Fear Lives! Risk Off

Monday’s wild ride down and up was followed by Tuesday’s up and down. This market is not kind to those with delicate stomachs, and it doesn’t promise to become kinder soon. China’s devaluation of its currency struck us as a desperate move to sustain economic growth. The government follow-up of lowering interest rates and bank reserve requirements was telling as to the depth of China’s concern. As other emerging-market countries followed suit and devalued their currencies, concern increased that currency wars might intensify. Price wars among department stores can get ugly. You can imagine what could happen in the hands of a politician determined to stay in power.

A few points: this is not 2008 redux. There is no housing bubble. There is no banking crisis. In 2008 firms like Goldman Sachs and Bear Stearns and Lehman Brothers were leveraged 35 to 1 or more; they are not anymore. Liquidity for overnight transactions evaporated, and counter-party risk soared. The banking system today is healthy, and there is plenty of liquidity. This doesn’t feel like a stock market bubble. While stocks aren’t cheap and many are downright frothy, we currently do not have the problem of pervasive overvaluation that abounded in the late 1990s. Most important to remember: stocks will, at inconvenient moments, go down. It is normal. It is a part of the process of price discovery. As the pendulum swings too far to the cheap, buyers will show-up and force it back the other way. It is not easy, and it takes time.

Emotion is the foe of the long-term investor, and fear is a powerful motivator. The stunning, nearly unhesitating rise from the market low of around Dow 6,700 on March 9, 2009 to the high of 18,350 in May 2015 has left many unable to remember that market drops are normal. Indeed, market drops are where long-term investors earn their stripes. During tumultuous seas, it is important to focus on the horizon and remember your discipline. It is not a time to try to be clever or cute about the most nimble, fascinating strategy. Market disruptions are times to make sure you understand what you own and why you own it. A friend quips that “If you’re not the first one to panic, you’re too late.”

Reflecting on the Crash of 1987, the bursting of the internet bubble, and the 2008-2009 financial collapse, investors recognize that all of these tragic moments are in the past and that someday we will all be looking back on the summer slide of 2015 with faint recollection. But until the current unpleasantness is in our past, be vigilant and resolved to pursue your investment discipline through whatever may come. Central banks around the world have driven much of the economic and market recoveries of recent years. Their efficacy is not limitless, and their policy consequences are not yet understood. Monday’s drop was remedied for a while by more intervention by China. It was not long-lasting. Wherever this downturn leads, keep in mind that this is not 2008: there is no banking crisis. Banks are much less leveraged, the banking system is healthy, and there is ample liquidity. I hope this helps. Warren Buffet says, “We attempt to be greedy when others are fearful and fearful when others are greedy.” If prices fall enough, you can be certain Mr. Buffet will step up. Finally, forget everything you learned in the 1970’s; if it feels bad do it! If it feels bad to buy, then buy. If it feels bad to sell, then sell. Most often it feels bad to do nothing when that is exactly what you should do! Make sure your investment reasons are sound and your emotions are absent.

When seas are calm and skies are sunny, the newest seaman can man the helm. As seas roils and winds howl, experience and expertise are demanded. Don’t feel bad for being scared, but don’t automatically use your fear as justification for action. Call your financial advisor for some hand-holding. That’s what we are here for. The Chinese word for crisis is Weiji. It is a combination of the words danger and opportunity. Warren Buffet will be looking to buy. Be alert. Be calm. Please remember that we construct portfolios consisting of large and stable companies with strong sales, cash flow, and experienced management teams. Stay steady, and please call us if we can help.