The Market: April 2014

While the major indices are more or less where they were a month ago, there have been major corrections in certain sectors of the market, namely biotech, internet, and social media.

The ETFs that track the biotech and social media stocks were down 21% and 22%, respectively. These are high profile sectors but are relatively small pieces of the general market and are unlikely to cause a broader sell-off of similar magnitude. I do think that the declines in biotech and social media illustrate an important lesson. Both industries have solid revenue growth in an economy where top-line increases are hard to come by. As a result, growth investors piled into these stocks.

Of course, rising prices spark greed, which pulls in more investors.

Stocks and markets don’t begin to fall because of downward selling pressure. They fall because once everyone that is likely to buy is in, there are no new buyers. Without new buyers, prices can no longer advance and it takes just one seller to start the avalanche. Just as buyers brought in new buyers, once prices fall, fear spreads, and sellers bring out more sellers.

Before investing, it is useful to look at whether the company is too widely owned.

Chasing hot stocks or ideas is a risky game. Many biotech and social media stocks are worth looking at but only at the right price. Perhaps the sell-off may provide attractive entry points to companies with exciting futures that now trade at more reasonable valuations. Declines like these can last longer than one anticipates so caution is warranted.

While parts of the market are declining and Russia is busy annexing parts of Ukraine, the broader market remains resilient. Most of this strength can be attributed to positive economic news that seems to be indicating that the sluggishness of February and March was really due to weather and now activity is picking up.

Manufacturing, employment, services, and consumer confidence all turned out solid numbers in April. Now we are in the height of earnings season and firms seem to be putting up good profit reports or at least figures that are better than Wall Street estimates. This should be supportive for the market. The bull market is getting old but there are precedents for up markets that last for extended periods.

In order to keep the bull market going, companies need to shift focus from the return of capital in the form of dividends and buy-backs to investing more in their businesses through research and development and capital spending on plant and equipment. If this happens, industrials, construction, and materials will be good sectors in which to invest. But businesses need to see a more robust economy before they will take on the risks of expansion.

We have been waiting five years to break from this sluggish recovery. Maybe we are getting close to the higher levels of economic activity that will give us escape velocity.

— Ian Green, Pendragon Capital Management

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Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.