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Everything’s Fine. Just Keep Investing!

Apparently, the price you pay doesn’t matter because stocks always rise over the long term.

Or at least that was the message Barron’s sent over the weekend (see Why the Market Will Keep Climbing). Looking at stock returns back to 1871, Barron’s found that of the 139 five-year periods, only 16 had negative returns. Adjusting for inflation it was more like 25, but still a very low number. There were no 15-year stretches without positive returns, unless you adjust for inflation–in which case there were only three.  And over 20- and 30-year periods, stocks were always profitable, inflation adjusted or not.

Market Returns (1871-2014)

Nominal Stock Returns5-Year10-Year15-Year20-Year30-Year
Source: Barron's, from WisdomTree data
Number of Times Negative164000
Number of Times Total139134129124114

I read Barron’s every Saturday morning. It’s part of my regular weekly ritual, and as a general rule I find the magazine to be sober and balanced. But this is shoddy analysis, and I would argue that it’s irresponsible to print.

Where do I even start picking this apart. I suppose we should start with the time periods involved. 1871? Really?

Think about that for a minute. That’s six years after the Civil War. How many stocks traded publically in 1871, and how many Americans had access to them? The answer is “not many,” and certainly not enough to draw meaningful conclusions about returns. Assuming price data from that period is accurate–which is a stretch–stocks were not the liquid investments back then that we know today. There were no mutual funds back then…no 401k plans…and certainly no online brokers. Most Americans measured their wealth in acres of farmland owned, not shares of stock. And in any event, prior to the 1920s the United States was what we would think of today as an “emerging market,” with higher risk and higher expected returns built into prices.

Stocks did not become a mainstream investment vehicle until maybe the 1920s. The first modern mutual fund–the Massachusettes Investors’ Trust–was created in 1924. But mutual funds–and stock market ownership in general–did not really go mainstream until the 1950s. And you could make an argument that mainstream investing as we know it today started in 1978 with the creation of the 401k plan. And the regulatory regime as we think of it today didn’t exist until the Great Depression.

Being generous, we could say that meaningful data starts in the 1920s. This would mean that more than a third of the data used to build the chart above is meaningless.

And what about dividends? Dividends are included in the historical returns. The only problem is that today, the S&P 500 yields 1.88%, or less than half the 4.35% median dividend yield going back to 1871. As recently as the 1980s, dividend yields were north of 6%.

Along the same lines we have bond yields and inflation. The great bull market of 1982 to 2000 came on the back of the “great moderation” in inflation and interest rates. Now in 2015, bond yields are near all-time lows. At best–and this is the scenario I see–we could see bond yields trade sideways for several years. But they certainly can’t go materially lower from today’s levels. So, any sustained bull market starting from today will not enjoy the powerful tailwinds of falling yields that we’ve gotten used to over the past 32 years.

And finally–and arguably most importantly–we have price. Stocks today are expensive. As in really expensive. The S&P 500 trades for 27 times cyclically-adjusted (i.e. 10-year) earnings. That puts it fully 62.7% higher than its long-term average and implies returns over the next eight years of just 0.4% per year. And that’s the nominal expected return, as in not adjusted for inflation. So yes, while these are positive returns, they’re certainly nothing to get excited about.

You know the caveat: past performance is no guarantee of future results. My criticism of the dated Barron’s data could be equally applied to the CAPE data I used above. And I should also point out that I’m not a congenital bear. I’m actually still very heavily invested in stocks, although my focus has shifted to cheaper overseas markets and to higher-yielding investments here, such as mortgage REITs and business development companies.


Where to Look for Cheap Stocks in 2015: CAPE Around the World
3 Under-the-Radar Value Stocks
2015 Investment Outlook

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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3 Under-the-Radar Value Stocks

It’s hard to find good value stocks in today’s market. After years of almost uninterrupted bull market, valuations are looking stretched. The S&P 500 trades at 27 times cyclically-adjusted earnings, making them 63.9% higher than their long-term average and implying annual returns over the next eight years of just 0.3%.

