Revisiting What I Consider My Best Article Ever – Importance Of Valuations & Avoiding FOMO

Introduction

During the past seven years, I’ve written over 450 public articles on Seeking Alpha and nearly 300 for my marketplace service, most of them in the past five years. But the very best article of the hundreds written was published almost exactly two years ago. It was titled “There Are Bubbles But Cash Is Not The Place To Be, Here Are 10 Stocks To Buy Now“. Since the very beginning of my writing career, I have been committed to writing actionable articles.

I had read many well-written and compelling articles about the stock market over the years, many of them macro-oriented, but very few were actionable from an investing standpoint. For me, laying out a macro thesis or describing the functioning of a business is only 1/3rd of an analyst’s work (and not even the most important 1/3rd). My view has been that in order for my work to be useful to readers it should be actionable and the results should be measurable in some way, so we can look back and assess the potential validity of the approach over time.

Because we’ve been in a very long bull market without a serious recession and deep bear downturn, I find myself disproportionately writing warning articles and sharing “Sell” ratings for stocks. (The year 2020 was an exception. That year, there were many buying opportunities.) Whenever I write one of these bearish articles, I also try to share an alternative idea or ideas I think would offer a better risk/reward than the stock I think is overvalued at the time. It’s twice the work on my part, but I consider it one of my responsibilities if I’m going to be bearish, to at least try to share an alternative that could work better. This was difficult to do when cash yielded literally nothing. And, frankly, it’s what made responsible investing difficult over the later stages of this bull market.

Since I like to share valuation articles that are actionable and measurable, I don’t usually write macro-oriented articles. Instead, I tend to build my macro-views into my individual stock analyses, but in February of 2021, cash yielded nothing while there was an extreme mania in the stock market. At the same time, inflation was picking up, and it seemed there was no place for a responsible, long-only investor to hide from poor future returns. The acronym TINA (there is no alternative), in reference to stocks, was on everyone’s lips.

It was at that time I decided to break with my normal article format and share a lot of broad areas of the market I thought investors should avoid, while at the same time offering as many positive investment ideas as I could find for investors to put their money in instead of putting it in cash.

The point of the article was that even though there were asset bubbles everywhere, it didn’t make sense to hide in cash. In the article, I took an “inversion” approach (borrowed from Charlie Munger) in order to make my initial case that there were bubbles in the market, and I asked what an investor would do if they wanted to ensure poor returns from their investments. The idea was to avoid these areas where poor returns were a high probability. Here is what I wrote in that article:

Perhaps we should first invert our thinking, and list what NOT to do if we want to achieve reasonably good long-term returns. In order to do that, we can think of things we should do if our goal is to produce poor long-term returns. If you really want to ensure you will produce poor returns over the next decade you should 1) go out and buy as many recent IPOs and SPACs as you can, 2) buy lots of crypto-currency 3) put more than 20% of your portfolio in long-duration bonds 4) buy stocks with low earnings yields 5) buy stocks with PEG ratios over 3.0, 6) buy stocks taking on massive amounts of new debt just to keep their businesses alive, 7) buy stocks who had a temporary 2-year lift from COVID and are now trading at high prices, 8) buy a new house that you don’t need just because your stock portfolio has performed well, 9) buy the stocks of businesses that have shown evidence they are being disrupted by new technology, 10) own index or mutual funds that are heavily weighted with many of the above types of stocks, and last, but not least 11) hold lots of cash because you think everything is in a bubble.

I’m going to take a moment here to run through the sample performance of some examples I shared where investors could get poor performance so we can broadly see how they have performed over the past two years.

#1 IPOs and SPACs

My first suggestion as a way to ensure poor returns was to buy as many IPOs and SPACs as possible. Below is a chart of Renaissance IPO ETF (IPO) since my article was published:

This certainly would have succeeded at performing poorly.

As for SPACs, last year when I followed up on the results of my article, I used Defiance Next Gen SPAC Derived ETF (SPAK) to measure the results of SPACs, but it has since closed (likely due to miserable performance). From the time of the article publication to the time of the closure, an investor would have lost between -55% and -60%, similar to the loss in IPOs.

