What to Buy in the Momentum Stock Slaughterhouse | TCAF 228
Audio Brief
Show transcript
In this conversation, the discussion centers on the fundamental macro regime shift from a decade of zero interest rates to a new era where capital carries a real cost, forcing a return to valuation-based investing.
There are three key takeaways from this analysis. First, the historic concentration of the S&P 500 requires a pivot from passive indexing to active management. Second, investors should replace the hunt for high yield with a focus on shareholder yield. Third, traditional safety sectors have become dangerously expensive relative to their growth potential.
The primary driver of today’s market dynamics is the end of free money. For over a decade, low inflation and near-zero rates meant that growth was the only metric that mattered. Now that money has a cost, the market is pivoting back to quality at a reasonable price. This creates a dilemma regarding the "Magnificent Seven" tech giants. While these companies dominate the index, their high valuations suggest the real opportunity lies in the "other 493" stocks. Specifically, sectors like Industrials and Energy offer attractive entry points compared to the crowded tech trade.
When seeking income in this environment, the podcast argues against chasing the highest dividend yields, which often signal financial distress or "yield traps." The superior metric is "shareholder yield." This approach targets companies offering moderate dividends of two to three percent, but pairs that payout with consistent dividend growth and share buybacks. This combination signals corporate discipline and creates a margin of safety that pure high-yield plays lack. "Dividends are facts, while earnings are opinions," making cash flow the ultimate truth detector in a volatile market.
A critical anomaly in the current market is the relative valuation of defensive stocks. Investors traditionally flock to Consumer Staples during uncertain times, but this safety trade has become overcrowded. "Boring" low-growth companies, such as toothpaste manufacturers, are currently trading at price-to-earnings multiples of twenty-four, effectively matching the valuations of high-growth tech giants like Google or Microsoft. Paying a premium multiple for zero unit growth represents a significant risk. Conversely, the ratio of Consumer Discretionary stocks outperforming Staples suggests that despite recession headlines, the market’s internal signals are betting on economic expansion.
The conversation also highlights a decoupling phenomenon described as an "anti-bubble." Historically, when a leading sector like software crashes, it drags the entire market down. Currently, however, capital is rotating out of expensive software and into tangible economy sectors like Materials and Financials, rather than leaving the market entirely. This rotation supports the broad index even as former leaders struggle, reinforcing the need to own assets in the real economy that are less susceptible to AI disruption.
Finally, a specific warning is issued regarding custodial risks in crypto assets, using the FTX collapse as a case study. Investors must understand that legal restitution in bankruptcy is usually pegged to the dollar value of the asset at the time of filing, not the asset itself. This means even a one hundred percent refund results in a massive opportunity cost if the underlying asset appreciates during the proceedings.
Ultimately, successful investing in this new regime requires ignoring broad index movements in favor of active selection, prioritizing tangible cash flows and relative valuation over past momentum.
Episode Overview
- A Macro Regime Shift: The episode articulates a fundamental change from a decade of "free money" (zero interest rates) to a new era where capital has a cost. This shift favors valuation, dividends, and real cash flows over speculative growth, marking a resurgence for active value investing.
- The "Magnificent Seven" Dilemma: The discussion explores the historic concentration of the S&P 500 in seven tech giants. The hosts debate whether to chase these expensive winners or find the overlooked opportunities in the "other 493" stocks, specifically in sectors like Industrials and Energy.
- Rethinking "Value" vs. "Growth": The podcast challenges rigid definitions of investing styles, arguing that "value" isn't just about low P/E ratios (like banks) but can include high-quality tech companies (like Apple or Google) when their relative pricing becomes attractive.
- Market Signals and Recession Risks: Through the lens of sector ratios (Consumer Discretionary vs. Staples), the hosts analyze current market sentiment, suggesting that despite fears of a recession, the market's internal behavior is signaling economic expansion and a "risk-on" appetite.
Key Concepts
- The Resurgence of Cost-Conscious Investing: For over a decade, low inflation and zero interest rates meant valuations didn't matter—only growth did. Now that money has a real cost, investors must prioritize "quality at a reasonable price." This environment favors companies with strong balance sheets and sustainable cash flows over those promising distant future profits.
- The "Shareholder Yield" Framework: Rather than chasing the highest dividend yields—which often signal financial distress (a "yield trap")—investors should look for "shareholder yield." This metric combines moderate dividend yields (2-3%) with consistent dividend growth and share buybacks. This combination signals corporate discipline and creates a "margin of safety" for returns.
- Relative Valuation and Sector Decoupling: A critical error investors make is looking at stock prices in isolation. The concept of "relative valuation" is crucial:
- Discount to Market: Finding stocks trading at 12-14x earnings when the S&P 500 is at ~20x creates a safety buffer.
- Sector Comparison: If low-growth "safe" stocks (like toothpaste makers) trade at 24x earnings while high-growth tech giants trade at the same multiple, the "safe" stocks are likely overvalued and the tech stocks relatively cheap.
- The "Anti-Bubble" Phenomenon: Historically, when a leading sector (like Software) crashes, it drags the whole market down. Currently, the market is experiencing an "anti-bubble" or decoupling: capital is rotating out of expensive software and into tangible economy sectors (Materials, Financials) rather than leaving the market entirely. This rotation keeps the broad index high even as former leaders struggle.
