While the extreme volatility since the start of 2016 has been extraordinary, it is important to keep in mind some basic lessons on investing.
- Stocks are fractional shares of businesses.
- Every business has an intrinsic value, which is calculated by fundamental analysis of the balance sheet, cash flows, and qualitative measures such as competitive advantages etc.
- Stock prices change every day, while business values change over much longer periods of time. (Imagine owning a restaurant or construction company. Do short-term fluctuations to stock prices matter?)
- Over time stock prices and business values converge.
- By buying businesses at deep discounts to intrinsic value, one can ensure an adequate margin of safety and strong upside potential.
Over the weekend I compiled a diversified list of U.S. companies and looked at their fluctuations from their 52-week highs. Most of these we don’t own in any size. I didn’t cherry-pick specific industries as I just wanted to use the table as an example. As can be seen, every stock regardless of industry is down. Just about all of these companies are or until recently, were considered to be strong financially. Most of the stocks on the list are down well over 20% and you can see the devastation that has hit the commodity sector. Industrials such as United Technologies and Caterpillar have also been hit incredibly hard as the U.S. dollar’s strength has generated material headwinds to their international businesses. Globally stocks are in a bear market. There are a few large-cap U.S. stocks which distort the numbers somewhat to reflect less damage than internationally, but they also happen to be some of the most expensive stocks from a valuation perspective so they are ripe for a fall.
It is important to understand that as stocks go down, they get cheaper. Ultimately, this means they become safer investments despite the fact that the declining prices often creates an atmosphere of panic. Many market participants aren’t focusing on fundamental analysis. Trading volumes are dominated by algorithmic programs or ETFs, which can drive prices far lower or higher, without a material change to the fundamentals. This is just part of investing in stocks and volatility is 100% to be expected. At T&T Capital Management (TTCM), we focus on the fundamentals and take a long-term perspective. This is why we are not scared that bank stocks have declined along with the general market as that is to be expected in the short-term during a market panic. The reality is that these companies have never been stronger financially. The big banks’ have on average, about 2% exposure to energy in their loan portfolios and these loans are asset-backed, meaning severities aren’t likely to be very high.
Key areas such as housing, automobiles, and consumer credit are very strong. U.S. GDP is expected to grow by 2.4% but even if growth is 1.8-2%, the lack of a recession would likely be a huge boom for most stocks we own. Over the last month the correlation between daily moves in the price of Brent Crude Oil and the S&P 500 index is 97%, which is the highest correlation to any comparable period in the last 26 years. Oil has a supply issue much more than a demand issue. The decline in oil prices benefits various industries and certainly benefits consumers. This correlation is not logical over the long-term and is just one reason why I believe that this correction will prove to be temporary. We are finding some of the most attractive investment opportunities that we have had since 2011 or even 2009 in some cases, so the worst thing one can do is to panic. For those that have cash on the sidelines, now is a great time to add to IRAs or any type of account as the reward/risk is great. If you don’t have cash free, the key thing to do is just let your portfolio play out. These stocks can move up just as quickly as they can move down. It is impossible to pick bottoms or tops, but by using a consistent value approach over the long-term we can take advantage of the ebbs and flows of the market. It is not uncommon for the average stock to move by 30-50% in a year, so one must use the fundamentals as the basis for investment rationale as opposed to reacting purely from inevitable price movements. Thank you very much and let me know if you have any questions at all!