#2 Crypto Returns

Well, if you didn’t lose your crypto via theft or fraud during the past two years, you at least accomplished something. In the article, I suggested precious metals, and in particular, I thought Platinum (PPLT) better served the needs of those looking for the sort cash alternatives crypto was promising at the time. During the past two years, I have transferred most of my precious metal holdings mentioned in the article into stocks, which are my preferred investments, but I still have about a 4% weighting to PPLT. Here is how it has performed compared to the price of Bitcoin.

My platinum alternative hasn’t performed particularly well over the past two years, but it has performed considerably better than bitcoin, and I suspect as time goes on, now that supply chains are starting to come back online, PPLT will perform better this year if we avoid a global recession. Bitcoin, on the other hand, has a much more challenging environment ahead of it, still.

#3 Overweight long-duration bonds

This mistake probably cost investors trillions of dollars over the past year or two. Let’s see how the iShares 20+ Year Treasury Bond ETF (TLT) has performed:

As bad as IPOs and SPACs and Crypto were in terms of the magnitude of declines, the declines in long-duration bonds almost certainly cost investors the most money. This is some of the worst bond performance in history. But it was absolutely identifiable and avoidable.

#4 Buy Stocks With Low Earnings Yields

There are lots of ETFs that could fit into this category, but I think the idea here was that these are otherwise quality businesses with good earnings growth, but their earnings yields were simply too high (implying low returns). So, we’ll use Invesco’s ETF (QQQ) as our proxy for this one.

Well, after the recent rally, QQQ is performing better, but returns are still negative after two years and we haven’t even had a recession, yet. Also, several mega-cap growth stocks are still fairly richly valued (like Apple (AAPL)) that probably need to decline still.

#5 Stocks with PEG Ratios over 3

I actually think that there are many stocks in this category that are way, way, overvalued. But here is a sample of well-known large-cap stocks that fit this profile from 2021.

A couple of them eeked out positive returns, but for the most part, returns were very poor.

#6 Businesses Taking On Debt To Stay Alive

For this category, I mostly had in mind airlines and cruise lines. And, I wrote warning articles on Carnival (CCL) and Southwest (LUV) during this time, and have been bearish on Boeing (BA) for five years, now. Here is how this group has done.

Again, we have a couple of them with modestly positive gains, but the overall trend is clearly negative, and often in a big way.

#7 Temporary COVID-lifted Stocks

These were stocks that benefited from the unusual nature of the pandemic and the response to the pandemic that investors should have known would be temporary.

Of this bunch, Quest Diagnostics (DGX) produced a gain, but most of the rest produced deeply negative returns. Again, entirely predictable.

#8 Buying A House You Don’t Need

Most people who bought a house in early 2021 are probably still doing fine and aren’t upside down, yet. But we can examine the retail housing related stocks, some of which were in the business of flipping homes at the time, to see the bubble that existed there and see how they did.

Other housing stocks like homebuilders are holding up better, but I think over time we won’t see good returns from them either given how much interest rates have risen. It will just take some time for that to be reflected in the housing market because people with fixed-rate mortgages won’t move unless they have to.

#9 Businesses Getting Disrupted

This is a hard category to find examples of because it tends to happen relatively slowly over time. My main point here is that it wasn’t particularly safe to hide out in a well-known stock if it is being disrupted. One’s returns might not be horrible, but they weren’t unlikely to be good if they took this approach.

#10 Own Funds Heavily Weighted To These Types of Stocks

I think one fund I haven’t shared yet immediately comes to mind. ARK Innovation ETF (ARKK), since it sums up a great many of these categories of investments.

Ouch! At least we have Cathie Wood to tell us all where the price of Bitcoin will be in 2030, right?

