Today’s stock market action should not be taken lightly, particularly on the heels of last week’s decline. Global and domestic stock indexes have now fallen beyond a “normal” correction and into territory that historically leads to further declines. The excessive selling is due to a growing perception that we are on the precipice of global recession, caused by slowing economic growth in China, a significant percentage of the global economy. It is during these periods that we do not think investors should just “sit tight” or think “portfolio diversification” and the “long term view” will come to their rescue. These theories did not work in 2008 and will unlikely work in the next bear market.

In recent weeks, you may have noticed that we have sold a number of your economically sensitive stocks and that we sold more during today’s volatile session (you may not see the trade confirmations until tomorrow). These sales have reduced your portfolio’s exposure and will continue to mitigate further stock market declines. We are not sure if we have entered a bear market and the beginning of a recession, but the broad selling pressure across all sectors suggests that it is a possibility – and reminds us of the beginning of 2008. Typically, economically sensitive stocks decline between 25-50% during recessions and many of those stocks are already down 12% or more so far. Keep in mind that there are some sectors and stocks that tend to do relatively well during these periods such as healthcare, utilities and consumer staples. Investors should endeavor to avoid being fully invested during a bear market since it takes a long time to recover the losses and they will need to have cash to reinvest once markets have bottomed. Should the market or individual stocks continue to fall further than today’s lowest point, further sales will be in order.

Of course there is a risk in managing risk. Should the market turn abruptly higher, and continue higher, we could potentially underperform on the upside for a short period. Given the action of today’s market and increasing global risk, we believe that it is “better to be safe than sorry” at this point and one should protect portfolio value with this more conservative strategy. Of course once the dust settles – which we doubt will be this week – we will be actively re-investing.

Over the next few days, remember that your portfolio is not the market – it has been, and continues to be, more conservatively postured. If you must look at how much the portfolio has changed since the market highs, measure by percentage – not dollars. Though we may see the market rally on a single day or string of days, it will not necessarily mean that are we are “out of the woods.”

In a few months we will all know whether this was the beginning of a bear market or a very dramatic short term adjustment in stock prices. However, for now, we will be taking this seriously and preparing for the worst, while – as always – hoping for the best.

Please let us know if you have any questions or if you have experienced any significant change in your financial circumstances – unrelated to the recent stock market decline!

Sincerely,

Your Team at Main Street Research