Wow… what a day… Feds revised down GDP for the last quarter, Taliban terrorist attempted to carry out suicide bombing attack against Dick Cheney, Greenspan shared his pessimistic insights about future of US economy (he thinks that US will fall into recession in the second half of the year), China showed first signs of its economic slow down. If you’ll add the mix computer glitch that overestimated sell-off speed and stop loss sales that were triggered by initial decline in indexes you have a perfect formula for troubles that resulted in the biggest sell-off since September-12th, 2001.
We are very happy to see that our new allocation hedged some losses. Today our portfolio dropped 2.66% (with allocation that we had last week we would loose 3.23% instead). Of course a loss is a loss but we are happy to state that TSPwire allocation declined less then major US stock indexes (i.e. -3.29% for DOW, -3.86% for NASDAQ and -3.47% for S&P500).
Honestly we strongly believe that investors overreacted. Articles about slowdown in China’s economy were out since the beginning of the year. Big deal – “China will not be able to sustain double digit growth in economy”. Double digit growth is not healthy to begin with. China tapped into all resources that could be turned into quick profits but not it runs out of those resources and have to concentrate on “conventional” economic growth and it unreasonable to expect that China will continue growth at the same rate it use to grow.
Decline of real-estate prices and high level of defaulted sub-prime mortgages were other reasons that spooked investors. If we’ll think two step forward that actually might be more profits for us. Decline in real estate prices should motivate speculators to pull their funds from housing markets and reinvest those money into stocks and bonds (i.e. drive prices us). At the same time housing bubble would deflate and would make houses more affordable.
Another reason why today’s sell-off doesn’t make sense is current average P/E (price/earnings) ratio. In a long term earnings and stock prices tend to grow at the same rate and average price-earnings ratio tends to stay the unchanged. However that was not the case for the last year. During the last 12 months earnings growth substantially outpaced growth of stock prices. For example average earnings of S&P500 companies rose 49% while prices only went up 23%. That basically means that stock prices did not become more overvalued during the last year. Instead stocks became more attractive for investors due to additional upward pressure that is caused by declined P/E ratio.
Overall we don’t believe that today’s sell-off marked the beginning of bears’ market. Our outlook is still very bullish and we see current situation to be a good opportunity to enter the market. (Author’s note: personally I was buy all ETF and stocks in my portfolio that declined more then 2%.) Current sell-off is unreasonable and market should correct itself very soon. Embrace yourself and stick to your strategy! What doesn’t kill us makes us stronger!