Reflections on a Turbulent Market

close up of financial figures on a computer screen

It had been an extraordinarily benign period for stock prices in recent months. U.S. stocks were in their sixth consecutive year of rising prices, with the S&P 500 more than tripling since the market low of early 2009. European shares also were strong, and Chinese shares more than doubled since last fall in a speculative mania. We’ve expressed caution toward stock markets for some time, as uncomfortable signs mounted. These included flat to declining corporate revenues, historically high stock valuations, an unusually long bull (rising) market without a decline of more than 10% in the past three years (once a year is typical), high levels of speculation in social media and biotech stocks, and margin debt (borrowing by investors to buy stocks) at record levels. A decline in stock prices seemed increasingly likely to us.
A key reason for widespread complacency seemed to be faith in the perceived ability of monetary authorities to support — and if necessary, manipulate — financial markets. Then China’s stock market bubble burst, and despite repeated efforts by the Chinese government, stock prices kept declining. In addition, the Chinese government took an initial step to devalue the yuan, because it had become quite overpriced relative to the U.S. dollar and especially relative to other regional currencies. This overvaluation was causing a sharp drop in the country’s exports. After only a 2% initial devaluation of the yuan, markets fell sharply, causing the authorities to intervene to try to restore order. But this surprise, along with reports of slowing growth in the Chinese economy, led to concerns that things just might not be well under control over there.
We maintain a cautious position overall while expecting more volatility that will likely provide opportunities to buy stocks that we like. Our position is unchanged. The U.S. economy continues to grow, with housing, industrial production, and consumer spending still rising. Yet the lack of income growth for most Americans and an outrageous degree of income and wealth inequality remain not only morally troubling but also unhealthy for our economic structure. We also have structural concerns about the stock market, as computerized trading seems to magnify moves, both up and down. It’s uncharted territory to be sure, along with the unprecedented intervention in financial markets by central banks around the world as they borrow huge sums to inject into markets to provide support.
We have maintained higher cash levels than normal in client portfolios because of these concerns. We also continue to focus on the long term by investing in companies that are well managed, financially strong, and whose stocks are undervalued. The sharp declines over the past two weeks resulted in even better values for a number of our favorite stocks, as well as pushing additional stocks into buying ranges. We’re emphasizing companies that have rising cash flows and dividends, and we continue to reduce our exposure to the industrial sector, while finding several technology stocks and real estate investment trusts (REITs) to be quite attractive. And as usual, there are specific stocks in other sectors that we also find appealing.
As we head into September and October, which historically has been a weak part of the calendar for the stock market, we maintain a cautious position overall while expecting more volatility that will likely provide opportunities to buy stocks that we like.