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blog:Calm in the face of 300-point drop

Vitaliy Katsenelson
Vail CO, Colorado

A market decline of 300 points sounds like a big deal, it definitely makes great headlines. But if you look at it from a calmer more rational perspective, it is only a 2.3% decline for market that was up over 25% in the last 12 months (more if you include dividends). If the market declined 100 points (a whopping 0.7%) a day for three day period most of us would not even notice it. I am not saying that the market will not go lower, it very well may. However, today’s 300 point decline should not be looked upon as a watershed event – that is what markets do, they go up and down.

That being said today’s market is not for the light hearted or ignorant. In general, stocks are not cheap, especially if you consider that corporate profit margins are hitting all time highs. High corporate profit margins are the showcase of corporate America’s might, of course not so positive if you expect them to revert towards the mean (or usually below the mean), as they have every time in the past. This will lead to lower earnings and/or slower growth in earnings. Finding inexpensive stocks became a trying exercise over the last of couple years, especially if you walked on the cautious side, and added a defensive criterion to your portfolio such as avoiding companies with significant exposure to consumer discretionary spending and the housing market.

There is plenty to worry about: Credit spreads are widening, collateral debt obligations (CDO) are being added as a footnote to alternative definition of nuclear waste, the consumer (two thirds of the economy) carried the economy for a long t ime by cashing in ever rising home equity. But all good things come to an end, great things come to an end with a big bang, as the housing market and easy credit has. Housing prices are declining nationwide, for the first time since World War II, easy credit is a thing of a past, breathing and being able to sign your name doesn’t qualify one for a loan, not anymore. We have already seen consumer weakness on Home Depot’s and Lowes negative same store sales, and lowered guidance by Best Buy – the bell cows of consumer discretionary spending.



Looking at the market from an index, top down perspective there are plenty of reasons that would motivate one to hit the sell button. But this is an environment where stock selection, patience and a conservative mind set are a must. Market sell offs, and we really have not seen a real sell off yet, will present great buying opportunities as investors will do what they always do, panic and throw out the baby with the bath water. Financial stocks (i.e. banks, brokerage firms) are a great example, they already were hit very hard, many are down in double digits. However, not all financial stocks are created equal, many have done the right things and only give loans to people who would pay them back, but investors will lump them in the same category as the culprits.

Vitaliy Katsenelson, CFA, has been involved with the investment industry since 1994. He is a portfolio manager with Investment Management Associates, where he comanages institutional and personal assets utilizing fundamental analysis. His blog is at http://www.ContrarianEdge.com.



He is also an adjunct faculty member at the University of Colorado at Denver, Graduate School of Business where he teaches Practical Equity Analysis and Portfolio Management class.


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