Making Hay Monday - March 27th, 2023

Announcement - Content Changes

Tighter Still

Image: Shutterstock (Modified)

“I think what’s reflected in the bond market is an elevated risk of recession and a credit crunch, but for whatever reason it hasn’t reached stock investors yet.” -Charles Schwab’s Chief Investment Strategist, Liz Ann Sonders

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Haymaker subscribers who have been with us for five months or more may fondly remember when I was able to track how my various buy/hold/trim/sell recommendations had performed. These numbers were calculated both in absolute terms and relative to the S&P 500 (if they were stocks held for appreciation versus for income).

As you veteran readers might also recall, a change in SEC rules with regards to written recommendations necessitated that I halt said tracking. But due to increasingly restrictive SEC guidance to people who, like me, are affiliated with a registered investment advisor (RIA)*, I now need to discontinue making individual security recommendations. However, I will be able to suggest portfolio adjustments on asset classes and sectors, at least for the time being.

It's my intent to provide as much guidance to our subscribers as I can under the new rules of the game. One example is that I hope to be able to include on a weekly basis a list of stocks making new 36-month highs and lows. To avoid running afoul of the latest SEC regs, I will simply report these as Barron’s does now with stocks making 52-week highs and lows. In other words, I’ll refrain from making any comments on the investment merits, or lack thereof, for these securities. However, you’ll need to do the research on the individual names on your own.

As readers are aware, I strongly believe there is more significance when it’s a three-year high or low versus merely on a yearly basis. To the best of my knowledge, there isn’t a financial media source that runs this type of screen. (let us know in the comments section if you are aware of one) My fear is that the SEC may eventually prohibit the dissemination of this data, as unreasonable as that might seem.

One of the most popular features of Making Hay Monday (MHM) has been the income security recommendation section. It’s my belief that providing suggestions on yield investments is generally underserved by most other financial newsletters. This will obviously now prove to be more challenging but, as you will read, I still plan to offer up suggestions in the income realm, subject to the limitations imposed upon me. 

The reality is that this is a return to the format of my original newsletter, the Evergreen Virtual Advisor (EVA). From the summer of 2005 until the spring of last year, when our Haymaker publications incepted, my primary content was focused on big-picture economic and financial trends. Over time, that service expanded to include a section made up of asset and sector recommendations in three categories roughly similar to what we’ve done via MHM: Likes/Neutrals/Dislikes.

As really longtime readers may remember, the original catalyst for launching the EVA was the rapidly inflating housing and mortgage bubble nearly 18 years ago. Ironically, about two weeks ago, a dear friend and longtime client reminded me it was reading the warnings in those, from 2005 through the summer of 2007, that caused him to retain Evergreen’s investment management services. In April of 2007, when the first mortgage lending blow-up occurred, involving New Century Financial, it became increasingly apparent that the housing bubble was experiencing its pinprick moment.

My reason for relaying this little bit of history is twofold: the first is that our readership has grown quickly of late; thus, many are not aware of the backstory. The second is to highlight my personal belief that my main strength is my IMAX, or macro, view of the world. In addition to my warnings about the housing bubble, I had previously cautioned clients on the perils of the late-1990s tech bubble. (Though that was before my newsletter-writing days, I have an abundant number of witnesses to that effect both on my team and among longtime clients).

Much more recently, I began to write my book Bubble 3.0 (subtitle: Who Blew It And How To Protect Yourself When It Blows Apart) in 2021. That was when the almost-everything bubble hit the peak-insanity stage, as what I had been referring to as Crazy Over-Priced Stocks (the COPS) went vertical. Despite the recent “junk rally” in many of these, most remain far below their 2021 levels. In many cases, they are still down 70% to 80%.

We started doing an early release of some chapters of Bubble 3.0 late that year, before we digitally published the full book in early 2022, followed by an audiobook a few months later. My main objective was to be on-record that we had just experienced what I believed was the greatest speculative mania in human history across a wide array of asset classes (using that term very charitably in many cases).  This included global bond markets which I viewed, and still do, as The Great Enabler of the BBB (Biggest Bubble Ever). Those zero and negative interest rates catalyzed nearly all of the craziness that hit its crescendo in 2021.

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To learn more about Evergreen Gavekal, where the Haymaker himself serves as Co-CIO, click below.

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Accordingly, one of my most strident warnings was about the bond market. My concern was that interest rates were about to soar in a belated reaction to the most virulent inflation in 40 years. If I was right, then investors were poised to lose money on both stocks and bonds. Unfortunately, that turned out to be the case in 2022. As some readers are aware, it was the worst year for balanced portfolios (i.e., a blend of stocks and bonds) since 1871. That’s not a typo!

My overarching message here is that getting the major inflection points at least roughly right is the most important service a newsletter like this can provide its subscribers. Of course, I haven’t aced all of the major trend changes. Longtime readers are aware that I’ve frequently admitted I blew it in 2013 by not reacting to the S&P 500 breaking out of its prior 13-year trading range. Since then, I’ve seen this pattern repeat again and again. That’s why I’m convinced another one of my best value-adds is to alert readers when these happen in the future. Screening for stocks, sectors and markets that are experiencing multi-year “range expansions” will be one of my highest priorities. (However, for the reasons mentioned above, I won’t be able to comment on individual equities fitting this criteria.)

Because the following Champions section is a bit longer than normal, as it includes some macro commentary, I’m going to stop here — other than to say thank you profusely for being a Haymaker subscriber!

