This week, the headlines have changed from "concern over being able to get a debt deal done" to "concern about austerity slowing down the economy." This new round of worries about sovereign deleverging ties in perfectly with today's discussion about some sectors to be invested in and sectors to avoid.
The Macro Thesis
The gist of our trade is that the economy ahead - the next 7-10 years or so - looks totally different than it did during the long boom. You need an investment philosophy that fits that world. And if you think what worked best during the long boom is going to keep on working, you've got a lot of disappointment and heartburn in your future. It's time to rethink portfolio construction.
A world of lower-than-normal economic growth, slow job creation, and perhaps most importantly, credit contraction and continued deleveraging, demands a different strategy. The crux of our thesis is that investors should get long the stuff that people need in countries and companies with clean balance sheets, and get short the stuff that people don't in places that are still highly leveraged or hold questionable assets.
You're going to need two things in the decade to come that you really didn't need during the long boom: Caution and skill. Gone are the days of mindlessly buying an index fund on margin and watching the profits roll in.
What to Buy
The first sector that investors need to take a look at and get overweighted exposure to is energy. I know that sounds obvious, but just because it's obvious doesn't mean it's not true. My guess is that you're as confident as I am that energy, as a sector, is going to outperform things like the financials or consumer discretionary over the coming decade.
Here are the top 10 holdings of the XLE as of last week:
Exxon (XOM) and Chevron (CVX) are great companies, as are the rest on that list. If you're going to own the XLE, then don't bother owning those individual names. Round the exposure out with some of these other companies. They fall into two categories.
I'll call this first group "value." These eight companies all trade at a PE of less than 15x on both this year's earnings and next year's. But they all have a PEG of above 1, so these probably won't sit idle. They're all trading between 1x and 2x book value, which means nothing if you're a bank holding dodgy MBSes. But for an energy company it generally means that your current price isn't expensive relative to your assets. All these companies are priced below the industry average relative to cash flow and are expected to grow both cash flow and revenues over the coming year. And to top it all off, every one of these has positive dividend growth over the last five years.
Basically, these are companies that trade at inexpensive levels and generate a lot of cash.
Chesapeake Energy is particularly interesting. Like a lot of energy companies, it wiped out pretty hard after the crude bubble in 2008, but since then it has crawled back rather admirably, doubling from the mid-teens to around 35.
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The company should be growing revenues and earnings as far as the eye can see and I particularly like its focus on natural gas. Sometimes we forget about natural gas, but it is an incredibly important resource for our country. Even as crude oil has pulled back in the last few months, Chesapeake has done very well.
Statoil is interesting too. It yields 4.6%. It is a Norwegian company, so you get a little different exposure than you do with some other energy companies.
It doesn't adhere to the above criteria, but Transocean is probably worth looking at again. In a world where natural resources are progressively more difficult to locate and extract, a company like Transocean is very relevant. It missed earnings estimates for a couple of quarters in a row, but it is still reasonably priced relative to sales and is trading at a slight discount to book value. It pays a 5% dividend, too, and has a global footprint which means it can avoid a lot of the baggage in the U.S.
I realize that the energy trade is kind of like preaching to the choir. Pretty much every rational individual I've ever come across believes that this is a sector that needs to be overweighted in investor portfolios. Whether or not asset managers actually do that is another story. But the consensus on Wall Street seems to like the energy sector, even if it's a little boring to get excited about. But boring works just fine for a Trade of the Decade.
The integrated majors are going to be particularly boring, but who cares? The risks are small, and while the returns may be modest, they relate quite nicely to the risks. That's the thing that matters when you're dealing with securities with dividend yields in the low/mid single-digits. I mean, seriously, who among us thinks that U.S. Treasuries at 2.7% represent better return relative to the risk than a company like Exxon Mobil with a 2.4% yield?