Don't Look Down

Déjà vu. In May 2006, just like a year ago, the market was hit by the twin economic headwinds of rising interest rates and higher oil prices. Investing is always a balancing act, and getting blown around by market volatility is never fun, but successful investors keep their perspective. At this point, the sell-off looks like merely a routine correction, and not the end of a bull market.

The S&P 500 fell 6.1% from its high. Since the “standard deviation” for the stock market is typically about 20% (“fair value” +/-10%), this market actually remains fairly well behaved. To paraphrase the bumper sticker…volatility happens.

What makes it more nerve racking is that we fear a bear market may be close. So any sell-off raises the question, “is this is it? Has a new bear market arrived?” After all, a tightrope walker on the ground is not threatened by a gust of wind, but 1,000 feet up in the air, that same breeze is more threatening. But, like the tightrope walker, investors should look ahead - not down – to avoid getting hurt.

We do fear that an eventual recession will cause a decline in earnings power. But signs of economic weakness are kind of hard to find. The economy is expanding quickly. The ISM new order and backorder indexes are both healthy. Even the post-bubble construction industry is still in growth mode at this point, and corporate profits continue to grow.

If the 8th wonder of the world is “the power of compound interest,” then the 9th wonder must be the awesome durability of the U.S. economic system. We are optimistic that markets will churn higher. Last year, like last month, commodity markets were hit hard by profit-taking. Since then, they’ve appreciated 37%. They fell again last October, and again in February, but are still higher today. We have an exit strategy for when the time is right, but we’re not convinced that it is a good time to switch horses at this point.

Investors should remain mindful that we are in a high risk market. But don’t look down. Look ahead. We think there may be more profits to be had.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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