Cyclical or Value stocks? There’s a common saying when, well-buying anything really – Buy low sell high. However, with the NASDAQ and the S&P 500 at all-time highs, we’ve all been guilty of doing the opposite, Buying the tops and selling (or ignoring) the lows. With the Teslas and the Apples of the World continually beating analysts estimates, is it time to buy up the beaten up stocks? Or, you know, buying low?
If we take a look at Gold, the Australian dollar, and Tech/Health stocks, they have all spectacularly rebounded from March. However, most, if not all, of these asset classes are affected by “spot” factors, ie. What is happening today. Gold has rallied on the devaluing of the US Dollar alongside its Safe Haven status. The Australian dollar has rallied on China increasing their commodity imports from Australia, and Tech has beaten expectations, has fortress balance sheets, and are generating cash flow even during the pandemic. Therefore, we can argue that their price is currently “high” and that we should sell to buy into “low” stocks. By holding these expensive assets at the valuations, they are now at; we implicitly take the view that these stocks will continue to relatively outperform cyclical or valuable assets in the future at the margin it currently sits at today.
Since we do not know when we can say the Coronavirus pandemic is fully behind us, the market either is a) assuming that the earning outperformance margin will continue into the distant future or b) only looking in the near future or c), a little bit of both a and b. Does this mean we should stay away from cyclical stocks forever? Here’s how I look at it
Let’s say you like Ferrari’s. Let’s say a dealer offers you the Ferrari you want (but can’t afford), at a price that you can afford. However, you’re only allowed to drive it sometime in the future at a date you don’t know, and till then, you’re not allowed to sell it. Also, you’re only allowed to take the bus, which shaves 4 hours of your day. Chances are, the Ferrari will be worth Retail when you’re finally allowed to sell it, probably. Will you take the deal?
This is similar to what investing in cyclical stocks is today. In the Ferrari example, you lose 4 hours which could have been used productively, on the bet that the value generated from losing 4 hours a day for an unknown amount of days will be less than the enjoyment + value you will get, once you’re able to drive/realize the value of the car. By investing in cyclical assets such as banks, airlines, etc., your bet is that their gain will outperform the potential further benefits of the Apples and Facebooks of the market. Of course, the analogy only makes sense if you compare Southwest Airlines and JP Morgan as the Ferrari’s of the cyclical part of the market.
It is hard not to get into the hype and not get into the high-flying tech stocks, even if they justify their valuations. However, by ignoring the noise and sticking to your fundamentals – buying low and selling high, you may see some outperformance in the longer term. Warren Buffet did.