As always, we’re honored and privileged to serve as your fiduciary investment advisor. We will be closely monitoring markets and ready to act should we feel it necessary. We thank you for the trust you have placed in us and will continue to work hard on your behalf.
I’ve obviously borrowed Margaret’s style of headlining her columns with a series of seemingly unrelated people, events, and songs. Today’s Client Memo will be a bit longer than usual because, well, there’s more to talk about.
Charts of the stock market going back 20, 30 or 40 years are reassuring because they depict a gradual rise in the value of US businesses. This represents the long term benefits of investing. We always say to focus on the long term, but the long term is of course made up of many short terms. Zoom in to any given year and the results appear much more chaotic. In 1987, the “flash crash” caused equities to drop 20% in a day but somehow stocks still finished the year in the black. More recently, in August of 2015, the Dow opened 1,000 points down on the way to a roughly flat year. Talk about volatility.
This amount of volatility is obviously troubling. No one likes seeing their accounts lose value, much less in a seemingly indiscriminate way, like a boxer taking punches on the ropes and hoping for the round to end. But in periods of tremendous volatility we often benefit from taking a breath and reminding ourselves why we own what we own to begin with. On average, stocks are likely to outperform just about every alternative over the next decade and beyond, just as they did in previous decades. Pullbacks and corrections remind us that there really are no free lunches. As investors, these are the days we must endure to experience the long term benefits of owning little pieces of America and the world.
We make it a point to not watch financial television whenever markets are way up or way down. It simply affects perception too much. When things look good, prosperity is around every bend. When things appear troubled, the sky is falling. Financial television is designed to grab your attention and trigger a response. There are often so many people on camera at once it looks like the intro to “The Brady Bunch”, except this bunch is yelling into the cameras instead of smiling like Alice. Everything about it is telling you as a viewer that you need to “Do something!” And the average lay investor, also known as a “retail investor,” has done just that.
The average retail investor’s sentiment is at a low not seen since the financial crisis and is a telling feature of the market’s recent selloff, which by most accounts has been triggered by retail investors and not institutional managers. I saw a headline recently that said the number of Google searches of the phrase “sell stocks” is at a high since 2008. This further emphasizes the retail investor’s fear, as most institutional asset managers probably aren’t typing open-ended questions into Google to determine their best course of action. Simply put, the average retail investor is scared.
Rhetoric associated with Presidential election years can increase the perception that things are negative. Every candidate has an incentive to paint the country with a grim brush. Ironically, a US Passport is still worth its weight in gold and then some in most corners of the world. Additionally, people all over the world without access to financial institutions continue to hold much of their life savings in $100 bills. Throwing away the television (or, less drastically, muting it) will help regulate our emotions in the face of negative market sentiment.
With Average Joes heading for the hills, what’s the “smart money” doing? It’s actually gaining confidence in US equities. The American Association of Individual Investors recent data points out that despite the average retail investor’s bearishness, institutional managers (including hedge funds) are increasingly optimistic. We think this “Average Joe selloff” is based on a number of factors, but most importantly is the rapid, emotional nature of the selloff that ignores the fundamental strength of US corporations and the US economy.
The market isn’t the economy and the economy isn’t the market. The market represents how Corporate America is faring, not Main Street. They’re related, of course, no doubt about it. We all live in the same world and it would be tough for corporations to prosper indefinitely if Main Street isn’t experiencing some good days as well. But Corporate America has vastly outpaced the average American in recovering from the financial crisis. In fact, large corporations are contributing more to US GDP than at any time in history.
The US economy, despite the doomsday prophecies by Presidential candidates and financial media headlines, continues to put one foot in front of the other. Growth here at home hasn’t been speedy by any means, but it has been reassuringly consistent. Joachim Fels of PIMCO recently reiterated their view of the “Triple B” economic expansion: growth that is Bumpy, Below-par and Brittle. We couldn’t agree more with this outlook. We’ve called it the “Low and Slow” recovery. We see this trend continuing for the foreseeable future.
Despite recessionary fears that seemed to have popped up in the last few weeks, domestic unemployment continues to trickle downwards. People are quitting their jobs at levels not seen since before the financial crisis. While slightly counterintuitive, “quits” are seen as a sign of strong confidence in the labor market as people rarely quit their job unless they feel they have a better one lined up or their prospects are better on the open market. Restaurants are serving more customers every month, which is a positive sign of the average consumer’s mindset because eating out is very quickly dropped when expectations of the future look grim.
