A few years before the start of this decadelong bull market, Paul Hickey, 45, and Justin Walters, 38, launched Bespoke Investment Group, a subscription research service that disseminates their stock market insights and investment recommendations. They’d met as researchers at the strategy shop Birinyi Associates before launching their Harrison, N.Y.–based firm in May 2007. Bespoke helps clients stay mindful of historical market facts and current opportunities. They have made some good calls: They became market bulls in early 2009, and told Barron’s readers to buy Netflix and Facebook in 2015.
The coronavirus has proved to be a particular threat to both the aged population and the aged bull market, so we visited the Bespoke founders for perspective. An edited version of our conversation follows.
Q: The market’s in the sick ward. What now?
A: Paul Hickey: We look at events like this historically. When you see these very quick shocks to the market, there’s a short-term unsettlement. But over six to 12 months, you’ve seen better-than-average market returns.
It’s a matter of the market finding its footing. Right now, we’re trading more on the fear of what could happen rather than what’s actually happening.
Justin Walters: It’s really easy to say, “Buy low and sell high,” but when emotions get running, investors typically do the opposite. We like to keep our emotions in check and look at historical data. And history shows that in times like these—when markets are panicking—that’s not when to sell. We look at buy opportunities.
Q: Where were markets before the virus?
A: Walters: Coming into the Feb. 19 high, the S&P 500 index (.SPX) was up 17% from October. Markets were very extended, which increased valuations, as well. So all we’ve done really is reversed those gains and gone back to where we were in mid-2019.
Hickey: In February, the S&P 500’s price/earnings ratio was in the 99th percentile relative to the past 10 years—which is obviously stretched. Now we’re in the 75th percentile. So the pullback has reset valuations.
Coming into the year, we were looking at a neutral set of pros and cons, a relatively even balance. That made us expect an average year for stocks going forward. Now, we’re down 6% on the year, so you have to place the bias toward looking for above-average returns going forward.
The coronavirus is creating uncertainty, but eventually that will play out. Then the market will return to a more firm footing.
Q: You watch certain measures of the market. What are they showing?
A: Hickey: Right now, it’s extremely oversold—from a price perspective and market internals, like breadth [the number of stocks affected]. Every way you look at it, it’s extremely oversold. When things get this oversold, you want to look for buying opportunities.
Q: Dare I ask for a forecast for the broad markets?
A: Walters: Coming into the year, we were looking for an average year for equities. You know, mid-single digits in percentage returns. So now that we’re down 6%, the potential for, say, a 10% gain from here is that much more attainable.
Hickey: With this coronavirus, there’s uncertainty in how many cases there are going to be. We haven’t even really started testing for it here. But you can envision an end to it.
With past big, finance-related events, there was less of an end in sight. The peak hysteria over this virus is going to be measured in weeks and months, not longer. It will pass relatively shortly. And once we do move past it, the election comes into view.
Q: How is the election relevant to markets?
A: Walters: If you’re looking at betting odds, President Donald Trump has a roughly 60% chance of winning re-election, which means the Democratic candidate has a 40% chance. Be it [Bernie] Sanders or [Joe] Biden.
Hickey: The common trend for years when you have a president running for re-election tends to be flat-to-negative returns. Then the market picks up in the second half of the year, as the market figures out what’s going to happen. Health-insurance stocks were down big; now, they’ve rallied with the changing tide on the Democratic side.
Q: Which non-U.S. markets should we be talking about?
A: Hickey: It has been a lost decade for emerging markets and a lot of international markets. As an investor, it’s very important to have diversification. We’ve been positive on those markets for the past year or two, and we haven’t yet seen the outperformance. The dollar has been strong recently, but that won’t last forever. When the dollar does start to weaken, emerging markets will be a primary beneficiary.
As an asset class, it’s easy to have exposure there. The iShares MSCI Emerging Markets exchange-traded fund (EEM), for instance, has more than a 3% yield.
Q: All of the S&P sectors have been clocked by the virus. Are there any industry distinctions?
