I like to give each Value Line issue a pretty through review when it comes in because it contains an incredible amount of information on stocks, sectors and the broader market. If they took away the Internet tomorrow, I feel like I could still use this publication to do a lot of my research and homework. Of course, I would also have to go back to searching the stock guide every month with a highlighter for smaller issues, so let's hope that never happens!
My first observation came from the front page of the issue. The service projects the mean three-to-five year appreciation potential for its 1,700 or so stock universe every week. It is a pretty good gauge of how cheap or expensive the market is at a given moment in time. Right now, it is at 30% for projected performance. That is the lowest I have seen it in some time -- it is pretty low on a historical basis, In fact, it is flashing something of a warning sign.
At the market lows in 2009, that figure stood at 185% and the average since 1973 is around 80%. I did a little searching and found a research piece from Castle Focus Fund (MOATX) that cited several studies indicating that the Value Line projections are historically too optimistic and the best expectation is reached by subtracting 50 from the actual number. Subtracting 50 from this week's very low reading (which is exactly the same is it was at the 2007 top), and you reach an ugly conclusion about the appreciation potential of the market form current levels.
This is just another one of those indicators such as Tobin's Q and GDP compared to total market capitalization that is flashing a caution sign right now. None of them are pinpoint precision timing indicators, but they do give one a sense of an overly rich stock market. This is confirmed in my mind by the lack of safe and cheap individual stock opportunities. I have no idea what the market will do in the short term -- and I believe that no one else does either -- but the weight of the evidence indicates that enthusiastic buying is unlikely to be rewarded.
The industry ranking for year-ahead performance contained few surprises for me. The rankings are based on the companies in the sectors ratings. Those are derived using the Value Line formula, which uses earnings and price momentum prominently. Homebuilding is the top ranked sector and the analysis seems to indicate that the currently low interest rate environment and improving housing markets will continue to be supportive. I really do not agree with that conclusion, but that's what makes markets.
I was happily surprised by precious metals being third best for year-ahead appreciation potential. I am long some of the miners, including Pan American Silver (PAAS) and Couer Mines (CDE), so I would love to see the sector outperforming in near term. The basic argument is that all the gold and silver spit out by the trading oriented ETFs has found a buyer at the current level and real demand for gold is pretty healthy. The service also points out that the current pricing environment makes it unlikely that we will see any new mining projects in the near future. That should reduce capacity in the precious metals mining industry.
Rounding out the top five best sectors in the Value Line universe are foreign electronics. Since I am long Panasonic (PRCFY), Sony (SNE) and Fuji Films (FUJIY), I am pretty pleased with this ranking as well. I like the life insurance stocks as well and they seem to agree, ranking the group in the top five for year-ahead performance. Thrift stocks complete the list and we all know how I feel about the potential in the bank and thrift stocks.
The interesting thing to me about the predicted sector performance is that most of these are stocks that we bought when they were very much out of favor with poor marks for the momentum oriented service that are now starting to improve. That is pretty much how value is supposed to work. We buy them when everyone hates them and hold them until prospects improve and the growth and index crowds begin piling into the stocks.
The sector news is heartening but the low median appreciation potential is a cause for some concern and caution.