The recent and volatile decline in global stock markets was set off by fears that weakness in oil prices and in the Eurozone might lead to a global recession. While most market sectors experienced a normal 8-10% correction, European stocks and oil stocks fell much further. This caused our team to sell stock in both of these areas and of companies linked in some way to these areas (prior to the worst of the decline). As you may have noticed, during that decline we also purchased stock in areas that were unaffected by these troubles such as companies in the healthcare and technology sectors. Since the rapid decline and ensuing recovery of global equity markets, your new positions have benefited — while the energy and Eurozone markets continue to suffer. The important question for investors is whether the lack of participation of energy and European stocks in this recent recovery signifies the beginning of something worse for overall markets…or is it just isolated to those markets?

There is little question that the recent volatility, both up and down, was a reminder to investors that global stock markets are inherently risky. However, as the bull market matures, it is increasingly important to pay close attention to the cause and effect of market changes. Investor’s concern about a weak or recessionary European economy and declining oil prices is well warranted. The global economic recovery that began six years ago has been one of the slowest in terms of growth and the Eurozone is an important element of that continued growth. A European recession would likely knock the US growth rate from its current, lower than normal 3% growth, to 1 or 2% or perhaps worse. If that were to come to fruition, stock prices would decline significantly from current levels. Historically, declines in oil prices have preceded declines in overall economic growth — raising our team’s awareness about current market conditions and the state of economic growth going forward.

All of these considerations and concerns aside, it is possible that recent weakness in these areas may be isolated events in those sectors only and that the bull market continues for all other sectors. Our purchases during the recent decline, which absorbed most but not all of the proceeds from our sales, demonstrate that we currently embrace this more optimistic view. Based on our research, it seems unlikely that the economic expansion will end in its sixth year and at a time when stock prices are not overvalued. Typically expansions last 7-9 years and end when price/earnings ratios (P/E) are in excess of 20 (the current P/E is 16). Therefore, we continue to be cautiously optimistic as evidenced by our recent purchases, leaving a bit more in money markets until the current “flashing yellow light” turns back to “green.” As our mothers once said: “better safe than sorry.”

About half of your recent sales were triggered by stop loss order while the remainder were sold by “hand.” In that spirit we continue to manage the risk of your portfolio, through its asset allocation, sector management and the use of carefully placed stop loss orders. It has yet to be determined if the recent correction is the beginning of something worse for the overall market. At this point we doubt it but we will be a watching all of this very closely.

All of us hope this update finds you well and wish you and yours very Happy Holidays. If you have experienced any significant changes in your financial condition, or have any questions, please let us know.

Sincerely,

Your Team at Main Street Research