There is never perfect clarity in financial markets

The stock market pulled back in August and September with most of the weakness in the latter month following Fed Chairman Powell’s comments that interest rates would likely stay higher for longer. Currently, only 15% of the S&P 500 companies are above their 50-day moving average. Interestingly, fourth quarter returns have tended to be quite positive in past instances when the market was weak in August and September.

On the other hand, there are many headwinds which we have mentioned previously: a slowdown in China and increasing trade tensions with that country, higher energy prices and labor unrest which reduce corporate profit margins, excess benefits from government handouts during the pandemic are exhausted with a corresponding increase in consumer debt. And now the threat of a government shutdown. We know the economy is slowing – whether it falls into a recession or not is unknowable at this time. Clearly, the Fed is expecting a soft landing, but its forecasts have an extremely dismal record. We do know that the yield curve inverted 14 months ago (short term rates are higher than longer term rates) and the typical lead time from a yield curve inversion to the start of a recession is…14 months.

Of course, there is always a litany of things to worry about, and there is never perfect clarity in financial markets. The past few years have been no exception. The market climbs a wall of worry and always goes up well before it’s clear that problems are solvable.

Particularly, in times of increased market volatility, it is useful to remember that your personal circumstances, time horizon and risk profile should dictate how you invest far more than what you think will happen in the markets in the short-run. During bear markets and corrections your portfolio value may temporarily decline, perhaps significantly. However, if you own solid companies, your dividend income will not decline. When you own a stock, you own part of an underlying business. Stock prices are much more volatile than the businesses they represent. Price volatility is a function of the market and short-term investor sentiment. We look for businesses with sustainable competitive advantages and financial strength. If their prices decline in the short term, we view it as an opportunity to add to a good company when it’s on sale. A long enough time horizon is the best hedge against most market risks. Over the long run, stock returns are driven by earnings and dividends.