Client Memo
To: From: Date: Re:
Greenspring Clients Greenspring Investment Committee September 22, 2011 Recent Market Conditions
Current Market Conditions The recent events in the global economy have caused fear and selling in many major equity markets around the world. Over the past two days, we have seen the US and Developed Foreign stock markets lose over 6% of their value, while Emerging Markets are down over 10%. While no one knows exactly why the market behaves as it does in the short term, from our perspective the largest uncertainty has to do with the fear over another banking crisis in Europe. Because European banks are large holders of Greek, Spanish, Irish, and Italian debt, many investors are concerned that any sort of sovereign default will cause significant carnage in the global banking system, which in turn could cause another global recession. In addition, investors may be getting the sense that they are on their own and government intervention has come to an end. The Federal Reserve has essentially run out of bullets, as interest rates are near zero, and fiscal stimulus (government spending and tax cuts) looks like a long shot given the partisan bickering in Washington, DC. What influences the stock market over time is corporate earnings, and investors are nervous that these recent events are going to cause a collapse in corporate profits over the coming year if a recession ensues. Perspective on Recessions Recessions, a normal part of our business cycle, occur because of an imbalance in our economy. For example, one area of the economy grows too quickly (often because of excitement and greed), and that growth (which is unsustainable) has to be unwound. This takes the form of job cuts, corporate bankruptcies, and a reduction in overall economic activity. While painful, this is a necessary part of the business cycle. The destruction of jobs and businesses in unsustainable areas of the economy allows capital to flow to more productive uses. New jobs and businesses, which are created through innovation, begin to pop up because they have a useful purpose and demand for their products. We saw this unwinding occur in 2000 (technology) and 2008 (real estate). At the same time, new businesses have exploded on the scene (e.g. Google, Facebook, Groupon) creating jobs and wealth where none existed before. The economy is still working through some of the excess from the real estate bubble in 2008. What is hard to see is where the current excesses are which would cause the next recession. Most economic indicators have basically bounced along the bottom since the crash in 2008.
Client Memo
Companies and consumers have been extremely conservative during this period, so there is not a lot of “fat” to cut, as you would tend to see entering a normal recession. While we think a recession may be likely, we also think that it could be fairly shallow, as most of the economic indicators are still below their 2007 peak and there are not significant excesses in our economy today that would cause a dramatic decline in activity. Greenspring’s Response Greenspring continues to manage client portfolios using a disciplined process. Because of that strategy, we are close to repositioning some of our bond positions into stocks. If the stock market were to fall another 5 percent, our strategic allocation to equities for most clients would drop below our acceptable threshold and prompt a buy. While we don’t know if this would mark the ultimate bottom, we have found that this strategy tends to work well during market declines, as we are able to pick up quality holdings at cheaper prices. While it may seem counterintuitive to buy when everyone else is selling, we have found that following the herd tends to lead to herd-like returns, which unfortunately have been dismal. The world is not coming to an end. Businesses and individuals will continue to innovate, creating new products and services that we cannot even dream of today. With all of the doom and gloom we have experienced over the past 11 years, we’d like to leave you with this thought. We have experienced two severe recessions over the past decade. During that time, the US stock market has lost 25% of its real value (after inflation). What many commentators fail to mention is how much progress these companies have made during that time, even though it is not reflected in their stock prices. Since March of 2000, corporate earnings have increased 78%, dividend yields on stocks are up 115%, and sales have grown 46%1. In 2000, investors were willing to pay extremely high prices for stocks, essentially disregarding fundamentals. Today, investors are again disregarding fundamentals, as stocks are becoming historically cheap. The pendulum has swung in the wrong direction. At some point, it will swing back. It always does.
This letter is for informational purposes only and should not be taken as investment advice. This is not a solicitation or an offer to buy any security. This material has been prepared solely for informational purposes and illustrates historical performance with indices. This does not represent any actual account performance. Indices are unmanaged. Investors cannot invest directly in an index. Although the material has been obtained from sources considered to be reliable, no guarantee can be made as to its accuracy. Greenspring does not render legal, accounting or tax advice.
1
Data Source: Standard and Poors (www.standardandpoors.com)