“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch
We are almost 10 years into a bull market birthed out of The Financial Crisis, throughout which, economists have described the stock market as climbing a “wall of worry”. The market continues to rise, but no one believes that it can continue. I am confident that at some point we will experience a correction. I am also confident that, many years from now, the companies we own will be much more valuable than they are today.
In my last post, I discussed the macro issues and narratives driving the economy. Market volatility has continued and, in addition to an extended trade war, US markets are now also concerned with rising interest rates, creeping inflation, and an inverting yield curve. There will always be news that creates market concern, but it is usually something unforeseen that impacts investors the most. And for that reason, it makes sense to dedicate this post to detailing our investment strategy and process, which emphasizes understanding the individual companies rather than the broader economy. The investment process focuses on investing in outstanding companies at reasonable prices and reasonable companies at outstanding prices. If we are invested in great companies and buy at great prices, then these investments will inevitably withstand any storms, and our investments will prove profitable.
“Love supersedes all armies.” – Dick Gregory
The market continues to benefit from positive investor enthusiasm fueled by a combination of factors:
- Strong corporate earnings performance for the first half of the year.
- A weaker dollar has made it easier for U.S. companies to sell their products overseas.
- U.S. wages have improved enough to encourage consumer spending.
- Interest rates remain low, providing continued sources of borrowing capital, and
- Earnings reports for the September quarter are expected to be positive.
On the policy front, the White House has placed the Healthcare initiative on the backburner to fully focus on tax reform which will be less likely to accentuate party divisions and, if approved, will benefit both large and small companies. RBC Capital Markets estimates that a drop in corporate tax rates from their current effective average rate of 27% down to 20% would add a proportional 7% to per share earnings. Smaller companies, which tend to pay a higher effective tax rate, would benefit even more from the tax cut.
With all of this good news, where can things go wrong?
“In the struggle for survival, the fittest win out at the expense of their rivals because they succeed in adapting themselves best to their environment” – Charles Darwin
2016 ended exactly how we predicted…..or perhaps the opposite of that. Election results contradicted most polls, and the market’s reaction to the Republican win was not the Armageddon that I expected. In fact, the Dow, Nasdaq and S&P indexes all improved more than 2.5% from the election to year-end. Benjamin Graham, the man considered to be the father of value investing, taught that “stocks aren’t pieces of paper or lottery tickets; they are units of ownership in real businesses whose underlying value does not change