Every market is different but there are still lessons to be learned from past markets that can be applied to the current situation. Some parts of today’s market appear quite similar to the 1999 market as told in the song by the artist formally known as Prince. In 1999, technology stocks were being bid up to prices that were totally disconnected from reality, US large company stocks were the only game in town and emerging markets were hated and selling at steep discounts.

Today, some technology stocks are becoming stretched in value, but biotech is acting more like the technology stocks from 1999.   What does it mean when a 29 year-old hedge fund manager buys a throw away drug for $5 million, takes the company public and suddenly it is worth $2.4 billion? To us, it means that investors are caught up in a bubble and are detached from reality.

Most stocks on the New York Stock Exchange are selling below their 200 day moving average. The stock market also is becoming narrower as fewer and fewer stocks are appreciating in value. Only a few large companies are generating returns for the large cap weighted S&P 500 Index. Just as in 1999, we have read several articles recently that declare that active management is dead and one should invest his or her capital only in large cap index funds. That strategy turned out to be a very short term winner as active managers outperformed passive index funds over the next several years. This market feels eerily similar.

Emerging markets in 1999 were cheap due to the Asian currency crisis and stock market contagion. Today, emerging markets are once again cheap, having slowly fallen in value compared to the crash in 1998. In 2009, many US investors were concerned about the US and placed a significant amount of money in international and emerging markets. These investors took cheap dollars and bought expensive assets based on emotion. With the recent trades we have made in our clients’ portfolios, we are taking expensive dollars and buying undervalued emerging market assets.

To support this statement, let us give you some data from an emerging markets mutual fund we own. As reported on March 31^st, the emerging market fund has a price-to-earnings (“P/E”) ratio of 10.4x, price-to-book ratio of 0.9x and yield of 5.44%. According to the Wall Street Journal, the S&P 500 Index is currently selling at a P/E ratio of 21.2x, price-to-book ratio of 2.9x with a dividend yield of 2%. In other words, the securities in the emerging markets fund are trading at more than a 50% discount compared to US stocks and it pays 2.5x more in dividends. Additionally, the long-term growth story for emerging markets remains intact.

What does this mean for portfolios?

With the end of QE, valuations are starting to become extreme on both ends of the valuation spectrum. We recently added to our emerging/international and energy exposures while reducing our large US company exposure. With our recent moves, we now have our second highest exposure in international markets – eclipsed only by our 1999 exposure.   You can make money in any environment and in any investment; it all depends on what you initially pay for the investment.

Book of the Month – The Great Beanie Baby Bubble – Mass Delusion and the Dark Side of Cute, Zac Bissonnette

This is a compelling story of business, marketing, how the bubble was created, love and personal eccentrics in Ty Warner. With Biotech in a bubble, this is a great read to keep one from investing in the hoopla. It is human nature to get caught up in a bubble and to try and make “easy” money. That is why it happens all the time in different markets (Chinese stocks, Beanie Babies, art, etc.). Mark and Jim remember in the late 90’s talking to a policeman at Mio’s in Mariemont and he was telling how there was a tornado warning early that morning and he went to tell the 30 people waiting outside The Villager at 4:30 to leave. Those people were waiting in line for the new shipment of Beanie Babies to arrive. What happened? No one left. They were so caught up in the craze that they were willing to risk their lives for these stuffed animals. That is what happens near the end of a bubble; common sense is thrown out the window. Keep in mind that is when one should be selling, not buying.

Sincerely,

Your THOR Team