As we close out the third quarter, global stock indexes are down approximately 9% for the year with most of the decline occurring in just the past six weeks. The decline in stock prices is linked to the threat of a global economic slowdown and/or recession. As we have discussed previously, the combination of slowing growth in China and elsewhere, combined with a US Federal Reserve policy focused on raising rates is a potential “one-two” punch that could knock the global economy into recession and bring about a bear market in stock prices. Were that to occur, it would take stocks down much further than current levels. As you know, our team has responded to these recent events and has reduced your stock exposure in those areas that would be most vulnerable should the worst case come to fruition. However, at this point, there is no certainty that “the worst case” scenario will play out. Therefore, we think investors need to watch a number of data points carefully and be ready to change direction if needed. What are those data points?

At this point there are just a few key data points to determine if the market can find more solid footing, most of which we will learn in the next few weeks. The Federal Reserve needs to send a clearer message that remains consistent. The recent decision to delay the hike in rates was expressed in a confusing manner and disrupted what little confidence investors had to begin with. A consistent policy based on sound logic will go far to reignite investor confidence. Quarterly corporate earnings reports are just beginning to come in and better than expected earnings in some of the more economically sensitive sectors would be great support for stock prices and investor confidence. Of course economic data such as employment and GDP here and abroad will be telling and may be supportive for stock prices. Lastly, stock market action and valuation are key to getting this wobbly stock market in a better position. We are now within striking distance of the low point reached in late August. If the market were to fall much further below that level, it might very well precipitate a deeper market decline. Your portfolio’s more defensive posture — and additional sales — should assist if this were to unfold. In terms of stock market valuation, the stock market”s current price/earnings ratio (P/E) is 16, which is neither overvalued nor a screaming buy. However, were this number to dip lower — say closer to 14 — we would find global stocks very appealing.

So far, as you know, we have been quite active in reducing your exposure to vulnerable sectors and adding some defensive companies to mitigate risk. Some of the selling was done prior and during the initial decline. During last week’s market decline this risk mitigation helped your portfolio, and should the market fall further, will continue to do so. The key in a bear market is to try to minimize the portfolio’s decline so that it can be more easily recovered when the market and the economy reinvigorate.

While we have been watching all of these data points closely (and continue to do so) we have been very busy making a list of great companies that we can add to your portfolio should the market find better footing and the bull market resume — something our whole team looks forward to!

We hope you find this update helpful. If you have experienced any change in your financial situation or have questions about your portfolio, please let us know.

Sincerely,

Your Team at Main Street Research