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Commentary

8 Investment Ideas

Smaller companies, value stocks, and emerging-markets are among the best ideas from a trio of panelists at the Morningstar ETF Conference.

Morningstar's Jeff Ptak closed out the Morningstar ETF Conference on Thursday with a panel called "Best Ideas." Panelists Rich Bernstein from Richard Bernstein Advisors, John West from Research Affiliates, and Mark Yusko from Morgan Creek Capital Management shared some of their best ideas today.

Small Caps
Ptak noted the torrents of dollars that have been flowing into large-cap index funds and ETFs. Does that make large-cap indexing a good or bad idea right now?

"It's a horrible idea," argued Yusko. Investors don't typically time their investments well, so these inflows aren't a positive signal for U.S. large caps.

Bernstein is keen on smaller companies. 

"If you believe that we're going to inflate away the debt, you'd want to buy companies that’ll have the greatest sensitivity to that," he said. That includes small companies, which should benefit as the profit cycle recovers.

Cyclical Stocks
Today's investor loves stable, high-quality dividend stocks and bonds, said Bernstein. What's contrary? Cyclical stocks.

"It looks as though profit cycles are troughing, and the worst of the profits recession is behind us," he argued. He expects profits to begin to recover both in the U.S. and in many global markets. We'll then move into an earnings-driven stock market, he said, at which point he expects cyclical industries to lead the way.

Energy and Commodities
"This is a time for cyclicals--specifically, pure energy stocks," added Yusko. Instead of investing in richly-priced diversified energy conglomerates like Exxon, he prefers true exploration and production companies.

"It's a tremendous time to be an investor in commodities and cyclicals," he added. "People don't appreciate cyclical nature of those industries."

Value Investing
"If you want to earn meaningful returns in next 10 years, you need to look at what has underperformed," said West. And value stocks have done just that.

"Value is really cheap today," said West. Because this investment style has done so poorly for the last decade, that should translate to a higher expected return over time. He admitted that value stocks may not outperform in next 12 or 18 months, but they should outperform the market longer term.

Developing Markets
Yusko sees too many negative trends in developed worlds: excessive debt and deflation. Then, there’s a new trend: nationalism, such as Brexit. 

"That’s a bad trend for profits," he said. "If Italy goes the wrong way, that could be a bad trigger for Europe."  And if the Japanese government can't get the yen to weaken, profits there will struggle.

The place to find profits today, said Yusko, is emerging-markets. Specifically, Brazil is recovering. Certain sectors in China--including consumer staples, retail, healthcare, energy. and technology/ecommerce--re booming. India is going to be growth mode for the next three decades.

West is also drawn to emerging-markets. Emerging-markets stocks are trading at a Shiller P/E of about 12 today, versus a P/E of 10 at year-end 2015. U.S. stocks, meanwhile, are trading at a P/E of about 27, he said. Plus, many emerging-markets currencies are also undervalued. That makes for a pretty rosy total-return forecast for emerging markets over the long term.

"But we don't know how that journey is going to take place," admitted West. The hardest part is having the patience to hold on and achieve those returns.

Inflation Protection
West said for most of the last three decades, we've experienced an equity bull market and declining inflation. That may not last.

"Regardless of your forecast, you should have inflation protection," he said.

Gold
Bernstein stated flatly that he is not a gold bug. But he likes the yellow metal today for a couple of reasons. For starters, investors buy real assets when inflation expectations are starting to go up, as they are now. On top of that, Bernstein is using gold to balance out risks and limit portfolio volatility.  

"For a long time, gold wasn't a diversifier; it had high correlation to equity market," he said. But it doesn't correlate as tightly these days with equities. For Bernstein, gold is an inflation hedge bet and diversification tool.

Cash
"Cash is underappreciated today--it's a great tool," said Yusko. While he likes emerging-markets and gold--and some of the beaten-down large-cap healthcare names--he's keeping some dry powder on hand.

“When there’s nothing to do, do nothing.”