“What is going on with the stock market, and what should I do about it?” That is a common question we are hearing these days. Even as professional investors, it is very difficult to specify why the market is acting so poorly or what triggered this recent weakness. Theories include failure of European Central Bank to stimulate the EU economy with forceful enough action, fears about end of QE3, fears of worsening global macro conditions (including in the EU, China, South America), our perception of Russia's seeming return to a Cold War-like mentality, the surge of ISIS, Ebola fears, and a sharp recent drop in many commodity prices, most notably oil.
The problem with most of these theories, other than the oil price decline, is that they have been concerns since well before the market’s recent pullback, and a price drop for oil is not by itself a bad thing. In the face of the market’s current heightened uncertainty, one thing we seek to avoid is selling stocks simply because they are going down. In our view, if sellers are going to be irrational about selling stocks, we feel that it is best that we not join in unless some fundamental changes cause us to rethink our views on a company. For any investor, at the end of the day, stocks represent ownership stakes in real businesses that should have been bought because the investor believes they have real value in the form of their assets, cash flows, intellectual property, etc. Assuming strong stock selection, we believe that value should continue to grow over time and compound, despite short term volatility in share prices.
We have been concerned in recent months that the slowdown in the Eurozone might intensify, and spread to the U.S. as it impacts multinational companies. The recent collapse in oil prices heightens this concern, as investors attempt to differentiate between a slowing global economy’s impact on oil prices versus the apparent market share battle between members of OPEC and other oil producers. Over the past several years, drops in the price of oil to its current level were relatively short lived, and did not translate into a meaningful pullback in exploration and production activity here in the U.S. However, investors are wondering whether this time may be different. We do believe that if oil remains in the vicinity of $80/barrel, some exploration and production activity here in the U.S. and perhaps elsewhere could be curtailed.
Fears of the spread of Ebola in the U.S. are also panicking some investors, although this is hard to measure precisely. While we believe the chances of a significant number of additional cases in the U.S. caused by domestic patient-to-patient transmission are extremely low, if this were to occur it could cause a temporary cessation of travel in the U.S. – which would clearly have an economic impact, even if it were short lived. We believe this is why airline stocks have been so volatile recently.
The busy part of earnings season is underway, and it will last a few weeks as the companies in the S&P 500 report third quarter results. We remain hopeful that earnings reports will not be as bad as many stock prices seem to be discounting, and that management teams will help to clear up some of the concerns which have made investors so skittish, especially for U.S.-centric companies. Recent data points from the U.S. continue to indicate that our country is on the same macroeconomic trajectory it has been on, with improving employment trends as well as a reasonably healthy level of industrial activity.
Lately, geopolitical events have been a more important factor than usual in driving markets, and there have been many violent swings up and down in the market. Volatility is so high at present that we believe it is more likely than not to decline, perhaps after another drop in the stock market. Our Domestic Equity Team is monitoring what we believe to be key indicators of the market’s current stress, and these data points, rather than irrational fear, will guide our investment decisions going forward.
Submitted by: John Roscoe, CFA
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