By Joel M Shulman Ph.D., CFA, ERShares Founder & CIO
Perhaps lost among investors in their mad dash to buy value stocks is the potential to bid up deep discount equities well beyond reasonable levels. While it is commonplace to bemoan the valuation of Tesla, which at 7X return in 2020 and an $800B market cap, would be on track to eclipse global GDP in less than 3 years. It is perhaps less commonplace to recognize over-exuberance among so-called value stocks. This may no longer be the case. Take for example a few of the neglected companies now approaching record price levels. This list includes well-known entities such as Marriott, Bloomin’ Brands (parent to Outback Steakhouse, Bonefish, etc.), and SeaWorld. Avis is also nearing a 15-year high and gets honorable mention for this list. Notwithstanding the compelling case that each of these companies deserve a healthy step up from pandemic bottoms, the height of current levels borders absurdity to even the most optimistic, rational investor.
Case in point. Marriott International, a longstanding beacon in the hotel industry, boasts a 94-year history, 7600 properties, and 30 hotel brands in 133 countries. Last year its revenues dipped 50%, coupled with plummeting margins, rising costs, skyrocketing debt levels, and other significant obligations coming due soon. If that weren’t crippling enough, heavily fortified, cash-bearing new entrants such as Airbnb, recently entered the arena with a disruptive approach that threatens the very underpinnings of the hotel industry. These new pioneers provide a variety of accommodations, without burden of capital investment, annual maintenance, or SGA infrastructure. This is almost identical to the case of Uber and Lyft who completely gutted the cab industry through disruptive technology. Moreover, as competitors feast on Marriott’s market share, the parent had to contend with a mountain of debt service arrangements, rising interest rates, and a never-ending supply of angry timeshare owners. Given these reasons it seems very perplexing to witness Marriott’s stock price anywhere close to an all time high level. Perhaps even more surprising than Marriott would be the examples of SeaWorld, Bloomin’ Brands, and Avis. In the past year, each of these companies has been flirting with bankruptcy, yet the first two rest at an all time high price.
SeaWorld Entertainment, still smarting from a 2013 film (Blackfish) and global campaign to boycott and shut down the enterprise, has experienced a catastrophic drop in attendance (81%) while fending off rumors speculating bankruptcy. An examination of the balance sheet suggests a healthy level of cash, but it belies the $2B of expensive debt recently raised (9.5% coupon) which was primarily used to cover past losses and resupply depleted working capital accounts. Recognizing that post-pandemic attendance will surely rise from the prior year’s debacle, it is still unclear how investors could price this stock to an all time high given longstanding neglect to property, plant, and equipment, and future debt hurdles. Bloomin’ Brands provides another puzzle to the over-priced “value” company situation. Parent to familiar brands such as Outback Steakhouse, Bonefish, and Carrabba’s Italian Grill, last year this company experienced significant drops in gross margins and revenues along with soaring debt levels. It has current lease and debt obligations that exceed short-term cash levels yet not unlike the other examples, this stock price has also recently reached the prized all time high accomplishment.
Each of these four examples undoubtedly warrants an increase from pandemic levels. However, it remains a mystery how investors can justify current all-time high price levels. In recent weeks we have witnessed high-flying tech companies fall, on average, 20-30% from market peaks, and in some cases as much as 50-60%. The latter appears to be a floor to the price drop. By contrast, strongly bid-up value stocks have the potential to drop much further. As Hertz, Sears, JCPenney, and other fallen angels have demonstrated quite clearly, the floor to an overvalued, debt-intensive company is not 50 or 60%, but rather 100%. Buyers beware. Price levels corresponding with Marriott, Bloomin’, Avis, SeaWorld, and other overpriced value stocks are vulnerable to a major correction without a chance for recovery. We maintain that investors need to be very careful in buying value stocks now. The value no longer exists in the traditional buckets contained within the Dow Jones and S&P 500. We maintain that it has reverted back to Tech. Prices are low, and we can see an extended rally for a few more weeks.
