Kellie, Darrell and I have watched the recent market volatility and wanted to share our thoughts with you. The S&P 500 Index entered correction territory on Monday, August 24 for the first time in nearly 1000 days, when it dropped more than 10% from market highs in May this year. Stocks slumped as investors seem to re-evaluate prices amid signs of a slowdown in China, questions about the path of the Fed policy, and a slump in oil prices. The beginning of a correction may be a harsh reminder for investors that markets don’t always go up. But it’s important to keep things in perspective.
The stock slump is likely a midcycle correction-not a massive selloff
The selloffs in the market over the period ending Tuesday, August 25 have been sharp-the 1000 point intraday decline in the Dow Jones Industrial Average during trading on August 24 is the largest point drop ever. But for stocks to experience an occasional correction is not unusual-a drop of 10% happens about once a year, on average. Well, no one knows what could come, and volatility is part of investing in stocks, there are some reasons to believe that this could be a bull market correction-pullback in stock prices that comes during a general trend higher-not the beginning of a massive selloff.
The question comes back to economic fundamentals, corporate fundamentals and, ultimately, earnings. When the market saw big bear markets in 2008 in 2002, there were double digit profit declines. More moderate corrections (10%), tend to be caused by a flattening of earnings growth, but not an outright profit or economic recession. The US economy remains in solid shape and suggests more of a mid-cycle slowdown, not an economic recession-and therefore not a prolonged bear market. The volatility may not go away tomorrow, but there is no fundamental reason for a massive selloff in US stocks.
The problems in China are real, but shouldn’t derail the US economy
The Peoples Bank of China recently surprised investors with its decision to depreciate the Chinese reminbi (RMB) by approximately 5% against the US dollar. The reasons for such a move include boosting a possibly weakening Chinese economy and, more importantly, allowing a more flexible currency regime so that the RMB will be included in IMF’s SDR (Special Drawing Writes), a necessary step to make RMB become a global reserve currency.
There is no doubt that the Chinese economy has slowed in recent times. However, many of the market concerns, including an imminent economic collapse, financial collapse and competitive devaluation, are in the view of our money managers overblown. China’s long-term economic fundamentals remain intact. The transformation from an investment driven export led into a more balanced economy driven by domestic consumption is underway. In the view of our managers, the current volatility is part of the growing pain. In the near term, they expect the Chinese authorities will attempt to maintain the stability of the currency, as well as inject liquidity into the Chinese banking system to continue to support the economy.
When markets are as turbulent as they have been in late August, it can be a difficult time for investors. In our opinion, the catalyst for the recent equity market selloff came primarily from concerns about China.
We have repeatedly said that the money managers we employ on your behalf have a job to invest your money in great businesses that are trading at significant discounts to what they believe they are worth. During times of volatility, a number of companies that you own would have sold off significantly for no other reason than they were being painted with the same brush as the rest of the market and many investors have reacted emotionally to the current environment.
When the markets act irrationally and toss out good companies with the bad, it provides our people with opportunities. We believe that they are seeing this in certain areas of the market. This doesn’t mean that stocks can’t go lower in the short term, since for shorter time periods, the mood of investors can determine stock prices. In the long run we have seen the fundamentals win.
A broad selloff may mark a return to more volatile times after years of usually calm markets. But that doesn’t mean the whole investment landscape has changed.
This doesn’t mean that staying calm in fully invested is easy for you, however, it is the most assured way of meeting your long-term financial objectives.
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