We have now experienced the worst correction since 2011. While these things are never fun to go through, they are 100% to be expected and 100% not to be feared. Valuations have been elevated and there has been a great deal of speculative activity on wide swaths of the market, none of which we are significantly exposed to. Much of this has been driven by low interest rates, which has pushed investment flows into common stocks. This has led to overpricing in momentum stocks, REITs, MLPs and consumer staples companies, to name a few. It is important to understand that this selloff has come after one of the longest and calmest bull markets in U.S. history. 10% corrections have been very infrequent, as have even 5% corrections. This sense of calm and low interest rates had a whole generation of investors using aggressive leverage to enhance returns.
One problem with leverage is that when it moves against you, margin calls can occur. This forces the market participant to liquidate securities or add cash to meet them. This can lead to indiscriminate selling. There is absolutely no reason why a Bank of America should have sold off to nearly $15 from $17, as it has virtually no exposure to China and is in the sweet spot of the American economy. It’s balance sheet has never been stronger and it is aggressively cutting costs. Book value is close to $25. The reality though is that market participants have had to sell whatever they can and many have panicked thinking that this is the next 2008. I would definitely take the opposite side of that bet. We are not in a recession and I don’t believe we are heading into one either in the next year or so.
The other technical factor that must be considered is that a huge amount of trading is now done via ETFs. Many hedge funds use ETFs to hedge or short the market, which means that they are selling many stocks that are already undervalued. This can lead to short-term distortions in price, which will be proven irrelevant in the big scheme of things. This is why Benjamin Graham said “in the short-term the market is a voting machine, but in the long-term it is a weighing machine.” As 3rd quarter earnings come through, it is very likely that many of our stocks will have recovered. I certainly don’t forecast our U.S. financials to be posting losses in the next quarter, but instead we are likely to see higher intrinsic values, bolstered by earnings and stock buybacks. The stocks will ultimately follow the fundamentals of the businesses, which are fantastic and getting better Unsurprisingly given our strategy, we have been buying stock and selling puts to take advantage of the better prices for accounts that have free cash, or have new money coming in.
Lastly, there is a lot of talk on TV about technical analysis. Many market participants that don’t look at financial statements, believe that by looking at a chart pattern, they can identify the direction of a stock or market. The reason it is so popular on TV is that it compels non-sophisticated market participants to watch instead of focusing on things that matter such as financial statements and 10ks.
If I ever personally start quoting technical charts to you, I’d advise firing me as your money manager. I don’t say that lightly. Now because many market participants do use technical analysis and are short-term oriented, charts can have an impact on things on a day to day basis. However, I’ve been in the business for over a decade and through my career I’ve worked with thousands of clients from around the world in various capacities. I’ve been around hundreds of clients and even traders that attempted using technical analysis as opposed to value investing. I cannot name a single one that has been successful over the long-term doing it. I know many people who have made money selling classes or generating commissions off of technical trading, but I can’t name one that has done it in the markets. I’m not saying they don’t exist, but the percentages are not good! Conversely, I don’t know a true practitioner of the value investment strategy that we use who hasn’t been successful over the long-term.
The whole key is being patient, disciplined, and don’t panic! Stocks fluctuate and volatility increases. That causes short-term losses that are completely irrelevant for the long-term investor. Even if you are retired or close to retirement, it is essential to keep in mind your investment goals. You shouldn’t be in stocks whatsoever if you can’t handle any volatility. This is why we put so much emphasis on education. It absolutely kills me when I see people panic and fortunately it occurs very infrequently for TTCM clients! Given all of the circumstances, volatility is likely to continue to be high over the next few weeks. We will see big moves probably in both directions and midday swings that will seem shocking. My best advice, ignore the noise. Realize that we have a business/investment plan. We buy fractional shares of businesses at discounts to intrinsic value with the expectation of long-term profits. We also use conservative strategies like covered calls and cash-secured puts to generate income and reduce risk. We’ve been through these types of situations many times and it is why we use the strategy that we use. The stage is set for attractive long-term investment returns in the securities that we are in and we just have to let them play out, which will only occur during the passage of time. Thank you very much and as always please don’t hesitate to contact me if I can assist with anything at all!
“The stock market is a volatile animal. There have been some traumatic declines in the stock market in the last year. Historically we have a decline of 10% or more about once every two years. That’s the nature of the market, even in good markets we have declines, and trying to predict its direction over the near term is an exercise in futility. Behind all the smoke and noise on the market’s surface, it’s important to remember that companies – small, medium and large – make up the market’s backbone. And corporate earnings drive stock prices. If you look at the 500 companies in the S&P 500, despite 10 recessions since WW II, earnings have grown 7% annually. That’s a pretty good track record.” — Peter Lynch