The US stimulus checks now commencing delivery, will generate confounding effects associated with countervailing forces. On the one hand a massive cash infusion piled on top of an already recovering economy will continue to stoke inflationary fears. Casualties to inflationary concerns include both bonds and equities, with the latter being punished for higher discount rates applied to distant cash flows. Offsetting market selling pressures associated with inflation (primarily by institutional investors), we are likely going to also experience a hearty infusion of retail (day traders) investors who will attempt to parlay their newfound largesse into a larger windfall. Past stimulus behavior provides a clear blueprint on retail buying behavior. Chief among their selections include a list of risky, (hyper growth) equity securities. And, investors who want to participate along with the herd can readily join popular investment chat boards and crowd into the same names (akin to Gamestop short squeeze, etc.). In the near term, we believe retail traders will triumph over institutional investors and help escalate equity prices. We realize that on any given day, potential selling pressures from nervous, interest sensitive institutional investors, can tip the balance toward massive reallocation. Regardless, retail investor flows will continue to exacerbate market volatility and focus on a relative handful of stock selections.
We believe the strongest gains will accrue to recently beat-up high flying growth stocks (including popular ADRs) with heavy concentrations in the Technology and Health Care sectors. Growth stock gains should dominate inflationary fears for much of next week, though interest rate spikes (especially among the price sensitive 10-year bond), could delay a tech recovery for an extended period of time.
The global economy has evolved considerably in the past century. Economic growth and productivity have witnessed a complete paradigm shift. Productivity fueled by industrial manufacturing, advancements in transportation, and innovations in oil drilling enabled developing nations to prosper and generate riches in steel, automobiles, airlines, and manufacturing facilities. Industrial Sectors built global titans such as Henry Ford, John D. Rockefeller, Cornelius Vanderbilt, and Andrew Carnegie. Much has changed since then. Today’s wealth creators no longer reside in Energy, Manufacturing, and other Industrial Sectors. Nowadays exceptional growth opportunities reside in Technology and Health Care and include Entrepreneurs such as Jack Dorsey, Jeff Bezos, Elon Musk, and recently departed Steve Jobs. And unlike the robber barons from past eras, they do not extract wealth from competitors through unethical practices or the breakup of unions. The new breed of Entrepreneurs creates wealth and jobs through capital markets that allow all stakeholders to share in the rewards as they grow. Moreover, today’s entrepreneurs lead by example and often have a loyal, sometimes fanatical fan base unlike tycoons from bygone eras who were universally loathed and lampooned.
The recent experience during the 2020 pandemic makes clear how much our global economy depends on nimble entrepreneurs who can pivot quickly and create wealth and jobs during uncertain times. Much of the wealth and job creation has occurred within the Health and Technology sector, and as we show below, has a heavy concentration among publicly traded entrepreneurial companies. Moreover, the growth in Health and Technology firms have strong ESG ramifications: virtually no environmental impact, provide major benefits to social growth and infrastructure development and are driven primarily by entrepreneurial leaders with strong governance traits. Given the well documented pattern of growth in the most recent periods, all signals suggest this trend will only strengthen in future years.
Clear Pattern in S&P 500 Composition–Technology and Health Care Sectors Gain Dominance
Early evidence of the Standard and Poor’s 500 Index (S&P 500) illustrates how even 60 years ago, Industrials comprised 85% of member constituents with Utilities and Rails holding 10% and 5% respectively (see exhibit below). Records from 1957 show how the S&P 500 total market cap was $172 billion with Standard Oil securing the top spot with a valuation of $11B. By 1976 the composition changed modestly with Industrials commanding (86%) of the total allocation, Financials (6%), Utilities (7%) and Transportation (2%). IBM was the heaviest market cap of $42B. In 2001 the S&P implemented a significant, more detailed classification makeover providing greater clarity in sector composition. General Electric ($398B) was the dominant firm in 2001 and the two main sectors were represented by Financials (18%) and Information Technology (18%) followed by Health Care (14%), Consumer Discretionary (13%), and Industrials (11%). By 2016, Apple ($600B) was the largest market cap company in existence, corresponding with Information Technology (21%) being the most significant sector. Other dominant sectors include Health Care (15%) and Financials (13%). In the approximately 60-year time of reporting, the S&P 500 grew total market cap from $172 billion to $18.6 trillion. Along with the substantial growth, however, the market composition changed considerably away from Industrials to Information Technology and Health Care.
