October 2007 |
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Have you ever seen a flock of birds almost magically swoon left and then suddenly take a right in one synchronized move? It is an amazing thing to watch and it invariably leaves me wondering how it happens. There's no need for a master plan. It's all just the result of a series of tiny and almost mindless decisions. It should come as no surprise that like other things in nature, financial markets often behave in the same exact way and may be doing it more often than in the past.
Over the past eighteen months, the markets have shown us some pretty incredibly synchronized moves. On three distinct occasions, markets around the world suddenly zigzagged left and right or, perhaps more accurately, suddenly down and then up again.
Back in May 2006 emerging market stocks fell about 25% in a little over one month's time. At the time, it was blamed on the strengthening Japanese yen and spiking oil prices. Seemingly every investor wanted out of emerging market securities in order to repay their loans denominated in increasingly expensive yen. Oil prices hit $75 per barrel which seemed really high and is ironically lower than it is today. However, emerging markets fully recovered in just five short months. In fact, today the index of emerging markets is up almost 100% from their low point reached in June of last year.
Again, in February 2007 emerging market's experienced another sudden spasm and fell about 15% in less than three weeks this time. This time the drop was attributed to speculative Chinese stocks falling 10% in one day and blamed on phase-one of the subprime mortgage mess that we're all talking about now. It certainly didn't help that former Fed Chairman Alan Greenspan (in a speech given in Hong Kong) started opining about the possible odds the US would fall into recession. However, despite this second warning shot to investors, stocks fully recovered in a little over one month. For the record, from that low set in March, emerging market stocks now sit about 50% higher today.
It is important to note that when we mention emerging market stocks and their subsequent drops and recoveries, large US company stocks also fell but by much less. They also recovered much more quickly in both cases. While often touted as a great way to diversify, worldwide stock markets now tend to behave much more in lock step than ever before.
Now, as almost everyone knows, stocks took yet another big dive this past summer. From mid-July to mid-August, emerging market stocks once again led the drop with a 22% decline in a bit over three weeks this time. Also, large US stocks fell 10% from their peak which was the first time they fell that much in over five years. Without stating the obvious, at this point the subprime mortgage debacle became a front page story and credit markets around the world literally came to a screeching halt. The Fed provided help to the banking system and the selling pressure came to sudden halt. From the low point reached in mid-August, emerging market stocks have already fully recovered and more. Their return from the mid-August low to today stands at 40%. As I write these words, large US stocks have also fully recovered from their drop and once again set new all-time records.
Now, what does all of this mean for investors? It certainly means that today's capital markets appear jittery but also extremely resilient to negative economic news. Three solid swipes at the knees of investors and they are still defiantly standing tall. Granted, they weren't smiling too much during the beatings, but they've shaken them off pretty convincingly. Frankly, the recovery time has been nothing short of amazing.
On the flipside, it also means that there is a good amount of guessing going on by investors. The guessing centers on the health of the economy over the next six to twelve months. Investors today have seen the Federal Reserve act aggressively to inject confidence into the financial system. Confidence is what provides the guts to "look over the valley" of an economic slowdown to an eventual recovery. The guessing is not about whether a slowdown is going to happen, it is matter of how deep it gets. The half-point Fed rate cut in September and the cuts to come are setting the expectation that the slowdown will be relatively shallow.
As you know, at the core of what we do every day is look for bargain priced investments. This is our foremost challenge, however looking at larger macro-economic issues does matter. It's a lot like checking the weather report before heading off to work. We liken the importance of having awareness to the economic backdrop to walking around with blinders on happily finding attractively priced stocks one at a time and then suddenly getting crushed by a large Mack truck!
The Mack truck of today is ascertaining where the real estate market is headed and the affect that industry-specific depression is going to have on overall consumer spending. The next six to twelve months will clearly tell that story and we will be intently looking for dangerous lightning in the storm clouds that everyone and their brother-in-law already notices.
The Fed and their manipulation of short-term interest rates will matter, if not only due to the large positive psychological affect it has on investors. Still, consumers will need to keep spending at least at a moderate clip to keep things from slowing down more than investors are already expecting.
In the meantime, having attempted to remove our blinders and look both ways before crossing the road, over the past two months we've picked up twelve new stocks (bringing our total to about thirty now) and we've gotten the chance to add to six existing holdings. As we've said before, this is the most active we've been in years. We're happy with the prices we've paid. In our view, price is a wonderful counterweight to risk. To that point, we've been able to pick up shares in companies at an average of 30% off their recent 52-week highs.
While we aren't putting it past the flock of stocks to veer this way and that as the economy-of-the-near-future unveils itself to us, we are comforted by fact that the Fed is decidedly in a interest rate cutting mode and that investors' have demonstrated that they can take blow after blow after blow and keep moving up.