In wake of stock market sell-off of the past few days, there is increasing evidence that small investors are getting scared. The Associated Press this morning reports that “the number of small investors who say they feel bearish soared this past week” and “some stock funds have been hit with their biggest withdrawals since 2012”. Here is the link to the AP article:
It may sound illogical but it is actually a
good sign. As we’ve noted previously, the stock market has not had more
than a 10% correction since mid-2011. This is longer than the statistical norm
for time intervals between “corrections” which, since 1945, have occurred on
average about every 20 months and average about 13% decline. The fact that
small investors are getting nervous and pulling out is positive in that it
relieves some of the extreme positive sentiment that is associated with rising
markets, particularly a rise like we saw in 2013 (which was up 30%, about 3x
the long-term average annual return).
We think the underlying fundamentals for U.S. companies remain
sound based on improving economic growth and higher earnings in 2014. At about
15x 2014 earnings, valuation is “neutral”, no longer “cheap” but not excessive
either. In addition, as we’ve mentioned previously, the financial arbitrage
that currently exists between the cost of debt and equity capital is also providing
support for equity valuations.
This morning’s auto sales and factory order data were lower than
expected, partly contributing to today’s sell off, but we note this data bounces
around significantly and does not move in a linear fashion. We don’t read much
into the softer data. There may also be some investor concern with Janet Yellen
taking over as chief honcho at the Federal Reserve, however our expectation is
she will maintain a gradualistic approach towards unwinding of the quantitative
easing program of the last five years. Concerns over slowing growth in China
are legitimate, however, with over $3.5 trillion in monetary reserves, we think
China has the financial wherewithal to engineer a “soft landing” for its economy.
We continue to believe the best opportunities remain in U.S. stocks, in which
we remain overweighted.
Our strategy of diversification among multiple asset classes is
an important way in which we aim to provide not only asset growth but also
reduce portfolio volatility, an important aspect of achieving improved
risk-adjusted returns. Corrections and market pullbacks are normal, and in many
cases, necessary, as they relieve extended positive sentiment and allow the
market to “recuperate” technically. We expect this correction will prove to be
another normal mid-cycle correction in an ongoing secular bull market.
