Good News Trumps Bad News

October 16, 2015

Below is a quote from the September 18 blog of Scott Grannis, a US market commentator.  A better summary of the US economy and would be difficult to find.

      “The bad news: this is the weakest recovery ever; the labor force participation rate has been falling for 15 years; productivity growth is dismally low; our national debt is at a postwar high of 72% of GDP; race relations have deteriorated; tax and regulatory burdens are suffocating the private sector; savers and retirees have been severely penalized by seven years of near-zero interest rates; the rule of law has been weakened by the emergence of the Imperial Presidency; crony capitalism (a euphemism for corruption in government) is rampant; the tax code is a nightmare; and transfer payments are at record-high levels that correspond to 20% of personal income and over 70% of federal spending.”

       “The good news: despite all the bad news, household net worth is at an all-time high ($85.7 trillion), whether measured in nominal, real or per capita terms; households’ leverage has fallen by more than 30% since the 2009 peak; the economy has been growing and jobs have been expanding for more than six years; 30-year fixed mortgage rates are 3.84%, only 40 bps higher than their all-time lows of 2012; housing starts have increased by an annualized 15% rate for the past six years; the private sector has created over 4 million net new jobs since 2007; inflation has averaged only 2% for the past 10 years; and the dollar is still one of the world’s strongest currencies.”

Stocks are not companies

It’s easy to forget when we look at our statements that within the mutual funds we have in our portfolio are businesses that have a history of profitability and who have survived and prospered through economic declines for decades.

The S&P500, an index of 500 US stocks which represent the US equity market (if not the global equity market) declined 11% in the seven days prior to August 25th of this year.  From its all-time high in May it declined 12.4% at end of day Aug 25th (a classic correction) and since then recovered 5% or so. (Note – the decline in the Canadian dollar compared to the US dollar has slightly masked the decline in the S&P 500 for Canadians)

The article linked below provides interesting insight into why? First of all – why exactly did the equity market decline and secondly, does it matter?  The answers provided by the press (China’s slowing economy and devaluing their currency along with potential rises in interest rates) don’t seem so supportive  when you dig deeper (see article download below)

Which brings me back to the idea that “stocks are not companies”.  A stock is purchased on an exchange and trades with prices set by the minute by buyers and sellers.  A company is owned by shareholders with the primary purpose of creating profit.  As a simple exercise, think of some of the companies you know that have demonstrated a history of success – however you define it.  Now, when you think of these companies, do you believe the value of these companies suffered long term damage of 12% during that August decline?

It would be impossible to prove anything at this time – however, we do know when we combine the values of these companies and look back – we see growing value.

The gains are always longer and greater than the declines

The chart linked below tracks the Dow Jones rises and falls over the last 100 years. The periods that make headlines are the drawdowns or losses – they can be very short – 3 to 5 months with a number of significant down days.  The periods of maximum gain however, are longer and greater and less sudden.

Ritholtz chartNote the average number of months of declines is 16 (a year and 4 months can be a long time!) but the average number of months of gains is 73.