December 24, 2018


Dear Investor,


It’s not quite the end of the quarter, but given the recent month of carnage, I decided to send this update now. After the worst December in stocks since the Great Depression, the S&P 500 is down 18% from its highs of late September. The media won’t call it a bear market until the losses reach 20%, but there’s no question we are already in one.

Over the past three months, emerging market stocks are down 8%, less than half as much as the U.S. market (which is down 17% over the same period). I believe emerging market equities and other international markets will continue to outperform domestic stocks for several years, perhaps as long as a decade, as their much better relative valuation drives superior returns. Emerging market stocks are trading at 10 times forward earnings, the bottom end of their historical range, while the S&P 500—even after this wrenching decline—is at 17 times, not so expensive but not cheap either. Every account I manage is overweight international stocks and underweight domestic stocks. This allocation hurt us in the first part of the year but has helped significantly on a relative basis since the end of September.

The change of stock leadership in the fourth quarter cannot be overstated. Value is returning to markets, with absurdly overpriced tech stocks like Amazon and Netflix finally collapsing under the weight of their insane price-to-earnings multiples. Meanwhile, opportunities are starting to emerge even in domestic large-value stocks, which are now trading at a reasonable 14 times forward earnings. I am starting to buy these stocks which now sport an enticing 3% dividend yield.

At times of large market declines, the temptation is to remain frozen, waiting for the slaughter to signal its end. But as they say, no bell rings to announce a market bottom. Instead, the right approach is to gradually buy into better valuations and lower prices. The object is to buy low and sell high, but many people do the opposite: buying in at the loftiest prices when everything looks rosy–and then standing paralyzed on the sidelines as the terrifying bear market renders prices cheap. As Warren Buffett says, “Be fearful when others are greedy and greedy when other are fearful.” The time to be fearful was back in October at market highs; now is the time to start being (incrementally) more greedy by using cash and bond positions to buy stocks.

In aggressive accounts, I have been putting excess cash to work over the past couple of months. In conservative accounts, I am starting to become more active, beginning to shift back to domestic stocks from being overweight bonds. Especially in conservative and moderately conservative accounts, this process shouldn’t happen all at once. Things are likely to get worse before they get better. But staying frozen as values emerge would make no sense. The average bear market at this stage in the economic cycle results in a 25 to 30% decline. So, ironically, by the time the media finally announces a bear market, it’s usually more than halfway over. To invest when stocks are trading at an 18% discount historically results in good future returns, so the time to be buying (even in conservative accounts) is now.

There’s nothing abnormal about bear markets; in fact, they are an ordinary and regular occurrence. They are painful to live through but they should not be feared. Instead, they should be used to an investor’s benefit. And as I said earlier, by the time they are called a bear, they are closer to the end than to the beginning. This is not to say that the pain is over. More certainly awaits. But now is the time to take advantage.

On another note: this bear market is likely to end in recession. I would never wish a recession on our country, but they are inevitable–and if one is to come, it might as well come now, as Trump’s already poor approval ratings will be sorely tested in an economic downturn.


Happy holidays and best wishes for the coming quarter.