A: Walters: While valuations for the broad S&P 500, coming into mid-February, were in the 99th percentile, financials remained in the 60th and 70th. And after the steep decline we’ve seen, those valuations for financials have dropped all the way to just the bottom one percentile of their 10-year range. So that’s definitely a sector where the valuations have come in really low. Yet default risk for the sector remains extremely low. We’d recommend an overweight exposure.
Q: So, buy financial stocks. Are there specific ones you like?
A: Walters: If you want to buy the entire sector, use the Financial Select Sector SPDR ETF (XLF) or the SPDR S&P Bank ETF (KBE).
Or even the individual stocks of the large banks, like Bank of America (BAC) or Goldman Sachs Group (GS). Since the financial crisis, their balance sheets are so much stronger. They have the ability to raise dividends, as the regulatory environment has gotten less stringent on them.
Q: Any other sectors that we would have been discussing if we weren’t in the isolation ward?
A: Walters: Energy is tough, right now. Sentiment is so negative on the sector. You’ve got the whole ESG [environmental, social, and corporate governance] trend, which is really hurting things. The energy sector’s weighting in the S&P 500 has dropped to 3.5%—which is smaller than utilities and something we haven’t seen since at least 1990. Just over 10 years ago, energy had a weighting of nearly 16%. So, just as a matter of asset allocation and long-term mean-reversion, we think the energy sector’s not going away. It’s a good time to probably pick some up something like the Energy Select Sector SPDR ETF (XLE).
Q: Which stocks do you like?
A: Hickey: One we like right now is Albemarle (ALB), which is a lithium producer. They’re one of the largest players in the lithium market in the U.S. There is a secular growth trend, with the move to electric vehicles and battery storage of solar power. Right now, lithium prices are weak, but that’s a temporary phenomenon as they right-size their production. We’re going to see double-digit growth in the market over the next five years, as the electric-vehicle market grows.
Historically, we’ve seen a correlation between the performance of Tesla’s stock (TSLA) and those of the lithium producers. If Tesla’s stock is too crazy for you to buy right now, Albemarle or the Global X Lithium & Battery Tech ETF (LIT) are good ways to gain exposure to the battery-electric sector without having to reach for Tesla.
Q: Any others?
A: Walters: Two videogame stocks: Electronic Arts (EA) and Activision Blizzard (ATVI). We like the long-term outlook for the gaming industry, with the rise of esports. Those two stocks underperformed on a relative basis in 2017 and 2018, so they haven’t gotten as stretched as other consumer tech names.
Hickey: You have Microsoft (MSFT) and Sony (SNE) releasing new consoles later this year. Videogame stocks tend to outperform in the months leading up to the release of new consoles. If we’re stuck in a pandemic, what better way to pass the time than that?
Q: When we’re “working from home.”
A: Hickey: Switzerland just banned events for more than 1,000 people. Schools are closing around the world, so if you can’t go out, you’ll be more likely to play a game at home.
Another stock we like is Slack Technologies (WORK). It’s one of the stickiest applications that any worker is using these days. Once they start using it, they always use it. The fact that it has become a verb—“Slack me,” rather than “email me”—just shows the power of the platform and the fact that it’s not necessarily a flash in the pan.
The worry is the competition from Microsoft. But engagement statistics for Slack are so much higher than they are for Microsoft Teams, which is a product they’re giving away. Slack is something that people actually pay for. The company came public at over $40, and it’s in the high-$20s now. It’s not a company that’s levered up or burning through cash.
Walters: And as we were talking about with the videogame stocks, if you are going to be stuck at home and working remotely, you’re going to need an application like Slack.
Q: Any investments you don’t like?
A: Hickey: Long-term Treasuries. The S&P 500’s dividend yield is now more than a full percentage point higher than the yield on the 10-year Treasury. That only happened once before—during the 2008 crisis. When you’re looking at a 1% Treasury yield, that “income investment” just isn’t providing much in the way of income.
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