With the trade war escalating, stock markets globally have taken a severe hit. Inability to answer all these questions related to market behaviour, policy and economics with conviction at this stage is reflective of the clouds of uncertainty hanging over markets, policies and the economy. One way to handle this is to question if it’s a good time to invest now that stocks are cheaper, or if it’s a bad time as the outlook for stocks has worsened. As value investors, we have to filter through the noise and look at the facts.
Stock Market Decline
Almost all stocks have been on a decline. Stocks more exposed to China have suffered the most in price — and this generally happened when there’s uncertainty. However, even stocks with no exposure at all are affected by this turn of events. Everything else equal, this could provide a buying opportunity.
The yield curve is inverting. We have just seen the 3-month Treasury Bill’s yield cross above the 10-year note yield in the widest divergence since the 2008 financial crisis. This is important because it could trigger a risk-off mode as people are more inclined to move to cash. This will slow credit growth and it is directly hurting stock prices. This also has a negative “wealth effect” where lenders begin to worry if about their loans and start asking for repayments. If this happens, borrowers have to sell their assets to meet their obligations, which will drive down asset prices and consequently force more borrowers to sell assets.
The Triple “B”s
Remember that I’ve mentioned something about the Triple “B” problem some time ago where the number of issuers in the investment grade market ranked BBB has never been higher? Well, the situation is still not improving.
“Put these companies altogether in a pot, and they’d make one enormous, money-losing super-unicorn, with more than $25 billion in annual revenue coupled to more than $6 billion in losses. It’ll be interesting to revisit this list in a few quarters to see if that pattern changes, and profits become more commonplace.”
How now brown cow?
Considering the facts, what we do now? Personally, I feel that stocks are valued pretty high at the moment. Besides the yield curve inverting (which signals the market should continue to decline), you also would have seen many other significant indicators that the market could soon enter a recession during this long term bull market since March 2009. With all these, I’m not really comfortable about committing a larger part of my portfolio into stocks at the moment.
I suggest you start your research with companies that have been punished the most by the trade war and see if the lower price is truly justified. One interesting pick I’m looking at is Valuetronics, an integrated electronics manufacturing services (EMS) provider. It has been hit hard by the trade war.
When you read through the numbers, you can easily see why the company is currently so unpopular. 31.8% of their 2018 revenue came from shipment into China, and United States alone accounted for 43.5% of the total revenue. However, at a EV/EBIT of 3.56, it is one of the cheapest stocks in my screener.
We need to keep in mind that this stock even though is worth less than before the trade war broke out, we need to estimate what we think the true impact of the trade tariffs is and compare that to the current valuation. I guess this is the hard part. It’s more an art than science.
The gut, as Peter Lynch said, is the key organ in investment decision making. It’s not the brain.