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Financial Market Update

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I wanted to update everyone on what has been happening and what we have been doing in the face of this unprecedented drop in the stock market.

We have officially entered bear market territory after an 11 year bull market.  Even though this has been very painful to go through – I personally have gotten very little sleep as I have been getting up in the night to watch the close of the Asian markets and opening of the European markets – its become apparent that the trading algorithms employed on Wall Street that drove the market to historic valuations over the past couple of years have turned against us and driven stock prices down to 2017 levels.

As I write this on Monday evening, the Futures are pointing higher.  This may persist until morning and give us a positive day or something in news may change things.  Either way, I thought it important to give you the three stages of a bear market.  The following was published by Tony Dwyer and I saw no reason to not just quote him.  In the discussion of the three stages, he compares the current market to both 2008’s Subprime Loan Crash and the 1987 Portfolio Insurance Crash:

1. “Panic – This happens toward the end of the initial crash, like what happened in 10/1987, 08/2011, and currently. The SPX was down 33% and 18% at the panic lows in 1987 and 2011, respectively. At last week’s low, the SPX was down 26.9%. You only know where the initial panic low is AFTER you have seen the multi-week rally.

2. “Relief – This develops after the crash with a violent multi-week reflex rally as investors are simply glad it stopped crashing. The relief rally in 1987 and 2011 recouped 30% and 40% of the losses from peak to panic low, respectively. This would suggest a bounce-back range in the SPX of 2750-2850 over coming weeks.

3. “Demoralization – This occurs when the market tests the panic low as the realization of weaker economic and corporate news is released, similar to what took place leading into the 12/1987 and 10/2011 test of the lows in those two market crashes, respectively.”

Managing an investment portfolio is a process.  When the market reaches all time highs, you reduce your market exposure and raise cash so you can invest lower when a correction occurs.  As I’ve written on the blog in past articles, we were very prudent to have cash on hand over the past couple of years when fundamentals (like earnings growth) were ignored by the algorithms and stock valuations pushed ever higher.  Fortunately, as the market has been falling, we have invested in some of our favorite companies, funds, and index funds at cheaper prices than we saw at the top of the market.

We continue to make purchases in our managed accounts, but we are anticipating that we are nearing the end of the Panic stage as discussed above and should be moving into the Relief stage soon.  As the market nears the 2750 level (and hopefully the 2850 level) we will be raising cash again so that we have resources on hand to buy our favorite investments for client portfolios.

Corrections and crashes are part of the investment process, but long-term success with your investment means that you need to not panic when the market goes down, even if it goes down significantly.  The Corona Virus will negatively impact corporate earnings for two to four quarters of 2020 and possibly 2021.  Stock prices are a function of corporate earnings, and mathematically from a discounted cash flow valuation, two quarters of earnings is only 5% of the total calculation while four quarters of earnings is only 10% of the total calculation.  A stock market correction of 30% like 1987 or 40% like 2008 undervalues company’s future earnings in a material way.

Warren Buffet, one of the greatest stock investors of all time, has said repeatedly over the years that the best time to buy is when there is blood in the streets and stock prices have been slashed to a fraction of their real value based upon future earnings.  This is one of those times that “uncle” Warren looks forward to in order to buy quality companies at a significantly discounted value.  That is exactly what we have been doing on behalf of our clients by raising cash when the stock market was making new highs and reinvesting it as the market has fallen.

There is no way to specifically say when the bottom of the correction might occur, but when stocks are valued downward significantly and you can buy a quality company whose earnings will return to a normalize growth rate at 17.95 price to earnings ratio (the current P/E for the S&P 500) from a 24 P/E just a month ago, this is a buying opportunity even if the market goes down some more.

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To give us some perspective, this graph shows you the S&P 500 since 1986.  I’ve annotated the major market disruptions so that you can see that sitting tight has always been the right decision.  Selling at the bottom of a correction or crash means you miss out on the recovery stage and lock in a permanent loss of capital.    To stress this point even more, below is a graph of the S&P 500 since 1922.

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Managing the volatility in the stock market is part of the process of investing.  If you are fortunate to have cash on hand, whether you are Warren Buffet or one of our clients, you can buy shares of stock, mutual funds, or ETF’s at discounted prices and over the long term benefit from the growth of corporate earnings and the stock valuations associated with it.

One of the hardest things to do is to remain calm and seeing clearly in the face of a stock market showing you paper losses.  However history shows that buying during corrections as we have been doing for clients produces very positive results over the long term.

Stay calm and let us do the worrying for you.