Dear Mr. Market:
What’s more exciting to watch: Duke versus North Carolina or Apple versus Amazon? If you’re reading this you know by now that it’s not a trick question but rather our annual opportunity to have some fun spinning the NCAA college basketball tournament into a platform to share our favorite investment themes.
My Portfolio Guide was the first investment firm to publish a March Madness investing tournament where we share our picks and match them up against each other. We break down and assign each of the four “regions” with an asset class and then pick teams (companies) that we think have the best chance at doing well relative to others.
This is the eighth year we’ve done this and it’s become one of the most popular articles on the entire internet!
Click the following link to see the entire bracket for 2018:
Many people now have the rearview mirror or armchair quarterback mentality right now. If you’re to be honest with yourself there are very few folks we met at this point last year that said without question that the stock market would soar to record highs. As a matter of fact, it was quite the opposite. Think back to the start of 2017 as most of us were still digesting the fact that Trump won the election. Most pundits felt that the “Trump bump” would be short lived and that the one thing the stock market doesn’t like is uncertainty …and we had plenty of it!
All that being said, we couldn’t have been more clear that if you kept your politics out of it you could have had a nice year! The easy trade was betting on America and the Large Cap asset class turned in a fine year. Guess what? We still think there is room to run here and the recent correction we experienced is exactly what the doctor ordered.
#2 US Steel (X) vs. #3 Reliance Steel (RS)
Unless you’ve been living under a rock you’ve heard that President Trump wants to reset the playing field on trade imbalances. Once again it becomes difficult to touch certain subjects since Trump is such a polarizing figure but if you step back and look at the policies he’s trying to propose most should not be any sort of surprise to you; it’s exactly what he promised during his campaign. He has led with an “America first” stance and his recent steel and aluminum tariff is simply following through on what many people voted for him to do. Do you know for a fact that tariffs are bad? Do recent headlines implying long-term economic disaster and inevitable trade wars have merit? People have short and selective memories and may need to be reminded that the last 30% tariff on imported steel was imposed in 2002 and not only was there no trade war but the economy continued to grow.
Several steel companies are actually ecstatic with the recent news. US Steel (X), based out of Pittsburgh, recently announced they now plan on reopening a steel making blast furnace next month. Much of this industry has a high degree of fixed costs so if utilization increases we can expect instant margin expansion.
Our steel match-up gives the nod to Reliance Steel (RS) but it’s really almost a toss-up. Our main bet is actually just a vote for the sector itself. Investing in this area is simply a good bet for an economy that is growing at 3% plus. RS is trading at just over 16 times earnings with a dividend of 2.14%.
Small and Mid Cap
Who is going to be this year’s “Cinderella” team? Every year a smaller “mid major” college seems to make a run or upset a more established powerhouse. While it’s unlikely (and to date has never happened) for a #16 to upset a #1 seed, what you will see is a #10 upsetting a #7. It wouldn’t be that shocking to see #10 Texas beat #7 Nevada but what if #12 Davidson beat #5 Kentucky?! That type of upset is exactly what we’re looking for in the Small and Mid Cap bracket.
We were quite bullish on both of these asset classes last year and believe there is still some fuel in the tank. In our current view they will do well for the remainder of this year but there will be considerably more volatility and this area is not for the faint of heart. Don’t fool yourself into thinking you’re a good stock picker if your small or mid sized stock pick did well last year; most of them did. “As the tide rises so do all the boats”. Stock picking and proper sector bets will be critical this year and we believe you will see massive disparity between the best and worst performing sectors in this asset class.
#6 Canopy Growth Corporation (TWMJF) vs. #8 Kush Bottles Inc. (KSHB)
To epitomize our emphasis that the Small cap arena is a volatile one, we’re highlighting two companies in a sector that is all over the place. Back in October we first covered several cannabis stocks and both Canopy Growth (TWMJF) and Kush Bottles (KSBH) were featured. Canopy at that time was trading at $9.97 and is now at $24.01. (+184% over 6 months!) Kush Bottles was under $2 and is now trading at $5.42 (+167% over 6 months!). So is the party over or just beginning?
We believe that this entire sector is still in the early innings of a long ballgame. You’re going to start seeing several of these companies actually make money instead of just polarizing headlines. We went from ignoring the industry to actively watching it as it’s no longer a joke. Whether you agree with the sector from a moral standpoint or not, there is no denying that the marijuana industry is real. With regulatory headwinds fighting against legalization and a surge of more common acceptance, there will eventually emerge some clear winners. Click here to read our original article for a decent overview about these two companies as well as the overall sector.
If you’re new to reading our material you may think we’re bragging about our clairvoyant and prescient picks from 2017. OK…in a sense we are! Allow us to reset the table, however. We had Emerging Markets winning the entire bracket last year and that was an absolute slam dunk as the asset class handily beat all others. The reason why we’re particularly proud of this pick is simply because most “experts” hit the exit door and only hopped onto the bandwagon late in the year.
We still believe long-term Emerging Markets (and International in general) offer a greater value than do domestic investments at this point in the global economic cycle. This year we go deep in our rotation and bring a bench player onto the hardwood…Welcome back Japan!
#1 Sony Corporation (SNE) vs. #6 iShares MSCI Japan (EWJ)
When it comes to picking economies that will outperform, Japan (EWJ) has long been left for dead. Very few investors realize that the Japanese economy grew at a 0.50% rate the last quarter of 2017 and albeit not at breakneck speed…it marked the eighth straight quarterly expansion which is the best we’ve seen in 30 years! Let’s be clear on one thing…we’re not long-term investors of Japan but over the next 12 months we believe there is some opportunity relative to other overheated economies.
