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Valuations, Panic Hit Record Levels: 5 Safe Bets

Swarup Gupta

Stocks have continued to trend higher recently, despite last week’s brief pause, largely an effect of a fall in crude prices. But several measures of market valuation are peaking, leading to the feeling that a correction might be around the corner. And even though the market’s preferred fear gauge has remained depressed for an extended period, a private index has surged.   

In such a scenario, picking value stocks that have low beta may be a prudent option. Beta measures the tendency of a stock's returns to respond to market swings. Low correlation stocks provide protection during turbulent times as they are less prone to day-to-day fluctuations.

Market Valuations Peak

Valuations have surged to levels not witnessed since 1929, according to market guru John Hussman. In his latest missive fired off last Friday, Hussman claimed that we were now experiencing the most overvalued market ever. The habitually careful head of Hussman Funds claimed that median valuations had peaked and other capitalization weighted measures were close to the highs last experienced in 2000. 

Additionally, surges in bullish sentiment and consumer confidence have been accompanied by losses in interest sensitive stocks. Hussman emphasized that more stocks on the NYSE hit 52-week lows last week compared to those that high their highest level over the same period.

It isn’t as if Hussman, who has a reputation as a “permabear,” has gotten his predictions right every time. But they did come true during the slides of 2000 and 2008. Additionally, the U.S. stock market in now valued in excess of 150% of the annual GDP.

This indicator, a favored metric of Warren Buffett’s, is now at an appreciably high level and close to the level witnessed seventeen years ago. Meanwhile, the Q ratio, a widely accepted method to measure the fair value of the stock market is at 1.0, well above its historical average of 0.65.  Noted economist Robert Shiller has also added his voice to the overvaluation chorus.

Credit Suisse’s Fear Gauge Surges, VIX Likely to Spike

Last week, Credit Suisse Group AG’s CS fear gauge rose to 35.6, registering an increase of nearly 10 points from the earlier week. This is also the highest level witnessed since Trump’s surprise victory was announced on Nov 9 last year. The investment bank’s barometer utilizes three month options on the S&P 500 in order to determine investors’ eagerness to seek protection against possible downside.

In contrast, the market’s preferred fear gauge, the VIX, has languished at levels close to 11 despite gaining in excess of 3% last week. In fact, such a level has been maintained over more than a hundred trading days. But Swiss financial services major UBS AG feels this is the calm before the storm. A combination of a near certain Fed rate hike and a weak GDP reading in the first quarter is likely to lead to market losses of more than 10%.

UBS has highlighted the rapid increase in the VIX premium, the gap between the gauge and the S&P 500’s realized volatility. This is perceived to be due to a lack of correlation in the S&P 500’s stocks, a situation which is likely to correct itself sooner rather than later. Also, the VIX is believed to be mean reverting, which means that it is likely to increase soon, signaling an increase in market volatility.

Our Choices

Stocks are likely to receive a boost as soon as the Fed announces its latest rate hike. But ignoring the threat of heightened volatility lurking on the horizon would not be prudent at this point. Instead, investors would do well to reallocate part of their recent profits into stocks which would provide protection in case of a sudden downswing in markets’ fortunes.

In such a situation, picking value stocks with a low beta would be a good option. Our selection is also backed by a good Zacks Value Score and Zacks Rank.

We narrowed down our choices with the help of our new style score system.

Our research shows that stocks with a Value Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 (Strong Buy) or Zacks Rank #2 (Buy) offer the best investment opportunities in the value investing space.

FLY Leasing Limited FLY is engaged in acquiring and leasing modern, high-demand and fuel-efficient commercial jet aircraft under long-term contracts to a diverse group of airlines throughout the world.

FLY Leasing holds a Zacks Rank #1 (Strong Buy) and has a Value Style Score of ‘A’. The stock has a beta value of 0.88. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 7.22, lower than the industry average of 13.06. It has a PEG ratio of 0.72, lower than the industry average of 1.37.

The stock has returned 17.2% over the last six months, underperforming the Zacks Transportation - Equipment and Leasing Market sector, which has gained 22% over the same period. This provides a good opportunity to buy the stock given that there is significant upside potential

Imperial Oil Limited IMO is engaged in the production and sale of crude oil and natural gas in Canada.

Imperial Oil holds a Value Style Score of ‘B’. The stock has a beta value of 0.98 and a P/E (F1) of 15.33x, compared to the industry average of 18.39. It has a PEG ratio of 0.61, lower than the industry average of 1.00. The stock has returned 2.2% over the last six months, underperforming the Zacks Oil and Gas - Integrated - Canadian Market sector, which has gained 7.8% over the same period.

This provides a good opportunity to buy the stock given that there is significant upside potential. The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

NN, Inc. NNBR is an independent manufacturer and supplier of high quality, precision steel balls and rollers to both domestic and international anti-friction bearing manufacturers.

NN, Inc.  holds a Zacks Rank #2 (Buy) has a Value Style Score of ‘A’. The stock has a beta value of 0.80 and a P/E (F1) of 13.54x, lower than the industry average of 15.30. It has a PEG ratio of 0.68, lower than the industry average of 1.20. The stock has returned 24.5% over the last six months, outperforming the Zacks Metal Products - Procurement and Fabrication Market sector, which has gained 19% over the same period.

Embraer SA ERJ designs, manufactures and sells aircraft and aviation-related structural parts to the world’s commercial aviation, executive aviation and defense markets.

Embraer holds a Zacks Rank #2 and has a Value Style Score of ‘A.’ The stock has a beta value of 0.51 and a P/E (F1) of 12.61x, lower than the industry average of 17.25. It has a PEG ratio of 0.90, lower than the industry average of 1.92. The stock has returned 25.7% over the last six months, outperforming the Zacks Aerospace - Defense Market sector, which has gained 20.9% over the same period.

Malibu Boats, Inc. MBUU operates as a designer, manufacturer and marketer of sport boats primarily in the U.S.

Malibu Boats holds a Zacks Rank #2 and has a Value Style Score of ‘A.’ The stock has a beta value of 0.98 and a P/E (F1) of 14.48x, lower than the industry average of 17.70. It has a PEG ratio of 0.97, lower than the industry average of 1.44. The stock has returned 45.3% over the last six months, outperforming the Zacks Leisure and Recreation Products  Market sector, which has gained 13.3% over the same period.

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Fly Leasing Limited (FLY): Free Stock Analysis Report
 
Embraer-Empresa Brasileira de Aeronautica (ERJ): Free Stock Analysis Report
 
Credit Suisse Group (CS): Free Stock Analysis Report
 
NN, Inc. (NNBR): Free Stock Analysis Report
 
Imperial Oil Limited (IMO): Free Stock Analysis Report
 
Malibu Boats, Inc. (MBUU): Free Stock Analysis Report
 
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