Where can investors find value in 2017?

“The more certain something is, the less likely it is to be profitable.” — Jim Rogers, investor and former George Soros partner

“You can’t buy what is popular and do well.” — Warren Buffet

“Be fearful when others are greedy. Be greedy when others are fearful.” — Warren Buffet

“The way to make more money is to buy when blood is running in the streets.” — John D. Rockefeller

Where does value lie in today’s market? As we all know it’s always in “the eye of the beholder.”

In other words, there is generally disagreement and perhaps that is what creates the bargain element.

If an investment is loved by all while being regarded as highly predictable (low risk) and top quality, then everyone knows and agrees, where is the next buyer to come from?

Conversely, opportunities and value are born in fear, skepticism and perhaps loathing. When this is well known and everyone agrees, where is the next seller?

Hey, it takes homework and a contrarian attitude to venture where others see only negativity. While no one knows when an investment hits bottom until it’s going up, there are often signs that sellers are exhausted and buyers have at least begun to nibble. It also seems wise to me that there must be some economic case that can be uncovered to find a reason for buyers to return to push prices higher before taking a plunge.

FOR EXAMPLE

A good recent example is the energy area.

When the price of oil dropped and bottomed around $25 per barrel, naturally just about anything associated with energy was held in the same regard as an offer to play with the skunk that lives in your garage.

Well, it would have been a good idea to open the door and enter the next morning. The energy sector as seen in the S&P 500 energy index (not an ETF) dropped from 735 in June 2014 to 409 in January 2016, an approximate 45% decline.

Now from the bottom until mid-December 2016, the index rebounded to around 564, a gain of almost 38%. You can see the chart by googling SP 500 energy index.

There were (are) many opportunities in related fields where the economics were not directly tied to the price of energy. Even today I believe it is possible to find opportunities in energy that are still cheap, pay great dividends while being only peripherally associated with energy prices.

Recently, due to the FED raising short-term interest rates and fear of returning inflation, long- term rates have been on the rise. Bond investments have given back part of their multi-year gains. I think the general consensus is that rates could continue higher for a longer time. The rate on a 10-year Treasury bond has risen from about 1.4% to 2.6% from July to December 2016, according to the Federal Reserve Bank of St. Louis.

Could one make a case to be a contrarian? Absolutely!

Sentiment is historically negative. Economist David Rosenberg notes that the Bloomberg Relative Strength Index was recently at 17.5. A reading below 30 is considered as oversold and the index hasn’t broken 18 in 40 years. There is also a heavy short position in the futures market.

Are all the sellers done? No one knows for sure, but there is certainly an extreme panic, at least short term.

Can a case be made from an economic point of view that bonds are cheap? Perhaps. Inflation is the big fear, so consider that the Consumer Price Index excluding energy is running around 1.75% and falling. If you look at the CPI excluding health care and shelter (rent) costs, the rate drops below 1%. Industrial capacity utilization is still low. A couple of other observations worth noting are recent doings with muni bonds and junk bonds.

Tax-frees have been particularly pummeled also, due to pending tax cuts which would make the tax advantage less attractive. The Muni Bond Index as seen in TheBondBuyer.com dropped 9% from 7/1/2016 to 12/31/2016. Junk bonds have actually held up better than Treasuries as can clearly be seen in overlaying charts from Worden TC2000.com since September 2016 of TLT (treasury) and JNK (junk bonds).

My experience is that if the stock and bond markets are really in trouble, junk bonds would be a good bet to lead the decline in either or both markets.

OTHER IDEAS

What else might we consider that could affect the stock and bond markets?

Besides low CPI there is also low wage growth, a sign of labor market slack despite low official unemployment figures. The U.S. dollar has been exceptionally strong recently making a 14-year high using the dollar index as seen at Investors.com. The effect of this is to curtail what would be now more expensive exports while cheapening imports. FYI, we import more goods than we export so this can be a headwind for the economy and an inflation killer at the same time.

The argument for inflation generally centers on massive government spending. All the shovel- ready jobs will likely be less “massive” than imagined and the biggie; no expensive wars. Both infrastructure spending, tax relief and regulatory relief will not start all that soon, so economic effects will be delayed. It is quite plausible that the consensus about higher interest rates far into the future turns out to be just plain wrong.

While anticipation in both bond and stock markets might be overdone at the present time, there is still no real evidence an approaching bear market in stocks.

Out-of-favor, high income selections with appropriate hedging for additional income can be an appropriate strategy for long term investors.

*Economic statistics from Evergreen, Gavekal and Gluskin Sheff.

Questions may be answered by calling 203-301-0133. Securities offered through LPL Financial, Member FINRA/SIPC. The opinions in this material are for general information. Donald Hutchinson lives in Milford, Safe Harbor Financial Management. The opinions in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser before investing. Investing involves risks including the loss of principal. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. No strategy assures success or protects against loss. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. The payment of dividends is not guaranteed. High yield/junk bonds (grade BB or below) are not investment-grade securities, and are subject to higher interest rate, credit and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.