Financial Markets have rebounded very hard from the Spring selloff related to tariff anxiety. This isn’t a shocking result, as we believed much of the hysteria was overblown and ultimately would come down to negotiations. With that said, many of the underlying issues related to trade and geopolitics, are still out there, as there are many very important trade deals that have yet to be completed. Probably more importantly for stocks, valuations are once again extremely rich, providing very little margin of safety. Having a margin of safety is what makes an investment “safe.” If we buy a business worth $100MM for $50MM, we can be slightly off in our estimates and still be successful. If we pay 100 cents on the dollar, then we need everything to hit just right for our investment to be successful. The S&P 500 and Nasdaq are trading at 24x and 29.2x earnings, respectively. Widely owned stocks such as Microsoft and Amazon trade at 37x and 35x earnings, respectively. Netflix has a P/E of 52x, Palantir trades for 228x earnings, and Snowflake trades for 196x earnings.
It isn’t just tech stocks that are trading at frothy valuations. JP Morgan trades at nearly 16x earnings and 2.9x tangible book, which is the richest valuations in the last 20 years. Even former TTCM favorite, Citigroup seems fairly valued at .9x tangible book value and 11.3x forward earnings, for a bank that struggles to generate a 10% return on tangible equity. Walmart trades at 35.4x earnings and Nvidia trades at 34x earnings with robust growth priced in. Many people seem to be forgetting that Tech can be a highly cyclical industry. All of these are just data points, but they reflect a market where very rosy results are already priced in, so as investors, it is a good time to be relatively cautious.
This is the exact opposite of how most of the industry acts. When markets are tanking, many pundits and other advisors preach taking chips off the table, only to get bullish once again when markets have rallied to new highs. The beauty of today’s market environment is that caution can still mean high single-digit, to low double-digit returns, because interest rates are very high and there are enough pockets of attractive securities to take advantage of. We have been buying some well-run business development companies that have dividend yields above 10% and that trade at discounts to their net asset values, which we view to be very attractive and relatively secure opportunities. Our REITs have performed very well, with stocks such as Crown Castle, Vici, WP Carey, NNN, and ADC generating fabulous dividends, while also showing upside on the stock prices. We have been very active with covered calls and cash-secured puts, targeting double-digit annualized returns, with less risk than the overall market. Bonds and Reits could be big beneficiaries if interest rates do go lower, which is possible given relatively subdued inflation numbers of late. The cash flows that they generate are likely to hold up even if the economy were to dip into a recession, which is not the case for many of the current stock market darlings.
By protecting capital during the downturns, we then have the ability to get more aggressive when stocks become cheap once again. We can sell things like bonds and buy stocks at deep discounts to intrinsic value, where the upside is much higher than what we see at current levels. This doesn’t mean that we believe the market will start a major correction tomorrow, next week, or next month. It just means that as valuations have gotten less attractive once again, the business-like approach is to not get caught up in the hysteria but instead focus on investments that meet our high risk-adjusted return expectations. I’d rather have a safe 8%, than a potential 20% return that has 50% permanent loss of capital potential when markets reverse.
