"The stock market is a device for transferring money from the impatient to the patient."
- Warren Buffet
Hardly has there been a more inglorious start for the markets than this. With the S&P 500 down 8% in two weeks, anxious would be a euphemism. But for the dates displayed on the front of newspapers, it would be hard to tell if it is January 2016 or August 2015 because the headlines are the same: "China Roils Markets", "Oil Drags Down Markets", etc. My nemesis, the financial press, never fails to parade fear mongers promising doom. Unfortunately I have to give them credit for being a worthy adversary. The pace of incoming telephone calls is testament to that. But facts should not be mistaken for wisdom. The ostensible reasons for this selloff are easy to discount and on balance there are more reasons to be optimistic than otherwise.
Chinese economic growth seems to be the chief bogey for doomsayers. China is attempting to transition their economy from manufacturing to a consumer/consumption base. The idea that such a transition would be seamless is naive. But it's a moot point for several reasons. First, trade with China involves mostly components; very little of our exports actually end there (less than 1%). Chinese consumption represents less than 0.7% of U.S. GDP and less than 2% of sales for S&P 500 companies. Second, our economy has never been pulled into recession by another country. Japan was the world's second largest economy from the mid 1960's through 2010. After Japan's 1989 economic collapse and ensuing 25-year stagnation our economy continued to prosper. Our recessions in 2001 and 2008 had nothing to do with an external country. We do not import recessions.
It's also popular to blame oil for the market's weakness. There certainly is a correlation. But in logic it is stressed that correlations do not prove causation. For example, global warming has a strong correlation with a decline in the number of pirates. Market commentators would thus conclude that global warming reduces crime. That a decline in oil prices would cause a recession is equally spurious. First, S&P operating earnings (a popular measure of profitability) ex-energy were up 11.7%, 8.4%, and 9.9% in the first, second, and third quarters of 2015, respectively. There seems to have been little spillover. Second, as net-consumers of energy, low energy prices are a strong tailwind for consumers. Here is a correlation that actually makes sense: Low energy prices leads to more money for consumers to save/spend elsewhere. Anybody willing to look down the road even a little would plainly see that low oil prices are a reason for optimism.
It seems to me that the market is in an alternate reality. The Chinese effort to transition to a consumer economy means two things. First, their demand for industrial commodities like copper, iron, and aluminum is reduced significantly. That means lower input prices for many of our domestic manufacturers, leading to higher margins and/or lower prices for consumers. Second, we do consumerism better than anyone. China's shift means a burgeoning end market for many of our best companies. Just listen to what Apple Inc., General Motors Co., IMAX, Nike, etc. say about the growing popularity of their products in China. With oil, it's hard to overstate the importance of energy prices on a modern, developed economy. High energy prices hurt everything; low energy prices are unequivocally a net-positive.
Regular readers of my newsletter will forgive me for repeating the fact that bear markets don't happen without recessions. There is no such thing as a bear market without a recession. The history of recessions suggests that they are most often initiated by some combination of high interest rates and/or high energy prices. Right now both factors are very favorable. The last time period we had low interest rates in combination with low energy prices was the 1980's; investors should be so lucky.
I break with my normal end-of-month newsletter schedule to remind readers that in these anxious times, to quote Franklin Roosevelt, "the only thing we have to fear is fear itself." This crisis seems to be one of confidence. The media adeptly plays to these fears and can easily leave one believing that it would be a good time to get out. However, the evidence is unambiguous: the danger really lies in trying to time the markets; investors who do get punished. Selling when things get scary and buying when it's easy is akin to selling low and buying high, effectively transferring your savings to someone with a stronger resolve. I can't claim to know what the market will do next week, month, or year. I do know that patience is one of the most valuable, and most difficult, characteristics of successful investing. Remember the obvious: stock markets have gone on to make new highs after market corrections 100% of the time. That stocks offer the best long-term potential over other options available is not controversial. So keep your cool, do not give into your fears, and turn off the news.
Brennan R. Redmond, CFA - Senior Vice President
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.)