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The past two weeks have shown how volatile the equity markets can be. The S&P 500 index stands at 2,656 at the Wednesday, October 24th closing. It looks to be down 9.17% from its recent peak of September 21st.
It certainly may go lower, but we think the next up-leg should resume before long. Foreign Stocks have experienced a considerable correction this year as the tariff battles have escalated instead of improving. U.S. stocks have also been in a fairly rolling correction all year. Nearly every sector has taken its turn in this pull back, with the only exception being the select group of growth stocks (Amazon, Google, Netflix, Microsoft, Nvidia, etc.) and a handful of other stocks. The Dow’sperformance has been boosted by a few stocks (Boeing, Visa, Apple, etc.). These few stocks had been holding up the U.S. market index all year due to their large weighting in their respective indices. This has helped mask the rolling correction and has left more conservative stock portfolios out of the growth thathad showed up in the indices returns. Up until now, the majority of the S&P 500 return has come from just ten stocks.
The current stock market pullback, although difficult to predict, is not unusual. Intra-year declines of 10% or more are typical and even common for investors seeking equity returns that beat inflation over time. Looking back since 2009, we have seen 7 of the past 10 years (including 2018) with intra-year return pull backs of at least 10%. Of those 7 periods, only one year had a negative return (-1% in 2015) within the S&P 500 index.
Given what has been reported from corporate earnings so far, it doesn’t seem like this pullback is caused by a looming recession. Earnings are beating expectations and revenue is doing the same for a high percentage of announcements. My sense is the selling is coming from institutional investors and because of this, the reasons can only be assumed. Due to the large percentage of stocks participating in the selloff, I think this down draft is a symptom of the debt excesses around the globe coupled with the increases in the Fed Funds rate. Someone or something is selling investments arbitrarily and I can only assume it is due to a need for liquidity. Given where short term interest rates and bond interest rates are in comparison to inflation, I don’t think cash and bonds are very good alternatives for long term investors. My guess is the liquidity is needed to pay down debt or is being used as a need for capital. If this is true, these types of sell offs tend to show up as fantastic buying opportunities to pick up well run companies on the cheap.
The last global credit crisis this severe was during the Great Depression (1929-1942). That crisis showed up first within corporations, then U.S. banks, then to the most developed governments and lastly to the least developed governments. History has shown that credit trouble has shown up in the most transparent systems first and the least transparent last. It took four decades before the debt could be shaken out of the world during the Depression and I suspect it will take a very long time for this to happen during this post U.S. credit crisis. Taking a look at the Great Depression, stocks of developed markets (the U.S.) did very well after the initial shake out. If we follow the same route, we could see the indices hit levels only imagined a few years ago.
With lower interest rates compared to inflation than we typically see, it allows capital accumulators to grow and expand with lower than normal capital costs. This can be a fantastic investment opportunity for capital accumulators if the debt excess causes changes in the world that are positive. Shareholders are capital accumulators and could be rewarded during this phase. Change is difficult for me and my guess is this is true with other too. Because of this, the changes necessary come with a lot of noise with the emphasis on a lot. This is why it is so important to have a discipline to follow that uses the information we have available to make decision that meet our future intentional goals. Fundamentals have shown to be the cornerstone to investing for the long term investor and I believe this will hold true into the future.
I hope this helps in explaining the current situation as I see it. Please let me know if you would like todiscuss.Rich