To give you a point of reference, U.S. stocks are more expensive today than they were in 2007 and nearly as expensive as they were in 1929—right before two of the biggest bear markets in history.

In order for stocks to grow into their valuations, we’d need to see a massive acceleration of earnings growth. But given that today’s earnings numbers are already inflated by years of massive share repurchases, I can’t say I consider that scenario likely.

Yet value investors need not despair. Here are three solid under-radar value stocks that I expect to do well even in a world of overpriced stocks.

Madison Square Garden

I’ll start with the Madison Square Garden Company (MSG), the owner of the New York Knicks basketball and New York Rangers hockey franchises. This is a relative value play; sports franchises in general are very much in a bubble. But MSG is vastly underpriced relative to its peers, and I intend to profit as its value “catches up.”

The values of premier sports franchises continue to explode, regardless of sport.  The New York Yankees and LA Dodgers are estimated by Forbes to be worth $2.5 billion and $2 billion, respectively, and this despite the declining popularity of baseball and its aging viewership.  In football, my hometown Dallas Cowboys are estimated to be worth $3.2 billion, though I can’t imagine Jerry Jones ever selling. The New England Patriots are worth $2.6 billion, and the Washington Redskins are worth $2.4 billion.  And these values are for a sport with only 16 regular season games.

I broke out MSG’s biggest identifiable assets and businesses and gave my best estimate of their current value. The New York Knicks franchise is probably worth something in the ballpark of $2 billion to $3 billion based on the recent sales price of the LA Clippers (Forbes puts the value at $1.4 billion, but this estimate was made before the Clippers sale).

The New York Rangers are estimated to be worth $1.1 billion, and the value of the Madison Square Garden arena is worth at least the $1 billion recently spent on its renovation. These assets alone put MSG’s value at $4.5 billion – $5.5 billion—or close to its current $5.75 billion market cap. At current prices, you’re essentially getting MSG’s other businesses—including its massive and profitable media empire—for free. And using industry comps, MSG’s media business is worth close to $2 billion.

Taken together, MSG’s major assets and businesses total $6.5 billion – $7.5 billion. Based on this very conservative estimate, MSG is worth anywhere from 13% to 30% more than its current market price. And let me stress, these are conservative estimates. It could easily be worth significantly more.

International Paper

Next up is paper and packaging company International Paper (IP). In an age of green awareness, there aren’t too many more politically incorrect stocks to own than a paper company. But like it or not, packaging is an important part of the modern economy, particular in the age of internet commerce and home delivery. And paper is a lot greener than some of the alternatives, like Styrofoam.

International Paper trades for just 13 times expected 2015 earnings and 0.77 times sales. That’s not half bad in today’s market. But International Paper also pays a respectable 2.7% dividend and has been aggressively raising its dividend since 2010 (International Paper briefly cut its dividend by 90% during the 2008-2009 meltdown). International Paper has grown its dividend at a 46.2% clip over the past three years. That pace of growth isn’t sustainable over the long term, but I still expect solid double-digit dividend growth for a long time to come.

But there is one major catalyst that could cause International Paper to soar by 50%-100% within the next 12 months: conversion to an MLP. Management has openly considered the idea, and tax experts expect any such planned conversion to be approved by the IRS.

Converting to an MLP structure would allow International Paper to avoid paying federal income tax, would free up plenty of cash flow for tax-advantaged cash distributions and share repurchases.

I would never recommend a stock purely because it might reorganize itself as an MLP. That’s lazy research and not likely to generate viable returns over time. But in International Paper’s case, the stock is an attractive, dividend-paying value stock assuming no change of status. Any benefit from an MLP conversion would be icing on the cake.

Lar España

And finally, I’ll leave you with one value stock completely off the radar of most investors: Spanish REIT Lar España (Madrid: LRE).

After raising about €400 million in its IPO last year, Lar has invested about €318 million of the proceeds thus far in a collection of high-quality Spanish real estate assets. As Spain’s economy has modestly recovered over the past year, it’s reasonable to assume that Lar’s assets are worth at least as much as what it paid, meaning that at a bare minimum Lar should be trading at its IPO price of €10. Yet shares currently trade hands at just €9.18.

