I strongly suspect a new blog post will be needed tomorrow or the day after or thereabouts with a lot of historical data on market sell-offs, time spans to recovery, and general reminders about these painful moments in the ebb and flows of markets. In the meantime, a real-time “ad hoc” understanding of what is going on in THIS market sell-off is in order. A greater intellectual grasp of why this is happening will not do a lot to soothe investors seeing the markets dropping, but ignorance is not bliss, and we want to lay out what we are seeing.
In the most abstract of explanations, and perhaps in the “too obvious to have to say” camp, the world is experiencing a classic, textbook “risk off” panic. Yes, certain asset classes are selling off the hardest (tech stocks, emerging markets, commodities, currencies, and higher risk parts of the market), but essentially ALL classic risk asset classes are being punished, and all “safe haven” asset classes are seeing money flow in. There is little individuality to parse through around all of that: Risk = sell; Non-risk = buy. These “risk off” waves sometimes last days and sometimes weeks. Really bad periods can last months. Future blogs this week will lay out the historical data behind this. But the less abstract and more explanation behind what is going on right now can be found on the other side of the world, and that is in China’s hard landing economically. Their economy is and has been in desperate need of structural realignment, and the implications of this will take time to sort out. The consequences of this will most surely mean real life pain to some sectors, and temporary pain through irrational contagion for others. Do I believe that China’s realignment will punish many commodity producers and industrial companies? Most certainly. Do I believe that China’s realignment will alter the need for diapers, bottled water, and candy bars in the United States? No I do not. Will the latter camp sell off while this “risk off” continues? Yes, they will. Will this make sense to their actual fundamental valuation? No, it will not. We have learned from past contagions that we do well to avoid direct exposure to the most painful parts of a blow-up, but that the avoidance of direct China investment etc. is not enough in these short term sell-offs. All houses on the block take in smoke when one house goes up in flames. Multinational exposure is hard to quantify, and the nature of a company’s exposure to China is tough to qualify. What is more exposed – a company that manufactures product in China which gets sold in the United States, or a company that sells a product to China? There is no delineation between those two things right now. Through time, there will be.
It is a tough “cheer you up” article to write when you are deeply bearish on the root cause of what is causing this panic – the structural realignment in China (declining manufacturing, currency adjustment needs, etc.). There are three categories here: Direct exposure (Chinese stocks), Less direct exposure (companies that sell a lot in China), and then category #3 (companies that are down now because EVERYTHING is down). We are in camp #3, and we believe that in a few days or so we will start talking about opportunity there. For now, we will talk about the single number one ingredient that has ever mattered in the history of investing – the avoidance of the great mistakes. We are glued to our desks, iPads, Surface Pros, phones, cell phones, and if we have to be, pagers, to keep you from making those mistakes.
But David, what will cause a reversal here? A lot of the fear and panic has to get out of the system. The weakest of hands have got to sell. And they will. No reversal will be possible until that happens. Unless you have a truly amazing temperament, sitting and watching for that reversal is counter-productive. It’s timing is unknowable, surely as it is inevitable.
David L. Bahnsen, CFP, CIMA
Chief Investment Officer