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Champions

Select financial stocks

For capital appreciation:

U.S. Large Cap Value

U.S. GARP (Growth At A Reasonable Price) stocks

Oil and gas producer equities (both domestic and international)

U.S. Oil Field Services companies

Japanese stock market

S. Korean stock market

Singaporean stock market

Gold mining stocks

Physical Uranium

Swiss francs

Copper-producing stocks

Relative to the bolded recommendation at the top of this list, chaos creates opportunities, and there’s unquestionably been a plethora of chaos in the financial industry lately. A contrarian’s knee-jerk reaction might be to just buy the leading ETF: XLF. However, in my view, this is not the ideal way to react when there is such a divergence of fortune. As you can see in the table below, some banks are far more exposed to hits on their investment portfolios. Additionally, a number of them started at weaker equity ratios.

Chart: Cembalest

There is also the important consideration of which are being hit with large deposit outflows. As we’ve seen, this can quickly imperil banks, even if they are among the top 20 largest in America (the 15th and 16th biggest have already collapsed, representing two of the largest bank failures in U.S history). In Europe, this effect has put extreme pressure on a pair of systemically critical financial institutions, one of which has been in existence for 167 years. The reality is that even the largest and strongest financial entities, particularly banks, are highly leveraged. Accordingly, focusing on those that are seeing deposit inflows is critical, in my view, even if those aren’t strictly into their banking division (assuming they aren’t a pure bank, per the following).

On the latter point, there may be a better opportunity among the more diversified enterprises; in other words, those that own a banking arm but also derive significant revenues and profits from their non-bank operations, such as brokerage and custodian activities. Ideally, they should have a reputation built over many decades for being a champion of their customers’ best interests and among the first movers in reducing transaction costs, particularly for individual investors.

Another key feature I’d be looking for right now, with those institutions making the above described cut, is considerable insider buying. That’s not foolproof, as sometimes senior management types have delusions of superiority that are not justified by the facts. Nonetheless, when they are collectively putting up millions of dollars during a time of crisis, it is a distinct positive. From what I’ve seen thus far, it’s a pretty short list of financial companies where this is occurring.

At a time when liquidity is of paramount importance, I’d also be homing in on those leading players in the financial industry who have hundreds of billions in available capital, with a high probability of more heading their way in the near future. On a related note, I’d be focusing on those whose investment portfolios have a relatively short duration. (However, for the past year, even those with bond maturities in the three- to five-year range have incurred substantial losses. This is why avoidance of major outflows is critical; if those are modest — or, better yet, positive — the institution in question should be able to hold their bonds to maturity, thereby eliminating loss recognition.) Further, you could be looking for financial institutions where their banking operations have very robust Tier 1 Risk-Based Capital ratios, like over 25%.

From a simple price standpoint, I’d be on the hunt for those that make the above grade and whose stock price is down 40%-50% from its peak. Similarly, it would be advisable to search for financial institutions where earnings estimates have held up comparatively well, creating a mid-teens P/E on this year’s profits projections and, hopefully, heading down close to a 10 multiple by 2025.

As far as financial institutions to avoid, those with considerable commercial real estate exposure, particularly office buildings, would be near the top of my steer-clear list. It’s telling — and concerning — that smaller banks hold roughly 70% of overall commercial property loans. That’s highly likely to further weaken them if I’m right that commercial real estate values are heading in a southerly direction. Again on the alarming front is the fact that commercial mortgage-backed securities (CMBSs) are trading at their lowest prices since October 2009. No doubt a prime cause of that is higher interest rates, but rising loan-loss concerns are also likely a factor.

If you do locate a company that fits this fairly exacting set of requirements, including having a solid loan book, I’d still suggest you buy a relatively small initial position. Then, be prepared to dollar-cost-average should it go lower. While this latest banking debacle doesn’t look as severe as 2008/2009, it’s no picnic, either. It’s also probable that it will create a negative feedback loop into the economy, creating even more loan losses, causing banks to become yet more cautious, further weakening GDP. This cycle will, of course, ultimately exhaust itself. Until then, though, it’s likely to be a most turbulent ride, not only for financial stocks but the overall equity market itself. If you don’t believe me, listen to the message from the bond market. It’s a much darker one than the vibes emanating from the stock market. History has repeatedly shown the bond market to be a better forecaster of looming trouble than stocks. Ergo, caveat equity investor!

For income:

Top-tier midstream companies (energy infrastructure such as pipelines)

BB-rated energy producer bonds due in five to ten years

Select energy mineral rights trusts

Mortgage REITs

BB-rated intermediate term bonds from companies on positive credit watch

ETFs of government guaranteed mortgage-backed securities

Contenders

The carnage in European financial stocks has created some interesting situations. One of the Continent’s largest banks has caught the Haymaker’s eye. Although it has fallen 30% in less than a month, it is holding well above three-year support. (As an aside, had a shareholder in a certain Swiss institution paid attention to this rule, it would have saved her or him a considerable amount of financial pain over the last month. This is another illustration of the dangerous nature of breaking long-term support.) As a result of the sharp drop in market prices lately, I’m upgrading European banks to weak hold category. To underscore what a dog with the fleas this sector has been over the years, it’s trading for about one-third of its collective market valuation back on 12/31/07.  

European banks

Small cap value

Mid cap value

Select large gap growth stocks

Utility stocks

Down For The Count

Profitless tech companies (especially if they have risen significantly recently)

Meme stocks (particularly those that have had sharp recent rallies)

Small cap growth

Mid cap growth

*Registration with the SEC does not imply any certain level of skill or training.

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