The best billionaire investors in the world have amassed their fortunes by being in the right place at the right time, and betting big.
Billionaires are billionaires because they think differently than the average person. They tend to see opportunities well before anyone else knows they are opportunities. They tend to go where some of the biggest risks are, because that’s also where the biggest returns can be found. They like to invest in situations only when they have an advantage. And when they have high conviction, they bet big.
Here’s a glimpse at these 8 big opportunities for the New Year:
Surprise Prediction #1: China – China’s slowdown this year, will turn into global economic fuel next year. (The Trade: iShares China Large-Cap ETF, symbol FXI)
China’s economic slowdown and stock market boom and bust has been one of the dominant themes of 2015. Multiple billionaires have taken the opportunity to load up.
Over the past 15-years, stocks have returned just 4.5% annualized. Meanwhile, Chase Coleman of Tiger Global has returned 21% annualized (gross of fees) on his long positions and became a billionaire in the most difficult stock market in our lifetimes. Coleman holds over 20% of his hedge fund in Chinese stocks. Billionaire Stephen Mandel, another top hedge fund manager, also has a huge chunk of his portfolio in Chinese stocks. And another billionaire, an astute macro investor, and one of the best performing investors in 2015, has one of his top positions in China.
Additionally, billionaire David Tepper thinks next year could be a boom for Chinese stocks and the economy, as he thinks the Chinese central bank could ease more aggressively than anyone thinks is possible. That positive fuel for the global economy could be the antidote for a global demand rebound.
Surprise Prediction #2: Stocks – The comfortable ride on the S&P train for the past six years is over. It’s a stock pickers market. (The Trade: iShares S&P 500 Value ETF, symbol IVE)
Billionaires have mixed views on the broad stock market. Bill Ackman and Leon Cooperman think stocks are a good value. Tepper has been uber bullish for much the past five years, but is more neutral now. Legendary billionaire investor Carl Icahn thinks there’s danger in high yield bond markets that could affect stocks.
More broadly speaking, the consensus view among the best investors in the world is that the broad stock market indicies won’t give you the easy returns we’ve had for the better part of 2009 to 2014. There will be more volatility, and it will be a stock pickers market! That’s when billionaire investors and hedge funds thrive. The winners will be the ones that can strategically identify the right stocks to own. A momentum driven market has favored index buying through this global economic recovery period, and now there is an over-due cyclical shift toward value. With billionaire investors and hedge funds primed to take advantage, the time to join our Billionaire’s Portfolio service couldn’t be better.
Surprise Prediction #3: Fed – The Fed could be forced to raise rates far more aggressively than they have planned. (The Trade: ProShares Short 20+ Year Treasury, symbol TBF)
As we said in the above, billionaire David Tepper thinks that China could ease more aggressively than anyone thinks is possible. If that happens, and it does indeed fuel a pop in global demand, the result could be quicker growth in the U.S. and quicker inflation than what is anticipated by the Fed. With that, the Fed could be forced to raise rates faster than expected.
For the past year the chatter among market participants has been about the potential for more a return to QE for the Fed (i.e. QE4). No one is talking about the Fed potentially being behind the curve on inflation, as they were for much of 2011-2013. This sets up the market for a surprise, which can result in sharp moves as people scurry from one side of the ship to the other.
Surprise Prediction #4: Commodities – Commodities are bottoming. (The Trade: DB Commodity Index Tracking Fund, symbol DBC)
Stanley Druckenmiller, billionaire and legendary macro trader, made his career picking tops and bottoms. He is taking a stab at bottom ticking commodities, loading up on gold, which is the top position in his family office fund. His former boss, George Soros has been scooping up coal and energy stocks. And in the most recent quarter, these macro trading legends have welcomed a lot of their fellow billionaires to the bottom fishing pond, as billionaire investors like Carl Icahn have been building stakes in stocks across the energy sector.
