The summer months can be a perilous time in the market for investors. Thinly traded stocks and seasonal softness creates a period of vulnerability. Considering that the market has real concerns of being overextended such a prolonged run, investors may be a bit trigger happy on the sell button.
Equities.com had an opportunity to catch up with global investor Monty Guild, Founder and CIO of Guild Investment Management, to discuss his views on the market right now. We separated the interview into a two-parter to focus on his views regarding China's outlook as well as prospects in the US market. See his thoughts on the US market below, and be sure to check out his thoughts China's volatile market here.
EQ: Looking back at the US market right now, if you look at the major indices we're not too far away from the all-time highs. But if you look at the sentiment over the last week or so, it certainly doesn’t feel that way. Do you get a sense that more investors are looking for an exit opportunity to get ahead of this long-awaited pullback or correction that we haven’t had yet?
Guild: I think that is the key here. Many people are trying to head to the exits early because they know we're coming into a difficult seasonal period in the stock market. Over my many decades in the business, September and October have been two very ugly months in the stock market. But there is another trend taking place. The Fed will raise interest rates. In fact, there's some leaked information that came out accidently that Federal Reserve’s economist advised the Board members that rates will probably have to go up four times to 3% to 4% over the next 12 months. My guess is that will be true. One in September or December, maybe one in February or March, and one next summer or fall, each by 25 basis points.
This would be because the Fed was a little slow in getting these interest rate increases going, and they're a little bit behind the curve. But it’s not because inflation is going to take off. We think currently inflation in the United States is about 1.7% and the Fed funds rate could rise 1% in the next year. As a result, you could see the prime rate go up to 3.5% or around that level.
A year from now, the risk would be that US inflation could be 2.5%. I’m not saying that is high but I’m saying that is above the 2% plan threshold that the Federal Reserve has set for inflation. I anticipate rates will rise and therefore people are focused on stocks that benefit from rate rises and avoiding stocks that get hurt by rate rises. Clearly, most rate rises occur because the economy is very strong. This is a different situation. Rate rises are occurring because the economy is growing modestly, but the rates have been forced down for such a long time they have to come back to normal levels again.
EQ: When we spoke with Anthony Danaher recently, he said investors need to find opportunities with growth that can outpace the rise of rates. Biotech has been a high-growth area for a while now, and investors do wonder if they can maintain that pace. Energy, if it rebounds, could be another interesting area. What are your thoughts on those two groups?
Guild: To start with energy, we believe a bottom is forming. We do not think oil will go back to the low $40s for US domestic prices. We do think that we're near a bottom, and we think that some of the better-quality energy companies can be purchased. I wouldn’t say the ones that pay you big dividends because they're vulnerable to higher interest rates, but the ones that can grow and have a lot of land positions in the developed areas to provide plenty of energy over the next few years. We like some of the bigger and better quality oil stocks. Not the multinationals but the domestics.
As far as biotech goes, we continue to believe that biotech is going to be a beneficiary of the growing human genome knowledge, and the fact that drugs can be targeted. We like the biotech stocks that are focused on the human genome research and then targeting drugs because these are companies that are going to be able to do very well. The market is definitely in a euphoric stage in biotech because of its high growth and consolidation. Big-cap companies are taking over some of the smaller and medium cap-sized companies in the industry. As a result of that, we think it will continue to be a leading sector, but will have periodic violent 30% type corrections, so you have to be very nimble and quick.
EQ: Disruptive technologies also seems to be a growing area of interest for you. Are there any other areas of the US market that you're following closer than the rest?
Guild: Yes, we love biotech, cybersecurity and mobile applications and software. That would be companies like Google (GOOG) and Facebook (FB). We think both of them are going to do very well in the mobile area. In cybersecurity, we're looking at companies like Fortinet Inc. (FTNT), FireEye (FEYE), Palo Alto Networks, Inc. (PANW) and other companies. If you're a major corporate organization in the United States, you have to spend a lot of money on cybersecurity. Big banks have come out and said that this is the only part of their business where they will spend whatever it takes. You must have cybersecurity to continue to exist and grow. I think that is a very obviously attractive area. These stocks are outrageously priced so we are waiting for a correction to buy.
EQ: How do you measure whether or not a cybersecurity stock reasonably priced? We know they're expensive and you don’t want to overpay for growth, but when you have large institutions saying they have blank checks, it's kind of hard to price these stocks.
Guild: Very true. What is going on is they sell at multiples of revenues. They don’t have any profits, so many analysts look at the revenues to the market capitalization, and if it sells for six times revenue, that is cheap. At 10 times revenues, it's expensive. If the top line is growing at a rapid rate, you correlate that to the market cap to revenues model. This is not a sustainable model for analysis that you would use to look at stocks year-in and year-out. It was created by analysts who have no other more rational metrics that are applicable. Within a few years, these companies will become mature and new entrants will take market share from old entrants, and at that point in time the growth will not be open-ended.
It very much depends on which sector of cybersecurity you're in. Are you in the fastest-growing sectors or the more mundane sectors? Differing sectors of cyber security sell at differing valuations. Faster growth currently sells at larger valuations of revenues to market cap. All of this is dangerous and we prefer to wait for a correction to add to these stocks.
EQ: With rates expected to be on the rise, one concern that you’ve echoed is the illusion of liquidity in the bond market. If rates rise even quicker than people expect, do you see a potential breakdown in the bond market?
Guild: Definitely. I see a 2008-like situation where those who were informed and knowledgeable about what was going on in 2008 felt that the system could come completely unglued and the banking system could fail. The public was not aware but those people on the inside of the banking community and on the inside of the government, like the Treasury Department and the Federal Reserve, were aware. They well knew that the banking system was on the brink because of all these derivatives that couldn’t be handled. That’s why Ben Bernanke, Hank Paulson, and others did what they did and you have had this ensuing period of massive bond buying and very low interest rates as a result.
Another crash like that could easily occur because liquidity through ETFs is a phantom. There is no real liquidity of these instruments at reasonable prices. Sure, there's going to be liquidity at a big discount to the current price, but I think if you want a bond fund or a so called money market fund or some kind of ETF that is ostensibly holding bonds and protecting you, there may be no liquidity. The government may even have to stop trading in them or create liquidity in some other way, maybe by government purchases or by allocating assets to them like they did to AIG (AIG) during the 2008 situation. AIG gradually came back and paid off most of their debts. The big banks all paid off their debt. Those financial institutions after being much worse than the automobile companies ended up paying a much higher percentage of their debt than the automobile companies did.
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