13 Oct

Newton's First Law

Over the past couple of weeks, the volatility in stock, bond, and currency markets has returned. The U.S. stock market, as measured by the S&P 500 Index, just posted its seventh consecutive quarter of positive returns (ending September 30). It's a feat not experienced since the mid 1990s, when the Asian currency crisis broke 14 periods of positive returns. The result is that we have grown accustom to positive returns.

Today we are experiencing a repricing of risky assets, and this usually happens faster in falling markets then in rising ones. Interestingly, we seldom see investors and traders express concern when markets are going up quickly.

 

The latest upheaval in the markets stems from growth concerns in China, the world's fastest growing economy, and Europe, where economists are searching for any signs of growth. Markets had anticipated continued growth in the global economy. When recent reports no longer supported this view, institutional investors started running for the door—at least temporarily.

We do not put a lot of faith into technical analysis, but it is worth noting that strong market movements tend to build momentum and continue to move in the same direction unabated. It seems that Sir Isaac Newton's first law of physics (Newton's_laws_of_motion) applies to markets at times.

In the short term, these market movements lead to dislocation (and investor anxiety). In the long-term, these fluctuations self-correct. For example, in a slowing economy, energy prices fall on the perception that there will be an oversupply of fossil fuels. The decline in gas prices leads to more disposable income which, in turn, prompts greater demand for consumer goods and services. This triggers greater economic growth. Greater growth supports higher energy prices, which then leads to moderating consumer sentiment and spending. During most periods, this feedback loop remains relatively stable. Currently, though, we are living through a period where stability is absent.

We have penned in recent blogs that equities (stocks) appear fairly priced and that credits (bonds) are expensive and provide poorer long-term prospects. Today, equities have cheapened while fixed income became even more expensive. We believe that the human fear factor is at work. Giving credit to our friend Gary Kohler (Blue Clay), market sentiment today is ruled by the fear of losing capital. Tomorrow, this will morph into the fear of missing out on appreciation as prices turn higher.

As fundamental investors, we continue to monitor and assess our investments for intrinsic value while achieving a balance between opportunity and safety. In this light, we remain enthusiastic about return potential during the next six to 18 months. We continue our strong preference for investments where a significant portion of the expected return is paid out in current dividends or interest.

Thank you for taking the time to review, and feel free to contact us to continue the conversation.

Join us for an EPIQ Educational Event later this month (October 28) titled Keep Your Secrets Secret. Please email This email address is being protected from spambots. You need JavaScript enabled to view it. if you would like additional details and an invitation.

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