Surprise Prediction #5: Oil – Oil bounces to $70. (Energy Select SPDR, symbol XLE)
The self-made billionaire energy trader, Boone Pickens, has recently called for $70 oil in six months. He’s not the only oil bull. Another famous and very wealthy energy trader has called a bottom in oil too, and is looking for much higher prices. His name is Andy Hall.
He was one of the first energy traders to load up on oil futures in 2002, when oil was sub-$30, on the thesis that a boom in demand was coming from China.
In a recent letter to investors, he laid out an extensive fundamental case for higher oil prices and suggested a cut from OPEC could be coming as well. On that front, he noted that merely a hint of an OPEC policy change in August of 1986 spiked oil prices by 50% in just 24-hours.
So we have two of the greatest and wealthiest oil traders in the world that are long oil and have called for a return to much higher prices sooner rather than later.
Surprise Prediction #6: Bonds –Treasury bonds have topped, corporate bonds will fall hard. (ProShares Short High Yield, symbol SJB)
Everyone agrees treasury bonds are a top – though it’s claimed a lot of victims, including Bill Gross. Perhaps the most dangerous area in the bond market though, is high yield bonds. Companies have been borrowing cheap money and buying back stock at an aggressive rate. Billionaires from Icahn to Druckenmiller think the music has stopped, and the high yield bonds will continue to sink, while weak companies that have been in the business of pumping up share prices through share buybacks will fall.
Surprise Prediction #7: Biotech – Biotech and healthcare stocks have a big year. (The Trade: Nasdaq Biotechnology ETF, symbol IBB)
Biotech has been volatile over the past year and a half as it is a stock pickers market in the biotech sector – sparked by a very rare statement from the sitting Fed Chairman about biotech stock valuations, and most recently because of the political backlash associated with soaring drug costs. When average investors run out of the store, when stocks go on sale, the world’s best investors go on a shopping spree. Biotech and Healthcare stocks are where the big additions have been made in the past quarter in billionaire portfolios. No surprise, with share prices beaten down, M&A in the sector is at a record pace.
Surprise Prediction #8: Technology – New technology keeps booming! (The Trade: DJ Internet Index Fund, symbol FDN)
The Silicon Valley VC, Bill Gurley, has been sounding the alarm about a tech bust. But the reining godfather of the Silicon Valley VC, Marc Andreesen, says we’re not in a bubble, we are working our way out of a 15-year bust (i.e. big innovation is in the early stages). If Andreesen is right, and the technological revolution is closer to the bottom of a cycle than the top, expect more game changing companies to emerge.
The common theme of all of these billionaire surprise predictions is that strategic investing is returning, and riding the Fed-induced rising tide in the broad stock market indices is over. Between 2000 and 2010, when the S&P 500 returned zero, the billionaire investors and hedge funds we follow in the Billionaire’s Portfolio had some of their best performance ever, with some returning 30% to 40% a year over that period.
That type of outperformance comes from being in places where they see an opportunity before anyone else thinks it’s an opportunity. While the ETFs offer a way to play it, the big returns will come from being in select stocks that these billionaires are buying to capitalize on a market that is broadly wrong-footed on many of these predictions.
To get our best of the best portfolio of billionaire owned stocks at our new Billionaire’s Portfolio, subscribe today.
The goal of the Billionaire’s Portfolio is simple: to provide retail investors with the same plain-vanilla stock investments that the world’s greatest billionaire investors and hedge funds own. And our subscribers can invest alongside these billionaires without the typical $5 million minimum investments and paying big hedge fund management and performance fees. Instead, they get access to our best of the best portfolio of billionaire owned stocks for just $297 a quarter.
According to the Wall Street Journal, hedge fund manager John Armitage of Egerton Capital made $1.5 billion for his investors last year. Armitage was said to be short oil and energy stocks, pressing those position as much of his peers were looking for a bounce.
In a world where some of the world’s best investors will end the year down double digits, Armitage’s net worth has likely grown toward the billion dollar level after collecting fees on his top-tier industry performance.
So who is John Armitage?
