The recent recovery in global stock prices has been astonishing and is of historic proportion. Investors would be very hard pressed to recall a period when stock prices have ever made such a big percentage round trip – both down and back up – in such a short period of time. The reasons for the global sell off have been well chronicled: Federal Reserve rate hikes, slowing economic growth and corporate profits, US government shut down, and tariff wars to name a few. Though these were – and are – legitimate concerns, why have stock prices shrugged these risks off? Is this the beginning of another significant, multi-year leg higher for global equity prices? Maybe.
One thing we know for sure is that stock markets serve as a discount mechanism to future events. Stocks have an uncanny way of rising just ahead of better news, or falling prior to the darkest part of dawn. That is why it is often best to buy stocks when the economy is at its worst – or when the list of worries is as long as it was during the first quarter. The other thing we know about stock prices is that shorter term movements – months, not years - are often driven by investor psychology – not necessarily fundamentals. Fear and greed can move stock prices quite significantly in both directions, as we have seen in the past six months. Is the recent volatility, both up and down, a sign that the market is discounting better news about the economy going forward? Or is it just a massive bout of investor fear and greed? We would suggest a bit of both, which means we should be careful but more opportunistic during any upcoming market corrections, so we can put the odds in your favor for a good year of investment performance.
It is pretty easy in hindsight to look back over the past three months of this recovery and think that only a fool would have been cautious during such a period. If we were managing just a sliver of your assets we would say the same. However, since we are managing a significant portion of, if not all of your liquid assets, we tend to take a more “safe than sorry approach” when the key pillars of stock market strength – economic growth and corporate profits – look as vulnerable as they have in the past six months. Often times “cracks” in these important pillars bring on treacherous bear markets and catastrophic declines (40-50%) in stock prices – i.e. 2001, 2008. These types of bear markets occur about every 9-10 years and can ruin a healthy financial/wealth plan or an endowment’s spending policy. Investors would be wise to keep that statistic in mind, should one think that risk management is a fool’s game.
As you know, you have had less stock exposure than normal during this period to mitigate the potential of a further slide in stock prices. This more cautious stance (less stock) has temporarily muted your upside. However, as we mentioned before, the difference between your return and the market would be easily rectified if we had a normal market correction of 7-9% which is – in our opinion and that of other bright investment experts – way overdue.
The laundry list of worries that we faced at year’s end have dissipated. The Federal Reserve has made a key pivot to be more accommodating while the economy looks to have slowed, but may be stabilizing at the current lower growth rate of 1.5-2% annually. This in turn may allow corporate profits to meet already lowered expectations. We can make great profits in a slower growing economy by tilting your portfolio to companies that can deliver consistent growth.
Given the fact that things look a bit brighter, we will continue to add stock where we see great value. If we do experience the way overdue, much anticipated, normal market correction we will most likely speed up such purchases to get your portfolio more in line with market returns. Though one might be tempted to add back any missing stock exposure now, or within days, we would suggest a more patient approach to yield the best returns over the longer term. If the economy is truly on a slower, but solid growth path, there will be better opportunities over the coming weeks and months to be fully invested. We are a competitive – yet careful – team and look forward to delivering performance for you regardless of market fluctuations or economic changes.
Though the skies appear to be a bit brighter and the clouds are dissipating, we are in the thick of corporate profit reporting for the first quarter. This may bring some disappointments and a return to volatility on the downside. Should profits and economic data experience further decline, we will continue to manage this risk by adjusting your portfolio’s allocation to stocks, your sector exposure and the use of carefully placed stop loss orders.
We hope this update finds you well. If you have experienced any significant changes in your financial affairs or would like to discuss your portfolio please let us know. Thanks for your confidence in our performance oriented, yet careful approach.
Your Team at Main Street Research
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