Markets are up….and here’s what I’m doing

It seems fears of the Brexit were short-lived markets, with markets hitting all-time highs.  Here’s how I’m dealing with this.

Just over a couple of weeks ago markets were seemingly paralyzed by fear at the prospect of the UK’s exit from the EU. The Dow Jones industrial average was in freefall with many banking stocks and travel sensitive stocks being hammered. However it appears that markets have brushed all of that fear side with the Dow recently hitting highs of over 18,500.

It’s certainly a manic market that were dealing with. I wouldn’t say that stocks are outrageously priced. I also don’t think that we’re dealing with a bubble. Certainly the market on the whole is more expensively priced compared to historical averages. Markets typically average a PEs of around 15. At this point in time the Dow is trading at a PE of around 17. Sure that’s high but still well-off the insanity of the late 90s when the PE of the Dow hit over 30.

So what am I doing in the midst of all of this? Firstly one of the things to be remembered is that bond rates are still at ridiculous laws so frankly your alternative to stocks are relatively limited in terms of earnings power and decent yield. That really gives me pause with respect to any revised asset allocation decisions.

I’m still comfortable sticking my lot in with stocks for the long haul. However I’m much more cautious about putting new capital to work in these market conditions. For the most part I’m continuing on autopilot with the strategies that I already have in place. That means continued regular investment into my 401(k) as well as steady periodic investment into my 30 stocks for 30 years.

I just can’t bring myself to put in any net new capital into the markets beyond these regular initiatives. I think this earnings season will really be quite instrumental in determining whether any significant opportunities for new investment may open up later this year.

By and large it appears that many of the large companies who reported earnings thus far have meet, if not slightly exceeded the expectations that have been placed on them. The banks have shown a certain amount of resiliency, technology stocks have shown promising growth and even oil stocks are starting to show signs of optimism.

What is also clear though is that it continues to be a bloodbath in retail with even historically resilient stocks showing some signs of wear and tear. Starbucks for instance was one of those that seem to be impacted by general retail slowdown. As I review earnings I am looking to reallocate capital away from companies where earnings seem to be more suspect over to sectors that are showing more resiliency.

I’ve decided to end my investments in Chipotle and Polaris. Chipotles bounce back from the woes of its food crisis scandal late last year is taking far longer than I expected. While I am happy to be patient and let this thing play out longer it’s occurred to me that I may have overestimated Chipotles’s brand strength and underestimated the ease with which consumers would substitute for other alternatives.

That suggests to me that there will be a real net loss of consumers that likely will decrease the frequency of their visits to chipotle if in fact they return at all. That doesn’t bode well for its long-term growth particularly given the relatively pricey multiple at which it trades.

In the case of Polaris, while I believe the company is a great business there are a couple of things that troubled me over the last year which have become clearer in the company’s earnings. Frankly I believe the stock is far more exposed to cyclicality and fluctuating market conditions than what I would like to see.

Off-road vehicles and snowmobiles are big-ticket discretionary expenses. Volumes are going to be severely impacted by the state of economic growth and the collapse in the oil price in oil-rich regions. The corresponding decrease in Polaris’s demand just really exposes how uncertain its earnings profile is. While the company has great brand strength and enviable returns on capital I’m not all that comfortable with such a cyclical business.

I have instead chosen to reallocate the funds that were invested in Polaris and in Chipotle back into a few names in the healthcare sector. I’m going with a more modest top up of my holding in Celgene. I believe that Celgene has been dramatically affected by irrational fears of government intervention in drug pricing.

My expectations are that the congress will prove less willing to pass concrete measures that will materially impact existing drug pricing. Biotech actually seems to me to be one of the few sectors that offers any real value and current market conditions.

So overall I’m happy to sit tight and just let my investments continue to ride. You invest in bear markets to then reap the rewards in bull markets like these. In hindsight, the spate of buying that I did earlier this year when there was a “China crisis” actually looks to have been fairly well timed. Most of the stocks that I invested in at that time I’ve shown strong rebound in excess of 20%.

I won’t be deploying any fresh new capital during these elevated market prices however I will continue with my regular accumulation programs given that I have a 20+ year view on these. I’ll also explore selective reallocation into companies where I that have strong business models, competitive advantages and discounts to intrinsic value. Biotech strikes me as one of those sectors at this point.

I will likely also increase my strategy of writing out of the money put options on select high-growth companies that I already own I’d like to continue accumulating these businesses however the current prices by and large are too rich for my liking at the stage. I’m more than happy to provide insurance on some of these companies and be a willing buyer of them should their prices fall to a level that I’m more comfortable to purchase at.

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