After declining 20 percent, global stock markets hit a low point about three weeks ago as investors sold shares in response to slowing economic growth. Since that time, markets have regained about a third of that loss as ‘bottom fishers” and the covering of short sales temporarily reversed the precipitous decline. Though rising stock prices have given investors temporary relief, the economic fundamentals are little changed from three weeks ago, and in some cases the data has worsened. Given current circumstances what should an investor do?
Most importantly, we have entered a period of higher risk for conventional financial assets, given the weak economic data. During this period, investors should be postured more conservatively. This should include less stock exposure than normal, particularly in companies that are vulnerable to economic decline such as industrial, financial and technology shares. As you know, we took steps in this direction on your behalf several weeks ago. In addition, investors should be wary of short term market advances, such as we have experienced in recent weeks. Though these periods may be a relief to investors, they may also prove to be short lived unless economic data points become more constructive which we believe is unlikely in the short term. Therefore, investors should be cautious and reserved until economic data points begin to recover. Though we are closer to the beginning of this economic contraction than the end, this whole affair is unlikely to last more than a few quarters. During this period, stock prices may need to further discount (i.e. decline), or trade sideways to reflect the reality of the current problems. However, once stock prices have fairly priced in all of the economic turmoil, a great opportunity will be presented to buy great companies at fantastic prices. Our research suggests that we are not there yet. Until the economic data points improve, we need to seek value in segments of the financial markets that provide the best relative return for you, with lower potential risk. In the past, the bond market would provide value and safety during periods of economic turmoil. However, given the historically low interest rate environment, we see little value in this market. Therefore, we must look for alternatives. We see several areas that provide this opportunity:
Common stock which represent companies that profit regardless of economic weakness, such as consumer staples, healthcare and utilities, particularly those which pay high dividends.
- Preferred stock representing companies that trade at a discount. These shares pay very high dividends and are much less volatile than common stock.
- Select Master Limited Partnerships (MLPs) that provide consistent cash flow and high dividend yield.
- Real Estate Investment Trusts (REITs) that focus on healthcare properties and offer significant dividend yield.
- Currency investments that allow us to benefit from rising currencies, such as the Brazilian Real, or declining currencies, such as the Euro.
- Investments that allow us to “short” stock of companies that are vulnerable if in fact a recession appears imminent.
Our research suggests that each of these segments and a combination of all of them should provide an opportunity in this less predictable climate. Of course, we will aim to mitigate risk in each area with careful monitoring and stop loss orders. If in the past you have indicated a disinterest in any of these areas, we will abide by those instructions. As well, if you would like to restrict any of these investments in the future, please let us know.
At some point, financial markets will be on better footing and we can invest in a more “growth” oriented manner. We will be watching economic data points closely for this opportunity and will be willing to change course. Until then, we will strive to provide you with the best risk adjusted return possible.
We hope this note finds you well. If you have any questions or would like to get together for a portfolio review, please let us know.
Sincerely,
James E. Demmert
Managing Partner