very much interested in REITs that have little exposure to retail.
My personal portfolios overall were somewhat conservative this past year due to high U.S. valuations, but I still maintained significant equity exposure for my indexed primary retirement account despite my concerns about U.S. stock valuation. I preferred option-selling over buying stocks outright for many of my non-indexed positions, which gave nice reliable income gains but missed some big upward price action. My significant international exposure has been helpful, and my core holdings have performed well.
And I want to give a shout out to Paul Kroger, who included this site on his list of the 30 best investing blogs.
Stocks I Like Now
To start with the weaker picks of 2017, I’m still bullish on Ventas (VTR) and the iShares Silver Trust (SLV) as we head into 2018.
Ventas, Inc. (VTR): Because REITs Just Went on Sale
I wrote an analysis of Ventas on Modest Money last week, so check that out if you’re interested.
The short version is that REITs as a group had about a 10% sell-off over the last 2 months, even as the S&P 500 has risen sharply. And many healthcare REITs sold off a bit more than that due to concerns about an oversupply of senior housing.
I have been selling puts on Ventas for the past year, generating income and waiting for a dip to buy. This time, due to the sell-off, my puts are almost certainly going to be assigned, and I’ll own shares of Ventas. The REIT now yields about 5.7% and is a better value than it was in 2017.
It’s not the kind of stock pick that will double in price any time soon, but it’s a solid high-yielding REIT and it is more conservatively positioned than many other healthcare REITs because they divested most of their risky assets and focus mainly on private pay properties now, which buffers them from healthcare politics and government funding.
iShares Silver Trust (SLV): Good for Diversification
Measured a number of ways, silver continues to be relatively inexpensive.
The gold-to-silver ratio is historically very high at 77x. That implies that gold is expensive compared to silver, or that silver is inexpensive compared to gold, based on history.
I think it’s a bit of both, based on comparing their values to other commodities or measurements of value. Silver is well within the norm relative to its inflation-adjusted historical price.
Silver is volatile, so I use it generate option premiums. It can crash relatively hard during recessions, but tends to bounce back more quickly than stocks. Basically, it’s a way to diversify away from equities a bit, and I have a small portion of my financial assets invested in it and producing option income.
SunPower Corporation (SPWR): High Risk, High Reward
This month I sold March 16 cash-secured puts on SunPower at a strike price of $7, for $0.53/share. This will give an 8% return in less than 2 months if not assigned, or will result in buying in at a cost basis of $6.47/share if the stock dips and I’m assigned. And depending on which way it goes, it can be repeated.
It’s a small position for me, and I don’t recommend it for most people because it’s a difficult situation. But admittedly, the situation fascinates me both from a technical point of view and a financial point of view.
SunPower was founded by a Stanford professor a while back, and produces the highest-efficiency solar panel on the market, with among the best reliability and warranty, for a premium price. It has to do with the way the electrical contacts collect electricity from the cells compared to normal panels.
This has given them a strong position in residential and commercial solar markets, where space is limited and a system that can produce more power with finite space is ideal. For example, Apple’s massive multi-billion-dollar new campus has a huge commercial SunPower installation, and Toyota’s new HQ has another massive one as well.
And considering that installation costs are a big factor in the overall price of the system, it often makes sense to go with premium high efficiency cells if you’re already going through all the money and hassle of installing a system in the first place.
But SunPower has not done well with utility-scale solar installations, because space is less of a constraint and it’s all about price-per-watt. They recently introduced their new cheaper P-series panels that might help reverse this problem and gain them some more market share, but we’ll see. The P-series panels are better than normal panels because they lose less efficiency when partially covered by shadows, due to the way the cells are cut and arranged.
The solar industry has had a rough couple years. Lower energy prices make solar panels less competitive, and the market has been flooded by cheap Asian solar panels, which has ostensibly driven some U.S. cell makers to bankruptcy.
This past week, President Trump initiated solar tariffs that will last for four years on imported solar panels, and will start at 30% and go down to 15% by the end. Analysts from Goldman Sachs have estimated that it’ll increase the price of utility solar by 3% and residential solar by 7%. Most of the cost is associated with installation rather than solar cells themselves, so it’s not as though the actual price will go up 30% for the end user. More like 3-7%.