In 2020, the S&P 500 composition shows Information Technology (27%) as the clear top sector with Apple ($2.1 trillion) as its most significant market capitalized firm. Health Care (14%) is the second most
significant sector followed by Communication Services (11%), Consumer Discretionary (11%), Financials (10%), and Industrials (9%). Notably, the concentration of the top 5 market cap weight stocks Apple ($2.1 trillion), Microsoft ($1.6 trillion), Amazon ($1.6 trillion), Alphabet ($1.1 trillion) and Facebook ($660 B) approximates half the total market cap of all 500 S&P constituents from just 19 years earlier.
Pandemic Accelerates Shift to Entrepreneurial IT and Health Care Companies by Order of Magnitude
Even prior to the COVID-19 health crisis in 2020, the trend toward Technology and Health Care was well established. However, the pandemic rapidly accelerated the timetable by a sizeable shift in magnitude. While the manufacturing, transportation, energy, and consumer discretionary sectors were essentially shut down, the Health Care and IT sectors, largely driven by entrepreneurial companies, immediately embraced the challenge to develop effective vaccines and immediate solutions to keep people safe and our economy running.
Work-from-home and virtual meetings, while developing in popularity prior to the health crisis, quickly became mandatory for economic survival. The health crisis fundamentally changed, overnight, long-standing habits and personal behaviors. In the absence of technological advances, individuals would not have been able to telecommute for work, enact virtual visits for business/personal conversations, utilize online shopping, complete ease of delivery or virtually visit with their health providers. Changes in behavior happened quickly, by necessity, and the health crisis expedited many work and personal changes that would have normally taken much longer to implement. It was Entrepreneurial Information Technology companies that primarily met consumer and business needs. Companies such as Zoom provide video technology for workers and students and other companies such as Amazon provide online shopping and ease of delivery. Netflix and Facebook provide entertainment and communication platforms to help fill additional personal needs. Notably, these companies represent only a handful of the many, entrepreneurial companies that quickly pivoted to meet market needs during a critical time period.
Importantly, Entrepreneurial Health Care companies like Moderna, Teladoc and Regeneron without hesitation promptly pivoted to build a new vaccine or breathing apparatus for victims desperately seeking a medical miracle. Other entrepreneurial companies enabled patients to virtually visit medical professionals in a timely, safe, efficient manner, without exposing parties to harmful disease. These entrepreneurs were the first to capitalize on an opportunity and propose workable, innovative solutions for the public. Not surprisingly, major Health Care companies were not actively visible in the early stages of the crisis. Traditionally, these companies miss timely opportunities and inaction due to sluggish corporate cultures steeped in corporate bureaucracy. Unprecedented circumstances disrupted conventional timetables. Health Care professionals and political leaders, who traditionally do not engage in active partnerships, fast-tracked processes and approval processes that were unthinkable until recently. Experimental drug tests have been discussed in real time, along with news updates concerning health and potential danger hot spots. All this new information can be attributed to innovative, entrepreneurial solutions.
Though the value of life, whether lost or saved, can be easily measured in the short-term with simple head counts, the true costs of the health crisis may require years to correctly assess. Fundamental changes in the way in which people live, work, commute and travel are likely. Further, individuals will likely change patterns in dining or entertainment venues (e.g., sporting events, theatre, etc.). Each of these changes have far-reaching ramifications on the quality and impact of life and influence the environment, social infrastructure and governance of our corporations and political establishments.
