Investors are left to reconcile two seemingly contradictory themes:
- Let’s say a certain stock goes from $38 to $41 over the last nine months. In-between, it touches $36 on the low side and $43 on the high side. Mostly, it traded in a range around $40. It demonstrated stability despite a slowing economy and rising interest rates.
- Concurrently, the market narrative has focused on fear and disruption. New developments in current events are almost uniformly received as new threats – anxiety about a damaging recession persists. The economy is in regression to the mean from a long period of easy money and expensive valuations to what looks to be a long period of higher inflation and moderate valuations. Chicken Little regularly makes the news to share insights about the falling sky. Less dramatic takes are not considered newsworthy and receive little attention.
The stock referenced above is the S&P 500 Index (with the decimal point moved so the 4,109 becomes $41.09). The narrative needs little elaboration – from stories of a “banking crisis” to the spin that the Fed will do something different from what they said they were going to do (they have actually done what they said they would do), the tactical
volatility is reported as drama. Of course, the valuation correction in the first half of 2022 was disruptive, but since then, it has leveled off. To the talking heads lathered up for commentary, is this really your first rodeo?
It makes us think of Kipling’s poem, “If.”
“If you can keep your head when all about you are losing theirs…”
Keeping your head about you means:
- Recognizing that inflation is a serious issue, and we need to take our medicine;
- That the interest rate reset will reassert the law of gravity pertaining to valuation, and that a market dominated by expensive momentum is unsustainable;
- Earnings and profitability will return as the measuring stick;
- That high quality and reasonable price will be treated favorably over longer durations and offers competitive advantages; and
- That risk management and rational investing are foundational.
Since last summer we have been talking about an L-shaped recovery. While there is likely to be a wide dispersion of results amongst stocks and sectors, the indices are likely to be flattish. Valuations are less likely to expand as interest rates rise and earnings growth moderates. We believe that selectivity is an essential tool in this environment. There are businesses that offer persistent growth, even in an episode of slowing expansion. Differentiating your strategy from the broader market becomes more significant when the rising tide does not raise all ships.
We are not Polly Anna, and we are not blindly optimistic. The geopolitical challenges are substantive, from China to Russia to Iran. The 2024 Presidential election will be noisy. However, our sense of conviction flows bottom-up – from the businesses in which we invest as opposed to the macro. Great companies can deliver even when the episode is challenging.