On one hand, a stated goal of the tariff is to protect U.S. solar cell makers. On the other hand, 99% of the workers in the U.S. solar industry are involved with installation and other non-manufacturing functions, and cheap imported solar cells are good for business. So a few U.S. companies could benefit from higher all-around solar cell prices while workers themselves that rely on installation volumes might lose jobs. And it may trigger a trade war.
Despite being technically a U.S.-based company, and despite being the premium-priced products producer (rather than the cheap foreign commodity ones), SunPower will be hit with the tariffs because they manufacture their cells abroad. They are currently appealing this because the U.S. is taking applications for exceptions, and SunPower has a decent case. And SunPower is delaying a $20 million expansion in the U.S. until/unless it gets a tariff exemption, potentially as a bargaining chip.
Another problem that SunPower has is that they signed a multi-year binding contract years ago to buy polysilicon at a certain price, but then polysilicon fell in price. SunPower is now stuck buying massive amounts of over-priced polysilicon, which is literally costing them hundreds of millions of dollars in lost profits. This is set to continue through 2020 and then the contract will no longer be an issue.
Due to all this, SunPower is operating at a loss. Shares were as high as $40 a few years ago and are now down to about $8.
If SunPower can survive financially until 2021 when their polysilicon contract is done and tariffs will start going away, they should have a bright future ahead. But with these tariffs, the bad polysilicon contract, and their debt, it’ll be rough. Potentially too rough.
The company is trying to sell its stake in 8Point3 Energy, which will give them more liquidity and let them focus on their core business. But SunPower announced their intention to sell it many months ago and still hasn’t done so, possibly because they haven’t found a buyer at the right price.
SunPower is majority-owned since 2011 by Total S.A., the French oil supermajor. Total bought 60% of the shares because they want to expand their energy diversity into renewables. This also gives SunPower more financial backing than it would have as a completely stand-alone company, because they can make deals where Total buys SunPower debt with the option to convert it to more equity, or other types of specialized deals.
The biggest risk for SunPower is that it’s possible they could go bankrupt if multiple things don’t go their way here. It wouldn’t be the first solar bankruptcy and it won’t be the last. If they don’t get a tariff exemption, don’t sell 8Point3, don’t have decent success with their P-series products, and don’t increase their international projects, it won’t be good.
Less seriously but more likely, is that they could have significant share dilution. A lot of bad news is factored into the price of the stock, which does produce great and unique products. An exemption from the tariff, better-than-expected sales of their new P-series, a good sale of 8Point3, strong international demand, or other factors may result in an upside swing in their stock price.
I initiated a minor position with a number of cash-secured put options, because the massive volatility of their share price gives strong option premiums and there’s lot of upside potential here if the company can get through this difficult time.
Last But Not Least: Have a Global Focus
U.S. stocks have dramatically outperformed most international markets over the past decade.
History tells us that this tends to revert back to the average, meaning international stocks are primed for relative outperformance over the next decade. That doesn’t mean it’ll happen every year, but over the long-term this is likely to be the case.
But it’s not just history we can base this on. As described at the top of this newsletter, U.S. stocks are very highly valued. The Vanguard Total U.S. Stock ETF (VTI) for example has an average price-to-earnings ratio of 23, and an average price-to-book ratio of 3.0.
In comparison, the Vanguard FTSE Developed Markets ETF (VEA) has a price-to-earnings ratio of 16, a price-to-book ratio of 1.7, and average earnings growth is only a little bit slower than U.S. earnings growth.
The Vanguard Emerging Markets ETF (VWO) has a price-to-earnings ratio of 15 and a price-to-book ratio of 1.7 despite having faster earnings growth than U.S. stocks.
Despite the strong 2017 performance for international stocks and particularly emerging markets, the fundamentals still support long-term outperformance compared to U.S. equities, even if any particular year could be bad.
Here’s a visual comparison of the three funds. Click for a bigger view:
Overall, international developed markets, based on multiple valuation metrics, give investors a better all-around deal at the current time than U.S. stocks. A bit less growth, but way lower valuations.
And emerging markets give an even better deal, albeit with more volatility. They have more growth and better valuations. I wrote an article about emerging markets recently on Seeking Alpha.
A key risk is currency fluctuations. When your home currency weakens compared to international currencies, your international holdings get a boost. When your home currency strengthens, your international positions get a drag.
When I invest in a broad international index with many currencies represented, it’s for the long-term and I’m willing to ride out various up-and-down currency swings. But when I invest in single-country ETFs, like Singapore or Brazil, I prefer to time my entry to when their particular currencies are stable or rising compared to the U.S. dollar.
