U.S. equity markets have just seen their worst January since 2009....
According to an article in Businessweek, Emerging Market stocks have had their worst start ever - down 8.5%...
The Volatility index hit 20%+, levels we haven't seen since Mario Draghi had to step in and save the world in the summer of 2012.
CNBC commentators are hedging themselves - wait for the 200 day moving average to buy - and those who bought protection in January and posted flat to up performance are patting themselves on the back (after that protection cost them half their return in 2013).
Even I myself have written about the perils of investing in Emerging Markets!
And yet now, after being on radio silence for half a year, I have the audacity to say, ignore it, buy, and close your eyes...
Where have I been in the past many months? Other than being quite happy I don't live in a Polar Vortex zone, I retooled my models keeping the good - of which there was a lot - and leaving out the bad - of which there was some. You certainly got a taste of it when I said stocks were a pretty good buying opportunity and wouldn't crash like 1987 (they didn't) or when I suggested Europe was quite cheap (it was and still is), but avoid the Staples and stick with the Cyclicals.
And based on that retooling, I conclude that the recent selloff presents an incredible opportunity to purchase U.S. stocks (SPY, IWB) which I think have the potential for further multiple re-rating. In fact, the recent baffling moves in the bond market have made U.S. stocks even more appealing because they have made fixed income even more unappealing.
5 simple reasons that stocks are attractive is because there is...
1) No recession or major slowdown on the horizon
2) No red flags coming from credit markets and continued improvement still possible
3) Delevered corporate balance sheets
4) Nothing else to do with one's money
5) Short-term there is way too much fear in the market and as usual investors are doing dumb things
Let me address my claims point by point.
No recession or major slowdown...
Other than the Permabears, no rational person is calling for a recession here. Here is the latest global PMI survey. Despite the brouhaha about China flatlining and the U.S. expansion slowing, global PMIs are above average thanks to other parts of the world (Europe) picking up the slack. What we have folks, is a pretty good global growth story with one region picking up slack for another.
But might this be the start of something bad?
My tried and tested Gold:Copper ratio says no. Typically when the price of Gold (NYSEARCA:GLD) is rising against copper, it infers a disinflationary phase. Today, we are in the opposite situation, in a global regime that is anything but disinflationary and that's why the price of Gold is falling against copper. As you recall from a prior article on Gold, I expect the Gold:Copper ratio to fall further yet to 300 - which at $3.30 copper infers $1,000 gold. Gold bugs, keep in mind that negative seasonality for gold approaches soon.
In the U.S. corporate balance sheets are healthy and credit spreads accordingly stable.
Taking a look at corporate cash flow for instance, we are at significantly lower levels than anything since at least 1995. If corporates were in imminent danger, than we would see debt service ratios rising. But they are not.
Furthermore, there's nowhere to really go in credit markets. Remember, credit investors are constrained in what they can receive. At the end of January, for an investment grade company, investors are accepting about 3.1% - which amazingly was about 15 basis points less than December's absurd number. This figure is significantly less than the Free Cash Flow of the market at large. It's like paying your mortgage, credit cards, and all your remaining expenses and still having something left over to do lot's of neat things with - like buy back stock.
Also, given the current level of market Return on Equity versus valuations versus borrowing rates, stocks are downright cheap in a relative sense. I know that doesn't square well with what the Bears have been saying, but it's the truth. If you continue to have trouble believing me, that's fine, think of it has "bonds are expensive." The takeaway is that the margin of safety lies with equities.
Given bond yields, I can make a much easier case as to why the market could rerate to near 4x book as opposed to dramatically fall from the 2.6x today.
But what if bond yields rise?
If bond yields rise, those who own bonds - or even worse - bond funds - will be out of luck. Those who own equities will be fine - so long as the rise in bond yields doesn't meaningfully affect the economy, net leverage, and all the other nuggets I have given you in this article. Ultimately, yes, at some point bonds become appealing. But I assure you, it certainly won't be at a 2.6% 10 year YTM versus a 4.5% free cash flow yield, 13% Return on Equity, 15x P/E stock market.
Economic changes don't happen overnight, the economy is a Super-tanker. It took 2 1/2 years from the start of the deflating housing bubble to the fall of Lehman Brothers. And back then there was also much less margin of safety as we continued to work off the valuation excesses from the prior cycle. Naysayers - the environment today is nothing like it was nearly a decade ago so stop comparing apples and oranges.
Finally, for those who are scared to buy in now because the market is falling. It's probably a good time to get in if you're scared because investors' collective judgment is usually wrong. Behavioral and cognitive biases are the biggest impediment to investor returns - believe me, I have made plenty in my life which is why I systematized a great deal of my investing and haven't looked back.
Below is a snapshot of yesterday's term structure for the VIX. I know I am getting technical here, but in a nutshell, typically the term structure is upward sloping. It costs more to hedge out future risks because the future is inherently unknown. In fact, what has happened recently is that the VIX futures became inverted. Basically it's like saying you know more than the market about the short-term stuff (that's known to all) then the long-term stuff (that's known to none). Indeed, Investors felt this wonderful conviction all the way through October! Sure thing, Mr. Investor - continue on with that strategy.
If you think that's irrational, I'd point you to the Inverse Volatilty ETF (NASDAQ:XIV). An explanation into term structure and pricing has been written by many great writers on Seeking Alpha, but let me say that playing an inverted VIX curve can be incredibly profitable given roll yield dynamics.
So in conclusion, the Stock Market is the only game in town. Play it because you're actually safer in stocks than most anything else at the moment.
Disclosure: I am long XIV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.