Context for the Correction

Since reaching a peak on September 24th, the stock market (S&P 500) has lost 9.6% of its value as of Friday, November 23rd, taking us back to where we started the year.  Losses have been greatest in the technology sector among previous high fliers, but the selloff has been broad based.  Even though it’s impossible to explain any market movements given the infinite number of factors that influence security prices, following is a list of potential explanations: 

Everything is Connected

The stock market continued to grind higher as an expanding economy and strong earnings growth outweighed concerns about trade wars and fragile politics both here and abroad. During the second quarter, the Gross Domestic Product in the US grew at a rate of 4% while corporate earnings surged by 25%. This economic expansion is predicted to continue for the remainder of the year.

Up in Smoke

There are sectors of speculation in every market that defy reasonable valuations. In the late 1990s, many Internet stocks with flimsy business models were bid up to stratospheric levels. One dozen years ago, speculation in the housing market reached historic proportions as the banks provided easy credit to risky borrowers. Housing prices in many markets are still way below the highs reached during the bubble. Last year, Bitcoin and other crypto currencies exploded higher only to deflate by 50% this year to date.

The latest craze is the cannabis market.

Tax Update

Fall is typically an opportune time to take stock of one’s finances in preparation for the upcoming income tax preparation season. For many taxpayers, income taxes for the 2018 calendar year may prove to be a much simpler process due to the passage of the Tax Cuts and Jobs Act late last year. However, that doesn’t mean that there aren’t any opportunities to take some strategic steps now to save on income taxes come April 2019.

A Balancing Act

The second quarter has been in many respects a continuation of the first quarter wherein financial markets have provided investors with little or no return on their investments. Today’s markets appear bewildered and subject to relatively sharp moves based on news stories and political maneuvering. Rising interest rates, potential trade wars, geopolitical concerns (populism, EU difficulties, sanctions) and a growing fear that the end is near for the long, but weak, economic expansion in the US all bear some responsibility for the confusion. Markets are driven by fundamentals and by emotions.

Auditors and our Research Process

Our research process starts with a screen to narrow down our investable universe to a more manageable number of names. As the screen is reviewed, more names are removed from consideration due to unattractive qualitative factors, such as extreme cyclicality of revenues or earnings. A few names are targeted at a time for a deep qualitative dive, which includes a checklist of characteristics we want the company to demonstrate, such as sustainable margins and shareholder friendly management.

Opportunity Funds: Great Tax Savings, but Caveat Emptor

he Tax Reform and Reconciliation Act that passed last year contains provisions that allow for significant tax benefits for targeted investments in certain economically distressed communities. The legislation incentivizes development in these areas by allowing deferral and/ or reduction of capital gains taxes regardless of the source of the gains. The goal of this program is to spur development and the law is a descendant of enterprise zones championed by the late Jack Kemp.

Return of Volatility

The first quarter of 2018 marked the return of the kind of volatility that investors have not seen for some time. In just the first ninety days of 2018, the S&P had 25 separate sessions where prices moved up or down more than 1%. This compares with only 10 such moves during the entire course of 2017. Thus, in the first few months of this year, investors are being treated to almost three times the level of volatility experienced in all of 2017. If last year was an unusually quiet ‘kiddie’ ride at the park in volatility terms—2018 by comparison is a return to more ‘thrills and chills.’