Placing This Week’s Selloff Into Context

Cascading negative news over the past couple of weeks have frightened investors and sent the S&P 500 Index below levels where we began the year. BCA Research says “The U.S. economy has stalled, the euro area debt crisis has intensified, and inflation problems continue to plague emerging market countries.” On Thursday, we lived through the worst market decline since December 2008.

How extreme were this week’s markets? The 7.2 percent decline for the S&P 500 represents nearly a three standard deviation move for the index. That means the move was nearly three times the average move in a given week, going back 10 years.

Though extreme, selloffs are common this time of year. According to the Stock Trader’s Almanac, August has been the second-worst month of the year for the Dow Jones and S&P 500 since the 1987 crash. The 7.2 percent decline for the S&P 500 was the worst week ever recorded during the month of August, beating out another dismal week for performance in 1974.

What does this mean? Many stocks can are now on “sale.”

We believe volatility can be your friend if you’re not overleveraged and take advantage of downdrafts. We often look to add to our top positions during down days, weeks or months.

In order to successfully navigate their portfolios through shifting markets like today’s markets, investors must understand the inherent volatility in commodities and international investments. I often coach investors to “anticipate before they participate.”

There are a few reasons to remain cautiously optimistic:

• Today’s job number was better than many expected
• Second-quarter earnings for S&P 500 companies are up over 17 percent on a year-over-year basis, according to BCA Research. This has been driven by a 13 percent rise in revenues for those companies.
• Current conditions are similar to 13 months ago when the S&P 500 was down 15 percent and prompted the Federal Reserve to initiate the QE2 program, BCA says. This means the door to QE3 has begun to swing open.

Being optimistic in today’s difficult market is certainly not traveling with the herd. Regardless of market conditions, those searching for reasons to be pessimistic will always poke holes in the optimistic viewpoint. This is a because “most people don’t want to risk looking dumb when it’s so easy to just go along with the herd’s view that the world is going to hell in a hand-basket,” writes Loretta Breuning, Ph.D. for Psychology Today. Breuning continues “Your brain scans for facts that fit the [your beliefs], and skims past facts that don’t fit.”

It’s also important to remember we must always view today’s market in a global context. The world has 7 billion people fueling the global economy. Today’s globalized world is quite different from the 1970s when many of the world’s 3 billion people were isolationists, non-participants in global commerce. Today, China and India are large contributors to the global economy. In these countries incomes are rising and consumption of goods and services is increasing.

Zachary Karabell did a great job of explaining this in a piece for The Daily Beast. In his piece, Karabell described this week’s selloff as “indiscriminate” and “programmatic.” Mainly, Karabell makes the case that focusing on the selloff ignores the shifting dynamics of global markets we’ve discussed for many years.

“So where does this sell-off leave us? The panoply above is vital—because it indicates that there is no cliff off of which the global economy is about to plunge, despite the blathering of pessimistic talking heads.”

“Yes, there is and will continue to be a risk of collapse; the events of 2008-2009 showed that we don’t have a safety net for our interconnectivity, and that is a real risk. But we do live in a much less levered world, and one in which there is a level of confidence, albeit new and untested, in the world beyond the reach of Wall Street and the capitals of Europe, to say nothing of the forgotten behemoth Japan.”

“Again, you’d be a fool to make a definitive market call for today or next week, but it’s hard to panic about a system that thrives where it used to lag and lags where it used to thrive. Those realities meet on the balance sheets of thousands of global companies who have been reporting just that for the past two years—booming abroad, treading water at home. This stock sell-off has little to do with profits, and everything to do with the relentless need for capital in Europe, plus an American investing class that is only slowly awakening to the fact that yes, this time it’s different.”

Karabell wrapped up his article with a piece of advice for investors

“This sell-off speaks to the continuing anxiety that a world not led by the United States and Europe and Japan is a world adrift. The smart money should bet that this swoon isn’t based on what we can see, but rather a fear of the unknown and the new. Welcome to the 21st century.”

What Karabell is pointing out is that the global fundamentals remain supportive of long-term growth.

This week was an outlier and extreme moves often present a buying opportunity. In a note yesterday, ISI Group’s John Mendelson framed this week’s selloff well: “There is nothing more bullish than fear nor more bearish than certainty.” Mendelson is saying that that if everyone is convinced the market is going higher, it may be a good time to sell. If everyone’s bailing out because of fear, it may be the time to buy.

Director of Research John Derrick contributed to this commentary.

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