First, before any commentary, it is important that while this newsletter deals with dollars and cents, when discussing global crises we keep in our minds and hearts the human cost, difficulties and sometimes tragedies that go along with events. We are not experts in health or politics. We have some insight into how investors behave and how investments may be priced or mis-priced. It’s apparent that the Coronavirus infection rate will continue to rise. There is little doubt that the measures to contain the virus such as working from home, closed facilities, canceled events and a general sense of caution will have a negative impact on the global economy. This is not to say that these measures are not correct and necessary, it is just a fact. Markets discount the impact of events before the actual numbers appear. The decline in stocks and corporate bonds is the market discounting future negative economic news. The question is whether these markets have discounted enough or is more to go. I might suggest that the markets may have priced in one to two quarters of flat to negative economic growth. If the contagion lasts longer, the economy will be in a slump for longer and I think the markets will have to continue to adjust. During these conditions the two preeminent competing urges that are present in the minds of investors are at their peak. One is fear. The other is greed. One can make a case that investors should sell everything and wait for the virus to dissipate. The correction in stocks we’ve had could easily become a 40% bear market. Conversely, many stocks have fallen sharply and now have low P/E ratios and/or high dividend yields. As Warren Buffett likes to quote from the book Reminiscences Of A Stock Operator, “be greedy when others are fearful”. I think there is a middle path. Market declines are a chance to evaluate a portfolio. It’s hard to sell everything. You may need the income. It’s also impossible to come back in at the bottom and you could miss a big rally when the coast is clear. What may work is pruning the portfolio – selling positions you really are “so-so” about and trading up to better quality names. Buy the stocks you always wanted to own but you thought you missed them. Smart investors focus on the long-term. Taking a short-term loss to buy shares of a company that will work for the long haul makes sense. Investors shouldn’t panic but rather occupy their minds with the idea that they are being strategic. Asset allocation should also be addressed. Are you over-weight a sector or an asset class? Make adjustments but don’t, in a panic, change your long-term investment plan unless your needs and goals have really changed. — Ian Green, Pendragon Capital Management
After a strong run-up to the end of 2019, the market began in 2020 with an upward bias that stalled as the Coronavirus began to spread in China. In response to the contagion, China has sealed off cities and transport to and from China has been reduced. The Coronavirus situation will reduce global GDP which will certainly put pressure, in general, on corporate profits. Certain industries like airlines, casinos, and technology will see a greater impact. The news surrounding the virus is not good but the markets have a way of discounting information. After a few down trading days, stocks rebounded. The stock market is either anticipating that the impact of the virus will be limited and/or investors believe the world’s central banks will add stimulus to their economies to help offset the dampening effects of the Coronavirus. Whatever the reason, for now, stocks want to move higher. Until proven otherwise, the Bull Market remains intact. Events like the Coronavirus usually are buying opportunities. Regardless of the trade issues of 2019 or the Coronavirus of 2020, China will continue to grow and continue transitioning from manufacturing-centered to a service-centered economy. The consumer markets in China have enormous potential led by giant internet/technology platforms with a scale much larger than the US. This is a good place for the patient, long-term investors to find buys. Similarly, companies in Asian economies that trade with China like South Korea, Japan, and Taiwan also will be places to look for opportunities as those stock prices have also been impacted by the situation in China. Setting aside China, the massive run-up in “disruptor” companies like Tesla, Amazon, and Shopify and in “big tech” like Apple and Microsoft should give even the most ardent Bulls some pause. Asset prices get riskier the higher they are valued. The market’s price to earnings ratio is moving up faster than profits. With a P/E of 19 and overall corporate earnings down for the past few quarters, the stock market is vulnerable to downdrafts. — Ian Green, Pendragon Capital Management
September ended the worst quarter for stocks in four years.
In the period July 1, 2015, to September 30, 2015, the S&P500 lost 6.9%. The index closed the quarter at 1,920, almost the same place it was in May 2014.
All asset classes affected
Market turmoil led investors to move out of almost all asset classes. Nervous investors preferred bonds to stocks. Out of Municipal bonds, Taxable bonds, US stocks, and International stocks, Municipal bonds were the best performing, rising 1.3% in the quarter. Taxable bonds fared next best with a -1.4% return.
US stock funds, on average, declined 7.9% and the average International fund dropped 10%. Large-cap stocks outperformed mid-caps and small-caps.
Sectors from real-estate to healthcare
The best performing sector within the stock market was real estate.
The worst was energy.
Healthcare normally is a defensive place to be. Yet, it performed poorly falling almost 14% in the quarter led down by the selling of biotech stocks. An observation with healthcare is that the Fidelity biotech fund was down almost 20% in the quarter which means that traditional healthcare like pharmaceuticals was thrown out with biotech.
Companies like big pharmaceuticals could be a buy. In a time dominated by index and ETF investing, there can be opportunities if you dig through the detail.
A bias against indexing
The quarter, with its August 24th min-crash, showed investors that more than ever indexers, ETFs, and high-frequency traders are driving the broader markets.
As a stock-picker and follower of the principles of value investing, I know I have a bias against indexing. But, I believe that the combination of index investing, ETFs, and high-frequency trading brings out the worst in momentum investing. It can create a snowball that can move prices lower in a hurry without any consideration of the underlying fundamentals of individual stocks or the general market.
We are in a world of quick, powerful moves. A strategy to take advantage of this needs to be developed. I don’t have it figured out, however, it seems that the only way to navigate the volatility that can appear includes the following combination:
- Looking for stocks that have been unfairly trampled (the aforementioned healthcare example),
- Keeping cash on-hand to buy the fierce drops, and
- A commitment to patience and a long-term view
Don’t underestimate this bull market
Regardless of the poor performance and the downward pressures on the market, stocks did manage to re-group and bounce as the 3rd quarter ended. In fact, last week was a strong one for stocks. This surprised many pundits.
At the end of the quarter, pessimism was high, as evidenced by mutual fund outflows and the voices talking “bear market”.
Maybe the bounce will prove to be short-lived, the result of an over-pessimistic market that was over-sold. Time will tell. I’ll caution the bears that this bull market has weathered a lot and to underestimate it has been a bad trade.
— Ian Green, Pendragon Capital Management