The following commentary was originally sent to Action Alerts PLUS subscribers on Feb. 9, 2016.
After U.S. stocks opened lower on the heels of a global selloff -- Japanese stocks closed down more than 5% in a flight to safety while European stocks (Stoxx 600) declined some 2.6% to their lowest level since 2014 -- we wanted to update subscribers on our view of the Action Alerts PLUS portfolio as whole, the general macro/market and several positions in particular.
The same forces that have dragged on global markets since the beginning of the year -- concerns around the Chinese economy, market volatility, weak global growth, collapsing commodity prices, geopolitical tensions and potential for a U.S. rate hike -- continue to invoke fear, panic and anxiety.
Japan's 5.4% selloff overnight pits worries about a global economic slowdown (particularly across Asia) against uncertainty around the viability of Prime Minister Shinzo Abe's monetary policy (as a reminder, the Bank of Japan recently introduced negative interest rates), with many economists arguing that negative yields are unlikely to boost the economy, with any impact de minimis when compared to the towering global forces casting a shadow over the economy.
Separately, European Banks have been crushed this year, with the benchmark index (Stoxx Europe 600 Banks) posting six straight weeks of declines, the longest stretch since 2008. Two of the region's largest banks have led the collapse, with Deutsche Bank (DB) down 35% for the year as it faces an onerous restructuring (headlined by questions around its ability to pay off debts) and Credit Suisse (CS) off 37% after posting a massive fourth-quarter loss last Thursday driven by sweeping charge-offs.
The pain is not isolated to these two players, however, as the entire European banking complex is facing a collective convergence of macro headwinds. The European Central Bank's negative interest rate policy means that banks have to actually pay interest on physical cash sitting on their balance sheets, which squeezes already-low net interest margins to shockingly low levels. At the same time, debt levels across the eurozone remain high, suggesting demand for loans (or any form of credit) will be low. Finally, the lack of capital market activity (in the former of M&A, IPOs, and trading) means that investment banking divisions are no longer generating fees, which should further pressure the banks' already-constrained top lines. Pair this with stagnant eurozone economic activity and the sector's decline is more understandable.
Within the Action Alerts PLUS portfolio, shares of Bank of America (BAC) have experienced heavy selling pressure over recent weeks given reduced expectations around a potential Fed rate hike this year. Despite the negative sentiment, we consider the shares attractive and believe the bank can become materially more efficient and grow tangible book value (we target $17 by year-end), and view its valuation gap on a price-to-tangible book value basis as unjustified.
BAC is trading at recessionary levels despite the absence of a recession. Even in a domestic recession, Bank of America would be able to grow its book value from $15.62 currently (based on analysis performed by analyst Mike Mayo, who had been BAC's biggest bear until he upgraded shares to Buy from Sell last Friday).
We do not believe investors are giving Bank of America credit for a much-improved balance sheet, improved capital ratios and potential for major capital returns (we estimate the bank will be able to double buybacks and its dividend in 2016 alone). We have held back from adding to our position (which is relatively small vs. our portfolio average) but would consider buying if the shares retreated below $12.20.
Beyond financials, among the hardest hit by the market's latest selloff are shares of Alphabet (GOOGL) and Facebook (FB), down about 7% and 11%, respectively, over the past week vs. the S&P's decline of just under 4%. What confounds the issue even further is that both companies delivered exceptional results and guidance (Facebook on Jan. 27 and Alphabet on Feb. 1). Both have benefited from an early morning relief rally, however, with shares of each up more than 1%.
The fundamentals for both Alphabet and Facebook, validated by recent results/guidance and driven by powerful and visible long-term growth trajectories, leave us with little doubt that the mass selling has been illogical. When fundamentals diverge from logic to this extent, however, we recognize there are undercurrents precipitating the action that are beyond our control. We are also especially careful considering FB and GOOGL are trading roughly 57% and 22% above our respective cost basis ($63.61 for FB and $578 for GOOGL).
These two stocks are part of the widely talked about "FANG" group -- Facebook, Amazon (AMZN), Netflix (NFLX) and Google/Alphabet -- which in aggregate rose 75% last year, vs. just over 1% total return for the S&P 500. Investors piled into these names due to their industry leadership and distinct competitive advantages (given their status as disruptors), which in turn allows them to accelerate growth in a market plagued by decelerating growth and overall top-line stagnation.
The moment the market took a turn for the worse this year (starting on the first day of trading), the group's legendary 2015 outperformance worked against it, placing a gorilla-sized target on the back of each respective stock. The same investors who had piled into the names in droves and made money hand over fist have sold out of their positions expeditiously as they actively look to take profits on the still-massive gains they had generated on the respective stocks. We have refused to trade around these names as we view both Alphabet and Facebook as long-term core holdings, not event- or technical-driven trading vehicles.
All in all, we will be looking for opportunities across the portfolio to raise cash by selling lower-quality positions (think: Mondelez (MDLZ) and Starwood Hotels & Resorts (HOT)) to fund our higher quality names. We will update subscribers throughout the day as the market evolves and we evaluate several opportunities.