Long-term investment success often requires short-term periods of patience, restraint and being value conscious. In today’s fast paced, short-term performance, digitally-driven world this can be a challenging combination. However, the discipline to step away from short-term “noise” and carefully examine the “forest” as opposed to the “trees” can result in significantly better long-term returns. This can often mean going against the crowd in the face of a falling or rising market. Years ago we learned that short-term movements in equity markets are driven by psychology, but long-term trends are driven by economic and corporate profit growth. This comes to mind during the past few months as we witnessed the dichotomy of sharply rising stock prices in the face of declining economic growth and corporate profits. Investors need to ask at this point which of the two – the recent direction of stock prices (up) or corporate profits (down) – has greater longevity? And, how will this play out over the next few months and the balance of the year?
Since our last Strategy Update, just a few weeks ago, stock prices appear to have lost their momentum. In fact, for most of March, global stock indexes were in the red. At the same time economic statistics and corporate profit reports have continued to deteriorate. Perhaps the long-term fundamentals are beginning to trump short-term psychology? Our team believes that this may be the case. The bond market, which has historically been the best predictor of such things, appears to agree. This is evidenced by the bond market’s recent yield curve inversion – short-term yields higher than long-term yields. This unusual phenomenon often precedes weaker economic data and profits. A bit more time, along with earnings and economic data in April, should bring the disparity between stock prices and underlying fundamentals back in line.
As we are all well aware, we faced the beginning of a bear market in the fourth quarter of 2018 with most indexes down 20% and many sectors down much more. Though we don’t predict Armageddon for the global economy or stock market, we also do not believe that a real bull market can begin again without at least a normal correction or perhaps something worse. We may be on the precipice of such a move given that the market has lost its momentum and we are heading into what is likely to be a dismal period of earnings reports and economic statistics from the first quarter, when the US Government was shut down. For that reason we continue to be a bit more defensive than your normal, fully invested portfolio.
As you may have noticed, our team continues to search for and take advantage of isolated opportunities in companies that represent great value regardless of the market's direction. These are difficult to find and, given the overall market environment, our pace of adding significant exposure has been slow.
It is always difficult to predict with accuracy the direction of stock prices, but one simple rule holds true: When the economy and corporate profits are rising, stocks do great! That has just not been the case over the past 4 months, which poses a risk to investors. As a reminder to anyone who has experienced a normal bear market, stocks typically fall before the bad news about profits as happened in October – and then have sporadic, often significant, advances as we’ve seen recently – only to decline again into poor earnings reports. Though global stocks historically decline approximately 40% during an average bear market, we are not predicting such an outcome. In fact, as far as we are concerned, we are ready to become more growth oriented as soon as stock prices and earnings growth are more aligned – most likely when stock prices are lower and most of the bad news about profit growth has been digested. We wouldn’t be surprised to see this come to fruition in the next few months. Moreover, we eagerly await having a more growth oriented posture and we are optimistic about our 2019 upside performance.
After decades of managing money, we have experienced a number of these short-term periods of being less invested and they have proven to be a bit trying in the middle, but valuable in the end. None of those past periods lasted more than months and we don’t expect this period to be an exception.
As you know, we are diligent about protecting your assets during difficult periods of time to mitigate the risk of a catastrophic decline. We will continue to pursue this strategy by managing your portfolio’s asset allocation, sector management and the use of carefully placed stop loss orders.
We hope this short update finds you well. If you have experienced any changes in your financial situation or would like to discuss your portfolio, please let us know.
Your Team at Main Street Research
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