Explore Emerging Markets

The idea: Right now, attractive investment opportunities are about as plentiful as they’ve been in at least a decade. The rub is that those opportunities are not where investors want to put their money. An investor today can practically invest in anything but the largest seven stocks (the so-called “Magnificent Seven” tech stocks) and probably do quite well. The bubble in US mega-cap growth stocks represents a huge concentration of risk, but the silver lining of bubbles is the opportunity to take advantage of scarcities of capital everywhere else.

The strategy: For investors who have the intestinal fortitude to endure significant periods of volatility, emerging market equities seem like a great place to be building exposure over the next year or two. This, no doubt, sounds preposterous to many readers, but that is exactly the point. Bull market leadership is always born out of skepticism and underperformance. It was the near collapse of the US financial system that laid the groundwork for US dominance in this past cycle, and it was the Russian debt crisis and Asian financial crisis that laid the foundation of emerging market leadership in the 2000s.

The big picture: While valuation is admittedly a terrible timing indicator, it is one of the best predictors of long-term returns. To that end, the discrepancy in the valuations of US and emerging markets is approaching all-time highs, despite emerging markets’ more favorable demographics and greater exposure to companies that could benefit if inflation remains structurally higher than in the past. Finally, given the 60% appreciation of the US dollar since the financial crisis through last September’s peak, a reversal could provide a powerful boost to international stock returns for US investors. Emerging markets always come with added risk. But at the moment the long-term performance drivers appear to be stacked in their favor.

Investigate Industrials

The idea: The industrials sector has underperformed the S&P 500 by about 800 basis points for the year, so it’s a laggard and that is where we like to hunt for opportunities. The industries populating the industrial sector — there are about 12 of them — are very idiosyncratic, unlike, say energy, where everything moves based on an underlying commodity. There are some industries that are quite cyclical, but there are company-specific and industry-specific factors at work, too. The sector offers a little bit of everything to investors, including cyclical, defensive and growth exposure.

The strategy: I’d focus on the waste, defense and select transport industries. The waste industry has very strong profitability and pricing power — a lot of contracts have price escalators tied to the consumer price index. The name of the game here is diverse and defensive business models with scale. Recent earnings for the sector were so-so, because of what we believe are transitory issues like weaker recycling prices and a delay in sustainability projects. Many of these companies are focused on accelerating renewable energy, with sustainability projects such as turning methane and other biogases emitted from waste into natural gas, and ultimately energy, so that is a huge kicker underappreciated by the markets.

The defense industry has also been a laggard. On a forward price-earnings basis, some of the bigger companies trade at a discount of 15% or more to the market and offer a dividend yield above 2%. The industry is one of those “steady eddies” — not like a go-go-go area like tech, but it has incredible cash generation and strong business models. The other area we like —  ride sharing — has been a winner year to date and over the past year. But our analyst believes the industry remains extremely attractive because of a $1 trillion-plus addressable market opportunity in mobility and the fact that the ride-sharing market has less than 5% penetration nationally.

The big picture: I look at the market as the majority of stocks having been left behind. This is an extremely opportunistic time, when we can pick up names we believe in for the long term, but that over the short term have lagged. We want to preserve and grow capital in a very balanced manner, with bottom-up stock selection and a focus on fundamentals. I call it the ABCs of investing — active, balanced, and company-centric. 

Broaden Beyond Tech

The idea: Financial asset prices are very high. Multiples are pretty stretched, especially in the high-tech names. Even Microsoft, which had terrific earnings, can’t justify these levels of valuation. We’re seeing some broadening out in the equity market, and are pivoting from growth to value into more cyclical names and small-cap stocks. 

The strategy: In cyclicals, it’s industrials, materials, and energy. Financials also have a nice cyclical and valuation aspect. So if we avoid recession, they should do well. And among financials, the big money-center banks are more diversified and can ride any downturn in the economy. If we have a downturn in the fourth quarter of this year or the first quarter of 2024, there is still lots of latent disease, if you will, in the regional- and community-bank area.

In small caps, we are at a 15- to 20-year valuation spread between small and large caps. They’re just so cheap. If you don’t have a recession, there has to be a mean reversion trade. Both growth and value present interesting opportunities in small caps — I’d look for a balance. The small-cap area is less efficient than large caps and active management can really add some value.

The big picture: We’re negative on non-US, developed companies. Europe is in stagflation. US economic exceptionalism continues to be the case and will continue. The US has more active monetary and fiscal policy, more mature markets and our demographics are better. We’re the best of all the big economic areas even though we’re not wonderful. Investing at home — as prosaic as it is — is a lesson that keeps on getting pounded home every time we have a crisis, even if it originates here. 

Scout Underperformers

The idea: I’m long uranium, silver and bank stocks. I like the risk-adjusted returns around long-term structural themes when things are beaten down and cheap. Nvidia and AI chips is a good theme, sure, but it’s not beaten up.

The strategy: A lot of environmentalists don’t like uranium, but the technology is better than it was a couple decades ago – it’s cheaper and safer, and smaller modular reactors are being developed. While it’s not perfect, the electricity produced by uranium certainly is, if not zero carbon, minimal carbon. A lot of people in Europe, the US and Asia are saying we need to revisit uranium as a sort of ESG version 2.0. ESG will embrace a new era of complexity beyond ESG version 1.0, which, to simplify a complicated topic, was about solar and wind.

You should definitely have some gold now for the usual reasons — it’s a good hedge to dollar weakness, which I think is increasingly likely. But I prefer to go long silver, and if gold gets into rally mode, silver will rally too. Gold and silver tend to move together, but silver is so much cheaper than it should be now. Gold is trading at about 80 times the price of silver, and in prior silver rallies, the gold/silver ratio has down to 35. If gold goes up 10%, silver can go up 20% to 25% pretty easily.

The more boring play is in bank stocks that are cheap and stable. Look at Bank of America trading at less than nine times earnings while the S&P 500 is at 20 times earnings. The stock is cheap relative to its own trading history, and to these inflated market conditions.

The big picture: All three of my ideas are sort of contrarian and have been underperformers. If you want to stay in things that have some risk, and I think risk will be on for some time, I think uranium, silver and bank stocks will start catching a bid.