Where will the crowd run next and how can you get yourself there ahead of it?
That, it seems to me, is the central question facing investors today. This is the kind of thinking that, for years, contributed to the outperformance achieved by George Soros, Stan Druckenmiller and others at the
. They were masters at dashing up the road a few miles, waiting for the crowd and then selling the crowd their positions at higher prices. So let's take a crack at trying to divine where the crowd is likely to surge.
First off, the crowd is likely to keep surging out of high-priced stocks and into lower-priced stocks. It may be a cold day in hell before people once again pay 600 times next year's earnings for a company growing at 100% with an unproven business model and technology subject to competition.
working are the high-priced growth stocks. What
working are value stocks -- consistent earners selling at lower multiples.
As a general rule, I'd say that trend is still your friend.
Salomon Smith Barney
strategist Marshall Acuff made just this point in a report issued today. By his lights, value stocks are just about flat year to date, while growth stocks are down about 17%. "Investors continue to reach for relatively high visibility of earnings growth during a period of diminished profits growth expectations. This interest is likely to continue over the near term," writes Acuff.
OK, so now what are the sectors that folks may soon come to see as having fairly steady earnings and relatively low valuations?
My list includes some insurance and reinsurance, some consumer goods, some oil and gas and some beaten up companies with real earnings that are off 75% from their highs. This list is obviously just one man's meat. Others will have different favorite sectors. The important point is to look for areas with improving fundamentals that most people have yet to overweight in their portfolios.
Today, I'm just going to discuss the insurance stocks. I usually hate to talk insurance. (Been dodging my life insurance agent for years.) And that's just the point. Most people have been equally uninterested in these stocks until recently. But, property/casualty companies (especially those that focus on commercial lines) and reinsurance companies are seeing real improvements in their business. Those companies with strong balance sheets can at long last afford to raise rates without fear of lesser companies lowballing them and stealing the business. In short, they are finally getting paid to take the underwriting risk.
And unlike many financial companies, the property/casualty and reinsurance companies are less vulnerable to asset quality problems. A Salomon Smith Barney report released this week says: "Property/casualty insurers are distinguished in that asset quality is not a major concern for these companies. As of the end of 1999, nearly 70% of industry invested assets were in fixed-income
97% investment grade, short-term investments and cash and another 20% was in common stocks."
That said, many of these stocks have already had a good run this year. The "easy money" may already have been made this year in the property/casualty stocks and the reinsurance stocks, as Solly noted in its report, but, "We see room for further gains in these stocks." So do I.
One that caught my eye is the
St. Paul Cos.
. It is by no means the best in class. It has shown in recent years below-average earnings and revenue growth. But it sells at a lower-than-average multiple, too. The company is expected to earn about $3.15 next year, according to Salomon, which implies a 15-16 times forward P/E multiple. If you believe, as I do, that property/casualty and reinsurance companies are still near the beginning of the up cycle, then it might be worth a look. St. Paul could easily benefit down the road from an upward earnings revision in 2001 estimates. Solly, which trades the stock for its own account, rates St. Paul a buy.
A more speculative play is
. It too trades at about 15 times next year's estimated EPS, according to Salomon, which seems to think a bit less of CNA's underwriting prowess, which is why it has a hold on the stock. They may well be right, but I would also note that the stock has also gone nowhere this year while its peers have surged. CNA may need more time more time to get its act together, but the Tisch family, which controls and has a lot of money riding on CNA, is not likely to let the stock languish too long.
In the U.S., reinsurance stocks have had such a good run that you might consider some of the ones based in Europe. The risks and rewards are not that different. After all, they are all global players. But the valuations are somewhat lower.
London-based insurance analyst Stephen Dias this week published a bullish call on one of the strongest reinsurance companies around --
. Dias writes that "the fundamentals in the insurance sector remain strong" and that "increasing rates in P&C reinsurance will drive earnings growth." (Goldman has done investment banking for the company.)
Why Munich? It has a great balance sheet, which you need when you are insuring the biggest risks. (Say, the likelihood that Tokyo gets wiped out by a tidal wave.) Dias also argues that U.S. investors will begin to move into European insurers because comparable stocks have moved up more here than abroad. As the Europeans raise rates in 2001 and produce improved earnings growth, Dias expects to see these stocks catch up to their U.S. peers.
Finally, I'd be remiss not to mention Warren Buffett's
. No company is better than Berkshire at getting paid to take underwriting risks or at investing the float generated by those insurance premiums. Its
subsidiary is poised to do exceptionally well in the reinsurance business where many competitors have had to drop out because they no longer have the financial strength to take the risks. That means General Re can raise rates. Berkshire also offers investors the ultimate in a portfolio of wholly owned and partially owned businesses with steady earnings. And as Mr. Acuff noted earlier in this piece, that is where the crowd will want to be for some time.
Next time, I'll take a look at the other sectors on my list that may attract the crowd in these precarious times.