Editor’s Note: As the clock winds down on 2016, this week we turn to the top minds in finance to learn how to navigate 2017’s choppy investment waters.
Today, one of the all-time highest-returning stock pickers in Agora Inc. history—Bonner & Partners’ Chris Mayer—shares what investors must do to stay profitable in 2017…
J. Reeves, editor, The Palm Beach Daily: There’s no doubt the markets “climbed a wall of worry” in 2016—Brexit… Trump… Quitaly—all to close out the year near all-time highs. Do you see more of the same in 2017? Why or why not?
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Chris Mayer, chief strategic analyst, Bonner & Partners: I think the post-election rally will be justified if Trump gets the tax cuts he wants. And it could go higher. People forget sometimes what a drag taxes are.
I recently read an analyst note that showed how Warren Buffett’s Berkshire Hathaway would enjoy a $29 billion windfall—that’s an 11% increase in Berkshire’s book value—with a tax cut from 35% to 15%. That’s huge.
Even if the tax rate falls to “only” 25%, that’s a $14 billion addition to Berkshire Hathaway.
(Of course, the irony here is that Buffett backed Hillary Clinton.)
Anyway, that’s just one example. But broad tax cuts to businesses and consumers are very bullish for many stocks.
It’s also interesting to note how many bears flipped to bulls after the election. Billionaire investors like Carl Icahn, Stanley Druckenmiller, and Prem Watsa, to name a few off the top of my head…
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Watsa runs Fairfax Financial, an insurance holding company based in Toronto that’s kind of like Berkshire. Watsa has been a macro genius and has made all kinds of great calls in his career.
Well, before the election, he had more than 100% of his equity portfolio hedged against a collapse of the market. He also owned lots of bonds and was betting on deflation. After the election, he sold 90% of his bonds and dropped his hedging to just 50% of his portfolio.
This week, he just did a big deal to buy a U.S. insurer. It’s the biggest deal in the 30-year history of Fairfax. I forget his exact words, but on a recent conference call about the deal, he said that Trump—with control of Congress—“has the potential to make the business climate for growth in the United States great again.”
Again, he was very bearish and now he’s very bullish.
I don’t know what will happen in 2017. As you know, I’m not a market timer, but if America is truly “open for business” as Trump says, that’s a bullish tailwind.
We’ll see. He’s not even been sworn in yet, so there is much work to do.
J.R.: The S&P 500 now sports an average P/E of 26. Average U.S. real estate prices have rebounded back above last decade’s “bubble” highs. The U.S. bond market—even after recent weakness—still hovers near all-time highs.
Where are you looking to find value for your subscribers in 2017?
Chris: The U.S. market often seems expensive to me. But fortunately, I don’t buy the market. I buy individual stocks. There are easily over 10,000 stocks in my universe.
I only need to find about a dozen worth owning.
Which reminds me of one of my favorite quotes from Benjamin Graham, the renowned investment theorist and teacher of Warren Buffett. He said (and I’m paraphrasing) that an analyst at all times should be able to find attractive opportunities in 1% of the stock universe. In his time, that would have been about 30 “attractive” stocks out of 3,000.
So my point to you would be: It doesn’t matter what the market average looks like. There are always—yes, always—interesting opportunities. The market just dictates the relative paucity or richness of such opportunities.
And besides, it’s a big world out there. In the Bonner Private Portfolio, we own just nine stocks right now. We started putting money to work in April, and we’re close to 60% invested so far. We’ve been patiently building a portfolio of cash-rich, undervalued names.
Of those nine stocks, four are overseas. We own one Canadian firm, one Japanese firm, one Swiss firm, and one French firm. All of these stocks you can easily buy with any U.S. brokerage account. The top candidate we’re looking to add is also based in Europe.
So, in a long-winded way to answer your question, I guess you could say one place we’re finding great bargains is in overseas markets.
But really, we find value where we find it. I mean, I have no commitment to look in any particular place or sector. I go where I find value, safety, and talented management with skin in the game and big upside.
In 2017, I expect we’ll continue to have an eclectic portfolio.
J.R.: Let’s talk about your strategy for success in 2017. Has anything going on in the markets changed your CODE approach to investing?
Chris: No. The CODE approach is a timeless set of principles. As you know…
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C is cheap—I want to buy undervalued stocks.
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O is for owner-operators—I want to invest with people who have skin in the game.
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D is for disclosures—I want to invest in stocks that have no red flags in their accounting and public disclosures.
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E is for excellent financial condition—I want to invest in companies with little or no debt and plenty of cash.
These principles are good in all markets and at all times.
J.R.: Where are the top “danger zones” you see ahead?
Chris: I think utility stocks are in that danger zone… You have interest rates rising and, since utility stocks often trade on their yields, this is bearish for them.
The key is whether they can raise their dividends to keep pace. They won’t.
Utility stocks face real threats from solar. And electricity use has decoupled from economic growth as people find ways to be more efficient.
Plus, the stocks trade for high valuations generally. I just don’t see how many of those stocks can work—and there is lots of downside when people realize earnings are not going to grow and the dividends are not as safe as people assume.
Another danger zone is the high-yield debt market. This is the market for less-than-stellar credits. If you look at the Russell 2000—an index dominated by small companies—you’ll find financial leverage is near all-time highs. And rates have just crept up.
I think there are a good number of firms in that index that won’t be able to refinance at higher rates. (And the tax-relief argument I noted earlier doesn’t work as well here because many companies in the Russell don’t generate significant taxable income.)
So, we could see problems in the Russell as those debts come due.
J.R.: What’s the most important thing investors can do to stay safe (and profitable) in 2017?
Chris: Hmm…
As an investor, the most important thing is to stay focused on what you own.
Stocks are not just ticker symbols. They represent real businesses with real assets and people. Don’t get lost in the abstractions of what the economy is going to do or what the Fed will do next. Stay focused on trying to understand what you own—how it creates value and grows and what it’s worth. Then use the ups and downs of the market to your advantage.
Peter Lynch, the great investor at the helm of Fidelity Magellan during its heyday, once said that the key to making money in stocks is not to get scared out of them.
Stocks will go up and down. The headlines will scream with fear. But stay the course. Take advantage of the market’s gyrations; don’t let them take advantage of you.
J.R.: Incredible insights, as always. Thank you, Chris.
Chris: Anytime.
Reeves’ Note: If you invested $100,000 in his advice in 2004, you would have been sitting on over $480,000 10 years later. His track record is so impressive that longtime PBRG friend Bill Bonner handpicked Chris to select stocks for the Bonner family’s $5 million fund.
Through his family trust, Bill will be investing at least $50,000 in every recommendation Chris makes. But you can get in on these ideas before Bill does. To learn how, click here.
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