Warren Buffett is considered one of the greatest investors of all time, but his style of finding stocks at a good deal has lagged the broader market this year.
“The top 10 stocks, mostly in the tech industry, account for almost half the S&P 500’s gain of 7.7 per cent this year,” according to the Financial Times. “In contrast, the S&P 500 value index has only eked out a 2 per cent gain so far in 2017, trailing behind the racier ‘growth index’ of faster-expanding companies.”
That growth has been concentrated in a handful of technology stocks, notably the “FAANG” group: Facebook, Amazon.com, Apple, Netflix and Google. These stocks may be due for a reversal, similar to past cycles.
“The Nasdaq 100 index of large technology stocks has just notched up its seventh monthly gain, its longest streak since 2009, and it has only rallied for eight months running twice before, in 1986 and 1995,” the newspaper reports.
Value stocks, such as financial and industrial companies, did surge after the election of Republican Donald Trump on a platform of tax cuts, less regulation and billion-dollar spending on roads, bridges and airports. But those gains faded as the Trump euphoria wore off amid legislative roadblocks and investigations into his campaign’s connections to Russia.
Meanwhile, stocks have gotten expensive compared with their historical averages. The S&P 500 is trading at more than 21 times its earnings, 30 percent higher than the long-term average of about 16 times. Yale economist Robert Shiller’s “Cape” ratio, which tries to smooth out short-term blips, is at 30 times, comparable to the 1929 peak that preceded a crash.
“It’s miserable,” Bill Smead of Smead Capital Management told the FT. The difference between value and growth stocks is “pretty extreme, and it feels like it’s accelerating.”
Even Buffett, chairman and chief executive of Berkshire Hathaway Inc., has bought tech stocks like Apple, and this year said he regretted not buying Amazon and Google, which have continued to innovate and grow revenues.
The growth in corporate profits is also cited as a driver of market gains, but one strategist says investors need to be wary of those reports.
Albert Edwards, global strategist at French bank Societe Generale, said earnings reports for U.S. companies show that their overseas profits have grown but are still falling domestically. The decline may even point toward recession.
“A 24 percent year-over-year surge in net U.S. overseas profits and a 12 percent year-over-year rise in financial sector profits have disguised the fact that domestic non-financial economic profits are really struggling badly and are still down 6 percent year-over-year,” Edwards said in a June 1 report obtained by Newsmax Finance. The data he cites are from National Income and Product Accounts produced by the Commerce Department.
The S&P 500 has jumped 13 percent to record highs since Trump won the presidency on November 8. The market’s moves have mirrored investor perceptions of the Trump agenda, such as the likelihood that tax cuts and healthcare reform will ever get to his desk for approval.
The market fell about 2 percent on May 17, the worst in eight months, after the former head of the FBI alleged in a memo that Trump was trying to interfere with an investigation into his campaign’s ties to Russia.
Edwards said U.S. companies are suffering from a rise in labor costs that may damp domestic business investment and result in a recession.
“Clearly the surge in U.S. unit labor costs … is continuing to drive the relentless decline in domestic non-financial economic profits into 2017,” he said. “This does not offer a sound footing for a recovery for U.S. domestic business investment – indeed quite the reverse.”
Business investment is a key part of calculating gross domestic product, or the total value of goods produced and services provided in a country.
“Although only 15 percent of GDP, business investment is the most volatile component of GDP and history suggests that in industrialized economies recessions are ‘caused,’ in an accounting sense, by swings in the business investment cycle,” he said.
The Federal Reserve is in the process of raising interest rates as the U.S. economy shows signs of strengthening, but that may backfire, Edwards said.
“It is worth bearing in mind, as the Fed continues to hike rates, that 10 of the 13 post-war tightening cycles have ended in recession,” he said. “Those are not good odds and I’m not sure why we should expect anything this time around?”
Edwards is sticking to the “Ice Age” thesis he introduced in 1996. The forecast advised investors to put money into bonds and be cautious with stocks as deflationary pressures like those seen in Japan spread throughout the world.
As another recession unfolds in the U.S., the Fed will have to buy more government debt, and drive yields on 10-year Treasurys to less than zero percent, similar to the monetary policies of Japan and the European Union, Edwards said.
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