For over four decades, Guild Investment Management and its founder Monty Guild have deployed a proven investing strategy, scanning for opportunities in both the U.S. and international markets. The key principle of the philosophy, as discussed in our previous interview with Monty, is to find opportunities that fall into the firm's risk-reward profile. Surprisingly, this simple rule has been quite fruitful over the years.
Equities.com had the opportunity to catch up with Monty after the firm's Global Macro Conference Call, which covered a wide range of various markets and trends as it usually does. This is part one of a two-part interview, discussing areas of the equities market that still present opportunities for investors, as well as certain overbought segments that investors should watch when the long-awaited correction comes. Be sure to check back for the second part of the interview when Monty discusses the commodities, fixed income, and international markets.
EQ: Guild is expecting the U.S. economy to grow by 4.7% for 2014, including inflation and real growth. Is the U.S. economy out of the “recovery phase” from the Financial Crisis, and into growth mode now?
Guild: Yes, I think the financial crisis of 2008-09 is behind us. The banking system is still not yet pumped up the lending. Lending is not happening yet because banks have been regulated by various new rules like Dodd-Frank and other regimes, which have cost them a lot of money and made them frightened to move ahead in lending. With that said, the rest of the economic growth from banking has grown.
EQ: That’s an issue regarding the velocity of money, and Guild expects that to ramp up going forward. Why is that?
Guild: There are three reasons why the velocity of money has not increased. Reason one is no lending, and the reason there is no lending is because there is no borrowing. The reason there’s less borrowing is because corporations have been afraid of the uncertainty toward the Justice Department, higher taxes, Obamacare expenses, and so on.
So they aren’t sure what their expenses are going to be. They knew the cost of capital would be low to make new plant and equipment decisions or new hires, but they didn’t know about the rulemaking attributes of the society and whether the new rules that will be promulgated will make it hard for them to make a profit.
Now that the trauma of the bear market and bad economic factors are behind them, with corporate profits booming the last several years, companies and board members are now more confident. They’re more willing to approve expansion plans at the executives’ requests, and the capital budgeting issues…there’s money to build the plants and hire the people. So that’s what’s happening.
EQ: U.S. stocks are trading at or near all-time highs, but there’s still a lot of opportunities out there. What are some areas that look good right now?
Guild: We basically believe that there are plenty of opportunities, and there are also segments of the market that are in bubble territory. However, we think the market will get a correction as is customary in the fall. After that correction, we think the market is an excellent buy. The market has been going for quite a while without a correction, so we’re lightening up and raising a little bit of cash so that we’ll have some cash available to buy in the fall.
We’re not bearish. We believe we’re still in a bull market, but we’re just more cautious than we have been.
EQ: Some areas of the stock market that you like right now include chemicals, security electronics, airlines, and oil exploration. What are some reasons you like these specific areas?
Guild: We also like big biotech. But starting from the top of the list, we like chemicals because raw materials are cheap. The raw materials for chemicals is natural gas, and natural gas is quite cheap. It’s in wide production in the U.S., and that production is increasing. We had a cool summer, which has caused gas prices to fall, making it even less expensive for chemical companies to get their feed stocks. Demand for chemical products and coatings all over the world for automobiles, industrial productions, and so on is growing. So you have growing demand and falling costs of production. That’s a positive trend.
For airlines, these companies benefit from the fact that they’ve gone from free competition to oligopolies. There’s only three or four major carriers in the U.S. now, and pricing has become much tighter. The U.S. airlines are not over-expanding and buying new equipment, which they were doing for decade after decade and destroying their profitability by doing so. Now they’re acting more rationally, and as a result of that, they have higher load factors, higher productivity, and higher profits. In the past, a new airline would commence and offer low prices to gain business, which would force everyone else to meet them with price cuts. That led to many airlines needing to be restructured or went through bankruptcy from the battle because the profits were not there. But those days, at least for American carriers, are behind us. Foreign carriers are still making those mistakes, but domestic carriers are not.
EQ: You mentioned biotech. What are some catalysts there?
Guild: What we like about this space is that new drugs are being produced and they are effective. Gilead (GILD) , which is a stock we own for our clients, is basically doing very well. We’ve had it for some time because they have Sovaldi, which is a new product that has a cure rate of 95% for hepatitis C after 82 days of treatment.
This is a disease that was killing people, and they would end up in the hospital with very expensive care issues. Sovaldi is expensive, and many have complained about the price of $1,000 a day for the price of the pill, but when you compare the cost of caring for people who have hepatitis C and are dying from it, it is tiny. That’s $80,000 versus millions of dollars to care for someone that’s dying from it.
EQ: We’ve seen a bit of a bidding war in the hepatitis C market as a result, with other companies trying to get in this space.
Guild: Right. Many are trying to get in the game, and within a year or two, there will be others in the space, but right now, there’s nobody else with a product that’s effective like this. Some of the other products are 20-20% effective, and they only slow down the disease. I don’t know anything that really cures it.
