Current Market Conditions And The Trade War With China

Hey, The Investor’s Podcast Network Community!

With the trade war escalating, the stock market has taken a severe hit. One way to handle this is to question if it’s a good time to invest now that stocks are cheaper, or if it’s a bad time as the outlook for stocks has worsened. As value investors, we have to filter through the noise and look at the facts.

Fact #1: Almost all stocks have taken a beating. You can argue that stocks more exposed to China should decline the most in price — and this generally happened. However, even stocks with no exposure at all are falling off a cliff. Everything else equal, this could provide a buying opportunity.

Fact # 2: Stocks are still trading at very low expected returns. Despite the recent drop, the US stock market is still priced around an expected return of 3.5%. So while it does look cheap compared to one month ago, the overall picture has not changed. Looking back in history, we have gone from “very expensive” to “slightly less expensive than Black Tuesday in 1929.”

Fact # 3: The yield curve is inverting, and we just saw the 3-month Treasury Bill’s yield cross above the 10-year note yield in the widest divergence since the 2008 financial crisis. This is important because it could trigger a negative chain reaction as people are incentivized to move to cash. This is slowing credit growth and directly hurting stock prices. This also has a negative “wealth effect.” Lenders start to worry if they will get their money back and start asking for repayments. Borrowers now have to sell their assets to meet their obligations of repayments, which drive down asset prices and consequently force more borrowers to sell assets.

Considering the facts, where does it leave us as value investors? I’m not excited about committing a larger part of my portfolio into stocks at the moment. Timing the market has always been tricky even at the high valuation we see today. While you can find indicators like the yield curve inverting (which signals the market should continue to decline), we’ve seen many other significant indicators that the market could soon enter a recession during this long term bull market, which has been raging since March 2009.

I suggest you start your research with companies that have been punished the most by the trade war and see if the lower price is truly justified. One interesting pick I’m looking at is Micron Technologies, a leading provider of advanced semiconductors. It has been hit hard by the trade war. When you read through the numbers, you can easily see why the company is currently so unpopular with investors. 32% of their 2018 revenue came from shipment into China, and Huawei alone accounted for 13% of the total revenue.

However, at a TIP Multiple of 3.1 (calculated as enterprise value / earnings before interest and tax), it’s the second cheapest large-cap stock in our screener. You can learn more about the screener that Preston and I recently developed for the TIP community here. We also plan to send free educational videos about our new tools in later newsletters. Stay tuned!

Alibaba, the Chinese e-commerce behemoth, is nowhere near the cheapest stocks in our screener. However, the price of its stock has dropped from around $200 a share to $154 in just one month. When you read through the numbers of Alibaba, the impact of the trade war is negligible. The company, which grew revenue 51% Y/Y last quarter, shows little sign of slowing down. When you factor in the Free Cash Flows, you get an expected 4% return plus growth.

I’m long both stocks, and I’m considering adding to both positions. We need to keep in mind though that both stocks, everything else equal, is worth less than before the trade war broke out. So as investors, we need to estimate what we think the true impact of the sanctions is and compare that to the current valuation. It’s more an art than science. If you want to do the research with me, here is a link to our mastermind discussion of Micron Technologies and a link to my pitch of Alibaba.

Since my last newsletter in May, we found two stocks trading at attractive valuations. I’ve attached our intrinsic value assessments of both stocks to this email. Here is the link to all of our stock analyses and how they have performed.

Your Friend,

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P.S. I’m hosting a TIP networking event in Vienna and Prague next month. At these events, you can meet other listeners of The Investor’s Podcast and me. They are completely free to attend (you just have to pay for your own drinks).

With the help of local TIP listeners in both Vienna and Prague, we found two great venues. We plan to meet up in Vienna at 7:30pm on July 3rd here and in Prague at 7:30pm on July 7th here. Preston and I are so lucky to have such awesome listeners.

I would love to meet you in person! If you would like to attend any of these events, please respond to this email and I’ll send you more information.