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Sunday, December 30, 2018

12/30/2018 Views- Not Particularly Cheap

I did almost no trading in December, and very little in November. On 10/28/2018 I wrote: “Now that I'm sitting on more cash and bonds than I have stocks, I'm almost cheering when the market goes down“. I still feel the same today. 

The problem is even after the market down turn, most stock valuations are only fairly valued if you assumes no recession in the next 3 years or so.

For example I am considering buying Goldman Sachs, which trades at about $160. Using consensus 2019 EPS, this trades under 7x earnings. Neither does that EPS look particular peakish. Over the past 10 years pretax profit actually held fairly steady, and the explosive EPS gains mostly came from lower tax rate and much lower share count.

So is GS cheap or what? The problem is about 20% of their revenue comes from the “Investment and Lending” segment, with the majority of that being gains from equity securities. In fact, from 2015-2017, this segment contributed 28% of GS’s pretax earnings! 

In estimating a conservative “normalized” earnings, I assumed 0 on those equity gains, and $160 stock price would represent under 12x P/E. This is a good valuation, but not a huge bargain for a highly leveraged, cyclical company prone to political attacks.

In a down cycle, that Investment & Lending “revenue” might not just be zero, it could be negative. Then this $160 price tag might be outright expensive.

Portfolio Positioning and Asset Allocation
Given my inaction, my stock exposure will likely maintain at the current level of 40-50% of liquid portfolio (basically my entire net worth minus home equities). I'm open to more if I see truly compelling value.

The 40-50% equity level is really more about how much cash I want, and less about how much equity exposure. As a full time individual investor, I don’t have regular income and have always maintained plenty of cash reserves. I also wanted to maintain plenty of “dry powder” to go in big in case there’s a recession.

I'd like to think the 40-50% allocation to equities implies a neutral view regarding the stock market. If stocks goes up I would have more than half of my portfolio invested, “net bullish” if you will. If stock goes down I will have ever decreasing exposure while keeping my dry powder high.