Armitage graduated from Cambridge University in 1981 with a degree in modern history. He started his hedge fund Egerton Capital in 1994 and has put up some of the best risk-adjusted returns in the hedge fund industry since. Egerton has returned 15% net of fees with significantly less volatility than the S&P 500 since 1994. That’s why the fund has amassed more than $15 billion in assets under management.
For a glimpse into the best ideas from John Armitage, below are the top 5 holdings of his $15 billion hedge fund, Egerton Capital:
Time Warner Cable (TWC)
Southwest Airlines (LUV)
Gilead Sciences (GILD)
Comcast (CMCSA)
Priceline (PCLN)
Today, shareholders of Keurig Green Mountain, (GMCR) woke up to a nice 75% pop in the value of their shares. A private equity firm is taking the company private for $13.9 billion or $92 a share. That’s made GMCR one of the biggest one day movers for an S&P 500 stock this year.
Most interesting, you could have participated in this huge winner.
Just last month, at “The Invest for Kids Chicago” hedge fund conference, Ricky Sandler of the $6.5 billion hedge fund, Eminence Capital, made a detailed presentation on why he thought Keurig Green Mountain was worth $85 to $100 a share. The stock was selling for around $50 at the time and Eminence owned $195,000,000 worth — the largest hedge fund owner of the stock.
Apparently the private equity firm JAB Capital agreed with Sandler. They paid a price at the mid-point of his valuation.
Now, if you were paying attention to this conference and bought the stock, clearly you could have made a lot of money. We attend or read the transcripts from every major hedge fund conference on the planet. These ideas are not often covered in the mainstream press or online media, and therefore are ripe for finding hidden investment gems like GMCR.
Today’s news is just one of many examples of stock takeovers that can be predicted by the presence of an influential investor. For example, just last month, at BillionairesPortfolio.com we predicted the takeover of MedAssets, thanks to the work and presence of activist investor Starboard Value (you can see those details here).
Of course, today’s star performer was Ricky Sandler and Eminence Capital. With that, here are the top 5 best ideas from Eminence Capital.
1) Zynga (ZNGA) – Another top idea Sadler presented at “The Invest for Kids Chicago” conference was Zynga. Sadler say Zynga is undervalued because it has $500 million in real estate (its San Francisco Headquarters) and a $1.15 in cash per share, meaning the market is valuing its underlying business for almost nothing. Sandler said if the stock were valued similar to its peer, King Digital, Zynga should be worth $5 a share or a double from its share price today.
2) AIG (AIG) – Another top idea of Eminence Capital is AIG. Eminence owns more than $350 million of AIG stock through a mix of shares and options, more than 5% of its portfolio. Billionaires Carl Icahn and John Paulson also own huge stakes in AIG and Icahn has said AIG could be worth as much as $100 a share or a 50% return from its share price today.
3) GNC (GNC) – GNC is the third largest position in Eminence Capital’s portfolio. It owns 6% of GNC. The stock is extremely undervalued as it has a forward P/E of 9, price to free cash flow of 11, and almost a 3% dividend. These valuation metrics put GNC in that “buyout candidate” territory, just like Keurig Green Mountain.
4) Men’s Wearhouse (MW) – Eminence Capital owns more than 8% of Men’s Wearhouse and has held onto the stock even as it’s been crushed. Men’s Wearhouse has dropped from $65 to $20 this year, making the stock very cheap. It has a price to sales of just .28. It sells below its book value. And it has a forward P/E of just 8 (about that of the S&P 500).
5) Autodesk (ADSK) – Eminence Capital’s top position is Autodesk. They own almost $300 million worth, making it nearly 5% of their portfolio. Autodesk is up 44% over the last 2 months, as it has been rumored to be another takeover candidate. A top $4 billion activist hedge fund, Sachem Head, owns 5.7% of the stock and launched an activist campaign on the company last month.
Billionairesportfolio.com, run by two veterans of the hedge fund industry, helps self-directed investors invest alongside the world’s best billionaire investors.
