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Are We There Yet?

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Fear is rising as the market falls. We have been suspended in mid air, waiting for the market to break out of a narrow trading range. Suddenly, we break the range, stocks fall and anxiety rises.

We need to put things in perspective. The S&P 500 is up 104% in the past five years, 1.27% over the past twelve months and is now down 2.99% year to date. It wouldn’t be surprising to see a 10% decline before this is over as stock prices move more in line with earnings and expectations.

The market has not “tanked”. In fact, if we take a long-term view then this is positive. The market has been on a bullish tear for 6 1/2 years and a pull back is expected. Risk aversion is heightened and the good stocks get sold off with the bad. There is opportunity.

Corporate earnings have been positive for the past 5 years, recovering from the severe downturn during the recession. Earnings typically begin to slow at this stage of the economic cycle. The strong US dollar will impact corporate earnings and companies with above average earnings and revenue growth will hold up best. China is over 20% of global GDP so slower growth will be felt around the world. There is plenty for investors to worry about and drastic scenarios are emerging to ignite fear.

This is not 2008. We are not headed for a US recession. In fact, our economy is relatively strong. Employment is healthy with a 5.3% unemployment rate and the US housing market remains strong. Higher interest rates would dampen the demand for homes and refinancing but it is hard to build a case for much higher rates with inflation below 2% and global economic weakness. A modest increase in interest rates would send a positive message about our economic health and would not be a surprise. Rapid or sharp interest rate increases do not look likely.

In May we wrote a piece titled “When To Sell” where we stressed the importance of asset allocation and discipline. We advocated trimming stocks that had done well where valuations were stretched. We said then that “it is very difficult to make a broad market call” and “it doesn’t hurt to trim stocks that have done well” ( see News & Notes at for the full article).

The reverse of this is to add to quality holdings if they fall with the overall market. Are we there yet? Is it time to put some cash to work? The answer depends on the stock. Making a call to sell stocks based on a market outlook is nearly impossible. Trimming stocks that have done well makes sense. The opposite is true when the market declines. There will be some stocks, such as the large energy companies, that fall to levels that warrant a look. It may not make sense to add to stocks across the board but selectively adding to holdings that have dropped makes sense.

This market decline is not severe. It happened quickly as some of the high expectation, leadership stocks such as Apple, Netflix and Facebook finally dropped. These stocks were widely owned so selling can be severe with few to buy.

Some argue this is the capitulation phase and the market may be poised to rally. The truth is that no one knows. There are compelling arguments for further decline and reasons to be optimistic. The S&P 500 P/E ratio is 17.6X – still above historic averages but lower than the 18.8X in May. There are many stocks trading below this with strong balance sheets, high dividend yields and good fundamentals.

Market timing doesn’t work. Investors sell at the top and rarely get back in until long after a recovery is underway. Stocks perform well over time with dips along the way. This pull back may not be over yet. A 3% decline for the year after so many years of gains may not be enough. There is no reason for panic or fear, especially if there is cash on hand to buy on opportunity. China, the problems in Greece, low energy prices and a pending hike in US interest rates are grabbing headlines and of some concern – but not enough to send stocks to 2008 levels. Any bit of good news, with fear and pessimism so widespread, could send stocks higher.