The energy market’s downturn has played a major role in the volatility we’ve seen recently. Countless headlines cite “Oil and China” as causes of the recent selloff. Part of that explanation makes sense. A hefty chunk of the S&P 500 are energy companies who have seen their shares hit hard based on the belief that we’re in for a long energy downturn. Fair enough. But the other side of the coin isn’t being represented at all. Just like the country as a whole, which is still a net importer, most Americans are energy consumers and not producers. Every week energy prices stay low is another week Americans get to fuel up at a steep discount to anything they’ve experienced in recent memory. If you’re a millionaire this subtle tax break probably doesn’t make you feel that much better, but if you’re the average American this is a huge windfall.
How far will energy prices, and specifically oil, fall? Who knows. It’s a fool’s errand to call a bottom but we do know that most energy producers are not profitable at today’s prices. Eventually, be it weeks, months, or even years, economics will come back into play and producers will be forced to shut down production. This in turn will lead to lower supply and therefore higher prices. This cycle has played out many times in the energy business. Hence the old oilman’s adage: “The cure for low oil prices is low oil prices.”
Panicking over China slowing down is like panicking over baldness. As human beings we tend to be “all or nothing” in terms of our responses to positive or negative long term trends. It’s what causes markets to fluctuate from wildly optimistic to wildly pessimistic. It’s what makes it difficult for politicians to close the budget deficit and start shrinking the national debt. It’s what makes it hard to cut out french fries and exercise regularly. The consequences are so far into the future that it’s hard to endure pain today in order to fix a problem 10, 20 or 30 years away.
Chinese stock market woes are constantly in the headlines. If the Chinese stock market was representative of the overall economy, it should cause concern. But it’s not. China’s market is really in its infancy in terms of having a sophisticated investor base, professional managers, etc. Chinese companies are more often funded with debt rather than equity, which further diminishes the stock market’s importance. Consider one more fact: whereas 40%+ of American households are invested in the US stock market, only 4% of Chinese households invest in their market.
With the NFL postseason upon us, I thought a football analogy might be fitting. The United States is home to roughly 320 million people and 32 NFL teams, so there’s about one NFL team for every 10 million Americans. Now imagine that China somehow became fascinated with American football and decided that they would start a Chinese NFL. Assuming they have as many Chinese NFL teams per person as we do here at home, there would be roughly 135 teams! DirecTV might even have trouble carrying that many games, not to mention all the extra playoff games needed to crown a champion from a field that large. One hundred thirty-five teams, representing varying geographic regions, just like we have here. What do Pittsburgh and Miami have in common, after all? How about Seattle and Houston? Buffalo and New Orleans? One hundred thirty-five teams with a packed stadium every weekend and all the ancillary food, beverages, hotels, souvenirs, etc. that go along with a major sports franchise.
We don’t think there’s any hope of a Chinese NFL in the near future, but the visualization is helpful to demonstrate just how big and diverse China really is. It’s hard to start or stop a train that big on a dime and therefore fears of a Chinese collapse aren’t warranted. Yes, their growth is slowing. But slowing growth doesn’t mean impending doom. Despite their naive attempts at “managing” their stock market, Beijing has done an admirable job guiding their economy through its first slowdown in decades. An economy that big simply cannot grow at 10% per year forever.
In the same way we want to invest in companies whose management act like owners, it’s instructive to see what people who have “skin in the game” are saying about China. Starbucks CEO Howard Schultz recently acknowledged that China is in a transition period, but still plans on opening 500 stores a year there. Apple CEO Tim Cook, who sells quite a few iPhones in China, recently said ”Frankly, if I were to shut off my Web and shut off the TV and just look at how many customers are coming into our stores and coming online, I wouldn’t know there was any economic issue at all in China.” General Motors President Dan Ammann similarly said “Last year, 2015, we posted another year of record sales in China…We’re getting back to a more maturing kind of growth rate there.”
While we don’t want to be “heroes” and dive in front of irrational sellers, we do believe that more businesses on our “wish list” are increasingly attractive at today’s prices. Over the next few weeks we will be picking up some of these companies either by using existing cash or by swapping out companies with less attractive prospects from these levels. We may also simply add to existing positions where the risk/reward seems to be most favorable.
Just like the Federal Reserve has begun “normalizing” interest rates, Arbor Wealth has begun the process of “normalizing” our bond holdings. As a firm that would probably be characterized as conservative by many, we have traditionally held many more individual bonds in client accounts than we have recently. This has been for a number of reasons, but mainly because we were wary of the bond market’s reaction to the Federal Reserve’s December rate hike. Those fears have obviously been subdued by the recent equity market volatility, but our desire to hold more individual bonds remains intact. It’s not ideal to buy bonds during a correction because their security tends to be at a premium (like generators during hurricanes) but we believe we will be able to work these into client portfolios successfully over the near future.
In closing, the world is still spinning. People are still doing everything they did three weeks ago. And while the New Year cheer might have worn off a bit sooner than it otherwise would have, 2016 still holds promise for investors who can take the good with the bad and stay the course.