Goldman Sachs just released its most loved stocks list among the hedge fund community. Goldman narrows the thousands of stocks represented in the most recent quarterly 13F filings down to their “most important” 25. At Billionairesportfolio.com, we’ve narrowed that list down to the five stocks owned by billionaire hedge fund managers with the most potential upside.
Below are the five stocks:
1) Charter Communications (CHTR) – Charter is one of the top ten most owned stocks by hedge funds. Billionaire hedge fund managers Stephen Mandel of Lone Pine Capital and John Paulson own large stakes in Charter. Mandel owns more than $1 billion worth of Charter. At the recent Robin Hood Investment Conference, one of Paulson’s portfolio managers said Charter could be worth as much as $325 a share, nearly 75% higher than current levels.
2) Yahoo (YHOO) – Yahoo is another popular stock owned by billionaire hedge fund managers. Billionaire David Einhorn and Starboard Value, a top $5 billion activist hedge fund, both own big stakes in Yahoo. The average analyst price target for Yahoo is $49 or a 50% potential return from its current share price.
3) General Motors (GM) – Another popular billionaire owned stock in the Goldman Sachs VIP (very important position) list is GM. Billionaire hedge fund manager David Tepper owns GM. If fact, GM is David Tepper’s largest equity position in his hedge fund. The average analyst price target for GM is $50 or almost a 50% return from its current share price.
4) AIG (AIG) – Billionaires Carl Icahn and John Paulson are two of the largest holders of AIG. Both billionaires have pushed for AIG to break up and spin off business units. Icahn recently said that if AIG breaks into three companies the company could be worth more than $100 a share. That would be a 56% return from its current share price.
5) Apple (AAPL) – Billionaires Carl Icahn and David Einhorn both hold Apple as their largest position. Icahn owns almost $6 billion of Apple. Piper Jaffrey recently put a $179 target price on Apple or a 51% return from its current share price.
Billionairesportfolio.com, run by two veterans of the hedge fund industry, helps self-directed investors invest alongside the world’s best billionaire investors.
At Billionairesportfolio.com we run an actively managed online portfolio of the “best ideas” from the world’s best billionaire investors and hedge funds. With that, we pay close attention anytime one of these great investors is making the case for one of their positions, particularly when feel confident enough to call it one of their best ideas. That’s precisely what we got a glimpse of these past two days at an annual fund raising event, the Robin Hood Investment Conference, hosted by billionaire hedge funder Paul Tudor Jones.
Here is a quick recap of their best ideas:
1) David Tepper- Billionaire David Tepper called the Chinese currency extremely overvalued. This view is in line with one he expressed in the past few weeks, arguing for the potential for China’s central bank to ease monetary policy more aggressively than most have thought. An aggressively easing PBOC and weakening of the yuan would be needed fuel for the sluggish Chinese economy, which would bode well for the outlook for Chinese stocks.
2) T. Boone Pickens – Self-made billionaire Boone Pickens told the Robin Hood audience to expect $70 oil by June of next year, which would be almost a double from oil’s price today. Pickens also said he liked the oil stock Pioneer Natural Resources (PXD). To trade Boone Pickens oil call you can buy the oil ETF (USO) or the oil and gas producers ETF (XOP).
3) Bill Ackman- Ackman reiterated his belief that Valeant (VRX) was extremely undervalued and that it should merge with Allergan (AGN) ,because Ackman does not believe the Allergan-Pfizer merger would be approved. Ackman also reiterated his view that Herbalife (HLF) was still a compelling short, with news from the DOJ to possibly come out today on nutritional supplements.
4) Larry Robbins – Billionaire Larry Robbins founder of the hedge fund Glenview Capital, pitched FMC, HCA and MON. Monsanto is Robbin’s second biggest position in his fund at almost $1.2 billion.
5) Dan Loeb – Billionaire Dan Loeb of Third Point said he thought Amgen (AMGN) and Allergan (AGN) should merge. Amgen is Loeb’s second biggest position in his hedge fund, at almost 13% or $1.4 billion.