It’s hard to complain about buying $1 worth of assets for 92 cents. But that is exactly the situation we have today in Lar.

Buying shares of Lar can be tricky and expensive for American investors, so make sure you chat with your broker before placing an order. In my experience, I’ve found that Interactive Brokers charges very reasonable commissions for trades in the Spanish market, and in the interest of full disclosure, this is the broker I use both personally and in client accounts to buy shares.

Disclosures: Long MSG, IP, LRE

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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2015 Investment Outlook

I gave a presentation to the Robertson Wealth Management team this week outlining my investment outlook for 2015, and I’m posting the presentation here. I don’t have a complete transcript prepared, but most of the charts are pretty self-explanatory. Enjoy!

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Where to Look for Cheap Stocks in 2015: CAPE Around the World

2014 was a lousy year for global value investors. Cheap markets, as measured by the cyclically-adjusted price/earnings ratio (“CAPE”) got even cheaper, while expensive markets got even pricier. (Note: the CAPE takes a ten-year average of earnings as a way of smoothing out the economic cycle and allowing for better comparisons over time.)

I expect this to reverse in 2015. At some point–and I’m betting it could be as early as the first quarter–global market valuations should start to revert to their long term averages. That’s fantastic news if you’re invested in cheap foreign markets. It’s not such fantastic news if your portfolio is exclusively invested in high-CAPE American stocks.

Let’s take a look at just how skewed the numbers are. The S&P 500 managed to produce total returns of 13.7% in 2014. But as quant guru Meb Faber pointed out in a recent blog post, globally, the median stock market posted a loss of 1.33%. The cheapest 25% of countries saw declines of 12.88%, while the most expensive markets actually gained 1.36%.

I should throw out a couple caveats here. These were the returns of U.S.-traded single-country ETFs, which are priced in dollars, and not the national benchmarks. The strength of the U.S. dollar relative to virtually every other world currency last year was a major contributor to the underperformance of the rest of the world.

All the same, it’s worth noting that we’re in uncharted territory here. As Faber noted in a recent tweet, U.S. stock valuations relative to foreign stock valuations closed 2014 at the highest spread over the past 30 years. Four out of the five biggest relative valuation gaps resulted in outperformance by foreign stocks the following year. The only exception was 2014.

Let’s dig into the numbers. The CAPE for the S&P 500 is now 27.2. That’s a full 63.9% higher than the historical average of 16.6, more expensive than at the 2007 peak, and close to the 1929 peak. The only time in U.S. history where the S&P 500 was significantly more expensive based on CAPE was during the peak of the 1990s tech bubble.



Sure, the “fair” CAPE is going to be a little higher today than in decades past due to record low bond yields (all else equal, lower yields mean higher “correct” valuations). But I should point out that yields are even lower in most of Europe and Japan, yet valuations are significantly cheaper. So while low bond yields might partially explain why U.S. stocks are expensive relative to their own history, it doesn’t explain why the U.S. is expensive relative to the rest of the world.

No matter how you slice it, U.S. stocks aren’t the bargain they were a few years ago. Research Affiliates calcuates that U.S. stocks are priced to deliver returns of about 0.7% over the next 10 years. Using a similar methodology, GuruFocus calculates an expected return of about 0.3%.

I’ve driven home how expensive U.S. stocks are. Now, let’s take a look at other global markets. Here are the world’s markets as measured by the CAPE and sister valuation metrics cyclically-adjusted price/dividend (“CAPD”) cyclically-adjusted price/cash flow (“CAPCF”) and cyclically-adjusted price/book (“CAPB”).  All figures reported in Meb Faber’s Idea Farm using original data from Ned Davis Research.

Czech Republic10.315.
New Zealand14.618.27.51.915.25
Hong Kong18.
South Africa20.945.314.83.436.5

[Note: The U.S. figures use the MSCI U.S. index rather than the S&P 500, hence the difference in CAPE value.)

