September was another brutal month in equities, and the third quarter was the the worst quarter of the past four years with the S&P 500 dropping 7%.
Every major index is now negative for the year, as are most sectors.
Equities
Within equities there was nowhere to hide as correlations all moved towards one.
Some equity classes have performed a bit better than others this year, but being well diversified across different style boxes has really not helped very much.
I continue to believe that the alleged benefits of diversification are both misunderstood and limited. In my opinion, when investors need those benefits the most, they are at their least effective.
Flashback
While August reminded me of August, 2011, September reminded me of the summer of 1998 when the markets also experienced extraordinary volatility.
Back then the issues were the collapse of Long-Term Capital Management and an Asian crisis which caused the S&P 500 to drop 8% and be down 1% for the year at the end of August.
From there the markets rallied strongly and closed the year with a total return of nearly 30%, all of which came in the final four months.
Smart Inaction
Sometimes raising a little cash and doing nothing is the right answer, as hard as that may be.
To be sure, there are differences between then and now, and to my way of thinking the most important one is that the Federal Reserve no longer has the conventional rate-cutting tool in its toolbox.
However, historically the domestic U.S. economy has been reasonably protected from international economic issues, and my sense is that this time will be no different.
China
Today’s concerns revolve around global economic conditions (particularly China and its implications).
In addition, there is the collapse of oil and other commodities, technical breakdowns in a number of indices, and valuation issues in certain sectors.
Other uncertainties include an abundance of debt, the timing and path of potential rate hikes and the ensuing shape of the yield curve, the inflation/deflation debate, and upcoming US elections.
None of these represent systemic risk to the financial system like 2007-2009, nor are there wildly outlandish valuations like the tech bubble of 2000-2003.
US Economy
So far the U.S. economy has maintained a slow but steady expansion.
However, the September unemployment report was surprisingly weak, and it remains to be seen whether it will negatively impact areas that have been doing well such as housing and consumer sentiment and spending.
Regardless, broadly speaking, today’s market is still somewhat expensive on traditional metrics, and my guess would be that the correction isn’t over yet.
I think the chances are good that we retest the August low, which would create better valuations and also bring more fear overall.
Strategy
Generally speaking I continue to like technology and also favor larger companies over smaller ones.
That said, the real goal is to find good companies and pay the right prices to own them.
The U.S. dollar’s strength continues to wreak havoc on any companies with significant international operations, although the pace of the dollar’s rise has slowed.
In my opinion, investors should take a serious look at Google (GOOG).
Cruising
I still like the cruise lines industry which continues to perform very well.
A number of analysts are warming up to energy companies.
Global oil demand is resilient, while production capacity levels are at historic lows right now.
Shares of super oil majors like ExxonMobil (XOM) seem to have stabilized as of October 9.
Photo Credit: Neil Kremer via Flickr Creative Commons
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