NEW YORK (TheStreet) -- Value stock pickers assume they will be operating in a bifurcated equity environment, split between sectors of the stock market that appear over-capitalized due to “rear-view mirror” success, and those that look undervalued when considering the present value of their future income stream. The combination of numerous forces, both positive and negative, will most likely create this bifurcation.
The strongest of the positive forces are historically low interest rates, a continuing bear market in commodities like oil, the most favorable household debt service ratio of the last 35 years and a huge population group between the ages of 22 and 32 years old.
The strongest of the negative forces are the strong U.S. dollar, slowing growth in China, the long-term bear market in commodities like oil and the over-capitalization of small-cap stocks/private equity/alternatives investments, which dominate many of the largest institutional and high-net-worth individual portfolios.
Positive Bifurcation: Dramatically Better U.S. Economy
The biggest change in the U.S. investment markets in the next year could be the coming rampage to buy houses among first-time homebuyers. Homes are historically affordable, interest rates are low and an avalanche of echo-boomer buyers are likely to assault this market.
Here is what Warren Buffett told a Fortune conference on Oct. 7:
You would think that people would be lining up now to get mortgages to buy a home. It’s a good way to go short the dollar, short interest rates. It is a no-brainer. But so far home construction pickup has been slower than I had anticipated.
This has not happened yet, and because it hasn’t happened, few stock-picking organizations are willing to be lonely in their stock selections in order to benefit from a potential onslaught of home buying. Much like investing in oil stocks at their bottom in 1999-2003, there just aren’t many companies which are publicly traded and fit our eight criteria for stock selection. You want to talk about lonely, residential real estate only contributed 3% of U.S. GDP so far in 2014.
In 1960 there were 160 million people counted in the U.S. census. The worst single year of housing starts in the following decade was one million starts. There are 315 million people in the U.S. today and fewer than one million housing starts this year. In our portfolio, Berkshire Hathaway (BRK.B) - Get Berkshire Hathaway Inc. Class B Report , NVR (NVR) - Get NVR, Inc. Report , Home Depot (HD) - Get Home Depot, Inc. Report , H&R Block (HRB) - Get H&R Block, Inc. Report , Comcast (CMCSK) and the major banks Bank of America (BAC) - Get Bank of America Corp Report , Wells Fargo (WFC) - Get Wells Fargo & Company Report and JPMorgan Chase (JPM) - Get JPMorgan Chase & Co. Report are companies that should benefit greatly from a massive pickup in home building in the U.S.
BRK.B does everything from residential real estate brokerage to carpets to paint. NVR is the nation’s fifth-largest homebuilder and gets 80% of its sales in the starter home category. Home Depot’s participation is fairly obvious and builds on terrific performance even before the first-time buyers show up.
HRB prepares tax returns for many blue-collar workers whose employment and wages would be positively affected by housing. When folks form a household of their own, they are much more likely to pay for monthly Internet access and watch more TV via Comcast. This is especially true for parents of a couple of toddlers, who are running around the house in the evening. The majority of the mortgage loans are likely to be provided by the three largest lenders BAC, WFC and JPM.
Buffett went on to explain why he is still optimistic this will happen:
Household formation falls off dramatically in a recession, at least initially. But that doesn’t last long. Hormones kick in and in-laws get tiresome, too.
Our economic recovery has been so anemic from 2009 to today that it has had the same impact on home buyers as a recession. Anecdotally, look around you. Today’s children are being born to couples who, no doubt, will want their kids playing in their own yard soon enough.
Gasoline futures have fallen over 90 cents from June 20, 2014 to Oct. 17. This is a massive tax cut to the average household in the U.S. and a creator of psychological confidence. We have held on to our over-weighted position in consumer discretionary companies despite the respite they have taken during the last year.
If you put an extra $100 per month into the wallet of the average consumer, it could positively affect purchases at eBay (EBAY) - Get eBay Inc. Report , Disney (DIS) - Get Walt Disney Company Report , Nordstrom (JWN) - Get Nordstrom, Inc. Report and Cabela’s (CAB) .
Negative Bifurcation: Out With the Globally Synchronized Trade
A strong U.S. dollar, a recession in China and a bear market in commodities led by oil are the exact opposite of what happened from 2000-2010. What did well in that stretch were U.S. small-cap stocks, commodities, emerging market equities, U.S.-based multinational companies connected to emerging markets, and alternative investments.
We appear to be in a seven- to 10-year bear market in commodities driven at the margin by an over-supply of and weakening demand for oil and gas. Americans have taught themselves to use less gasoline and the Chinese economy is being forced away from its commodity-heavy reliance on fixed-asset investments. This movement comes while China is making another effort to avoid a bust like we had in the U.S. in 2007-09. Energy is 35% of most commodity indexes and an important expense in the creation of most of the other commodities.
The S&P 500 is loaded with companies that did well from 2000-2010 and are likely to be directly affected by these negative forces. They should be avoided. At the end of a cycle, indexes have a tendency to be over-weighted in what did well the prior 10 years because they are “market cap” weighted. Since Japan began to weaken its currency versus the U.S. dollar in October 2012 commodities have had a very hard time, as have emerging market equities. It is a good picture of the next five to 10 years for determining winners and losers because it won’t just be the yen that could go down a great deal among currencies if the U.S. economy performs much better than most experts forecast.
Our portfolio currently owns no energy, basic materials and heavy industrial stocks. We are also under-weight consumer staples, which along with energy, basic material and heavy industrial stocks get a big part of their revenue and saw a big part of their past 10-year growth come from China-led emerging markets.
We are expecting an opportunity for Main Street to beat Wall Street, for domestic-oriented companies to beat ones with large foreign revenue, and for U.S. domestic-oriented large-caps to outperform both large peers and small-caps overall. This is the bifurcation envisioned over the next five years.
At the time of publication, the author's portfolio was long BRK.B, NVR, HD, HRB, CMCSK. BAC, WFC and JPM, although positions may change at any time.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.