Lastly, be aware that certain funds like the MSCI EAFE index are heavily concentrated in Japan (a full quarter of the whole fund). And many broad emerging markets index ETFs are heavily concentrated in China (up to a third of the fund in many cases). I recommend reading my article on international stocks and ETFs, because it gives ways to avoid inadvertently over-concentrating in certain countries.
U.S. investors tend to invest heavily in U.S. stocks, and hold a small allocation to an international fund that they usually don’t realize tends to be concentrated in just a few countries. There’s a good case to have significant international exposure going forward, and to have it broadly.
A strong dollar could derail international performance in any given year, but the long-term fundamentals and valuations favor having substantial international exposure, and especially to emerging markets.
Many of those markets have indeed “emerged” compared to a decade ago, and are now truly consumer-driven economies rather than useful to foreign investors merely as commodity plays. This warrants increased exposure, in my view. Especially at the right valuations.
My Personal Portfolio Updates
In addition to holding a diversified set of automatically re-balancing index funds in my primary retirement account (U.S. stocks, U.S. bonds, and international stocks), I hold these investments in my other accounts:
I manage all of my accounts and monitor my net worth by using the free tool from Personal Capital, which makes everything easy.
Changes since the previous issue:
-My 1/19/2018 cash-secured puts on Discover, Starbucks, and Synchrony all expired profitably without being exercised. I renewed the Discover and Starbucks positions for April with higher strike prices.
-My 1/19/2018 cash-secured puts on Intel expired right in the money, so I was assigned Intel shares. I then sold April covered calls on the position at a higher strike price of $48. This is just an income-focused cash cow position and it already looks like I may be selling the shares in April due to Intel’s surge in stock price.
-My 1/19/2018 covered calls on the iShares Silver Trust expired profitably, so I sold some year-out covered calls on the position. This generates basically a 4-5% income yield on SLV and leaves over 12% annual upside potential while I hold it, as described in my article on generating income from precious metals.
-I swapped out my Vanguard Emerging Markets ETF for the iShares Core MSCI Emerging Markets ETF because I wanted some South Korean exposure in the fund. MSCI (and thus iShares) classifies South Korea as emerging while FTSE (and thus Vanguard) classifies it as developed.
-I sold 3/16/2018 puts at a strike price of $7 for SunPower at $0.53 each. This will return about 8% in two months if not exercised, or will mean buying shares at a cost basis of $6.47 if the stock dips and the shares are assigned. This is my smallest position.
Virtual ETF Portfolio Updates
Each newsletter for fun, I update a virtual ETF portfolio.
It takes about 5 minutes per newsletter to manage, and helps show where I think value is in the market without focusing on individual securities.
You can see the previous version from the November issue here.
For reference, the S&P 500 is at 2,872.87 and the S&P 500 TR is at 5,606.08.
Changes since previous issue:
-All of the 1/19/2018 put and call options expired without being exercised, including the ones for SLV, SPY, and VNQ.
-Several ETF distributions were received:
- VNQ paid a distribution of $252.72 for 200 shares held.
- IDV paid a distribution of $264.27 for 700 shares held.
- VWO paid a distribution of $21.21 for 100 shares held.
- EWZ paid a distribution of $5.03 for 100 shares held.
- EWS paid a distribution of $64.07 for 100 shares held.
-I bought 100 shares of the Vanguard Total Stock Market ETF (VTI) for its most recent price of $146.86.
-I sold 300 shares of the iShares International Select Dividend ETF (IDV) for its most recent price of $35.88.
-I bought 200 shares of the Vanguard FTSE Developed Markets ETF (VEA) for $47.88.
-I bought 100 shares of the iShares MSCI Emerging Markets Small Cap ETF (EEMS) for $57.26.
-I bought 200 shares of the FlexShares Morningstar Global Upstream Natural Resources ETF (GUNR) for $35.42.
-I sold 4 $18 strike 1/18/2019 covered call options on SLV for $88 per contract.
In summary, U.S. stocks are at historically high valuations, while international stocks and particularly emerging markets are at more reasonable valuations.
The energy/commodity and financial sectors in the U.S. and globally are still reasonably-priced as well.
There’s an argument to be made that natural resources, including energy and other commodities, will have a strong 2018 if global synchronized growth continues this year.
I plan on publishing the next newsletter issue in March, where I’ll give a status update on a number of recession indicators and where we stand with them.