October 20, 2014
Please pardon the interruption to our regularly scheduled programming, but the recent market activity has issued me a call to arms. The S&P 500 and the Dow Jones Industrial Average, as of this writing, are officially in negative territory year-to-date, both down roughly 8% since their September peak. Many blue chip companies are now firmly in correction territory, dropping more than 10%. The headlines are frightening, the experts foreboding, the anxieties rising. This is what it looks and feels like when fear begins to cloud our thinking. This is when investing gets hard, our focus becomes myopic, and our rationality retreats. Let me try to make a few points to combat that phenomenon.
The first thing to point out is that this selloff is not the result of any "new" news. The press ostensibly blames European growth scares. However, Europe has been growing more slowly than the U.S. for decades. Their tax and regulatory schemes, the dominance of their government budgets in their economies, their challenging demographics, has long stifled their private sector. Add to that the geopolitical challenges of a rogue authoritarian regime in Russia and you still have nothing coming close to the crises Europe has survived over the past five years, namely the recession of 2008/2009 and then the sovereign debt crisis of 2011. Europe has been in and out of recession more times in the past five years that the U.S. has in the past twenty. European growth concerns are nothing new.
The next thing to point out is that turning on the financial media and hearing about how Ebola is driving market sentiment down borders on lunacy. The likelihood of an outbreak that creates meaningful economic damage is so small, so remote. Far more likely, I'll look back at this newsletter a year from now and say something to myself like, "oh yeah, I remember when Ebola was a talking point on CNBC." To clarify, Ebola is an admittedly scary headline which is being used to keep us glued to the TV. Its effects are on sentiment alone. And it is highly unlikely to be more than that.
Also interesting to hear is how the decline in oil prices is suddenly an economic risk. Energy is a variable cost to most of the global economy. As costs go down, resources are freed up for other purposes. To make a long story short, this ultimately translates into stronger consumers on which something like 70% of U.S. GDP relies. Add to that a slowly improving employment situation, a relatively low-debt consumer, a cash-rich corporate sector, and you have a basis for sustained economic improvement.
Finally, the financial media uses terms rarely heard outside of financial conversations such as "capitulation" or "death-cross". These are a technician's way of timing the markets, which we all know is ultimately not a strategy for investing success; it's small ball. The big picture remains, which is that stocks represent attractive opportunities relative to their alternatives because: Interest rates remain at historic lows; Stock valuations are moderate; Federal Reserve policies remain accommodative. Every major bear market in living memory has occurred when not one of these conditions were true. We are therefore, in my opinion, highly unlikely to see a 2008/2009 scenario.
Taking a look at stock market history will quickly reveal that dips happen all the time in good markets. Sentiment is the bedeviling factor here. Swings in investor sentiment can be a self-fulfilling and reinforcing factor that causes prices to overshoot both to the upside and to the downside, and the only way to have anycertainty as to which is with hindsight. So instead we must rely on insight. The evidence suggests that selling into weakness in order to buy back in later costs investors far more than it makes them. It is therefore a truism that in environments like this "the only thing we have to fear is fear itself." The best thing to do is to keep a cool head and resolve not to make decisions based on fear. Better still, emulate Sun Tzu and use a cool head to look for ways to turn this market weakness into an advantage. Be confident in the belief that it will pass, even though we are unable to know just when. In other words, don't panic.
Brennan R. Redmond, CFA - Vice President
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.)