Is 2016 the Year of the Value Trap?

by Jeff Miller, New Arc Investments

Wall Street loves to name things. The unofficial definition of a “value trap” is a cheap stock that is stuck around the current price.

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Those who focus on what happened in the past have a big advantage. They can cite facts, past performance, and explanations that make them seem to be really smart. They are helping you to understand what has recently happened, and also sharing the current conventional wisdom. How can anyone disagree? The story would get an “A” in a journalism class.

Explanation of what has already happened is fine for a journalist, as long as readers are cautious about extrapolating the results. Piling into crowded trades might work for a while, but eventually leads to big losses. The very best journalists do not become great investment managers.

As an example, I once read an article in a print magazine about the worst current stocks to hold. The author had some sort of earnings screen which cranked out stocks with low earnings. I owned four of the ten! What the author did not understand was that my stocks were all asset plays, valued on the basis of things like real estate holdings and other hard assets. I used his list to explore other possible ideas.

Michael Santoli and Value Traps

Michael Santoli, who has broad experience in market commentary, recently became a Senior Markets Commentator at CBNC. I have followed his work for many years and turn off the “mute” if his topic seems interesting. That means I regard him as interesting and pretty good. He recently presented on the theme of this blog post: Is 2016 the Year of the Value Trap? He accurately observed that cyclical stocks trade at low PE’s at times of economic tops and high PE’s when the market is low. This widely-known observation (Peter Lynch from 30 years ago, for example) is certainly accurate. Santoli listed several current value trap stocks. He informed us that the market was suggesting the top of the economic cycle.

Since I have a value approach, driven by a sophisticated analysis of economics, I looked at his list with interest. Several of my holdings were on his list (Ford, Gilead, Gamestop), and I added another today! (Delta)

Santoli’s Error

Santoli’s work is an accurate representation of current thinking, and therefore solid journalism. The problem is that he is attempting to explain what already happened. He does this very authoritatively. His real message is that traders have a fixation on yesterday’s news. Here are the problems: