A sigh of relief can be heard by all after two brutal years in the equity markets. But there is something interesting occurring that is gaining little attention. Companies with consistent, stable cash flow, (and not highly leveraged) are underperforming more risky leveraged assets.
What's going on?
Johnson & Johnson and Procter & Gamble are two firms that did not crash when the markets plummeted over the last 12 months. Likewise, they have not rallied strongly as investors are questioning the prudence of investing in these types of names. Even Warren Buffett has been questioned about the strategy employed at Berkshire Hathaway despite 40 years of incredible results.
What these companies have in common is their focus on strong cash flow and non-leveraged businesses. Value focused companies tend to have reduced volatility both up and down and there are periods with sleepy returns. And in a market focused solely on hope, these assets are proving to be a less interesting investment for investors. But should this be the case?
In a recent interview on CNBC, Mohammed El Erian, CEO and co-CIO at PIMCO, stated that he believed the current equity market rally would stall as economic reality confronted excessive hope.
- Bull Market Won't Last: Pimco's El-Erian
If that's the case, the type of assets that you will want to own in your equity portfolio will be positions destined to weather challenging economic conditions with strong cash flow; exactly the type of assets that have underperformed in this recent rally. Of course, if he is wrong, conservative cash flow positions will continue to lag.
I suppose as an investor you have to ask yourself what you believe the economy's current state is and will be. That will drive your investment choices.
Frothy rallies can bring great returns but one needs to be very careful playing the high volatility game. As always, it depends on the length of the race you are running; a sprint or a marathon or something in between. That will dictate the type of assets in your portfolio. Make sure your equities match your time horizon; a mismatch could prove a very costly mistake.