Horacio R. Marquez: Financials are Number One

By Ian Wyatt, Chief Investment Strategist, NewsletterAdvisors.com

 

 Horacio, what are your short-term and longer-term views of the markets?

I have seen plenty of countries blow up and come roaring back within two to three years: from the Asian crisis that encompassed all the countries in the region, blowing up their entire banking systems, to Brazil, Argentina, Mexico and Russia. And the little secret about all those blow-ups is that countries react and come back much faster than the pundits and Wall Street would make you believe. The one exception is Japan, who fell into a deflationary spiral which took ten years and lots of pain to get out off. The US is clearly taking all the right measures to avoid a deflationary spiral, the most dreaded economic phenomenon.

So while in short term we are working through the tail end of the housing market correction and the bank de-leveraging and recapitalization, we need to understand that markets go to extremes. They always overdo the downside and the upside. We are clearly overdoing the downside right now, with very cheap valuations across the board, especially in financials.

The breakdown of the oil bubble, on the basis of some demand destruction and very importantly the heightened expectations of lifting the ban on drilling in the U.S. continental shelf has also helped. Environmentally conscious Brazil has finally achieved energy self-sufficiency and will soon be able to export oil and gas because of a decades-long very successful effort in deep sea drilling in front of their pristine Rio and other beaches and in ethanol production.

So it is precisely in these circumstances that people need to see who are going to be the big winners in the longer term, and wait for a moment of maximum pessimism in that stock to go in a buy as the market collapses.

Once you have done this, as Charles Schwab advised, you need to play some more golf or do more fishing, rather than staying glued to the screen following your purchases tick by tick. And you will be handsomely rewarded in the longer term.

The investment process is a matrix of processes that requires long hours, depth of analysis in several investment methodologies and a strong discipline. The objective is to have all the main disciplines of analysis working for you before you pull the trigger, so that there are many lines of defense behind your investment rationale.

Namely, I want to have the fundamentals, valuation and technicals behind me. By fundamentals, I need to see the global, country, industry and sector fundamentals behind me to start with. Then I move to the companies within those fundamentals, wherever they might be in the world that will benefit the most from them. But the most important call is the country and economic sector; studies have shown time after time that this decision is the one that gives you the vast majority of the return. In fact, it is so important, that I launched a service that specializes in these ETF’s (which we call shadow stocks), to take advantage of them, the diversification, superior risk-rewards and additional investment opportunities that these ETFs allow.

Very importantly, all of this analysis has to be positive for the long, medium and short term. So if something changes in the short term, we can afford to wait for the longer-term factors kick in. Or if we get stopped out, some of our investors with longer investment horizons might decide to stay for the longer term. We do not recommend trades that people cannot hold long term. It is a conservative approach that has worked marvels so far.

Obviously financials is number one. In all these financial crises the strongest banks thrive in the longer term and the weakest get taken over or collapse. After the 1991 U.S. recession Citigroup’s stock proceeded to appreciate by 32 times its value over the next ten years. It is important to differentiate between banks.

Right now they are finishing charging off their errors of the past (subprime mortgages), while they see their core business (success of the present) actually expand. These strong banks will be winners and see much higher stock prices in the next few years: Citigroup, JPMorganChase, Wells Fargo, Bank of America and US Bancorp.

We are also in the midst a secular process of industrialization and urbanization in emerging markets along with an incipient consumer boom, led by China, India, Brazil and Russia. This requires a massive amount of infrastructure, especially transportation in cars, buses, trains, ships, ports, roads, electric power plants and transmission networks and buildings and all the appliances that go in them. The common element in all these physical investments is steel, which is in short supply.

But there are too many attractive sectors at these very low market valuations. To name a few: transportation, especially U.S. trucking, courier and package services, consumer cyclical, basic materials, capital goods and even selective energy and agro, after their recent corrections.

Right now, we are playing many investment themes at these low levels and it is very tough to pick the top three. But I will stick with Citigroup Inc. (NYSE:C), which, as I expected beat earnings expectations handily and as I was proclaiming was being manipulated down with naked shorts. I expect a multi-bagger gain in Citigroup over the next few years. This will be driven by Citi’s very powerful global consumer and institutional franchises, their huge deposit base and their currently increasing net interest margins.

In investment banks, I like Lehman Brothers Holdings Inc. (NYSE:LEH), which has a solid capitalization, as it has de-levered substantially and raised capital, and is consistently ranked as the premier fixed-income investment bank in the world. Lehman’s stock is trading at a ridiculously low valuation versus book value and the firm will either be taken private, they will be taken over by a major international bank at levels much, much higher than these or remain independent and thrive longer term with their superior franchise.

Jumping into steel, it is too difficult to see who will make the most capital appreciation, since it goes down to execution, and some economic differentials across countries that are shifting too quickly to call safely, so the steel sector Index fund (NYSE:SLX) looks appetizing here, and for people who prefer individual stocks I prefer the Asian steelmakers and the global leader, ArcelorMittal (NYSE:MT), which are supplying the areas with the largest shortages.