Gilead is also coming out with another product later in the year, and when that’s combined with Sovaldi, it will cut the cost of the regimen from $80,000 to something less. So they’re almost like a big tech company cutting their own cost and cutting the price of their product to increase demand. Many foreign countries are also not using Sovaldi because of the cost, but as the price comes down, people all over the world will start to use it more and more.
But this is just one example. There are many other products like that among the big biotech companies. Another example would be Biogen Idec Inc. (BIIB) , which has gone up a lot recently and I wouldn’t chase it here, but these kinds of companies have also very good new drugs that have been approved and are very efficacious. So after a long period with no big blockbuster drugs, the biotech industry seems to be able to find blockbusters and a number of them at that. So this is going to change the availability of new products in the biotech industry, which will help the profitability of the industry a lot.
EQ: Security and electronics, particularly the shift from physical to cybersecurity, has been a trend that Guild has been monitoring. What are some reason why this is compelling to you?
Guild: That’s more complicated because some of the companies that are doing the cybersecurity are defense companies that have a lot of other businesses they’re in other than cybersecurity. That makes them much less attractive because they may have a defense business where maybe the demand is not there and the sales are not growing. So security is good, but we have to focus on the companies that can grow fast in that area. Demand is growing radically, and those companies who can make cybersecurity a substantial enough part of their business so that they are not overwhelmed by other slow-growing businesses is the way to go in that industry.
I would defer to our analyst Rudi von Abele, who follows that sector more than me, to know what’s attractive in that sector. However, some names we’re looking at include Juniper Networks (JNPR) , Palo Alto Networks (PANW) , and FireEye (FEYE) . But many of these are very overpriced, so you’d wait for a market correction before getting into these.
EQ: That seems to be a common theme in that there are some areas that Guild seems to like, but would need a pullback before they make more sense. Generally speaking, how aggressive or conservative are you right now toward the market?
Guild: That’s right. There’s areas like Technology and Consumer Discretionary that fall into that category. We’re not thrilled about consumer discretionary spending because we think the U.S. consumer has been becoming more frugal over the last few years. We don’t think conspicuous spending is going to be coming back soon for the public at large. It may for some sectors of the public, but not overall. But we still need to keep an eye on that.
The same is true with Financials companies, which we aren’t enthusiastic about either. When interest rates rise, there will be some Financials companies that will do better. Right now, they’re under attack by the government, and the economic consumption is just not that high.
As far as the consumer goes, the internet is really upsetting the consumer apple cart and making retailers adapt radically and rapidly. So that remains to be seen how that will spin-out. We were overstored when internet retailing began, but now we’re grossly overstored in America; there’s just too many stores. So retailers is not a great area to be investing in.
EQ: So what looks good right now with the absence of a correction?
Guild: The groups that we would buy right now would be certain biotechs and certain oil companies that have been increasing production. We think the oil price will stay around $98 and $103.
EQ: So what would be the appeal for the exploration and development companies in the energy space?
Guild: What we’re looking for in those are oil-related sectors. We are not looking at natural gas related sectors because there is a glut of natural gas. We’re looking for companies that can add production and they’re undervalued. We find most of those kinds of companies in Canada at the present time. So small Canadian oil producers that are a bit under the U.S. radar but are increasing their production by quite a lot. They’ll be recognized over time by U.S. investors and the stocks will go up.
Three that we own are TORC Oil & Gas ($TOG:CA), Whitecap Resources ($WCP:CA), and Crescent Point Energy ($CPG:CA). So those are three Canadian companies we think are pretty undervalued. We also like some American energy stocks and would buy them right away on dips without a broader market correction. These are companies that have more production coming ahead than people realize, and companies that will discover new fields and new wells within existing fields. These would be companies like Rosetta Resources (ROSE) and Emerald Oil (EOX) .
EQ: In our previous interview, you described Guild Investment Management’s philosophy of finding opportunities that present a three-to-one or four-to-one risk/reward ratio. Considering where the markets are right now, do you believe it is easier or harder to find these kinds of opportunities?
Guild: Well, there are certainly bubbles in the market where the ratio shows a potential reward of 20% but risk of 60%. But there are other undervalued areas as well. For instance, some of these new medical marvel technologies and cures for serious diseases may be coming forth, and these companies have the potential to go up three or four or even five times as much as they could go down. So we’re enthusiastic that some sectors of the economy are still producing those kinds of opportunities whereas other sectors aren’t. We would avoid the favorites that are selling at 40 times, 50 times earnings. We think these will lead to tears in the long run, but in the short turn, they could keep rising.
It’s important to remember that when you see stocks going up 20% or more in a single day, a lot of that is short covering because many hedge funds out there have been short these overpriced stocks and many of these stocks have been falling. So you end up getting these short squeezes, but longer term I think these stocks have to go down in price.