Finding Value in Optimism

“Buy not on optimism, but on arithmetic." 
— Ben Graham
 
 
Extreme optimism took hold of the market as investors responded to approval of a $1.9 trillion deluge of new stimulus spending by the federal government and the rapid rollout of COVID-19 vaccinations. The euphoria led to a widespread runup for equities and drove the so-called Buffett indicator to its highest level of the past 35 years. 
 
The ratio, shown below, compares the market cap of virtually all publicly traded U.S. companies to the GDP of the U.S. As illustrated, investors are paying nearly $1.85 for every dollar of GDP produced—or about a 40% more than the historical average. When updated GDP numbers are released in the coming weeks, we expect that ratio to move even higher.
 
Signs of Over Exuberance?
Total Market Cap to GDP

Heartland Advisors Value Investing Total Market Cap to GDP Chart
Source: FactSet Research Systems Inc., Quarterly data 3/29/1985 to 12/31/2020
Total Market Cap is represented by the Wilshire 5000 Total Market Index. All indices are unmanaged. It is not possible to invest directly in an index. 
Past performance does not guarantee future results.

As economic growth and inflation expectations moved higher, so too have yields on the benchmark 10-year U.S. Treasury bond—reaching levels not seen since before the pre-pandemic days of early 2020. The sudden uptick was a headwind for shares of technology companies and other growth stocks as it caused investors to favor near-term cash flows over rosy forecasts for sales growth further out into the future but low or no earnings now.
 
Additionally, we are beginning to see a welcome return to investors rewarding or punishing businesses based on underlying fundamentals. This rotation has boosted attractively valued businesses and those positioned to benefit the most in the early stages of a return to economic normalcy.
 
In response to recent strength, we are taking a longer view by investing in businesses we believe are well positioned to drive free cash flow growth and those with financial strength that can be drawn upon in response to long-term uncertainty in the aftermath of the pandemic. We believe this tactic may produce a portfolio of companies that should endure when interest rates rise, and government stimulus dries up.
 
Sincerely,
Your Heartland Team

 

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