Yeah, you heard us right. This pullback is awesome.
We’ve received a lot of questions the last couple days about our reaction to recent market declines. We’re more than happy to share our view.
What’s causing the pullback? In short, inflation worries caused by the news that wages for American workers increased in January, and the attendant fear that inflation means rising interest rates. While rising interest rates would mean it could cost more to borrow money and; therefore, the earnings of companies that rely on debt could be impacted negatively, the immediate cause of this concern is actually very good news. People getting paid more usually results in increased demand for goods and services, which in turn grows the economy. This is particularly true when the wage increases are at the lower end of the pay scale. And while it’s too soon to say for sure, it seems likely that some, if not most, of the January increase is the result of 18 states raising their minimum wage as of January 1. The wage increases could scarcely have gone to a group more in need, or more likely to immediately spend their raises back into the economy. Long term, we think the news is bullish. And even if inflation and interest rates do increase a little as a result, let’s remember that those things are now starting from a place near their all-time lows. If anything, an interest rate hike poses little threat to the economy compared to the dangers posed by real, long-term, systemic threats. See our whitepaper on redefining portfolio risk here.
Nevertheless, the market has registered its short-term concerns. Should we worry? In our opinion, not so much.
First, note that this consolidation isn’t all that bad. As of this writing, February 6th at 10am, equities are at approximately the level they were last Thanksgiving. We’re fine.
Second, there are real upsides to this. Some stocks we love are finally approaching attractive valuations. We’re seeing lower prices for great, medium- to long-term growth opportunities. Others that had been at fair prices before are now at extremely attractive valuations. For those with investable cash available, this type of event can represent an attractive buying opportunity.
Third, additional benefits of a consolidation may be obtained if, upon recovery, we see the long-awaited return to fundamentals-driven equity markets. Generally, investors today are pouring into index funds, resulting in too many dollars chasing too few stocks. Indexing, which is not based on fundamentals, is illogical since it buys overvalued, outdated, and otherwise undesirable stocks indiscriminately along with the better ones. Remember, the price you pay up front for a stock is your best long-term predictor of returns, all other things equal. Paying a huge multiple for a stock because it’s in the S&P 500 Index is nonsensical on its face. Fundamentals-based, value investing is the antidote, and maybe this is the wakeup call we needed to bring us back to reality. “Fundamentals” aren’t named that because they’re optional; fundamentals are the actual lifeblood of the business you’re buying.
In sum, we say be glad for an overdue consolidation, and view it as your chance to position for longer term gains.
The GAA Team
Important Disclosures http://greenalphaadvisors.com/about-us/legal-disclaimers/