We tend to believe October was a revaluation exercise; simply put, as interest rates rise so do discount rates reducing the valuation of future cash flows. While the downturn has been sharp, liquidity tightening remains benign and market/economic fundamentals remain strong. However, as we write this note, the markets are showing an upswing. Whether it lasts or reverses is anyone’s guess.
We chuckled at Jason Zweig’s (Wall Street Journal) recent remake of Rudyard Kipling’s poem “If”:
If you can keep your head when all about you,
Are losing theirs and blaming it on the Fed;
If you can trust yourself when guests on CNBC shout anew,
But make allowance for their shouting dread;
If you can wait and not be tired by waiting,
Or, surrounded by nonsense, don’t deal in nonsense,
Or, inundated in indicators, scoff at what they’re indicating,
And cherish the thought that uncertainty is immense….
Well said. Much of what has driven the October sell‐off is based on the notion the US Federal Reserve will be too hasty in raising interest rates, which will curb economic growth thereby ending the business cycle. Ultimately this fearful refrain ends in the dreaded “R” word, recession.
Government leadership has not helped dispel concerns, with the ongoing dispute between the US and China resulting in a tug‐of‐war on tariffs. At the same time, elsewhere in the world we have tensions between the EU and Italy over the Italian budget, flash reactions to killing of a journalist in Saudia Arabia, the US navy sailing in the South China Sea, and pipe bombs being sent to high‐level Democrats. Don’t get us started on the energy business here at home.
What is more surprising than markets falling is the fact that people are surprised when markets fall. Of course, there are lots of smiling faces on CNBC that will provide plenty of reasons why markets are falling (or rising), most of which is simply “filler” for programming time.
The reasons for market direction are quite straightforward. If the market is rising, investors are expecting corporate profits will rise and are prepared to pay more per share for that growth (multiple expansion). But if falling, investors are uncertain about long term profits leading to gyrations in multiples and, therefore, prices. This is, admittedly, an oversimplification ‐ Mr Market is an ever‐changing creature and the causes for rising and falling can also be ever‐changing. In short, we never really fully understand the reasons for a particular market movement at any given time.
Yet the underlying premise that we’re headed toward recession (in the near term) is flawed. In fact, economic activity remains strong globally, interest rates remain well below historical averages (though higher than they were at the beginning of the year), and corporate profit growth remains strong. While the latter has certainly been positively impacted by US corporate tax reductions, year‐over‐year earnings have seen positive growth net of these changes.
So, you might ask, why the October blow‐off? As mentioned earlier, there’s no real gauge to determine whether investors are being prudent or imprudent at the present time. While clear that certain areas of the market incorporated very lofty expectations for growth (FAANG companies – Facebook, Apple, Amazon, Neflix, Google – would be good examples), a recent article by Bank of America noted that companies that had reported “positive” earnings surprises in this quarter were actually punished by the market – indicating all the good news was priced into the share prices going into the report.
We tend to believe October was a revaluation exercise; simply put, as interest rates rise so do discount rates reducing the valuation of future cash flows. While the downturn has been sharp, liquidity tightening remains benign and market/economic fundamentals remain strong. However, as we write this note, the markets are showing an upswing. Whether it lasts or reverses is anyone’s guess.
While true that the past month has kept October’s reputation intact as one of the most volatile months of the year, the most opportune time to invest is when investor fear is at its highest. Of course, these words tend to fall on the deaf ears of investors who have participated in stocks with some of the massive early gains, like cannabis. After all, those who are aggressive in the bull phase will suffer thelargest decline in the correction.
In the art of investing, as Zweig alludes, better to keep your wits about you at all times. Patience, combined with a long‐term outlook, will undoubtedly prove successful.
