Happy New Year and I hope that you have a wonderful and healthy holiday season. The year is off to an excellent start as value stocks have started to catch fire. Bond yields have risen quite dramatically in the first few days of the year, which has caused the expensive tech stocks to sell off, while value has rallied. The disconnect between growth and value valuations is so extreme that there is a long way to go. Earnings season starts in earnest late next week when the big banks start reporting. I’m very optimistic and see tremendous value in several of them. 2022 should be the year that the Puerto Rico bankruptcy is concluded, which has majorly positive ramifications for the bond insurance companies that we are invested in.
We are finding great value in selling options, garnering very attractive premiums on puts at levels far below current stock prices. Often these returns are close to 10% annualized despite the stocks having to drop by roughly 50% for you to lose a penny, on some of our more conservative strategies. This provides us with a tremendous amount of protection and target returns two to three times what can be achieved by junk bonds. This of course if immensely important given that inflation is still a nasty factor impacting everyone and seemingly almost everything. Today’s ADP jobs report was excellent, which bodes well for the economy. Omicron is clearly immensely contagious, but has been less virulent thankfully. If seasonal trends hold, we hopefully are close to the peak and we should see things begin to decline again. Fortunately, for the most part we have avoided major lockdowns and restrictions, so the economic damage is likely to be mostly related to increased pressures to the supply chain.
We are very optimistic on 2022 after a great 2021. Our key positions trade at single-digit price to earnings ratios and many at discounts to book value. These valuations are typically about 1/3rd the average valuation in the indices, despite solid growth and profitability. This is just a factor of several years where the most expensive stocks got more expensive while the cheapest stocks got cheaper from a valuation perspective. If we see mean reversion, that could lead to several years of value dramatically outperforming and I would not be surprised if the overall indices are negative over the next 5 years, given what I believe to be a quite obvious bubble in many markets, including stocks and bonds. This is where those 5-9% dividend yields we have been talking about, combined with tools such as covered calls and cash secured puts, which can double those cash yields, really will play a key role in future returns. To sum up, it is early, but things are going well and I expect them to get better as options roll off and as we see earnings filter through. Higher rates are terrible for the overall market, but good for our largest investments, which benefit significantly from them. This is why our portfolios’ can sometimes seem to zig when the market zags. Remember, various factor strategies such as value and growth go in and out of favor. ARK was the star in 2020 but was one of the worst funds last year. The key is having a logical process and sticking with it so you aren’t chasing performance. When the inevitable bear and range bound markets come, value should really shine through in a big way. We plan on posting a lot of research and education this year, including webinars, videos, etc., so stay tuned.