It’s easy to be negative. With energy prices and geopolitical
tensions running high, and with housing and the economy starting
to slow, is it any wonder that consumer and investor confidence
levels in recent weeks are at low levels?
Yet, our recommendation has been to stay the course. As we mentioned
last month, some individual investor sentiment surveys were at
their lowest (most bearish) levels in years. To us, that was a
contrarian signal. August ended up being the 2nd best month of
the year for the S&P 500 with a 2.4% gain (it was up 2.7%
in January).
Also, despite a general sense that the market really hasn’t
done much this year, it’s fairly remarkable to note that
the S&P 500 has been positive in 7 of the 8 months so far in
2006.
Seasonal Patterns
We have been hearing a lot about “bearish seasonals” from
clients and prospective clients, and we have talked about them
ourselves. To note, since 1900, the Dow Jones Industrial Average
typically has had its worst month of the year in September. The
average return in September is -1.2% (February and May are the
only other months with negative averages – at a mere -0.1%).
September is also the only month that is positive less than half
of the time (41%). In sum, September is typically not a friendly
month to stock market investors.
Yet, as with all rules of thumbs and averages, they are not infallible.
The last two Septembers have been positive. Nonetheless, there
has been hesitation on the behalf of some to invest in the market
because of this bearish seasonal pattern. While those investors
could be right this year, it could be argued that September is
actually the BEST month of the year to buy the market.
First off, buying on price weakness – when stocks are on
sale – is better than buying them when they have already
risen. Second, the fourth quarter of the year is typically the
strongest of the year. For example, a glance at the table to the
right shows just how important the fourth quarter has been over
the past five years to the full year’s result.
Wall of Worry
So why is the stock market making gains when the housing market
is slowing, oil is still around $70 a barrel, no solution seems
clear in Iraq, terrorism is disrupting our lives and Iran and
North Korea are rattling their nuclear sabers?
Interestingly, the stock market often posts gains in angst-ridden
environments.
In fact, it is so common that Wall Street has a phrase
for it; climbing a “Wall of Worry.” Today it’s
not too difficult to dream up scenarios of the future that look
sort of scary. Yet, the market is currently on track to post
its fourth consecutive positive year (knock on wood).
Another example of climbing a wall of worry is the 1950s. That
decade was one of the best decades to own stocks, but from a geopolitical
basis everyone was scared of nuclear war. Remember all the school
drills where you had to run into the bomb shelter or hide underneath
your desk?
Housing
Housing is indeed a concern to us. If housing really does flip
over hard, then it’s no reach at all to think that consumer
spending will also turn lower. How deep can the correction be?
While some suggest that housing could have a soft landing, soft
landings are usually built on the back of hope and not hard data.
Nonetheless, some of the crucial variables to housing are the
general level and trend of interest rates. Currently, with the
Fed on hold regarding short-term rates, and with longer-term rates
a half a percentage point off recent highs, the interest rate backdrop
is more favorable for housing and consumers than it was a few months
ago. In addition, in an historical context, the absolute level
of interest rates is not high — either in nominal or real
(inflation-adjusted) terms.
Another encouraging sign to us is that the stocks of homebuilders,
which have lost approximately half their value over the last 12
months, have actually stabilized and risen a bit in recent weeks,
just when the news on housing has been its darkest. Typically,
if a security or market holds up well when the news is bad, that
generally means that better prices are ahead for that particular
security or market.
In sum, the impact on the economy and markets of a deep and prolonged
slump in housing remains a concern and we will continue to look
for signs that things are getting better or worse. But right now,
the news is not all bad.
Peter Lynch’s Eight Rules
In recent commentaries, we invoked some of the sage advice from
legendary money managers such as Sir John Templeton and Warren
Buffett. For good reason, their writings and actions have influenced
the way we think about managing money.
Another is Peter Lynch, who achieved his fame by averaging a return
of 29% per year running the Fidelity Magellan Fund from 1977 to
1990. Peter’s approach was opportunistic, he turned over “lots
of rocks”, and his portfolio was widely diversified.
At an investment conference in New York City well over a year
ago, Peter provided some of his rules for investing (our comments
in italics):
- Know What You Own
Do your homework
- It is Futile to Predict the Economy, Interest Rates and the
Stock Market
Diversify broadly
- You Have Plenty of Time
Be patient
- Avoid Long Shots
Invest, don’t speculate
- Good Management is Very Important and Buy Great Businesses
Meeting with management is important
- Be Flexible
Be humble and adaptable
- Knowing When to Sell is Hard
Have a sell discipline
And perhaps most important, and appropriate, for today’s
environment …
- There is Always Something to Worry About
Yet, the market has a powerfully positive history! As Peter has said, forget
about all the bad news because the crucial variable to good investing is
not having great intellect, but having a strong stomach.
Sincerely,
Eric M. KobrenRusty Vanneman, CFA
PresidentDirector of Research
Portfolio
ManagerCo-Portfolio Manager