6) John Paulson – Billionaire John Paulson’s top associate Samantha Greenberg pitched Charter Communications (CHTR). Greenberg said that Charter could be worth as much as $294 over the next year or almost a 60% return
from its share price today.
7) David Einhorn – Billionaire David Einhorn pitched Consol Energy (CNX). Einhorn first took a position in Consol at around $37 last year, today it sells for $7.80. That means if Consol just went back to the price Billionaire David Einhorn paid that would be more than a 350% return.
It’s a busy week for following the moves of the world’s richest and most influential investors. We have the Robin Hood Investors Conference in New York, which normally produces some investing nuggets from billionaire investors. And the deadline for their quarterly public disclosures to the SEC on their stock holdings is today (13f filings).
Remember, in the second quarter, the world was in the cross hairs of the calamity in Europe, surrounding the threat of a Greek default and exit from the euro. As Greece brought the world to the edge of disaster, the world’s biggest investors showed some fear, as they began shuffling their portfolios. While the turnover was much more subdued in the third quarter, there are a number of interesting buys and sells from the world’s top investors.
1) Billionaire hedge fund manager, David Tepper, who probably has the best 20 year track record of any investor alive, made quite a few interesting moves last quarter. Tepper slashed his holdings in large cap tech: Apple (AAPL) Google, (GOOG) and sold all of his Alibaba (BABA) stake. Tepper initiated new positions in Nike (NKE), Allstate (ALL) and Southwest Airlines (LUV).
2) Billionaire value investor Seth Klarman initiated a new 52 million share position in Alcoa, making him the second largest shareholder in this beaten down S&P 500 stock. Alcoa sells for just $8 a share but has a book value of almost $10. Alcoa is down almost 50% YTD, so Klarman is trying to pick a bottom in this aluminum stock.
3) Warren Buffett initiated a new positon in AT&T (T) and Kraft Heinz (KFC). Buffett now owns an incredible $22 billion of Kraft Heinz making his second largest position or 18% of his portfolio. Buffett also purchased more IBM (IBM) and trimmed his stakes in Goldman Sachs (GS) and Wal-Mart (WMT).
4) Billionaire hedge fund manager Dan Loeb of Third Point also took a new position in Kraft Heinz as well, almost $600 million. Loeb also took new stakes in Time Warner Cable (TWC) and Avago Technologies (AVGO). Loeb sold all of his SunEdison (SUNE) and Perrigo (PRGO) positions.
5) At the Robin Hood investment conference this morning, billionaire hedge fund manager, David Einhorn of Greenlight Capital said his “Best Idea” was Consol Energy (CNX), a coal and natural gas stock. The fund owns almost 23 million shares of Consol making it one its largest holdings. Einhorn first purchased the stock at $37.58 in late 2014, today it sells for $7.76. If Consol goes back to Einhorn’s purchase price it would mean a 350% return.
6) In an interview at the Robin Hood Investors Conference, Jamie Dimon, the CEO of JP Morgan, gave a rare glimpse into his billion dollar portfolio. Dimon said that he owns 3 stocks: Yum Brands (YUM), Boeing (BA) and Union Pacific (UNP).
7) Billionaire Leon Cooperman initiated a new almost $100 million stake in Valeant Pharmaceuticals (VRX) at prices between $155 and $260. Cooperman also initiated new stakes in Pfizer and Amazon. That reiterates our view that billionaire investors hedge funds continue to buy more healthcare and biotech stocks, even as the rest of the world is running from the sector.
Billionairesportfolio.com, run by two veterans of the hedge fund industry, helps self-directed investors invest alongside the world’s best billionaire investors.
Everyone has read news in the past about a big buyout in the stock market. And often the news will report that the stock in the company that is being acquired skyrocketed on the day. Envy tends to follow.
Generally, companies that are bought, are bought for a significant premium. Otherwise, shareholders would likely reject the offer. So when you hear of a big takeover, it’s not unusual to hear of a 20%,30%, even a 100% pop for shareholders on the day of the announcement.
So how to you identify the next big takeover? One of the easiest ways is to follow big, influential shareholders into stocks where they are pushing companies to sell themselves.