Specifically within the Japanese economy we decided to hone in on one stock that comes in at the #1 seed of our bracket and ultimately “wins” it all in 2018! Sony (SNE) has absolutely been on fire the past year returning +62%. Although it’s not too far from its 52-week high (currently trading at $50.95) we really like the valuation relative to other domestic choices. SNE trades at just over 13 times earnings and while it doesn’t offer much of a dividend we see this stock setting a new high before year-end.
Bonds and Alternatives
The NCAA selection committee always has a tough job. Inevitably there will be a team or two that feels they got snubbed and in some cases an entire conference gets overlooked. In our opinion the latter is exactly how we feel about Bonds. Although it’s part of our core investment philosophy to never fully give up on an asset class, this is one “region” that we think you could put less emphasis on. We recommend keeping some bond exposure; not so much for the income but ideally for the ability to have stability when we get another market correction.
The only highlight in this area will be Gold and Commodities. These two investments get lumped into the “alternative” bucket and we believe you will see them do far better than most Bonds/Fixed Income. Lastly, there is a new “team” to look at in this region. Even though BTS Tactical Fixed Income (BTFIX) doesn’t go too far we believe the approach to take in Bonds this year is to be very nimble. Whatever you do, don’t just buy a bond fund and think the manager can somehow evade the headwinds this asset class hasn’t faced in over 30 years…In our opinion it could get pretty ugly here and it will happen one paper cut (interest rate increase) at a time.
#2 SPDR Gold Shares (GLD) vs. #5 PowerShares Diversified Commodity ETF (PDBC)
It won’t take too much of a detective to learn that in the Bonds & Alternatives region of our investing bracket we are almost ignoring Bonds/Fixed Income. The asset class is clearly our least favorite which allows us to pare down exposure and reallocate towards areas that can still provide us with a little bit of a hedge should we get into some stock market turbulence. With all that said, we believe this is the year to get some exposure to gold (GLD) and increase your current allocation to commodities (PDBC).
For the record, we have historically been the last one from ever being accused of being a “gold bug”. As a matter of fact we have long been rather bearish of the shiny metal as it’s simply a non-yielding asset. Gold is traditionally a great hedge for inflation, right? WRONG! This is a classic misnomer that experts yap about and we then cringe hearing the general investing public regurgitate it. Just because someone says something over and over doesn’t make it true!
For your knowledge there are several stretches of market history that counter traditional wisdom: From 1974 to 1980 gold increased +353% while inflation went up +67%. From 1980 to 2001 gold decreased -67% while inflation rose +126%. We’re just giving you a couple quick reference points but at best there is a weak connection if any at all between gold and inflation so tune out anyone who spouts this nonsense.
Switching gears though…we’re advising almost a 10% allocation to GLD this year in part as a ‘crisis avoidance’ measure! (more is coming…) Along those same lines we have rarely been more bullish on commodities (PDBC) and believe that a stronger reversion to the mean is also on the near-term horizon. We liked commodities last year too but admittedly were perhaps too early on this pick. That said, we’ll be stubborn and double down on our bet for the remainder of 2018! All kidding aside, in our opinion global commodities are at a cyclical bottom and compared to stocks they have not been this undervalued in over 40 years! While we pick GLD over PDBC for the sake of this fun exercise, just make sure that your portfolio has a combination of both and the sum totals upwards of at least 15% of your portfolio.
Final Four Summary:
The fun part of producing this article each year is that it allows us to share some of our thoughts, strategies, and the investment themes we believe will likely play out in the months ahead. It’s all done with the caveat that we may only own a handful of the 48 investments listed on our bracket. Truth be told…most experts who pick stocks are no more successful than you would be doing the same job! The real winners are the ones who are able to pick enough stocks in the right areas and maintain the proper asset allocation relative to their investment goals.
Obviously every tournament (in the case of March Madness) only has one final winner. With this exercise, however, we are able to build an intelligent portfolio that will have a number of “winners” along with some stinkers. As an investor you actually have the opportunity every year to own multiple “teams” in different “regions” (asset classes).
Long story short, don’t fixate on the one stock that wins it all; take a look at the whole picture.
On previous years we typically dissected more match-ups and even dug a bit deeper on specific companies. Why not this year?
Without intending on being a killjoy the reason is that we’re simply not overly ecstatic about the broad stock market. We think we’ll finish positive for the year but it won’t feel good getting there. Last year gave people false confidence again. Although we believe we are far from dipping into a recession, our radar has spotted a tiring market. With that being the case some of our picks are a bit contrarian in nature. It wouldn’t surprise us at all if the #1 vs #5 match-up in Large Cap beats everyone (Amazon and Apple) but we too are getting a bit long in the tooth talking about stocks like this and need a break!
In summation, tread carefully this year. There is money to be made but spread your money around different asset classes and don’t just chase what went well last year. Lastly, we will wrap this up with a pretty bold statement/prediction: At least three out of our four finalists will finish 2018 positive. Find a stock picker or financial advisor who nails 75% of his or her picks for the year. If we flop on this bout of bravado you can bet we’ll fess up and eat our words next year.
In the meantime, good luck in your own brackets and enjoy the Big Dance!