Health Care and Information Technology companies will continue to emerge as key contributors going forward. Health Care, in particular, will gain in prominence as life expectancy is expected to continue to climb.
Surging Life Expectancy Boosts Health Care Sector
Arguably the strongest contribution any sector has made to mankind is within the Health Care sector. Although humans have inhabited the planet for well past 100,000 years, it has only been in the past 100 years that life expectancy has changed appreciably. Prior to the 1800s, regardless of location, human life expectancy was less than 40 years (see graph below). This longevity was true regardless of birth origin or economic prosperity.
In the twentieth century, the gap began to widen considerably between developed and developing nations as modern health care emerged. Differences were substantial, corresponding with geographic location, and medical advances (see graph below). Those in developed nations, such as the United States, could expect a life of 70+ years whereas those in an emerging market would perish in approximately 1/2 that time. In some nations (primarily within Africa) average life expectancy fell below 30 years.
In recent years, the gap between developed and developing nations has narrowed with developing nations experiencing the strongest growth (see graph below). People residing in developed nations generally anticipate an average life above 80 years whereas those in developing nations rests closer to 65. Notably, life expectancy has virtually doubled in the past 200 years for all peoples with residents in developed countries receiving benefit in the 1800’s and developing nations seeing significant changes in the 1900s. Given the steady state in this important statistic for 99.95% of human existence, the recent medical advancements and pharmaceutical developments that have led to the doubling of life expectancy, in such a relatively short time period, represent a remarkable transformation.
Through these medical breakthroughs, individuals have been impacted in an unprecedented, positive manner. Humans now enjoy a longer, healthier presence with continuing enrichments delivered by the Health Care community on an ongoing basis, and it is this area that provides the most promise on a continuing basis. New research and innovations tracking early evidence of organ disease and malfunction, along with advancements in genomics (DNA), wearable technologies and artificial intelligence all will help extend the quality of life for humans. Many of the scientists behind these innovations are Entrepreneurs who drive much of the growth and through their companies we can monitor to gauge their representative journey through the Capital Markets. Although it is IT companies that dominate S&P 500 constituents, as we move to smaller capitalization area, it is Health Care companies that dominate, indicating the sector’s great potential for exponential growth in the near future.
Though 2020 has been a dismal year for most retail and travel company stocks, the same cannot be said for U.S. technology stocks such as Amazon, Tesla and Zoom Video. But how long will this growth trend continue?
All year long, stories have surfaced of global businesses that are thriving in an otherwise uncertain economy. These companies are showing exceptional growth and are, thus far, proving to be excellent investments. In just the past month alone, Non-U.S. equity ETFs have seen investments of over $25 Billion.
Based on these and other global trends, it is apparent that Non-U.S. Equities, especially Non-U.S. Small Cap funds, are outperforming U.S. equities across the board.
Here are three key ways that Non-U.S. Small Cap funds can outperform U.S. equities:
The time is right for an intermarket reversion. Over the past 50 years, U.S. Markets typically exceed Non-U.S. markets for periods of approximately 4-5 years before reverting, and then Non-U.S. markets dominate for a comparable period. We are now completing a period of 12-year dominance by U.S. Markets, which is about 2-3 times longer than the typical pattern. Moreover, during this period of 12 years, foreign stocks have significantly underperformed U.S. stocks. The Nasdaq 100 (QQQs) generated over 1000% (SP +400%) while the Shanghai Stock Exchange appreciated only less than 150%.
Tech Rout is Underway
In September, Tech stocks experienced a significant correction, with U.S. Large cap Tech dropping more than 10% in a single week. High-flying Tech stocks, such as Tesla, dropped even more. Though clearly some Tech stocks will continue to appreciate, it appears that the U.S. Tech sector as a whole is now fully priced.
P/E Relative Valuation
The price-to-earnings ratio of the Non-U.S. Small Caps at 15 is less than a third of the 47 P/E of U.S. small cap stocks. This provides further evidence that Non-U.S. Small Cap funds are currently better relative value.