This week, we owned a stock in our Billionaire’s Portfolio, MedAssets (MDAS), that was taken over for a 33% premium. We held this stock for only two months, following the lead of one of our favorite activist investors, Starboard Value.
Starboard is one of the best at articulating recommendations for management and helping them execute on it. We followed Starboard Value into Office Depot and doubled our money. Starboard is run by the Wharton educated Jeff Smith, who is a tenacious and detailed activist investor. He has one of the best activist track records in the business. Since inception almost 13 years ago, Smith’s fund has made money on 82% of their activist campaigns (prior to MDAS). That’s one of the highest win rates in the industry.
Starboard took a huge activist stake in MedAssets in August and wrote a detailed letter to the company, outlining a plan to unlock value, which included strategic alternatives (such as the sale of the company).
Fast foward just two months: MedAssets was the second biggest winner in the entire stock market on Monday.
There has been a lot written about billionaire investing and activism over the past couple of years. It’s become a very hot topic. And the investors themselves, which once coveted anonymity, now utilize the spotlight to their advantage. Twitter, the internet and the media obsession with their wealth gives them the platform to spread their message about underperforming companies, and garner support from fellow shareholders. Still, finding the right investors to follow, and identifying the right opportunities is paramount.
Out of the 29 campaigns we’ve exited in our Billionaire’s Portfolio since the inception of our service, in August of 2012, five of the stocks were acquired.
That’s 17% of the stocks we’ve selected, and exited, that have been taken over for big premiums – so, strong anecdotal evidence that following influential shareholders that are pushing for a sale works!
Last week we heard from three top billionaire investors, publicly, and for different reasons. In all cases, they gave us some valuable nuggets.
On Friday, Bill Ackman held a conference call defending his multi-billion dollar position in Valeant. In the face of the scrutiny, he predicted Valeant shares would trade $448 in three years — a quadruple from recent prices.
Dan Loeb wrote released his quarterly investment letter last week describing his weak performance for the year and the challenging investment climate, yet expressing his high conviction for two stocks (a good read and good game plan outlined): Baxter International and Seven & i Holdings.
And billionaire David Tepper, who famously coined the Bernanke put and sparked a broad stock market rally back in 2010, said on Friday that he thinks China needs to ease more and faster, and that could set up for a situation where the Fed has to tighten quicker and more aggressively. He likes GM as way to lever the U.S. economy. He also said he has added to HCA Holdings.
Today, at the DealBook Conference, we heard from two other influential and legendary billionaire investors, Carl Icahn and Stanley Druckenmiller. Druckenmiller said he is short euros. He thinks the currency move underway will last for years, not months. He is long Amazon and is short “a bunch of value companies that buy back stock and need cyclical growth.” He used IBM as an example of one of those companies (owned by Warren Buffett).
Icahn weighed in on the controversial Valeant (sort of), implying he was involved but not saying whether it was from the long or short side. Rather than talk specifics on stocks, he dropped some interesting perspectives on investing and his success. He admitted he wasn’t a brilliant stock picker, nor does he think anyone is. He’s in the business of finding problems and fixing them. He has famously said he makes money “studying natural stupidity.” Today he added that he’s made so much money over his career because there are people running companies that are in over their heads and have bad incentives, he makes money holding these people accountable.
What about the weak spots in his portfolio? He says “activists get caught in cycles, you need staying power, ability to buy more when they drop.”
Full disclosure, at BillionairesPortfolio.com, our subscription-based premium online portfolio service, we own Transocean (RIG) and Freeport McMoran (FCX), piggybacking Stanley Druckenmiller and Carl Icahn’s investments.
The S&P 500 is now more than 200% higher than at its crisis-induced 2009 lows. Despite the powerful recovery in stocks, the rally has had few believers. All along the way, skeptics have pointed to threats in Europe, domestic debt issues, central bank meddling, political stalemates, perceived asset bubbles — you name it. As it relates to stocks, they’ve all been dead wrong.
