October 16, 2014
When the Good Turns Bad
Change wears different cloaks. When things turn from bad to good, the cloak is a pleasant surprise, a wonderful flourish. When things turn from good to bad, the cloak is a dark shadow, accompanied by dissident organ chords. One would think that in today’s high tech world changes in financial markets would be devoid of drama, but it is quite the opposite. It all depends upon who is delivering the information. News services have evolved their own level of melodrama, while financial news channels have transformed news into infomercials.
As an experienced financial professional, I regard changes in markets as situations that evoke specific actions. When financial markets turn from bad to good, I will respond by including more equities. Conversely, when markets turn from good to bad, my response will be to reduce exposure to equities and include more bonds.
Equity markets have recently turned from good to bad, and we are now in the fourth correction of 2014. The first correction started in late January. The S&P 500 fell -7.5% in two weeks and then fully recovered in three weeks. In April the S&P 500 fell -4.3% in two weeks and recovered in three weeks. The third correction started in late July. The S&P 500 dropped -4.4% and recovered in three weeks. Yesterday this current correction, which started three weeks ago, had the S&P 500 down 9.8% from its September high.
This is the most severe correction of 2014 and we have been responding by reallocating portfolios into more defensive positions. We have been selling small cap, mid cap, basic materials and emerging markets equities, and buying longer-term bonds, emerging markets bonds, and utilities securities, all of which are holding up quite well. We continue to hold large cap, health care, pharmaceutical, technology, financial and real estate securities.
It is impossible to know how long or how much farther this correction will persist. The sharpness and severity of this correction implies that it may take additional time to rebuild a good base and form a recovery rally. Should the correction worsen significantly we will take additional defensive action. When the correction has run its course, we will be going back on the offensive. Either way, our discipline and experience allows us to sidestep the drama and take appropriate steps. Bad to good or good to bad, we have a plan.