Since the beginning of 2016, stocks around the world have been in freefall. We are seeing volatility and panic at levels, not seen in at least 5 years and in some areas since the Financial Crisis. There is no doubt that this is a very challenging time to be an investor as virtually no stocks have been immune to this onslaught. While falling prices can be alarming, it is important to keep in mind over the short-term, stock prices can vary quite substantially with fundamental business values. Investing is about buying securities at discounts to intrinsic value. We may be buying a dollar for 60 cents, but in the short-term there is nothing that necessarily prevents that dollar from selling at 40 or 50 cents. The key is that these “dollars” that we are buying are actually growing in intrinsic value. When the panic subsides and market participants shift focus once again to earnings, balance sheets, dividend raises etc., the snap back should be quite strong.
There have been many studies that show that often a very large percentage of market returns come on a few individual days of the year. Often these days occur after you get capitulation during a panic. On Friday and through mid-day Monday, the Nasdaq has been down greater than 3% each day and other indices have followed suit. Many very large companies are down 15-25%, or more, over the just the last week. Have the fundamentals really changed that much? Of course the answer is no. This is why putting too much emphasis on short-term results is a surefire way to underperform long-term. Stocks are cheaper than they have been in years and valuations are incredibly attractive, particularly for the stocks that we own. For the current price of the big U.S. banks to be justified, the companies would have to lose many tens of billions of dollars each over the next few years. Where are those losses going to come from?
Energy loans are 2-3% of their loan portfolios with many of them to investment grade companies, and just about all of them are asset-backed loans. Bank loans are higher on the capital structure in comparison to most bonds, meaning that even in a bankruptcy the loans are not necessarily bad. Real estate is still performing well. Prices are rising and this is very good for the consumer, as are dramatically lower energy prices. The jobs report Friday was adequate with some signs of wage growth, which has been lacking. In an environment where there are less unemployed, are people more likely to default on their mortgages, credit cards, or auto loans?
It is important to understand that the vast majority of stock trading is done by high frequency funds that use algorithms to buy and sell stocks. The explosion of the ETFs has also made it easier for stocks to be sold or bought in bulk with no regard for valuations. Just as stocks have crashed of late, they can recover quite quickly. After 2008’s misery, 2009 turned into one of the great buying opportunities of all time! The economy while not being great, is so much better than 2008 that it is staggering.
Not all recessions are like 2008, which was the worst since the Great Depression. One of two things must happen. Either stocks will have an epic rally from these depressed levels, or the global economy will have imploded. No recession has ever started because of low energy prices and I don’t expect that to be the case now.
While we all worry about retirement and meeting our investment goals, this is where time horizon is so very important to keep in mind. If you are invested in stocks, you must have a longer than 1-year time horizon and ideally it should be quite a bit longer than that. With stocks lower than they have been in 22 months, it is natural to feel like you aren’t making the progress that you need. While I have no foresight as to when this panic will subside, I do know that it will. I also know that we have the biggest disconnect between price and value since 2009. This is where the opportunity is. If you haven’t made your IRA contributions, get your funds in. Don’t let emotion grip you and make paper losses real losses. Many of these stocks have 50-100% upside from current levels. As you look at your portfolio 3-5 years out, I’m very confident that you will be very happy that you remained invested when stocks were as cheap as they are now.
While we aren’t exposed to many tech stocks which are taking the biggest punishment, other areas of our portfolio such as the banks have gotten hurt badly, despite profitable and improving businesses. In the old days, these banks would be buying back their own shares and the stocks would never have traded at these prices when they are so well-capitalized. Now in today’s regulatory environment, stock buybacks and dividend increases are regulated by the Federal Reserve and the CCAR process, which occurs in March. I believe we will see big stock buybacks and dividend increases from the banks that we own, which can be a major catalyst. At current prices, stock buybacks are incredibly accretive and will increase our per-share ownership in these companies. There is no way around it, but 2016 has started terribly for stocks! It is always darkest before the dawn and we will get through this. At TTCM we will not deviate from the deep value investing methodology and we will not hide from anybody when times are tough. Communication is important and as situations change and new developments occur, we’ll keep you posted! If you ever need anything, we are at your service so don’t hesitate to give me a call directly at 805-886-8140.