Overdue Correction to Overdone Correction

If you like volatility you had a great time last week as the major markets were whipped around like a yo-yo as traders unwound major bad bets causing violent selling of S&P 500 stocks making normal trading impossible. Most long term investors were paralyzed to an extent, wondering how exaggerated these short term moves would affect the markets. The surge in volatility played a big part in the S&P 500 Index moving from an all-time high to a 10% correction in only 9 days of trading. Now, we are searching for a short term bottom, watching and monitoring volatility based securities to calm down and margin pressure to subside. Trading activity on Friday may have provided a short term clue that these crazy volatility traders may have hit their zenith with margin pressure dying down in late afternoon trading and the S&P 500 Index bouncing exactly off an important technical level to close positive on the day.

I have written and talked about the dangers of margin for traders and investors caught on the wrong side of an unexpected move many times. This is exactly the powder keg that was created by traders and hedge funds betting that volatility would remain low and oddly putting significant money into funds designed to exaggerate moves in major market averages. Once this powder keg went off the short term avalanche of counter trades to offset these bad bets caused a surged in S&P 500 Index selling. This caused most of our good stocks based on good companies with sound fundamentals to be sold aggressively without distinction. While this activity is scary to watch, some perspective and common sense comes in handy for long term investors. A good tag line I heard last week said; common sense is as uncommon in investing as it is in real life.

The surge in volatility at the extremes seen last week doesn’t last very long and usually subside quickly after they erupt. Therefore, we watch and wait for the craziness to subside and look for bargain prices for our best companies. And, a market that was trading at a high unsustainable level was quickly adjusted to a manageable 16.8 times based on forward earnings. This is a level that will bring in most long term investors to purchase stocks for their portfolios. If interest rates calm down, then I believe a short term bottom is close at hand. If interest rates move higher and volatility remains high in the stock market we will have to gear down a bit, waiting for calm waters that are sure to come.

Fundamentally, I continue to review many companies that we own that are delivering outstanding earnings and outlooks for their operations. You would think they were living in a different world. And, to an extent they are as they focus on products and services that consumers and businesses are buying. For the most part, good companies are enthusiastic about their prospects and are not paying close attention to the short term volatility in the market. My advice is that we should do the same.

Have a great week,

Roger N. Steed

February 12, 2018

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