by Tim Melvin | September 19, 2013 12:24 pm
I am not a market timer, nor have I ever played on television. If I was to ever give you a specific market prediction, you would be well-advised to splay me upon the head and shoulders, then do exactly the opposite of any short-term directional advice I ever give you.
In fact, I think all specific market predictions, including my own, are worthless.
What I am pretty good at is taking note of red flags that indicate we might be getting frothy and overdone to the upside, or a little overly depressed on the downside. These conditions can take months to play out, though, so it’s not as much a prediction as it is an indication that it might be time to be fearful or greedy based on the long-term condition of the stock market.
One screen I run on a regular basis looks for large-cap stocks that trade below their tangible book value. In general terms, if 20% or more of the S&P 500 trades below book value, the market is probably getting cheap enough for long-term investors. If it is less than that, it’s time to review your portfolio and look for fully valued or overvalued securities in which to take gains and raise cash levels.
Right now, just 6% of the S&P 500 trades below stated book value, and less than 2% of them trade below their tangible book value. So by this measure, only a handful of stocks in the entire universe would qualify for inclusion in a value portfolio right now.
A few interesting companies out there have seen a lot of buying from large-cap value types of late. For instance, it is harder to find a portfolio that doesn’t own shares of American International Group (AIG[1]) than one that does. Right now, AIG trades at roughly 75% of book value — and that’s after a 40%-plus gain in the past year! Other nattered insurance companies like my favorites Hartford International Group (HIG[2]) and Genworth Financial (GNW[3]) also are cheap compared to book at a respective 79% and 44% of TBV.
The money center and regional banks have staged an impressive rally in the past year, and after hardly being able to turn around without finding a bank stock below book value, only three big banks qualify right now. Bank of America (BAC[4]) and Citigroup (C[5]) might not see the 2007 highs again in my lifetime, but they are seeing better credit conditions as well as active capital markets, and thus have been recovering. I personally refuse to buy them because of my feelings on too big to fail, but other value funds have been accumulating the shares.
Zions Bancorporation (ZION[6]), at 94% of tangible book value, continues to be a credit-improvement and reserve-release story, and might be worth a small stake.
Two companies targeted by the screener dig stuff out of the ground, and that is one of my favorite themes right now. I am long both iron ore producer Cliffs Natural Resources (CLF[7]) and WPX Energy (WPX[8]), an oil and gas E&P firm.
The final stock is First Solar (FSLR[9]), which trades at 93% of book value — however, I am skeptical about the future of solar energy for the next several years.
What I take away from looking at the valuation of large-cap stocks right now is there are only a few stocks worth considering for a long-term value portfolio, and red flags are flying. The opportunity set is getting very thin, and that has always been a sign to start taking a more cautious approach to stocks and reviewing and pruning long-term portfolios.
As of this writing, Tim Melvin was long HIG, WPX and CLF.
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