After a rip-roaring start to the year in January with
the Dow Jones Industrials climbing to new highs, the
stock market in February and March was characterized by
falling share prices, lower valuations and higher
volatility. Market analysts call the recent decline a
healthy correction, a decline of 10% from the January
high and much anticipated. As share prices significantly
declined in the face of rising earnings, valuations came
down to more reasonable levels and, as we write, the
market seems to have stabilized in April. Though stocks
are essentially flat for the year, investors have become
more cautious questioning whether the long bull market
is sustainable. We are reminded that it takes a certain
amount of intestinal fortitude to be a long-term
investor. It has been a tumultuous time. Short term
sentiment is a fragile thing that can turn on a dime.
During 2017, investors viewed rising valuations with
complacency, buying any dip in prices and deferring
profit taking. (Revisit on our website, “Where Have All
the Sellers Gone?”, our note of October 2017.)
Anticipation of and final passage of tax cuts along with
regulatory relief promised a surge of corporate profits
and, to a lesser extent, middle class take-home pay.
Stock valuations continued to soar in January until, at
the end of the month, over-extended, the market began to
As market psychology quickly changed, analysts talked
about tax reform as baked into the market. Politics, all
but ignored last year, started to dominate the market.
President Trump’s proposal to place tariffs on foreign
imports, for example, sparked fears of a damaging trade
war though we suspect that the President’s hard line is
a negotiating tactic that will yield to compromise. As
we write, the market is sure to struggle with the
implications of the weekend military strike against
Syria in retaliation for alleged use of poison gas
against civilians. Gold and oil have rallied as tension
As is the case during the long bull markets, investors
become complacent, if not euphoric, about high
valuations. Corrections remind investors that stocks do
not go up in a straight line. But now there is something
new in the air, an emerging skepticism about how highly
stocks should be valued, a sense of vulnerability, that
there is a dark side to technology. For example,
Facebook stands accused of violating the privacy of its
users by selling their data in pursuit of profit. What
was once viewed as a unique and highly desirable
business model now seems likely to be vulnerable to
government regulation which could impact future
profitability. Tesla has a market valuation that rivals
General Motors though it produces and sells only a small
fraction of the cars GM does. Profits?… not for the
foreseeable future. The company is now facing a cash
flow crunch due to production delays which will probably
force it to raise new equity, diluting current
shareholders. Is the Tesla car a visionary product of
the future deserving an unlimited corporate valuation or
is the company just another car company selling at 6
times some future earnings? Some are beginning to
wonder. We view such skepticism as healthy for the
Good news: the economy is growing nicely. Growth is
expected to approach 3% as the year progresses.
Unemployment at 4.1% is historically low. Discouraged
workers are reentering the jobs market keeping wage
growth and inflation in check…for now. First quarter
corporate earnings are on track to rise 17% or so
year-on-year, an astonishing gain.
The Federal Reserve will continue to raise short-term
interest rates this year in a deliberate and methodical
manner that should support the equity markets. The risk
here is that, aside from geo-political military
confrontation, the economy overheats, forcing the Fed to
accelerate a rise in interest rates to combat inflation.
As of now, we feel that the correction is just that: a
correction, not the start of a bear market. Lower stock
prices coupled with higher corporate earnings means
lower valuations. This should help support the market.
Internationally, growth is picking up in tandem with
anticipated higher growth of US GDP. So, we anticipate
an OK year for the market, not a great one. In the
meantime we will have to get used to the tumult.
As a Registered Investment Advisor
regulated by the Securities and Exchange Commission, P.R.
Herzig & Co. is required annually to offer our clients
copies of our form ADV Part 2. This form describes in
plain English our business and how we operate. The form
can be found on our website, prherzig.com. Hard copies
are available upon request.
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