December 20, 2018
Do you remember 1931?
This was the year that...
· May 1 Empire State Building opens in New York City
· Mar 14 1st theater built for rear movie projection (NYC)
Yeah... I don’t remember any of that either (although I’m sure a few of you do!).
1931 was the last time stocks had this bad of a start to December - and that doesn’t include yesterday’s drop of around 1.5% which came after being up as much as 1%, early in the day. For anyone who thought that the Federal Reserve Chairman, Jerome Powell was going to come the rescue of falling markets and deliver a Santa Claus Rally, they were mistaken.
For the month of December, the S&P 500 is down 9.33% and for the year 2018 it is down 7.01%. Since reaching an all-time high of 2930.75 on 9/20/2018, the index is down 14.46%. This is a touch better than the performance of global stock markets with the All-World Index (excluding US) down more than 15% for the year. For most of 2018, global markets have been down and with the US being the lone bright spot. In December, the script has flipped but global markets are still down 3.76% for the month.
As global markets have sold off, we have followed our exit strategy rules across all portfolios and now have substantial cash to allocate to new investments. Many of the investments that we have sold along the way continue to be fundamentally sound long-term investments and we constantly monitor these positions for technical re-entry signals. And, along the way many of the stocks that we have had our eye on for several years but have always been too expensive for our liking have come back into buy-range from a valuation perspective – which is exciting. When I looked yesterday, across our entire book of business we held roughly 37% of our assets in cash, treasuries and CD’s. This is highly unusual and won’t last for long – but it is great evidence that our rules-based strategy works extremely well when it comes to capital preservation. Should markets continue to sell off, we will continue to raise cash. If markets turn around and run higher from here, we will still be in our best positions and we’ll act quickly to redeploy capital into our best ideas.
On the bright side, bonds have reclaimed their position as a hedge against a falling market in this quarter with the Barclays Aggregate Bond index up 1.39%, and up 1.59% for the month of December. We have been adding treasuries yielding around 2% (annualized) and will continue to use these instruments to generate a reasonable yield on our cash position while we wait for the markets to settle down.
To be clear, we have no interest in predicting or picking the bottom of this event any more than we were keen to call the top, 3 months back. As I mentioned in my last blog, timing the market doesn’t mean being all-in, or all-out. It just means correctly assessing the situation and behaving rationally and in accordance with a sound and rigorously developed rules-based strategy.
Right now, there is more debt built up in the global financial system than there ever has been before. The amount of debt carried by households, companies and governments is at unprecedented levels and was never “reset” during the financial crisis. Far too many companies that should have gone bankrupt long ago have been able to borrow more, and more, and more – perpetuating a malinvestment cycle that is also unprecedented (in my opinion). The survival of these companies starves our economy of true innovation by burning capital that would otherwise have been invested in other innovative ideas – both good and bad.
If you have a few minutes, I would encourage you to watch this interview of Jeff Gundlach on CNBC the other day. There is more but I can’t seem to find the full interview. Additionally, Jim Chanos was recently interviewed (also by CNBC) and this short clip is worth your 90 seconds.
There are plenty of reasons to be concerned. But there are also reasons to be optimistic. We are more than ¾ of the way to marking an “official” bear market (-20% from highs), and history is full of examples where markets go down 20% only to stop going down there and charge much higher over the years to come – and there are always reasons to be concerned.
This too shall pass – perhaps like a kidney stone. The only question is when.
Every bear market (20% drop) doesn’t need to be accompanied with a “financial crisis” or “great depression”. In fact, most are not. So, there are plenty of reasons to think we are close to the end of the sell-off. If that is the case, we will be ready to scoop up valuable investments with our cash. If not, we will continue to follow our predetermined but dynamic volatility-based stops, and this will preserve our capital for the future.
Chief Investment Officer
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