#11 And Last, But Not Least, Hold Lots of Cash

This is probably one of the most important parts of the article from two years ago, so I’m going to quote a large portion of it here:

My goal here is to convince readers that I understand the short-term utility of holding cash during certain periods (like the one we just experienced in 2020), but I also recognize that over the medium-term and long-term, cash is not going to be a good investment. Every force in the universe is conspiring to reduce the purchasing power of cash right now. They will eventually win. We haven’t had a lot of inflation in the US for quite some time now except in healthcare and education. That’s true. So, I am not one of these people who thinks there has been secret unreported inflation going on for decades that the academics and bureaucrats are keeping hidden from us. But I do think that when trillions upon trillions of dollars are pumped into the economy and interest rates are held artificially low, that inflation will eventually happen. I expect that it will meet or exceed the 10-Year Treasury Yield. I’m not saying there will be hyperinflation. I’m saying that we know long-term bonds are bad investments and that holding too much cash long-term has a 90% probability of being a bad investment. Any good quality, reasonably priced stock will provide much better returns over the next 5-10 years. This is my case against holding too much cash and medium and long-term bonds, and more importantly, at least not actively being on the lookout to invest these funds in good individual stock opportunities if you have the skill to do so.

I think this assessment was spot on.

Cash started to yield a little bit toward the end of last year, but, for the most part, an investor who parked large amounts of money in cash would have lost around 10-12% in purchasing power over the past two years.

At the time, there was a big outcry from those calling a market bubble. And they were correct. But only a few of them acknowledged that cash would lose money in real terms and duration bonds were in a generational bubble as well. And those that did acknowledge these problems, essentially never offered a good solution.

So, I took it upon myself to try my best to answer this challenge and share some individual stock ideas that I had purchased myself, which I thought would offer a good value for investors over the medium term. One of the ideas I shared was People’s United Financial Bank, which got a buyout offer within two weeks of the publication of the article. Since it’s no longer listed, I can’t share a chart, but it was bought out at over a 20% premium from the time the article was published.

Next, I shared three refiner stock ideas, in which I personally had a big overweight position. I have since taken profits in all of them, but here is how they have performed.

These were all double positions for me, so they performed quite well. The returns in the chart here are actually pretty close, on average, to the average returns I had.

Next are two financial stocks, T. Rowe Price (TROW) and Principal Financial (PFG), in which I took profits around January of last year. I wrote a public article about those sales titled: “6 Financial Stocks I Recently Sold, And 2 I Will Hold For The Long Term” I’ll first share the performance through today, and then the performance through the publication of my sell article.

If a person held onto them through today the returns would have averaged +27.29%, and if they sold on the day of my sell article they would have been about +20%.

I really wanted to share ideas from a wide variety of industries, so I selected Elevance Health (ELV) (formerly Anthem) a health insurer, BorgWarner (BWA) an auto supplier, Lockheed Martin (LMT) a defense contractor, Meta Platforms (META) a mega tech, and Bristol-Myers (BMY) a drug maker. Combined with the three financial stocks I shared and three refiners, this was a pretty well-rounded basket of specific stock ideas. (Actually 11 in total instead of 10 as the title states.) Here is how this group has performed:

Meta is negative and has underperformed the S&P 500 index, but all of the other ideas outperformed the S&P 500 and outperformed inflation.

Excluding the PBCT buyout, the average equal-weighted returns of the remaining 10 stock ideas I shared was about +43.44%. If you include a platinum position as part of the mix it would have been +37.35%. Again, these were spread out among several different industries and I had purchased them all myself within the three months leading up to the article publication.

Two Lessons

The first lesson is that investors who are focused on the medium term of 3-5 years, should resist the fear of missing out, FOMO, at all costs. Some basic rules to live by here are 1) don’t invest in stocks that don’t have long-term earnings data and haven’t experienced at least one recession. Make them prove they can earn money in different investing environments before buying them. 2) If the media is talking about a stock or asset class a lot, avoid it because it’s either overvalued or a total scam.

The best investments are usually the ones few people are paying attention to. 3) You do not have to own every winner in order to perform extremely well in the stock market over the long term. You don’t have to swing at every pitch. Swing at the easiest pitches. Often times in my article I’ll share the price at which I would be willing to buy a stock and readers laugh and say I’ll never see that price. My response is that’s okay, I will buy something else that will make me more money. (And, in the case of most of the bubbles I warned about two years ago, I will avoid losing money.)

