Global Stock Markets Down 12% From Highs — But You Are Not!

 In Strategy Updates

To say that it’s been a rough start to the year would be an understatement. All global stocks are underwater this year and in general have made little progress since March of 2014! What is very interesting (and somewhat unsettling) about the current decline is not the distance of the fall in stock prices – just a bit more than a normal correction – but rather its speed and acceleration. Had this decline occurred over 4-6 weeks, it would likely be considered normal. What does this market action tell us about the state of the global economy and the future direction of stock prices?

Your Stocks Are Holding up Better Than the Market.
As we highlighted four months ago during the a similar decline, the stock market appears to be suggesting that a global recession is a possibility. Our opinion was based not on just a declining stock market, but more importantly on which stocks were falling “the most” during that decline. As we wrote then, and as is the case now, the market is punishing any and all stocks that are economically sensitive. This includes consumer discretionary, energy, industrial, technology and materials stocks – most of the market. We want to remind you that since August, we have significantly reduced your exposure to these sectors based on our concerns. We are, and have been, less invested in stocks. More importantly, we have changed the nature of your stock exposure since last summer. Rather than being broadly diversified across all sectors, you are overweight those sectors that are typically immune to economic difficulty – namely healthcare, consumer staples and utility companies. At the same time, we are very underweight or completely out of the most vulnerable sectors such as oil and materials stocks – copper, steel, etc. This more defensive posture is reducing the decline of your portfolio relative to that of the market. So our message today is “yes the market is falling – but, unlike an index fund investor, your portfolio is not falling at the same rate or depth!” So when you see the market down, keep in mind that your stocks are NOT the market!

How much more will stocks fall? …and when will the more Stop Loss Orders kick in?
As much as the recent decline in stocks has been newsworthy and unsettling, stock indexes are only 12% off the market highs reached last summer. This does not constitute a bear market and is just slightly more than a normal correction. Investors should be careful about getting caught up with the negativity associated with this recent weakness as – so far – it does not indicate that a bear market is inevitable. You may have noticed that throughout the last two quarters, and in recent weeks, we have sold stock either due to stop loss orders or through our own selling. Those stocks that remain in your portfolio have not fallen enough to initiate the stop loss – which for all intents and purposes is a good thing. Should the market fall further, you will likely lose more stock exposure, further mitigating your downside. If this occurs it would be associated with significant negative news in regard to the global economy and may be the beginning of a bear market. At this point it is too early to tell if this will come to fruition. Investors should be careful about jumping to conclusions based simply on the last week of trading.

On a positive note, we cannot recall a period when investors have been more pessimistic with nearly everyone having a similar negative view. Recent investor intelligence polls indicate one of the highest levels ever of individual and institutional investor pessimism. Historically, global stock markets typically advance significantly from these levels, proving as always that the “crowd” is usually wrong. These indicators along with a number of others suggest that the recent weakness will soon abate. Over a more intermediate time frame, stock prices have become less expensive relative to earnings with the current price/earnings ratio at 15 – a level not usually associated with the beginning of a bear market. Based on these data points, it is possible that we look back on 2016 as the year that started horribly but ended well.

As you think about your portfolio and listen to the news, keep in mind that your stocks are not the market, and are not acting like it. Also keep in mind that, so far, the latest decline is just a bit more than a normal correction and has yet to demonstrate that this is “the beginning of the end.” Should markets get worse we will continue to manage your risk through your portfolio’s asset allocation, sector management and our carefully placed stop loss orders.

We hope this update is helpful – as always if you have experienced a change in your financial circumstances or would like to discuss your portfolio, please let us know. Enjoy your long weekend!
Your Team at Main Street Research