Stock markets around the globe have been panicking on fears of Chinese growth. Today’s made news was the China manufacturing index slipped deeper into contraction territory. The Dow is now down just about 10%, which is correction territory. In this type of environment, just about all stocks fall. Yesterday many of the momentum stocks that I mentioned in my last article, such as Netflix were down by 5-7%. Once again I’d reiterate that we’ve had no expectation of strong global growth and have been concerned about China for the last few years.
If you look at the U.S. economy, the key areas of strength are really related to real estate and credit. Housing prices have continued to increase and credit metrics have improved to levels that are rarely seen. Also keep in mind that most of the big fines that have plagued the big U.S. banks are now in the past. These companies have been focused on improving efficiency and have much lower costs than they have had in the past. They also have double the capital and very little exposure to China, so earnings are likely to continue to be strong. Just as important, the big banks’ that we own in size still trade at discounts to book value and in some circumstances tangible book value. Those book value numbers are increasing via retained earnings and stock buybacks. This is absolutely essential in protecting our investments and it differentiates us from most of the market, which is highly expensive. This is why you really don’t want to get too caught up on the day to day stuff. Below is a link to an article, which explains that the banks likely should be trading at a much higher multiple due to their much safer and consistent balance sheets and earnings power.
The biggest impact we’ve seen is that volatility has increased. That jacks up all option prices causing short-term mark to market losses. These volatility losses become completely irrelevant when the options expire as both the time value and volatility values go to zero, and the only thing that matters will be where the stocks are relative to our strike prices. Your short option value on your TD Ameritrade account statements is reflective of the amount of premium you’d earn if all of your options were to expire worthless. Worst case of course, we end up owning the stocks we want to own at a cheaper price and we get all the upside or downside associated with that. For most accounts the short option value is greater than 10% of the account value with most options coming due in late January of 2016. Time decay will quicken over the next few months as these options roll off. In the past, we’ve seen many of our largest gains come in the last few months of the year, just due to the way that options work as they get closer to expiration. I have no idea what the market will do between now and January but I do believe that our businesses will grow in value during that time horizon and the stage is set well for us with our option positions.
It is easy to get caught up in the pessimism when markets are finicky. You just have to keep in mind that we aren’t in the stocks that are overvalued. We are in businesses that are really in their sweet spot and that are growing intrinsic value for the most part. Many of these companies are actually buying back stock so these selloffs actually can be a good thing. It is a great time to invest during this volatility as pricing on both stocks and options is fabulous! As always, please let me know if you need anything or have any questions whatsoever.
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