The Insolvent Investor

Investing and economics – it isn’t easy.

Posts Tagged ‘stocks’

The only underpriced asset is risk (or, where to invest in difficult times)

Posted by Warren on September 16, 2008

Last spring, a friend of mine at a hedge fund was complaining that he couldn’t find any undervalued assets. Everything was over-priced – stocks, bonds, real estate, commodities, high-yield bonds, the dollar, the Yuan, gold, emerging markets equity, emerging markets debt, timber. Every imaginable asset class was fully priced.  That is, except for one – risk.

The investing world learned this the hard way in 2007, and I believe they will continue to learn this through the remainder of 2008. If I had to make a prediction where the next bubble may lie, it would be in the market for risk. The cost of debt and equity will continue to rise, and investors will demand premiums for risk no less ridiculous than the premiums paid for dot com stocks in 1999.

My advice, get in on the bull market for risk! Go forth and buy straddles, have your bankers structure synthetics, do whatever you need to. But do not forget, risk is still the underpriced asset.


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Small cap biotech stocks are risky but undervalued

Posted by Warren on August 5, 2008

Biotech companies are not immune to the business cycle. Although many make life saving drugs that are consumed regardless of economic conditions, many others make products that are discretionary (eg, Botox). Also, many smaller biotech companies rely on larger pharmaceutical companies to license their drugs and even purchase their entire companies. Big Pharma’s ability to do this often can be compromised if their stock prices are depressed (as happens to almost all equities in economic slowdowns).

Despite this, many small biotech companies could be seen as underpriced because many investment analysts do not understand them and are risk adverse.

One such example of a company is Infinity Pharmaceuticals. I own shares in this company because I think it is underpriced relative to the expected value of its drug pipeline. Moreover, it is an early stage biotech company so very few analysts cover the stock and very future institutional investors are holders. I anticipate within the next 2 years a large pharmaceutical company will offer to buy them at several times their current value. However, there is also a greater than 50% chance one or more of their drugs will fail and the stock will become worth a faction of its current market capitalization. I recently a post on the company on SiteJabber.

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Markets will remain irrational longer than you can remain solvent

Posted by Warren on August 4, 2008

He didnt listen to Kaynes

He didn't listen to Kaynes

Or so said economist John Maynard Keynes. The US equity markets of today, one could argue, are overpriced. While PE ratios are not high by historical standards, US corporate earnings are poised to fall. The American consumer who has driven the global economic expansion of the last 15 years is out of gas. Housing prices will continue to fall and remain low for years to come. The asset to debt ratio of Americans is at its worst since the before the depression.

Where amongst all this gloom is the silver lining for investors? I don’t think there is one.

With so much liquidity sloshing around, undervalued assets are not to be found. The emerging markets of India, China, Latin America, and Eastern Europe are all over-bought (and likely more precarious than is conventionally believed). Commodities are overpriced. Gold is expensive. So unless you’re willing to try to catch a falling knife and bet against one of these asset classes, a smart investor should probably be almost completely in a mixed basket of currencies. This may not produce the 20% annual returns of the late 90s, but it will keep your portfolio well above the market return for the years to come. Live to fight another day.

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