The 2016 Stock Market Correction
Contributed by Alan Leist, III
So as not to bury the lead, we are now increasing equity positions because pockets of value have emerged in the market. Companies are doing fine and the U.S. economy should avoid a crisis. The pricing pendulum has now moved beyond the center point and, although the momentum may swing further in the wrong direction in the near-term, disciplined investors can capitalize on the volatility.
The Strategic team is in the market trenches on behalf of our clients every day. After another volatile week, we take a break from our usual commentary to offer Strategic’s thoughts on the stock market correction from our unique perspective.
The Correction by the Numbers
If you have turned on a television, glanced at a computer or, for the old-school among us, actually read a newspaper recently, you are well aware of the stock market slide that has welcomed 2016 with a thud. As of the market close on Friday February 12th, the S&P 500 was down 8.5% on the year and 10.9% from the all-time high. Other markets, both in the U.S. and abroad, have fared worse. Some individual securities (think low quality financials and oil companies, for example) have fared much worse.
Why the Sell-off
There are any number of theories as to why stocks have sold-off so sharply in recent months. A few to consider:
The world’s 2nd largest economy will implode under the weight of slowing growth and massive debt!
- Our Take: The reality is that the world’s growth catalyst is no more. Settling into slower growth is the reality of the difficult transition to a consumer based economy. The story will be with us for decades to come. Time to get used to it and adjust accordingly. Expect moments of panic along the way that should ultimately prove to be transitory.
The slide in the price of oil will put people out of work, strain bank balance sheets and lead to political unrest in oil dependent countries.
- Our Take: Oil is an issue mostly due to a supply glut not the dramatic slowdown in demand that would signal an ominous outlook for global economic growth. The natural response to low prices is to limit production. Oil should stabilize in the year ahead as supply is constrained. Yes, there will be some pain along the way but the market and economy should grind through it from here.
Financial institutions, particularly those in Europe, are teetering again as bad debts and weak profits stress the system. It is Lehman 2.0!
- Our Take: The baby has been thrown out with the bath water in many cases. U.S. banks, while not perfect, are better capitalized vs. the last crisis and therefore should be able to weather a storm.
The U.S. economic data is mixed and not strong enough to survive the dual threat of a global slowdown and uncertain monetary policy.
- Our Take: The word we have been using for the U.S. economic health is “OK” and that has not changed. The economy will feel fragile at times but ultimately it should grind out the growth that avoids a recession. The consumer, bolstered by low oil prices, ample savings and improving labor prospects, is positioned to lead the way.
Investors remember the Great Recession all too well and believe that history will repeat itself.
- Our Take: Today’s environment has stronger underpinnings than the 2008 collapse. Investors understandably think the worst is imminent but the next recession is more likely to be of the garden variety kind vs. one for the history books.
The Truth is Out There
Each of these theories (and a few others) all have merit and have influenced market prices. Each headwind on its own is daunting. Taken as a group, the wall of worry is indeed high. In our view, these factors hide a simpler truth.
As the bull market rocketed +200% higher from the 2009 lows, stock prices detached from economic fundamentals, propelled forward by easy money policies around the globe.That period of excess requires a period of digestion until fundamental factors can set the balance right again. In short, the economy and corporate profits are in the process of catching up to stock prices. Time and the occasional sell-off are part of the process.
Quality, Value and Diversification
In our view, the best way to manage a correction is to own (and buy) assets with balance sheet strength and operational excellence (Quality). When buying, ensure that the price paid offers a comfortable margin of safety (Value). And lastly, do not put all of your eggs in one basket (Diversification).
These portfolio attributes are boring at times but are, in our opinion, the best way to protect and grow capital over the long-term. By adhering to this discipline, we can own what we would call ‘Strategic Stocks’ (or like-minded funds) with confidence when the overall market is under pressure, rebalancing the overall portfolio to capture unique values when they appear across asset classes.
As markets raced to ever higher heights over the past year or two, our Quality and Value approach guided us as we trimmed or outright sold equities. During this period, cash tended to build in portfolios as new opportunities to deploy this capital were few and far between. Now, the market pendulum is swinging back to the buy side. Valuations in general have become more favorable and we are taking advantage of recent declines to add to a number of positions where we feel there is opportunity.
Every client situation and portfolio is different. The strategies outlined within this commentary do not apply to everyone. That being said, we look at a few strategy highlights to illustrate our current thinking.
Developed International markets are one area where we have focused our research. This market recently plumbed three-year lows. While near-term headlines are concerning, the market’s reaction appears excessive. This act of rebalancing can be unsettling as it often leads to buying assets that are truly “unloved” by the market. However, rebalancing to targets anchored by long-term goals remains a key component to maintaining a prudently diversified portfolio. A systematic approach to rebalancing can lead to locking in profits in the better performing assets, while enabling the opportunity to buy into lower performing assets at attractive levels. This approach is the mechanism for capturing the benefits of non-correlated returns.
In the Core of client portfolios that hold Strategic Equity Income and/or Growth stocks, we have recently purchased an oversold bank, oil company and semiconductor maker, among other high quality assets. These are, in our view, great companies with solid fundamentals poised to deliver solid returns to patient shareholders.
We do not know. Nobody does.
We control what we can control, confident that the market should reward disciplined investors over the long-term. As advisors, our job is to ensure that client portfolios are positioned and managed prudently for that journey. The little things add up. A disciplined process rooted in fundamentals helps us to sleep easier at night knowing our clients can reach their goals no matter what the market may do tomorrow.
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