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Our long held conviction of a normal bull market correction appears to be falling into place. Recently, short-term technical indicators have begun to confirm our longer-term fundamental concerns. The recent record highs in the Dow Jones Industrial Average and S&P 500 masked substantial declines in other parts of the market. As value managers, we consider avoiding serious risk much more important than generating short-term profits. Only when historically reliable metrics indicate that either short-term risk is low or substantially large future gains justify the risk, do we focus on how much money we can make. During the past year or so, risk levels in US stocks and corporate bonds have gone from dangerous to outright scary. Until the last couple of weeks, investors who were completely focused on short-term results largely ignored those risks. Extreme investor complacency was evidenced by multiple factors; a market that combined record low volatility, record high stock indices, the lowest sustained real interest rates in history, and the multiyear absence of even a normal correction (that occurs in 8 years out of 10). Even in a perfect world this would be crazy; but in world with potential crises in the Middle East, Ukraine, and the south China sea, as well as rising US interest rates, rapid slowdown in China, turmoil in Hong Kong, borderline recession in Europe, severe contraction in Russia, uncertainty in Japan, and paltry growth in Emerging Markets, it represents myopia to the point of insanity. This insanity was fueled by Fed policy that eliminated any nominal return at all on risk free investments.
The absence of risk-free options drove investors to maintain stock positions at prices that could only be justified by manic risk taking or historically unreliable short-term indicators. Admittedly, large cap (i.e. Dow and S&P 500) stock valuations (current P/E ratios) appeared reasonable when compared to ridiculously low bond yields. With real (inflation-adjusted) US interest rates at levels never before seen in modern history, bond prices are in a bubble (like internet stocks or home prices a few years back). These levels are without historical precedent.
5.30.14 - Bank Lending and Economic Growth
2.20.14 - February Flash Update
1.15.14 - 2014 Annual Forecast
12.10.13 - Bursting of the Bond Bubble
11.13.13 - A New Top for Stocks?
7.23.13 - Bursting of the Bond Bubble
5.9.13 - The TINA Hypothesis
4.15.13 - The Bernanke Illusion
3.15.13 - US Economic Outlook
2.1.13 - 2013 Annual Forecast
12.10.12 - Tax Reform: A First Step
9.17.12 - QE3
5.1.12 - All the Good Ones Are Taken
3.12.12 - March Flash Update
2.23.12 - February Flash Update