Market sentiment has been highly volatile lately. Unbridled optimism is abruptly replaced by fatalism in the blink of an eye as traders react to the news of the day. The Dow Jones Industrial Average has logged a triple-digit move no less than 33 times, or on 44% of the trading days, since April 1, 2010. Yet despite all that volatility, the DJIA is still only about 5% below its close on March 31. We appear to be in the midst of a classic trading range – a period in which only Wall Street traders and stock brokers consistently make money as volatility creates trading activity, trading revenue, and commissions.
That such uncertainty exists is probably not a great sign for the near term. As we all know, the markets don’t like uncertainty. But the uncertainty should not come as a surprise. As we survey the landscape, we find there are many possible outcomes to a wide range of issues: the European debt crisis, the housing market, federal agency interpretation of the new Financial Regulatory Reform bill, the direction of unemployment, Chinese growth, inflation/deflation, deficits, higher taxes and healthcare costs, the 2010 elections, etc. etc. For our part, we continue to believe we are in a “new normal” environment of sub-par growth for the foreseeable future. We must go through a period of deleveraging after consumers lost trillions of dollars of wealth in the housing and stock markets, leaving baby boomers ill-prepared for retirement. In response to the lost wealth and high debt levels, consumer savings rates have trended higher, and we expect this to continue. More saving and less spending will translate into sub-par economic growth. We believe the markets will more fully appreciate this reality as government stimulus initiatives are lifted. We are especially concerned about the fate of the housing market as mortgage rates rise in the absence of federal government support. We believe that housing is a much bigger factor than the consensus now believes, and falling home values, foreclosures and underwater mortgages will be a drag on the economy for years.
Having said all that, we would neither get too exuberant over the rallies nor too downcast over the sell-offs. Our consistent message has been that nobody can consistently predict these wild swings in the market. Numerous studies have shown that investors missing out on the best single-day rallies have historically forfeited a huge percentage of their long-term returns. Therefore, if we cannot predict when these days will come, the best we can do is buy good businesses and hold them with the expectation that their value will be realized over time. In other words, we believe this type of market supports a long-term, buy-and-hold approach to investing rather than invalidating it.
We continue to believe that despite the economic headwinds, value exists in this market for high-quality, defensive multinational companies trading at reasonable valuations. These kinds of companies with rock-solid balance sheets have lagged the market rally since the lows in March 2009. It should not be surprising that quality companies lagged during the recovery. First, they did not fall as much as the markets were dropping; and second, economic and market recoveries typically favor the lower-quality companies that had been “left for dead” going into the recession. But going forward, we believe investors will more highly value financial stability, transparency and earnings visibility as the macro headwinds become more fully appreciated. And the simple fact is that stocks are a very important way for investors to achieve their retirement, philanthropic and inheritance goals. Faced with ridiculously low yields on bonds, investors simply don’t have many other alternatives to stocks because stocks have consistently produced superior long-term returns. We believe this time will be no different.
We therefore would counsel you to temper your emotions as we endure these wild swings. Headwinds certainly exist, but there is also money to be made.