Where To Find Money In A Tough Market
In hindsight, the six-year bull market was an easy rally to predict. Valuations were very low in early 2009, and Federal Reserve policy has been remarkably accommodating.
Yet the forward view may not be so rosy.
Sales growth is getting harder to achieve for companies in the S&P 500. Analysts are expecting sales per share at S&P 500 companies in 2015 to decline by 1.4%, while earnings are expected to eke out 2.5% growth to $120.17 per share, according to FactSet Research.
Sales growth has not been stellar in recent years, but companies have been able to increase earnings through expense management and lower interest expense. Net margins on results over the last four quarters are at 10% for the companies in the S&P 500, well above the 8.6% average over the last ten years.
It is going to be progressively more difficult to squeeze out higher earnings on cost management alone and higher interest rates could be another headwind on profit margins.
This tough corporate environment is coming as the Federal Reserve inches closer to a less accommodative monetary policy. Global growth has yet to fulfill the promise of increased easing by developed nation's central banks and U.S. firms are increasingly struggling against the strengthening dollar.
Stock prices are not exceptionally pricey and there's little reason to believe we're in for a bear market, but flat asset prices could be the theme for much of 2015.
A Buyer's Market
While anyone with a dartboard and a list of stocks could have made money over the last six years, making money through the rest of this year may take a little more skill.
At this stage of the economic cycle, and after more than half a decade of returns, some sectors are going to start looking expensive, based on growth expectations. That could lead to profit-taking. That's why investors need to think tactically with their portfolios.
That is where hedge funds and private equity firms come in. These firms employ extremely intelligent staffers that seek ways to hedge market risk, while generating a return on assets. They often have access to investments that most of us can't touch.
Alternative assets like real estate and hedge fund strategies offer a lower correlation to stocks, which will help protect your portfolio from general weakness in the market. Some of this lower correlation is from different macroeconomic drivers like real estate, while some is also due to the hedging ability of managers. Over the 18 years to February 2015, REITs had a correlation of 0.57 to stocks, while market-neutral funds had a correlation of just 0.31 to the market.
The Blackstone Group LP (NYSE: BX )
Blackstone's total revenue rose 14% last year to $7.5 billion, much of it due to an 86% increase in private equity revenues. The company is bearing the fruit of investments made years ago. Distributable earnings have grown at a compound annual rate of 41% over the last five years. Shares trade for 3.8 times book value and pay an 8% dividend yield.
KKR & Co. LP (NYSE: KKR ) traditionally operated as a private equity firm. After an IPO in 2010, the firm diversified its holdings across asset management, real estate and credit opportunities. The firm acquired KKR Financial Holdings last year to expand into high-yield strategies and direct lending.
The firm manages $62 billion in private market investments through private equity energy, real estate and infrastructure and $37 billion in public market investments through credit and hedge fund investments. Distributable earnings jumped 33% last year to $2.0 billion as the firm realized an increase of $504 million in carried interest on investments. Shares trade for 5.0 times book value and pay a 6.1% dividend yield.
Risks To Consider: While these companies are experts at squeezing profits out of a tough market, they are still beholden to general asset prices. Revenue could fall if the stock market drops significantly.
Action To Take --> Private equity and alternative asset firms can still benefit when market volatility increases and sales growth slows at traditional companies. Piggyback on the trades of financial masters enables you to continue making money, even as the broader market slows.
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