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Summary

  • Although the market is fairly valued or slightly overbought, there are pockets of significant froth.
  • At some point in 2014, these speculative sectors are likely to have a painful shake out.
  • High yield/low beta stocks are a good play in a more volatile market in 2014.

"In all things it is better to hope than to despair" - John Wolfgang Von Goethe

"Reality is merely an illusion, although a very persistent one" - Albert Einstein

President Obama rode the campaign mantra of "Hope and Change" to a historic election victory in 2008. It was a powerful theme for a nation going through the volatility and turmoil of the financial crisis and weary of two wars overseas.

Unfortunately, this message has proved to be better suited to campaigning than the hard work of governing. Despite a more than $800B stimulus package and a Federal Reserve that has quintupled its balance sheet; GDP growth has muddled along at 2% annually since the recession ended and job creation has been anemic.

To put in perspective, GDP growth is less than half the norm of the other 9 post war recoveries and is the weakest on record. This accounts significantly for the president's record low approval ratings and probably points to losses in the 2014 mid-terms after 2010's "shellacking".

I see a similar message being bought into within some parts of the market over the last year. Although I believe the overall market is either fairly valued or somewhat overbought, some stocks and sectors have disconnected from any rational valuation metrics in my opinion.

You can see this in Netflix (NASDAQ:NFLX) which has more than quadrupled since the beginning of 2013 and now sells for over 200x trailing earnings. Amazon (NASDAQ:AMZN) is another stock driven more than hope about future earnings than current results. The online retailing juggernaut currently goes for almost 90x FY2015's EPS projections.

Probably the best illustration of this mantra of hope and change within some parts of the market is in the alternative energy space. A recent event also should be taken as a warning shot to investors in this sector. The small cap 'alt energy' space that was on fire to start the day last Tuesday with gains ranging from 10% to 20% in early morning trading on the back of solid results from FuelCell Energy (NASDAQ:FCEL) after the bell Monday, March 10th.

However this rally went poof in the afternoon partly on a Citron report saying their intrinsic value calculation on Plug Power (NASDAQ:PLUG) is just 50 cents a share. Plug Power, Ballard Power Systems (NASDAQ:BLDP) and FuelCell Energy totally reversed their earlier gains and all ended down 15% to 40% for the day. We haven't seen a one day reversal like this one in quite some time and it could be a harbinger of things to come.

One cannot cover the alt energy space without mentioning the meteoric rise of Tesla Motors (NASDAQ:TSLA). This stock has gone up more than 600% in the last year and now sports a market capitalization nearing $30B. To put this in perspective, this is almost half the market capitalization of Ford (NYSE:F) which produces millions of cars annually. In addition, investors are assigning an approximate value of ~$750K per vehicle Tesla is projected to produce this year.

In addition, the company would have not have any prospects of being profitable over the next few years without some very generous state electric vehicle credits which adds thousands of revenues to each car Tesla sells in California. U.S. taxpayers are also providing a $7,500 tax credit to each buyer of a Tesla vehicle. My own opinion it is ridiculous in the time of huge budget deficits to provide these sorts of tax credits on a vehicle that costs more than the average American family makes in a year.

Similar generous taxpayer subsidies exist at Elon Musk's other alt energy venture, Solar City (NASDAQ:SCTY). Some call Mr. Musk a visionary. My take is that he is brilliant at selling a vision and probably the best "Crony Capitalist" of our generation. However, I would not be an investor in either venture right now.

In order to believe that valuations in the alt energy space can be maintained or the stocks can advance further in the medium term, one has to believe this major technological "change" is different from all others that have preceded it.

Whether it is electrification of American industry, the beginning of Television & Radio, the advent of personal computers or the internet boom; new disruptive technology always follows the same path.

A new game changing technology develops and triggers exponential growth. This growth attracts scores of competitors and investors who bid up the entire industry to atmospheric levels. Eventually there is a shakeout and every player in the industry sees their stocks get crushed. Some never return and go bankrupt. Out of the ashes, the strongest players thrive although starting at much lower levels.

One can see this in the internet boom and bust. For every Amazon that survived there were many Webvans & Pets.com that were never heard of again and a Cisco Systems (NASDAQ:CSCO) which survived but never approached its previous levels. And there are the Googles (NASDAQ:GOOG) who come into the market after the bust and thrive.

My take is that these speculative areas of the market go through a shake out sometime in 2014 as the Fed continues to back away from providing the same levels of liquidity it has delivered over the past five years.

Rather than "hope" that these sectors can continue to go up or believe in these plays will "change" or deviate from the paths of every other major technology development, I rather play it safe as the market consolidates its gains from 2013's over 30% rally. For me, this means keeping a good portion of high yield/low beta plays I have outlined recently (I,II) in my portfolio. My mantra in 2014 is "Keep it simple, Keep it safe" not "Hope and Change". What is yours?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: Hope And Change Is Not A 2014 Investment Strategy