It's interesting to see how capital is being allocated in the market today. As I combed through the recent filings by various hedge funds and mutual fund managers, I couldn't help but notice the strong trend of mutal fund and hedge fund managers investing almost exclusively in the usual Nasdaq suspects -- Apple (AAPL), IBM (IBM), Oracle (ORCL), and even Microsoft (MSFT). While I'm not suggesting these are bad companies or poor investments, I think it's worth looking at whether these stocks are truly likely to offer the best value to investors over the long-term.
Given that the market has sold off hard with significant parts of the industrial and financial sectors off nearly 30%, it befuddles me to see how uncreative most fund managers have been in allocating capital over the last month. To me the value in a market that has sold off this hard will not likely be in names that are barely off their all-time highs. The fact that Apple and IBM both have market caps north of $200 billion with Apple's stock pricing the company near $400 billion and are barely off their all-time highs suggests this strategy is not just uncreative, but also likely to result in a portfolio that is likely to underperform the broader indexes long-term.
Looking at the most beat up stocks and sectors in a market selloff like this is important, but this is still just a starting point. Next, you have to identify the kinds of companies that are still executing on a business model that is likely to remain strong even if the growth outlook continues to weaken. As I wrote in my recent article 3 Stocks Hedge Funds are Missing, one thesis that is still working very well is finding companies that do business with the right mix of corporations and cash rich governments instead of being at the mercy of debt ridden consumers or public entities like state governments that are significantly reducing spending levels. A few companies I mentioned in that article were Boeing (BA), Cummins (CMI), and Eaton (ETN), the latter a company that just a couple days ago came out and reiterated its strong guidance for the rest of the year. Each of these companies does business almost exclusively with companies and governments, offers significant cost reductions to their clients, and has seen their share price selloff 25-30% over the last couple months. These are the kinds of companies that use a mix of products and services to improve the cost structure of governments and companies that have strong solid balance sheets and the capacity to borrow at very low rates.
The second place I think you can find good value in this market is in consumer staples that have the kinds of commodity costs that have dropped significantly. With the European Central Bank's recent reversal in monetary policy now signaling that lower interest rates are likely ahead, and the Fed's reluctance to pursue new and larger QE policies, the euro is now falling against most major currencies while the dollar continues to rise and put pressure on a number of key commodities. With oil prices dropping significantly, a stock like Kimberly Clark (KMB) that is in fairly recession proof businesses involving products such as diapers and toilet paper will likely see significant margin expansion since a significant amount of oil is used in many of their products. Walmart (WMT) may also benefit if gas prices come down as middle income consumers looking to save money may actually trade up from looking for extreme value at venues like the dollar stores.
FInally, and to me this is the best value in the market today, are stocks that will strongly benefit from both the new developments in European Monetary Policy and falling commodity prices. Here I think European exporters offer some of the best value. My top pick amongst them is Siemens (SI) since this company has already sold-off nearly 40% over the last couple months over growth and debt fears. No market has been harder hit in the selloff than the German market, and no sector other than financials has been harder hit than the industrials. In addition to trading at 7-9x the low end of next year's estimates compared to the usual 18-20x earnings multiple, this company will be a huge beneficiary of a cheaper Euro and lower commodity prices. The business model of Siemens is also likely to hold up better than most even during a slight or moderate recession. The recent industrial production data from Germany was very positive, and Siemens is in many businesses such as medical equipment development, that will likely stay fairly strong even in a challenging economic environment.
The Euro has recently already broken major support lines against the dollar and continues to sell-off hard against most major currencies after the ECB's recent decision to pullback on their hawkish trend of raising rates no matter what the economic data suggests. With European economies slowing, European Banks facing severe liquidity issues, and inflation risks now coming down, the ECB's change in policy is likely here to stay and will involve further rate cuts. Given that the Euro is currently trading at near 40% premium against the dollar, even a 10% move down would create a huge advantage for European exporters who export significantly to the U.S. market. While some are predicting the Euro could go to parity with the dollar over the next three years, I think even using a base case of a 10% move in the Euro against major currencies like the dollar would create a huge additional revenue boost for a company like Siemens whose stock has already sold off over 30% in just the last several months and which sells many of their products in the U.S.
To conclude, while many fund managers and individuals are likely to find temporary safety in companies barely off their highs in a volatile market, these investment strategies should be questioned by people who are willing to look out longer-term. Obviously, investing in some of the best run companies in the world like IBM and Apple is by no means a bad investment. But if you want to look for true value in one of the worst selloffs we've seen in some time and are looking for more than 5-6% return, I think you have to look a little bit harder at stocks that have sold off more. The facts that an entire continent has recently reversed their monetary policy and that commodity prices may continue to trend lower should create some good investing opportunities for institutions willing to look a little harder. While risk is hard to take in any negative environment, these are exactly the times when taking a little bit of short-term risk can really pay off.