The truth is, global central banks are in control. They have been coordinating since 2009 to save the worldwide economy from an apocalyptic spiral. Because the crisis was global, and the structural problems remain highly intertwined globally, the only hope toward achieving a return to sustainable growth was through a coordinated effort to restore stability and confidence. And with that backdrop, they had to create incentives for people to take risk again. It has worked! With the Fed moving closer to exiting emergency policies, this past year, the QE baton has been passed from the Fed to the ECB and the BOJ.
As part of the massive QE programs in Europe and Japan, the Bank of Japan has been outright buying stocks and the ECB might be next. After doubling the value of the Nikkei with his economic stimulus program, the architect of Abenomics, Prime Minister Abe, has said they are only “half way to its goals.” With the tail-winds of central bank influence to continue (Reason #1 to buy stocks). Here are three more simple reasons you should be buying, not selling, stocks:
1) History
If we applied the long-run annualized return for stocks (8%) to the pre-crisis highs of 1,576 on the S&P 500, we get 3,150 by the end of next year, when the Fed is expected to begin the slow process toward normalizing rates. That’s nearly 52% higher than current levels. Below you can see the table of the S&P 500, projecting this “normal” growth rate to stocks.
2) Valuation
In addition to the above, consider this: The P/E on next year’s S&P 500 earnings estimate is just 16.2, in line with the long-term average (16). But we are not just in a low-interest-rate environment, we are in the mother of all low-interest-rate environments (ZERO). With that, when the 10-year yield runs on the low side, historically, the P/E on the S&P 500 runs closer to 20, if not north of it. If we multiply next year’s consensus earnings estimate for the S&P 500 of $126.77 by 20 (where stocks to be valued in low rate environments), we get 2,535 for the S&P 500 by next year — 23% higher.
3) Recession Risk
For those who argue the economy is fragile, the bond market disagrees with you. The yield curve may be the best predictor of recessions historically. Yield curve inversions (where short rates move above longer-term rates) have preceded each of the last seven recessions. Based on this analysis, the below chart from the Cleveland Fed shows the current recession risk at 3.66% — virtually nil.
What about the impact on stocks of a rate hiking cycle? Historically, through the past six rate hiking cycles stocks have performed well, contrary to popular belief. Still, there is an important distinction this time: The Fed moving away from emergency policies is a celebratory event for stocks and the economy. After nine years of crisis, and a near global apocalypse, the Fed thinks the economy is robust enough take down the “high alert” flag.
Billionairesportfolio.com, run by two veterans of the hedge fund industry, helps self-directed investors invest alongside the world’s best billionaire investors.
This morning, the European Central Bank primed global stocks by telegraphing more action (more stimulus) to respond to the recent shake up in global economic activity and sentiment.
It had to happen. In the grand scheme of things, the ECB’s sentiment manipulation this morning was the bare minimum of what had to be done.
The global central banks (led by the Fed) have spent, committed and promised trillions of dollars to manufacture the tepid recovery that’s underway, in hopes that they can bridge their way to the point where economies begin to organically grow again. That bridge has not yet reached the point of organic growth. And it’s not even that close. With that said, the recent collapse in oil prices, and the threat to an implosion of the energy sector was getting narrowly close to undoing what the central banks have done to this point. And, not only is another downturn unpalatable, but it’s apocalyptic. The bullets have all been fired. Fiscal and monetary policy would have no shot to ward off another global destabilization.
The plan for the continuation of the global central bank-led (and manufactured) economic recovery has been clear. And the evolution, where the U.S. economy began leading global growth, while Europe and Japan were just embarking on big and bold stimulus is likely the reason Bernanke felt comfortable enough to exit. Think about it, the Fed hands off of the QE baton to the ECB (Europe) and the BOJ (Japan). Meanwhile, the Fed can make the first step in moving away from emergency policies. Europe and Japan have all of the ingredients to execute on their big QE promises to continue providing fuel for global growth and stability (they need a weaker currency).
