by Brad M. Weafer, CFA Chief Investment Officer
We counsel taking a long-term approach to investing and caution clients to ignore, best as possible, short-term stock price movements. In that light, it almost seems incongruous to comment on market gyrations. However, we recognize volatility over recent weeks (both positive and negative) has left many clients feeling uneasy. In December stocks were hit hard, coming close to registering an official bear market with the S&P 500 down almost 20% from the highs reached in September to a low on Christmas Eve. The market subsequently rallied near 10% in the ensuing two weeks, whipsawing anxious investors.
Equity price movement aside, little has changed since we last commented on markets in mid-December. The main concerns continue to center on policy errors from a trade war with the Chinese and tightening of credit conditions by the U.S. Federal reserve. Recent economic releases have partially confirmed what bond and equity markets were telling us, these policy choices are starting to have an impact on the real economy. We have seen deteriorating data from the housing and manufacturing sector, lower CEO confidence, and a severe flattening of the yield curve. These are all incremental negatives points to slowing economic growth. However, none of the key indicators we rely on suggest an imminent recession. With corporate profit margins at cycle highs though, the risk to earnings should be the economy weaken further is real and suggests some caution going forward.
Fortunately, all is not bleak. Impressive employment gains, wage increases, and healthy consumer spending all point to a robust consumer economy. Against that fundamental backdrop, sentiment for equities has turned sour in a hurry, historically a contrarian positive for stocks. The recent decline in stock prices also reduced valuations to more attractive levels, another positive should the previously mentioned margins prove sustainable. With the economic picture turned more mixed, political turbulence in Washington has gained more attention. High profile cabinet resignations and a partial government shutdown are weighing on investor sentiment adding to the unease. Trying to forecast markets is difficult and requires us to sort out the “signal from the noise”¹. Our analysis suggests some increased caution, but no rash action. While we do not advise a reactive posture, there are still actions we are taking:
Focus on Protecting the Downside
We favor a disciplined approach focusing on high quality individual companies. Our portfolios contain highly profitable companies, with stable business models, that are trading at attractive valuations. By avoiding highly levered, deeply cyclical, expensive and speculative businesses; we lower risk. This approach outperforms passive indices when markets fall, calming the nerves of anxious investors. During the fourth quarter and calendar year 2018, all our proprietary equit strategies beat their benchmarks in a difficult market environment. Famous tennis star Martina Navratilova may have put it best; “What matters isn’t how well you play when you’re playing well. What matters is how well you play when you are playing badly.”
Stay Disciplined
Staying disciplined does not mean doing nothing. Emotions are the enemy of smart investing. When markets get turbulent, it can be easy to forget this and stray from a long-term approach that works. During good and bad times, we adjust portfolios based on our best estimates of risk and reward on a go forward basis. This includes being mindful of the prospects for individual companies and different asset classes. During the fourth quarter, we adjusted portfolios accordingly, reflecting a more cautious outlook for risk assets. This approach is nothing new and not isolated to recent events. Instead, this is an ongoing fundamental pillar of our investment process. Our team of investment professionals continuously monitor our exposures and reflect our well researched views.
Find Compelling Opportunities
For the patient investor, volatility creates opportunities. Our analysts work hard to stay unemotional and find compelling investment ideas that have been put “on sale” by the market. In more turbulent times, there are often chances to add to existing positions or find new companies to own. We are focused on identifying the individuals investments with the most attractive return opposites and acceptable risk.
Reassess Client Risk Tolerance and Asset Allocation
Since the financial crisis ten years ago, we have all become accustomed to above average equity performance. After the recent tough stretch, you may feel differently about the amount of risk and volatility that is acceptable to you. Now is the time to have conversations with your Wealth Manager to make sure you have the proper mix of riskier assets (like stocks) and lower risk assets (like fixed income) aligned to meet your long-term goals and objectives, and still allow for peace of mind.
¹“The Signal and the Noise” is a 2012 book written by Nate Silver, outlining the practice of using the principles of probability and statistics and applying them to forecast real-world situations.
Market Commentary Disclaimer: This publication is for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information contained herein is the opinion of Boston Financial Management and is subject to change at any time based upon unforeseen events or market conditions.