Overall, the market looks overvalued right now with several potential crash catalysts. Indexes like the S&P 500 (SPY) (VOO) and Nasdaq (QQQ) remain quite elevated relative to their recent and all-time histories and the housing boom has left prices in bubble-like territory:
These elevated prices are largely due to the fact that interest rates remain near historically low levels and the expectation that the Federal Reserve will continue to fight to keep them in a lowish band due to the heavy debt burden on the U.S. government's balance sheet:
Meanwhile, the macroeconomic outlook is negative, with many calling for a recession, and a wide variety of market valuation models (including the Yield Curve, Buffett Indicator, P/E Ratio, and S&P 500 Mean Reversion models) indicate stocks are overvalued. As a result, Charlie Munger of Berkshire Hathaway (BRK.A) (BRK.B) recently predicted that "considerable trouble" is coming:
What we're getting is wretched excess and danger for the country. Everybody loves it because it's like a bunch of people getting drunk at a party; they're having so much fun getting drunk that they don't think about the consequences. Eventually, there will be considerable trouble because of the wretched excess, that's the way it's usually worked in the past.
While all this is true, instead of running for the hills, we continue to find pockets of opportunity in the high yield space. In particular, these two sectors look particularly attractive to us right now:
There has been a greater than 20% pullback in miner and materials stocks over the past several months:
While the pullback is somewhat justified in the short-term as commodity prices have also fallen, we believe this provides investors a golden opportunity to build overweight positions in quality investment grade producers in this sector with an eye towards very favorable long-term trends for the sector. These include:
On top of these bullish macro trends, investment grade materials companies are in phenomenal financial shape, with their balance sheets flush with cash and their cash flow statements showing billions of dollars of free cash flow pouring into their coffers. This in turn is leading to historically high capital returns to shareholders in the form of dividends and share repurchases. Some of our top high yield investment grade picks of the moment that we expect to generate outsized returns over the next 5-10 years include Rio Tinto (RIO), Southern Copper Co (SCCO), LyondellBasell Industries (LYB), Newmont (NEM), and Barrick Gold (GOLD).
Midstream energy - particularly our top picks in the sector - have massively outperformed the market year-to-date:
However, we believe that there remains compelling value in the sector for the following reasons:
Our top picks of the moment include: Energy Transfer (ET), Plains All American (PAA), Western Midstream (WES), and Enterprise Products Partners (EPD). Each of these businesses is gushing free cash flow, paying out a hefty and very safe distribution, and has a strong investment grade balance sheet.
The stock market is a scary place to invest these days given the still lofty valuations, the negative macroeconomic outlook, and the rising geopolitical risks. However, for long-term income-oriented investors, there are still plenty of attractive opportunities for allocating capital at steep discounts to intrinsic value while also positioning a portfolio to outperform in the current stagflationary environment and benefit from long-term macro trends. By investing in investment grade, high yielding materials and midstream stocks, we believe we are well positioned to continue delivering alpha in our Core Portfolio at High Yield Investor.
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This article was written by
Samuel Smith is Vice President at Leonberg Capital and manages the High Yield Investor Seeking Alpha Marketplace Service.
Samuel is a Professional Engineer and Project Management Professional by training and holds a B.S. in Civil Engineering and Mathematics from the United States Military Academy at West Point. He is a former Army officer, land development project engineer, and lead investment analyst at Sure Dividend.
Disclosure: I/we have a beneficial long position in the shares of GLD, SLV, PAA, ET, EPD, WES, SCCO, GOLD, NEM, RIO, LYB either through stock ownership, options, or other derivatives. 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.