October 14, 2014 

Dear Investor: 

The S&P 500 has now fallen 7% from its highs. Whether or not losses make it to the technical definition of 10%, this is now a full-blown correction. We’ve gone without one for over two and a half years. Markets have come very far, very fast. They never go two steps without one step back. In many ways we’ve now gone four or five steps without a single major setback. It’s not pleasant to watch. But it’s better welcomed than feared because it sets up the new bull run that will follow—and it allows us to put some cash to work that was accumulating in client accounts.

The fall in the S&P 500 is eclipsed by losses in overseas markets and in certain sectors such as metals and small-caps, where the 10% mark was met some time ago. A look at the following peak-to-trough declines give some idea:

Small Company Stocks:  - 14.1%
Emerging Markets: – 10.9%
Europe: – 16.4%
Energy: – 20.4%

No one knows how far this correction will run, or if it will ultimately become a bear market in the main U.S. indices (as defined by a 20% fall). Many pundits will give predictions of precise percentage declines, but no one can actually know.

Historically, buying stocks at this level proves very profitable. Far more important, these prices represent compelling value in many (but not all sectors). For example, domestic stocks are slightly undervalued, but not extremely cheap—even after the 7% decline. At 15 times projected earnings and 7 times operating cash flows, they are getting there.

Despite falling 14%, small company stocks are overpriced. At 18 times earnings, they are priced at a large historical premium to larger multinationals. Europe, keeling into recession, and at 16 times earnings, is also not the same bargain it was in 2011.

The real opportunities lie in emerging markets and deep cyclical stocks like steelmakers. I have not seen bargains like this since 2009 and I can’t help but salivate over emerging markets gems like Taiwan Semiconductor, Petrobras, Nucor and Ambev trading at large discounts to their intrinsic value. Emerging market stocks are trading at an aggregate multiple of 11 times earnings. With a prospective dividend yield of 2.91%, you get paid to wait. I have rarely (if ever) seen an equity asset class trading at such a discount relative to long-term growth rates. Of course, emerging market growth has stalled, but that is well priced in to shares. Surprisingly, emerging market stocks have been falling since their peak of July, 2011. They have not participated at all in the bull market of the past three years. The EEM emerging market ETF was over $50 then and is now at $40.92, an 18% decline at a time when the S&P 500 made new high after new high.

Today’s global woes are many: from Ebola to Hong Kong to Isis, it’s not hard to find reasons to sell. But history shows that stocks purchased at 11 times earnings are likely to make you good money over a three to five year period no matter what depressing news the future holds.

I am always available to answer questions and address concerns, especially at times like these.
 
Please never hesitate to call.