Value Hunt

No way, you can fight it every day
But no matter what you say
You know it
The rhythm is gonna getcha
--Gloria Estefan

The recent price waterfall finds many value investors, and even a few long time bears, turning bullish. Buffett, Hussman, Grantham, others. The claim is that, for the first time in years, U.S. equities reflect compelling value.

To be sure, lower prices should make one more bullish. The time to be bearish was when prices were way higher. My own valuation work indeed suggests some pockets of value out there. For example, high quality big pharma names such as Merck (MRK) and Pfizer (PFE) are trading at enterprise value to free cash flow perpetuity levels below .9 (1.0 or lower indicates 'fair value') while sporting 6-8% yields. Historically, such levels have provided compelling entry points in this sector.

Basic materials also reveals some value. Oil refiner Valero (VLO), for instance, trades at a P/E of 3 and yields 4%.

Opportunities do seem to be surfacing, as one might expect with the Dow down nearly 40% this year.

That said, I would not go so far as to say that the entire market is a screaming buy. At true bear market bottoms, the S&P tends to trade at trailing P/Es of 5-7 and dividend yields of 7-8% or higher. Currently 12ish P/Es and 3%ish index yields suggest we have a ways to go--perhaps even 'overshooting' to the low side.

Moreover, my valuation work suggests that the median company is generating puny free cash flow and is lugging a bloated, debt laden balance sheet. Getting to a more positive median context likely requires an extended period of reduced growth and debt reduction.

Seemingly, then, stiff macro headwinds are likely to work against stock price increases. It doesn't mean prices can't go up. But from where I sit, this structural factor poses the primary risk to investment positions in the current market environment.

positions in MRK, PFE, VLO