Dear Client,
It’s here; we've finally entered a correction phase (-10%). On Friday the Dow Jones Industrial average finished the day down 10.1% from its May peak. By Monday the S&P and NASDAQ joined the Dow, with all three major indices solidly in correction territory. Even though it was inevitable for the market to have a pull-back, this correction feels tremendously disconcerting since it’s been so long since the last (2011), and the decline has been so steep.
Over the past four years, there have been several near misses, but ultimately it never happened. While there were a number of major headlines last week that contributed to this sell-off (Tsipras resigning as PM of Greece, copper hitting six-year lows, and the two Koreas firing artillery at each other), our take is that the straws that are breaking the camel’s back are China and oil. On Friday, oil briefly dropped below $40 per barrel and closed at $38.18 today. The weakness that began last summer has picked up steam from continued high production levels in the U.S. and Middle East along with growing concerns of a global slow down. The latter is being fueled in large part by China, whose government is having great difficulty in propping up their volatile stock market. Generally speaking, lower oil prices are a good thing, because lower cost at the pump puts more money in our pockets. However, there seems to come a point when oil prices going too low is perceived as a potential harbinger of bigger problems. Forecasts on where oil finds a bottom are all over the place, with some analysts suggesting it may go as low as $25. At some point, one might speculate that the Saudis will reduce output and that may provide some support.
The fact is that we just don’t know how deep or how long this price correction will go. Given that it has been so long since our last correction, we wouldn't be surprised if we saw another 5 to 10% on the downside. Since World War II, there have been 27 corrections of 10% or more. This generally equates to one about every 20 months or so, and the average decline has been 13.3%. Regarding timing, corrections typically average 77 days, but there also instances of quicker recoveries.
Before we allow the current slide to push us to undisciplined action, let’s take a look back in time. Remember 2008 when we all worried that the financial world as we knew it could be at an end? During those days of considerable fear, investors could've bought J.P. Morgan at $15 per share, Wells Fargo at $7.80 per share, or even Apple at $12.50. Even after the steep sell-off of the past few days, these and many more well run companies have recovered and set new all-time highs. We now look back on that time as a “golden opportunity” to make investments.
While we've been expecting a correction for some time, we didn’t know what— in particular— would trigger it or when it would come. However, in appreciation of our perceived increase in risk levels, we built significant cash positions in several of our focused strategies and invested new money in stages. There were points where this caution hurt, but we are now hopeful it puts us in the enviable position of having dry powder with which to target opportunity.
Currently, we are making a few adjustments by phasing money into the areas where we see the most opportunity. Energy and commodity producers had already been pummeled prior to the current sell-off. Several companies in this space have strong balance sheets and are paying very attractive and, we believe, sustainable dividends. The recent price declines are creating other opportunities to own high quality companies from other sectors at reasonable prices as well. We are looking for good business models and balance sheets along with sustainable dividends. Finally, the emerging market countries are already priced at a significant discount to the U.S. We believe in their long-term growth story and feel this sell-off may provide an attractive opportunity to shift toward an asset class with higher volatility but great potential over the long term.
As we’ve said before, we want to sell when others are willing to buy and buy when others are willing to sell. This is the basic theme of value investing. While buying things on sale may seem like a logical approach, quite often it is emotionally difficult. It is far easier from an emotional standpoint to follow the herd and buy things that have done well recently or capitulate and exit when things look worst. No one has perfect foreknowledge of the markets or the turning point for when out-of-favor assets will become investor darlings again. In order to help allay these very normal emotions we would encourage you to keep a long time horizon, know that we plan to maintain a focus on quality, and that we will never put all of your eggs in one basket.
We have reviewed every position we have. We will be making adjustments and hoping to add attractive positions. All in all, we generally feel good about the slow but continued recovery in the U.S. and the likelihood of Europe working out their problems. We also believe that the growth of the emerging middle class around the world will prevail and provide a positive catalyst over the next couple of decades.
We maintain that diversifying among different types of assets, as well as different strategies, gives us the highest and best potential to reach goals. We will always keep that foundational tenet, along with each client’s individual goals, in the forefront as we make investment decisions during this time. Please don’t hesitate to contact us with questions or concerns and, as always thank you for allowing us to work for you.
The CCA Investment Team