- Customized Peer Groups: Traditional sector labels (like "Industrials" or "Consumer Discretionary") can be misleading. A more sophisticated approach involves grouping companies by economic drivers. For example, a paint company might trade more like a retailer (Home Depot) than a chemical manufacturer. Understanding these true peers helps reveal when a stock is actually mispriced.
- The "Dollar-Value" Bankruptcy Trap: Using the FTX collapse as a case study, this concept highlights a legal risk in custodial assets. "Making customers whole" usually means returning the dollar value of the asset at the time of bankruptcy filing, not the asset itself. If the asset (like Bitcoin) appreciates significantly during the proceedings, the investor effectively loses that upside, suffering a massive opportunity cost despite getting a "100% refund."
Quotes
- At 0:13:00 - "When cost of capital is zero, valuation doesn't matter. But when cost of capital is something other than zero... valuation matters." - Explains the fundamental macro shift that makes fundamentals critical again.
- At 0:13:48 - "The S&P 500 is trading at 20 times earnings. The equal-weighted S&P is trading at 16 times earnings... You're starting to get paid to take risk outside of the Magnificent Seven." - Highlights the valuation disparity hiding within the index.
- At 0:15:37 - "You don't want the highest yielders. You generally want the second quintile of dividend yielders... and you generally want to pair that with dividend growth." - A practical rule for avoiding yield traps while seeking total return.
- At 0:19:15 - "Dividends are facts, earnings are opinions." - A reminder that accounting can be manipulated, but cash payouts are definitive proof of financial health.
- At 0:24:26 - "Markets are broadened out by earnings growth... If earnings growth broadens out, participation broadens out." - Explains that market rallies widen only when profitability extends beyond the top few companies.
- At 0:25:22 - "Why does the greatest value manager of all time [Buffett] have half his portfolio in Apple? ... It's about opportunity set." - Challenges the rigid boxes of "value" vs. "growth" investing.
- At 0:26:39 - "Peer groups are what allow you to see when something is attractive or not, less so than an arbitrary rubric of 'is it cheap to itself' or 'is it cheap to the market.'" - Emphasizing that context and correct comparisons matter more than raw data.
- At 0:28:51 - "I think we have an anti-bubble going on... Nobody wants to own the AI winners... and then the stocks, the companies that are being displaced by the bubble... they're also getting destroyed." - Describes the unique pain currently felt by both momentum winners and those being disrupted.
- At 0:35:31 - "Until the current software debacle, there has never been an instance where: An S&P 500 Industry that was so large... has sold off so hard... And, the market remained at highs." - Highlights the historical anomaly of the current market resilience.
- At 0:53:05 - "If you had a Bitcoin on the [FTX] platform... you are getting back 16,000 dollars. Bitcoin is 48,000 dollars... But in reality, you lost your Bitcoin." - Clarifying the difference between legal restitution and actual economic recovery.
- At 0:57:50 - "If you're in the camp looking for a recession... you do not want to see discretionary stocks outperforming staples to this degree." - Explaining how sector rotation acts as a barometer for economic sentiment.
- At 0:59:45 - "Staples are extremely expensive... Why would I pay a 24 multiple for toothpaste and toilet paper—which has no unit growth—versus paying 24 times for Microsoft or Google?" - Pointing out the "bond proxy" bubble where safety has become too expensive.
- At 1:13:50 - "If you bought [Ethereum] in 2021... you have made zero money... despite the fact that you feel like we're in a crypto bull market." - Contrasting general market sentiment with the specific, lagging performance of secondary assets.
Takeaways
- Pivot to Active Management: In a concentrated market where the top stocks are expensive, move away from passive indexing and toward active strategies that can underweight the giants and find value in the "other 493" stocks.
- Target "Dividend Growers," Not High Yielders: Avoid the temptation of the highest dividend yields on the screen. Instead, filter for companies with moderate yields (2-3%) that have a history of consistently raising their payouts.
- Look for the "Second Derivative" of Trends: Instead of buying the direct "picks and shovels" of a boom (like Nvidia for AI), look for the boring industries (insurance, healthcare) that will use the new technology to become more efficient and profitable.
- Re-evaluate "Safety" Stocks: Be cautious with Consumer Staples (defensive stocks). If they are trading at P/E multiples similar to high-growth tech companies, they offer poor risk/reward profiles. "Boring" does not always mean "safe" if the price is too high.
- Monitor the Discretionary/Staples Ratio: Use the performance of Consumer Discretionary (XLY) vs. Consumer Staples (XLP) as a recession indicator. If Discretionary is outperforming, the market is betting on economic growth, regardless of news headlines.
- Beware of Custodial Risk in Crypto: Understand that in a bankruptcy, your claim is likely pegged to the dollar value at the absolute bottom of the market. Self-custody or understanding legal terms is critical to avoid opportunity cost losses.
- Rotate into Tangible Assets: Consider increasing exposure to "real economy" sectors like Materials, Energy, and Industrials. Capital is rotating there as investors seek assets that cannot be easily disrupted by AI or software shifts.
- Diversify Internationally (specifically Japan): Look at Japan as a value play. Corporate governance reforms there are forcing companies to return hoarded cash to shareholders, creating a compelling entry point compared to the U.S. market.
