The Slide Continues

We've yet to have any relief from this year's global selloff in stocks. Three weeks into the year and both the Dow Industrial Average and S&P 500 are down roughly 10%. The decline in the U.S. markets is being led by international markets - specifically China and world oil prices.

China's slowdown has investors nervous about the impact on the economies of their trading partners. The Chinese government has proven to be incompetent or untrustworthy in managing their financial markets, currency and economic statistics. So trying to quantify the potential effects abroad has become a bit of a guessing game. As we've mentioned before, the markets hate uncertainty.

Additionally, the resulting decline in commodities prices is causing serious concerns for countries whose economies are primarily built on raw materials exports. The decline in oil prices is the most significant problem for these countries and has the biggest potential to lead to political destabilization. Adding to the worries is the fact that sanctions on Iran are being lifted this week and thus they are now able to sell their oil in the open market. This will only add to the over supply problem.

So should you worry about the stock market? The answer is based on who you are. Participants in specific sectors of the energy industry are, and rightfully should be, worried about their business. The underlying forces that have driven down oil prices are legitimate and likely here to stay for the next couple of years. We doubt the sub $30 per barrel prices are sustainable, but it will likely be a long time before we see $60 (let alone $100). Our thesis has always been that, on balance, cheap oil is a good thing.

 

For the rest of us, this selloff should be seen as a less significant event. It's important in times like these to separate the stock market from the fundamentals. Ignoring the stock market, things look a lot better here in the U.S. We've had pretty good jobs reports the last few months. GDP has been steady and early in the earnings season, corporate profits have been healthy. So we don't view this sharp decline as being driven by the fundamentals.

Instead, this month's market decline appears to be driven by fear and selling pressure from outside the U.S. Our experience has been that these headline driven events tend to be short lived. This is especially true for equity portfolios such as ours. Almost all of our equity positions are constructed using securities that track major indices whose performance is a function of U.S. economic health. We're not making bets on specific sectors of the economy or industries. Therefore, we expect these investments to look past the news and respond to the data over the course of the year, which takes us back to the subject of oil.

Energy costs account for a significant part of everyone's expenses. It's hard to see how a reduction in costs is a bad thing for the rest of us.