I wrote Friday that I'm on something of a "buyer's strike" due to high valuations, which prompted several calls and e-mails along the lines of: "I thought you value guys didn't pay any attention to general market conditions!" It's true that I pay very little attention to the market's day-to-day movements, but only a fool operates in an information vacuum.
Even the late Walter Schloss -- one of the original old-school, deep-value investors -- talked about market levels in his 16 Factors for Investment Success. When writing about when to sell a stock, he advised: "Before selling, try to re-evaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P/E ratios high? Is the stock market historically high. Are people very optimistic, etc.?"
In other words, market levels do matter. Now, I'm not on the verge of becoming a macro investor and making bold bets on the direction of indices or currencies, but I also keep in mind what legendary investor Henry Kravis recently told Bloomberg Magazine.
Looking back over the first 40 years of his firm KKR (KKR) , Kravis said: "Our focus used to be much more on the micro, which meant we focused on the company and didn't look at the macro enough -- [but] that's something you have to take into account if you want to be a good investor. Certain times we got into trouble and made mistakes; I think there were macro issues that were really out of management's control."
Kravis said KKR has since added a macro group to the firm, which has changed the way the company approaches investing and deal-making. Personally, one of the biggest macro factors that I'm considering these days is the fact that there simply aren't a lot of cheap stocks out there.
For example, I sometimes run a basic Schloss-based screen to look for stocks that trade below book value while offering strong balance sheets and insider ownership that's near three-year lows.
Well, when I run this screen today, it comes up with just 10 stocks -- and just two have at least $100 million in market cap. I already own one: Trans World Entertainment (TWMC) . The other, Steel Excel (SXCL) , has been on my watch list forever but doesn't pass enough of my filters to buy.
Of the other eight stocks that the screen comes up with, one is a biotech and I'm smart enough to know that I'm not smart enough to evaluate those. I also eliminated the other seven stocks using a simple checklist that ruled them all out as investment candidates. So, even if I set aside my view that the market is too rich (trading at about a 25.0 price-to-earnings ratio), there's really nothing to buy outside of the community-bank space.
There's also a bit if an "evolution factor" at work here. As I've mentioned a few times, I've really upped my research-and-testing game this year. I've run scores of tests looking for what does and doesn't work in the market over time. I've also gotten a lot of assistance from people like Tobias Carlisle, who are really good at this and have shared some of their wisdom with me.
One of the biggest takeaways from all of this testing is that value strategies do outperform the market -- but achieve this by crushing it the first three years after a bear market. They later revert to a mean and eventually underperform as the market nears a peak.
In other words, the returns that low-price-to-book and low-EV/EBIT stocks offer are spectacular in a bull market's first few years, but level off over time. This tells me that investors should embrace the Hetty Green/Mr. Womack/Andy Beal strategy even more tightly than before. Buy into bear markets, then step aside from the broad market after three or four years as more and more investor enthusiasm returns.
Don't dig through the junkyard of stocks that remain cheap (usually for good reason). Instead, most of us should just drift toward a portfolio of REITs, community banks and closed-end funds that have activist involvement and wait until the market falls again.
It's been seen years since the S&P 500 hit a bottom and stocks are now at record levels. Given those facts, I think it's wise to take super-investor Richard Rainwater's advice: "Most people invest and then sit around worrying what the next blowup will be. I do the opposite. I wait for the blowup, then invest."