Why it’s a tough market for fundamental investors (3/30/11)

Being a fundamental investor by background, I find today’s markets unusually treacherous. But that’s okay, it comes with the territory.

While it is increasingly difficult to find stocks, on a standalone basis, that make for attractive candidates, they exist. (Many are Japanese these days, as you may have heard me say before.)  Anyway, going through models that I and associates have put together, we strive to come up with scenarios that warrant today’s valuations.
Going one step further, if we can’t really feel comfortable buying them today, what’s going to give us comfort that they will trade higher?
For me, it’s only one thing, the US dollar. Once again, I try and grapple with what a dollar is worth.  I say this because on a day to day basis, the overarching macro theme that has pushed stocks higher is mostly not company specific. It’s what investors call “beta.” These days, beta rules the roost. Others call it “risk on/risk off.” The best way to deal with this is pairing trades if one has conviction. But then, the short leg of the trade could hold back gains that beta would otherwise bring. Less risk… but less returns. A conundrum.

Another phenomenon that has returned is the ultra high PE stock with tail optionality. What I mean is that a good portion of value is not based on the next three years of cash flow, but something further out. Like a terminal value on Year 10 cash flows. Model junkies out there know exactly what I’m talking about.

This makes it hard to comp equities off of bonds. That’s a sound way to look at investments. Any investments. If you can get x% in bonds, try and get x% plus some juice investing in equities. But if it is a story stock, like many seem today, then one never knows. Examples of story stocks include $GMCR, $NFLX, $OPEN, $SINA, $REE, etc. The list goes on. Like venture capital, if you are in the right name at the right time, you may do well in it. But one cannot expect all these names (and more) to continue to excel.

If you are a stock picker, don’t fret. The time will come. It always does. But right now, focus on the billions moving currency, bonds & oil, and look at trade flows. Everything else is secondary for now. And that could change in a heartbeat.