So far in 2014, the market has returned to a period of unevenness and volatility. This is a far cry from just last year. A year-end article in the Wall Street Journal recapped the best investments for 2013 and pointed out that “boring” was best for making money during the year. It detailed that U.S.-based stocks did well and beat more aggressive strategies pursued by hedge funds and other investors that try to time the markets, play commodities, or invest in ETFs. Market experts predicted strong performance in emerging markets that didn’t pan out, but could in 2014. Below are some investment ideas that also qualify as “boring”, but represent the best places to put your money through the remainder of 2014.
The U.S. Energy Space
An article in the Financial Times detailed that energy companies are aggressively seeking to expand in China to help it unlock what is proving to be massive oil and gas reserves in shale rock formations. The article estimated that China’s shale reserves could exceed U.S. reserves by 68%, and possibly holds the largest reserve base in the world. However, the reserves appear to be several miles below the earth’s surface, as opposed to just a mile or two in many of the largest reserve areas in the U.S. Additionally, a number of intangible aspects of capitalism favor investing in the space Stateside.
The biggest concern regarding China's prospects is that large firms with a heavy dose of state intervention control the energy market. If this had been the case in the U.S., the shale revolution might have never taken place. Instead, small and medium firms in the U.S. pursued unconventional methods to revive older and mature oilfields through the country. There are also an estimated 10,000 service companies that have helped supply a nascent shale industry that has really taken off.
Despite faster growth in international markets, the U.S. remains first in the world as an oil consumer, a nuclear power producer - as measured by electricity generation and consumption. Back in 1993, it was the world’s top oil producer, but the fracking revolution has helped it stay second and only slightly behind Saudi Arabia today. The U.S. is now also the top natural gas producer, whereas two decades ago it was number two behind Russia.
The fracking space will likely hold the most potential and is revolutionizing the domestic energy market. It also has huge potential effects on indirect industries including chemicals, manufacturing, and energy transport that collectively represent more unique (and potentially lucrative) areas that the many of investors could easily overlook. In short, the energy space in the United States remains the most robust and exciting in the world
Several years ago, rapidly-industrializing markets outside of the U.S. were all the rage. These include massive potential markets as nations like Brazil, China, and India grew their economies. But since the end of the credit crisis, emerging markets have fallen out of favor. Developed markets, including the U.S., have more stable economies and political systems to support growth.
However, a contrarian strategy in emerging markets is warranted for 2014. Valuations have become more reasonable and there are plenty of markets that will do well. China is slowing, but transforming from a centrally-planned export economy to one based on domestic demand and the private sector. This is very likely to be a bumpy transition, but there are already signs China is on the right track. Henry “Hank” Paulson, the 74th Treasury Secretary and former head of Goldman Sachs, has a forthcoming book that will dive into China’s uncertain but important transition to a purer form of capitalism.
Stocks for the Long Run
A current argument against a further rise in the stock market is that valuations, such as the S&P 500’s P/E ratio, are high. In particular, the Shiller cyclically-adjusted P/E (cape) ratio has been widely cited as suggesting the market is expensive and due for a pullback. But Jeremy Siegel, a professor at the University of Pennsylvania, has pointed out the problems inherent in Yale professor Robert Shiller’s ratio. Siegel states that "Cape ratio’s overly pessimistic predictions are based on biased earnings data. Changes in the accounting standards in the 1990s forced companies to charge large write-offs when assets they hold fall in price, but when assets rise in price they do not boost earnings unless the asset is sold. This change in earnings patterns is evident when comparing the cyclical behavior of Standard & Poor’s earnings series with the after-tax profit series published in the National Income and Product Accounts (NIPA)."
He goes on to state that "For the 2001-02 and 2007-09 recessions, S&P reported earnings dropped precipitously due to a few companies with huge write-offs, while NIPA earnings were more stable. Yet before 2000, the cyclical behaviour of the two series was similar. Downward-biased S&P earnings send average 10-year earnings down and bias the Cape ratio upward. In fact, when NIPA profits are substituted for S&P reported earnings in the Cape model, the current market shows no overvaluation."
Specific Ways to Play the Above
Taking into consideration the above investment areas, the nearer-term outlook for stocks in general and emerging market looks quite favorable. There are plenty of opportunities to buy individual stocks at P/E ratios well below the overall market. Equities also have outperformed most other asset classes over the long term. Stocks have returned 10% annually over the past century and have returned close to 15% annually since the end of the Great Recession.
Looking at some specific names, Chesapeake Energy (NYSE:CHK) and even energy giant Exxon Mobile (NYSE:SOM) represent direct ways to play the positive trends in the U.S. energy industry. Peripheral industries that can benefit include chemicals, such as Dow Chemical (NYSE:DOW). A conservative way to play the emerging market space and invest in stocks is through U.S. multinationals. For instance, Yum! Brands (NYSE:YUM) operates KFC, Taco Bell, and Pizza Huts across the world and is focused on China as its primary growth avenue. McDonald’s (NYSE:MCD) has a similar investment thesis, and Tupperware (NYSE:TUP) garners most of its revenue from developing markets.
The performance of the stock market in 2013 demonstrated how investing in equities can reward investors. A 10% gain for 2014 seems plausible and would put the stock market returns back at historical averages. More aggressive investors may want to invest directly in emerging markets, but others can play it safer by investing in U.S.-based companies that operated both at home and on an international scale. For those that prefer to stay stateside, the U.S. energy space is ripe for years of positive upside, especially in the fracking space.
Disclosure: The author owns shares of Tupperware and McDonald’s