“Bears,” I muttered, adding a new fear to the pile. ~ Stephenie Meyer
In our February investor letter, the markets had not yet hit correction territory, and we were focused on what “normal” volatility looks like – because we just hadn’t seen it in a while.
As we entered 2018, the MSCI World Index had lacked a move of even 1% over the previous three months, which was the longest stretch of calm it had experienced since 2005.
After that, the markets got a lot more volatile, and fell more than -10%, entering actual correction territory. Corrections like these are more common than recent memory would tell us, and absolutely necessary to keep markets healthy and to prevent bubbles from forming. During secular, or long-term, bull markets, we can expect them every 11 months on average.
The big questions is:
Is this a healthy correction… or the start of a bear market?
After such an extended absence, the magnitude of selling that’s normal for a correction took on an unduly sinister appearance. However, there hasn’t been actual evidence that global economic and earning fundamentals have started to deteriorate. Job and payroll reports have come out with strong numbers – even more positive than most were expecting. Company earnings are remaining strong. The pullback appears to be based more on fear of what might come than on facts.
We’ve said for a long time that valuations have not been the most attractive, and the pullback has helped to correct some of that. While markets have typically had their best returns when pessimism is so extreme, it’s still not a time of screaming deals, where you can pick up a bunch of great stocks that people are giving away.
At this point, the bears have not yet woken from hibernation, though they may be stirring. Earnings have not slowed, and the global economy has not started to contract. Indicators that measure such things as industrial production, payroll employment, private non-residential employment, personal consumption expenditures, and manufacturers’ shipments are all trending upwards. There has never been a meaningful bear market without some kind of recession, and the economics don’t support a recession. In fact, the fundamental economics are why policy makers continue to raise interest rates – something they likely would not continue to do if the data pointed towards a recession.
Nobody really enjoys pessimistic market pullbacks. Even Warren Buffett has said that he doesn’t particularly like pessimism but he does like the values it produces.
So … why?
A former colleague used to give this opaque and somewhat frustrating answer when people would ask why the markets were down on that particular day:
“There’s more sellers than buyers today”
Or, if the market were up:
“There’s more buyers than sellers today”
And that’s often the reality of short term market behaviours. While it’s not entirely a zero-sum game, there are always two parties to a transaction.
Tomorrow, there may be a few people who decide they’re going to sit on their cash for a while. Or that they want to liquidate some shares in order to take a vacation. Tomorrow, some people may just not show up to buy – often, for a variety of reasons that may have very little to do with the inherent value of a particular stock.
Whether individual buyers have taken their wallets home today, or due to any number of other factors, a demand source has been taken out of the equation, and created a vacuum. If the buyers aren’t showing up that day, but a number of sellers are, who are willing to take a trade at a lower price, then you will see a change in value that may have very little to do with the actual market value of the underlying company.
Perhaps of note, we’ve taken a bit of risk off the table recently, and engaged in some defensive positioning. The rally in bonds has been a great opportunity to adjust allocation, especially in light of the upward trend of interest rates. However, we aren’t calling for a bear market at this time. We’re keeping an eye on the indicators, staying disciplined in our process, and attempting to remain on the right side of big moves.
– Dan Darchuck, CEO