With the associated headlines of last week’s stock market performance, and its continued retreat on Monday, we believed it prudent to send a note addressing recent economic developments and our related positioning of portfolios.
The current selloff is a result of failed global growth expectations, particularly in China, and China’s initial resulting policy response, which was disappointing to some investors. In our recent quarterly letter we highlighted the volatility occurring on China’s stock market. More recently, China announced a devaluation of its currency sparking concerns that their growth was a bigger issue than thought. It is important to note that China is not the sole reason for the recent global stock market performance but more the lightning rod of overall global economic growth not meeting “hoped for” expectations.
MARKETS AND THE MEDIA
Undoubtedly, the ugliest part about the recent week is the speed at which negative sentiment can perpetuate into the psyche of investors and ultimately the markets. There are institutional traders poised to take advantage of market uncertainty (both up and down). The speed and capital behind these traders is large and can cause significant short-term volatility. This, coupled with emotional selling by investors focused on the short term, can create sizable market sell-offs. Helping perpetuate these sell-offs is a confluence of media outlets sensationalizing every market movement in a hope to attract viewership. During these times we remind ourselves that media companies make money by selling advertising to a large viewership, not investing money.
HOW TODAY’S CONSERVATIVE APPROACH LEADS TO TOMORROW’S OPPORTUNITY
This year we have been positioning client portfolios more conservatively as our outlook on the markets and economy have generally followed a cautious tone. In short, we continue to be underweight in riskier assets such as emerging markets and high yield. In addition, we have trimmed equity exposure in portfolios and reallocated those monies to fixed income, providing additional benefits to the portfolio when markets stumble. Lastly, a number of the active managers we utilize have built up cash reserves within their portfolios. Most notably, FPA Crescent, a substantial holding in client portfolios, has built a 40% cash / bond position to take advantage of opportunities like this.
Although our portfolios may be more conservatively positioned, they will undoubtedly decline in the short term as markets decline from the current moves being seen. We have entered a phase in the market where growth has become a major focus of returns in the aggregate. When those growth expectations fail to manifest themselves, selloffs will ensue.
Staying disciplined to our investment principles is what allows us to act differently than the crowd and be able to focus on the long-term goal of growing your investments. Unfounded media hysteria is likely to continue, especially among short-term traders and “market experts” whose goal isn’t to affirm your balanced portfolio, but rather to leverage the moment for exposure and awareness.
WHAT DOES “NORMAL” VOLATILITY LOOK LIKE?
JP Morgan recently released an interesting graph (see attached PDF) outlining intra-year volatility. As noted on the graph, over the last 35 years (1980 – 2015) the average “intra-year drop” in the S&P 500 was 14.2 percent. Thus, in an average year the S&P500 will drop over 14 percent from its’ intra-year high to an intra-year low. Yet in 27 of the last 35 years the S&P500 still realized positive returns for that year. Over the last few weeks, the S&P 500 has dropped approximately 11 percent from its intra-year high, so nothing out of line. In the short term, we do not know how long the current turbulence will last. Regardless, we will continue to focus on exercising prudent and disciplined judgement in managing client investments.
In closing, we would like to reinforce that events like this will happen. In fact, we should all expect it. However, we recognize that knowing volatility will happen does not remove the human emotional element of fear and concern that can arise during unpredictable market swings.
Please follow this link to see the annual returns and intra-year declines in a chart format.