We see some familar names on the list. Greece remains the world’s cheapest market by a wide margin. Of course, Greece is also in the middle of an election cycle that may well result in the country getting booted out of the Eurozone. Interestingly, Russia is cheap following Western sanctions and the collapse in the price of oil, yet there are several far more stable countries that are cheaper, such as Austria, Portugal, Hungary and Italy.

Two countries that I’ve liked for years based on valuation–Brazil and Spain–round out the top ten. To put things in perspective, the most expensive market on this list–Spain–trades at nearly a 60% discount to the U.S. market based on CAPE. Yes, Spain has its problems. Its economy is stuck in a slow-growth rut, and unemployment remains over 20%. But Spain is also home to some of the world’s finest multinationals, such as banks BBVA (BBVA) and Banco Santander (SAN), telecom giant Telefonica (TEF) and fashion retailer Inditex (IDEXY).

There are different ways to use this data. You could buy and hold country ETFs, such as the Global X FTSE Greece 20 ETF (GREK), the Market Vectors Russia ETF (RSX) or the iShares MSCI Spain ETF (EWP). Or you could go with a convenient one-stop shop like Faber’s Cambria Global Value ETF (GVAL). GVAL is nice collection of cheap stocks from around the world. As of last quarter, GVAL’s largest country weightings were to Brazil, Spain and Israel.

Disclosures: Long GVAL, EWP, BBVA, SAN, TEF

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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Mea Culpa: My Biggest Investing Mistakes of 2014

2014 has been a rough year to navigate. I went against the grain in January and bet big on one macro trend—that long-term interest rates would fall in 2014 rather than rise—and invested heavily in equity REITs and mortgage REITs. That bet paid off handsomely, and my conservative, income-oriented portfolios have had a great year.

But where do I even start on all of the investing mistakes I made this year…

In my more aggressive portfolios, I made large allocations to emerging markets…just in time to see most emerging markets have the worst January in years.  My pick in this year’s InvestorPlace Best Stocks contest—South African telecom giant MTN Group (MTNOY)—was a play on the emerging market theme, and it has landed me squarely in last place.

I invested in Russian stocks during the Crimea and Ukraine crises believing that Western sanctions would be mostly toothless and that Russian stocks were too cheap to ignore. Well, that theory sounded great…right up until the price of crude oil collapsed, sending Russian stocks into a tailspin.

Oh, and while I’m at it, I didn’t see the crude oil collapse coming. My income oriented portfolios had a large allocation MLP general partners, and the collapse in MLP prices eroded most of my outperformance from earlier in the year.

I also recommended Prospect Capital (PSEC), noting that I believed a dividend cut was unlikely given the strong insider buying patterns I saw. Six weeks later, it cut its dividend.


But my biggest mea culpa of 2014 was getting into Brazilian stocks at precisely the wrong time. The iShares MSCI Brazil ETF (EWZ) rallied 42% going into September of this year. Even after that move, I believed Brazilian stocks to be cheap and underowned. With a new, market-friendly president taking office, I believed Brazil was primed for several years of solid returns.

There was just one problem. The new market-friendly president lost the election. Dilma was reelected and Brazilian stocks gave up all of their gains for the year. EWZ is now scraping along at close to its lows for the year.

What lessons can we learn from all of this?

No matter how sound your investment thesis looks, there can always be “externalities” that come out of left field. This year, we had plenty of them—the Russian annexation of Crimea, the Argentine debt default, the Ebola outbreak and the crude oil collapse, to name a few—but there will always be something.

When this happens, don’t look for someone or something to blame. Instead, try to keep a level head and approach each trading day as a clean slate. Look at your portfolio objectively and ask the following question: If I didn’t already own the stocks I have in my portfolio today, would I buy them now, knowing what I know?

If you can’t credibly say yes, then you need to consider selling or at least tightening your stops.

It’s not easy to maintain that kind of detachment. I struggle with it constantly, and if I am to be honest I don’t consider myself particularly good at it. But it’s a trait I notice consistently among great investors.

Disclosure: Long PSEC, MTNOY, EWZ

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.

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