Monday, February 3, 2014

Who's Got the Bigger Story: Sports or Financial Markets? (A view on recent markets selloff)

The stories aren’t too different!   Denver Broncos’ Super Bowl performance and today’s financial markets’ performance can’t be described in any flattering terms that I’m aware of! 
Well, at least the markets showed up to play.
Ok….enough w/metaphors.

Some thoughts on recent market moves:

After January’s 5% drop in the Dow, today’s 2% selloff is bringing the stats awfully close to the 10% level that market pundits dub ‘correction’ territory.   Given the strength of today’s move, both breadth and depth, the 10% mark doesn’t seem too unreasonable to consider.

In my view, this corrective move is long overdue.  

As I argued for some time in the final months of 2013, the market was reaching levels where valuations were supported by far too optimistic views of future earnings growth, and far too mild perceptions of global headwinds.  The terms that I’ve been using to describe our portfolio positions have all included some version of ‘cautiously optimistic’, or ‘defensively optimistic’, noting that, in general, the world has become a healthier economic place in recent years, with global companies facing superb opportunities for new markets (hence “optimistic”), but plenty of reason to be sober about those growth prospects and to not price in overly optimistic views into equity valuations (hence, “defensive”).  Earnings season has been one of the key catalysts for the recent selloff, adding to the already deep concerns that markets have for the impact of Fed tapering on Emerging Market countries.  Both issues have hit with a vengeance since 2014 began, first with earnings being ok but underwhelming and often coming with bleak guidance for future prospects, coupled with several Emerging Market countries continuing to see tapering inspired capital flight, which triggered the falling dominoes of sinking currencies, more stress on funding current account deficits, rising imported inflation, and counter-cyclical central bank policies as defensive responses.

The question is where do we go from here?   Is this the beginning of a 2008-style market rout?  Or is it a healthy re-calibrating of equity valuations with global realities?

At this time, I believe it’s the latter.  In general, company balance sheets are in excellent condition, having used the past few years of low-interest rate environment to either pare down debt levels or to refinance to lower costs.  Operating leverage is also quite strong, as companies have cut costs and forced themselves to operate ‘lean and mean’.  The inflating impact on margins has been a good thing.  But among the ‘defensive’ arguments is that companies can only squeeze expenses for so much and for so long.  At some point, if there isn’t sufficient revenue growth, then it’s likely that margins will shrink, along with EPS, and then equity prices. 

The selloff since New Year’s, in my view, is creating equity valuations that are more in sync with the combination of global opportunities and global challenges.  With the historically high levels of cash that I’ve been holding in the portfolios, among other things, I’ve been adding to companies in the Discretionary space that are likely to benefit from a growing middle class in many EM countries around the world.  I’m continuing to look for and add to companies that play into the US energy infrastructure buildup that is likely to underpin the growth of domestic based sources of all kinds of energy.  I’m looking to add to key players in the alternative energy space, in particular, solar.  I’m focused on the tech sector, with a preference for companies with a global reach, masterful innovation skills, and likely to be at the forefront of next-generation products and technology. 

These kind of market selloffs are not fun to experience.  And the day-to-day mark-to-market on positions can be humbling.  But unless signs emerge that would materially alter the view that I’ve expressed above, I’m viewing the pain of recent weeks as an opportunity to add value to the portfolios.  As things evolve, I will keep you posted, and as always, if you have any questions, please let me know.


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(Please note: This article is solely meant to be thought provoking and is not in any way meant to be personal investment advice. Each investor is obligated to opine and decide for themselves as to the appropriateness of anything said in this article to their unique financial profile, risk tolerances and portfolio goals).
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Additional Disclaimer: currently long many stocks/ETFs.  Positions may change at any time without notice.

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