The Fed’s exit from emergency policies shows their confidence in the economic recovery. And the ECB and BOJ can “print away”, suppressing global market interest rates (which helps the Fed), fueling higher global stock prices (which helps everyone), and fueling capital flows into the U.S. to further bolster U.S. recovery.
The question is often asked, when referring to QE, “what is the transmission mechanism?”
Here’s the answer: 1) Stability – QE assures people that the central bank(s) are there, acting, and ready to do more, if needed, to defend against any further shocks to the global economy and financial system. That creates stability. And with that stability backdrop, major central banks promote incentives for people to borrow again, to spend again, to hire again. 2) Risk-Taking – Ultra-low interest rates and a stable environment promotes the rebirth of housing activity, and encourages investors to reach further out on the risk curve for more return. That means more demand for stocks, and higher stock prices. Higher stocks and higher housing prices create paper wealth. Paper wealth gives people comfort to borrow again, to spend again and to hire again.
That has been the recipe. And it has worked! The key ingredients continue to be higher stocks and higher housing prices (even if at a modest growth rate).
Central Banks Need You To Buy Stocks
With the ECB doubling down on their commitment to do “whatever it takes” and with the architect of the massive
QE program in Japan, Prime Minister Abe, uttering those same words in the past month, the pressure valve on the Fed has been released and should clear the path for the Fed to make its first move on interest rates in nine years this coming December.
When we consider where we’ve been (fighting back from what was potentially the Great Apocalypse of economic crises), and how the economy is performing now, the fact that the Fed thinks the economy is robust enough to remove emergency policies is, indeed, a time for celebration.
And with that, there are plenty of reasons to buy stocks, not just because central banks need you to. But frankly, most people don’t seem to understand this central bank dynamic anyway. And that’s precisely why sentiment has been gloomy on stocks for the entire recovery, dating back to the 2009 bottom.
Given this negative sentiment, with respect to the economic outlook and the outlook for stocks, it’s not surprising that the declines in stocks along the way have been sharper and more slippery because of this pervasive fear in the investment community. Along the way that has created great buying opportunities. This recent decline is no different. Often market sentiment tends to over emphasize events. And it tends to be wrong (contrarian). Nonetheless, when events pass, as we’ve seen along the way, regardless of the outcome, the fog lifts, and the underlying fundamentals return to dictate performance.
From a valuation standpoint, when rates are “low,” historically, the P/E ratio of the stock market tends to run north of 20. And, of course, we are not just in a low interest rate environment; we are in the mother of all low interest rate environments, even with the Fed ready to begin moving. North of 20 is precisely where the valuation on stocks has gone in the past year. Now, based on next year’s earnings estimate, the market is valued at just 15x. A move to 20x earnings would mean an S&P 500 around 2,600 by next year. That’s 30% higher than current levels.
Why would a low rate environment tend to mean higher valuations for stocks?
Economics are about incentives, and when rates are ultra-low, people are incentivized to switch out of bonds and into stocks, to seek higher yield/higher returns. When we think about the direct implications of this incentive dynamic, we look no further than the amount of cash that big funds are holding, and where that might find a home.
Historically, one of the most predictive indicators of stock market bottoms is how much cash fund managers are holding. Right now, cash is at levels only seen during the 2008-2009 Great Recession period. Fund managers are holding 5.5% of their portfolio in cash and their allocation to stocks are at the lowest levels since 2012. Furthermore, 35% of all funds are now overweight cash.
When you see fund managers so pessimistic on stocks, while holding so much cash, it has historically been a signal for a huge move in stocks. These managers are paid to invest, and cash has always been the dry powder that’s fueled every rally in stocks throughout history. When fund managers are not holding cash and are fully invested, they have no powder left to buy stocks. The only way they can buy a stock is to sell another stock, which usually occurs at market tops.
The last two times fund managers held this much cash while being so underweight stocks was 2009 and 2012.
What happened? A huge rally! Between 2009 and 2011, the S&P rose 41%. Between 2012 and 2014, the S&P 500 rose 46%.
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