The second lesson is that valuation matters, and learning how to value businesses and stocks is an essential investing skill. Sometimes commenters on my articles will say that I simply got lucky when I warned investors of a potential stock price decline after the stock price declined as expected. While it’s difficult to disprove luck, and on any given warning or investment luck plays a role, over time, if you have a big enough sample, the role of luck is diminished.

It could have been luck that 11 stocks from at least five different industries, which just happened to all look like good values using my methods massively outperformed all the bubble assets and the major indices during the past two years. But how likely is it, really, that valuation and business selection didn’t play the primary role?

Valuation isn’t the only investment strategy. Over the short term, valuation often doesn’t actually work all that well. But once we get two or three years into the future, then we start to see a better correlation between business quality, valuation, and stock price. The investors who say nobody can invest better than the market average are simply wrong. And investors who say valuing a stock is the same as “market timing” are wrong as well.

When my article was published two years ago, it was a horrible time to invest in “the market”. My warnings on bubble investments didn’t even coincide with the top of “the market”, which wouldn’t happen until nearly a year later. And while the publication of my article ended up being almost the exact top for the bubble assets, I actually didn’t think it was likely the top when I wrote my article. So, it’s not about timing the market. It’s about estimating medium-term return expectations using reasonable assumptions, preferably backed up by history, to do it.

Cash (And Growth) Is Now The Place To Be

In my follow-up article last year, I noted that cash “still wasn’t the place to be”. That quickly changed, however, with Russia’s invasion of Ukraine soon after the article was published. By May of last year, I had shifted to roughly 1/3rd cash, and I’ve been around 1/4th to 1/3rd cash since then. However, I haven’t been stagnant over the past year. I’ve added over 20 growth and tech stocks to my portfolio. I don’t write about my growth strategy publicly, it’s exclusive to my marketplace service, The Cyclical Investor’s Club, but I have written publicly about some deep cyclical purchases like Micron (MU) and Advanced Micro Devices (AMD) last fall.

It is these sorts of beaten-down tech stocks, usually more than -70% off their highs, where I am finding the most value in the current market. However, in order to invest in them, an investor has to be able to stomach lots of volatility. Some of them, like Etsy (ETSY) lost around -50% before recovering recently. And others, like Airbnb (ABNB) will probably take a long time to prove themselves. An investor has to accept that sort of volatility and take a pretty long-term view with these sorts of growth stocks.

I share these as some large-cap examples of the types of stocks I’m buying right now. Quality businesses with good long-term growth prospects that aren’t particularly “cheap”, but who will likely produce good growth for a long time in an environment where real growth is likely to be scarce.

The good part is that now that cash is yielding 4% to 5%, an investor can balance out this volatile growth and deep cyclical investments with cash in a portfolio, and not take on much additional volatility compared to the market. The key benefit of this approach is that if the market does decline and go into an extended bear market, then an investor can take their cash and add quality stocks and much cheaper prices. Or, if the market simply rotates as it has been doing, many growth stocks have already been purchased at decent prices, and they stand to gain the most if the market never has a really deep sell-off.

This sort of barbell approach is how I’m dealing with all the uncertainty of 2023.

Conclusion

Investing with the goal of achieving above-average returns isn’t easy. The way I like to think about it is if the S&P 500 can deliver 10% annual long-term returns, and Warren Buffett can achieve 20% annual long-term returns, then there is a big gap between those two where an above-average investor who isn’t as smart as Buffett can get 15%. And that’s basically what I try to do. But in order to have a chance at getting returns like that an investor has to avoid most bad mistakes like the ones outlined in this article. They also have to buy the stocks of quality businesses at cheaper prices than the average investor typically buys them. Both aspects are important but they are possible to achieve.

With the likely market average return looking more like 6% over the medium term from here, maybe a good investor only can get 9% in this environment, and a great investor gets 12%. Over the long term that’s still a very big difference in ultimate outcomes over one’s investing career. So, it’s my view that it’s worth taking the time to learn how to invest better. It is possible, and those who do so will be rewarded over time.