So what does this all mean for you? How can investors capitalize on the opportunities created by these industries and companies around the world?
Diversifying your portfolio geographically through ETFs is a critical move that allows you to take full advantage of the current landscape. Now, more than ever, this opportunity is one that shouldn’t be passed up.
Why it is important to diversify geographically through ETFs now:
Diversification in the Tri-Polar World (US, China, Euro)
Most investors are heavily invested in U.S. Markets and should, instead, consider diversifying their portfolios globally. Though ADRs provide ease of entry, direct investment in local markets better reflects true market opportunities. By employing an investment strategy that not only distributes your capital across multiple US companies, but also across emerging opportunities around the world, you can balance your portfolio in a way that is nearly impossible to accomplish with U.S. equity investments, alone.
Stock markets outside of the U.S. often move at a different pace than the U.S. market. This gives investors, who are already actively trading in the U.S. Stock Market, the comfort of knowing that a portion of their portfolio is less influenced by potential risks that primarily affect only U.S. Markets (e.g., U.S. Elections). Moreover, the sliding dollar bodes well for Non-U.S. investments. With an overseas investment, the continuing depreciation in U.S. currency implies an added benefit for U.S. investors who can potentially gain from overseas stock appreciation along with the currency benefit.
When investors place funds in a Non-U.S. ETF or Mutual Fund, they invest with experts who are experienced in buying and selling foreign stocks. This is important since buying stocks in foreign markets with foreign currency and local traders is often extremely difficult and expensive for individual investors to set up.
Non-U.S. Equity ETFs are accessible to all interested investors, with no minimum investment restrictions. The costs tend to be very low and usually amount to an annual cost of less than 75 cents for every $100 invested per year.
The performance for Non-US Equity ETFs has been rising since the Spring of 2020, along with other global markets. Though no one can promise future results, recent evidence suggests that the pendulum has already shifted—with Non-U.S. outperforming US stocks in recent weeks. This trend might very well continue for the foreseeable future.
Newcomers and seasoned investors alike can take advantage of the growth potential of blossoming, global businesses through Non-U.S. ETFs and Mutual Funds. Compared to other investment opportunities—bonds, real estate, gold, etc.— Non-U.S. Equities, especially Non-U.S. Small Cap funds, are well positioned to provide strong future growth.
Would you like to know where you can find the next Trillion $ growth stock? If so, ERShares may have an answer for you. It is an ETF with NYSE Ticker: ENTR. This ETF invests in the leading Entrepreneurial publicly listed companies around the world. ERShares was among the first to introduce a thematic approach to investing, having started 15 years ago following research conducted at Harvard University.
Our methodology is a proprietary trade secret, but the basic message is clear: ERShares selects the most entrepreneurial, strong growth, global companies and puts it to market in one easy-to-invest fund. Many investment companies claim Disruptive Technology, but only ERShares ensures that the right technology is matched with the right leaders. They believe that without the best entrepreneurial minds, technology alone will not get very far.
The ENTR ETF specializes in innovative HealthCare and Technology companies packed with All Star leaders including Elon Musk (Tesla), Jeff Bezos (Amazon), Reed Hastings (Square/Twitter), Jack Ma (Alibaba), Larry Page, Sergey Brin (Alphabet), Mark Zuckerberg (Facebook) and many others that are not yet as well-known but who will likely soon join that list.
ENTR is currently one of the strongest performing ETFs in its investment class and has an annual cost of 49 cents for every $100 investment. Moreover, the Fund Managers do not settle on prior performance and are constantly seeking exciting new growth stories in HealthCare and Technology to add to their ETF. The Markets have been strong for most of 2020, though frequently experience periods of volatility. Will this trend continue? Nobody really knows for sure or can offer promises about the future. However, ERShares team has confidence that whenever the next great growth story emerges, it will likely be led by a successful Entrepreneur, and probably reside within the ENTR ETF.