The current correction in stock prices should not
come as a surprise to readers of our quarterly
commentaries. We have long argued that prices were high
and that it was only a matter of time before excesses
would be purged. We have maintained high cash balances,
an unpopular stance, arguing that selling high, only to
use proceeds to buy high, was not a sensible course of
The S&P 500 is, as we write, now down 12% from its
summer high. The decline has been precipitated by a
series of events: the devaluation of the Chinese Yuan,
faltering growth in China and the rest of the emerging
economies (Brazil, Russia, Thailand…), the fear that a
rise in US interest rates would weaken economic growth
in America and strengthen the dollar, further
undermining growth. Geopolitical events aside, there is
a general uneasiness that world GDP growth is slow and
fragile, with economies prone to blow-up. By choosing
not to raise short term interest rates at its recent
September meeting, the Fed has re-enforced this
We have written in past letters that the zero
interest rate policies of the Fed and the European Union
has resulted in a misallocation of capital. Projects
financed with zero percent money are not necessarily
viable at more normal rates of 3% or so. As a result,
excess capacity has been built for which there is little
demand, which could eventually crush prices. Hence the
crash in commodity markets, excess iron ore production,
excess steel capacity and excess oil.
Fred Hickey makes an interesting observation in his
recent monthly letter, The High Tech Strategist. The
astronomical valuations of private start-up internet
companies is creating a bubble in West Coast real estate
values, particularly around San Francisco and Silicon
Valley. Private companies, having raised huge sums from
private investors at bubble like valuations, are
snatching up office space at increasingly high rents.
Should reality begin to set in that many of these
companies are not viable and at some point may be unable
to pay the rent, the extent of the real estate bubble
will become apparent.
Another sector that is correcting sharply is biotech.
We have singled out this sector for its overvaluation a
number times. In a recent week one biotech index fell
14%, a crushing decline. We expect more damage to the
sector as biotech exchange traded funds (ETFs) are
liquidated, forcing indiscriminate selling across the
While investors focus on the market's fall from its
highs of last summer, many large capitalization stocks
have been hit even harder over that same period:
Monsanto down 34%, General Motors down 27%, Amgen down
27%, IBM down 25%, to name a few. Herein we are starting
to spot value. We are beginning to consider investing
some of our cash balances in stocks that now have more
realistic and attractive valuations. Noting that we are
entering October, a month which has witnessed nasty
declines in the past, we are wary of calling a bottom.
We will be watching up-coming earnings reports closely
for signs of encouragement.
We have experienced a number of bear markets over the
last 30 years. They have all been unpleasant but in time
stock prices return to growth. During market downturns
it is important to temper short-term expectations and
focus on the long-term resiliency of economic growth.
Please read our important notice
about these letters and the securities they mention.