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“The most important thing in life is to stop saying 'I wish' and start saying 'I will.' Consider nothing impossible, then treat possibilities as probabilities.”
— Charles Dickens, David Copperfield


February 10, 2018

For the Dow Jones Industrial Average, three of the stock market's worse point decline days have occurred in the first six trading days of February. This 2,874 point drop represents an 11.2 percent "correction," but gains from the other three trading days have limited this fall to a mere ten percent. Point records have been smashed, but not the more important percentage ones. On percentage terms, these daily point declines don't register in the top 100 market losses in history.

The last record high was January 26; two short weeks ago that now seems more realized in a dream. On that Friday, the Dow closed at 26,616.71. We now nervously rest at 23,825.46. Bitcoin fever has beset the Dow!

Markets have numerous adjectives associated with it. Here, the terms bear market and crash may come to mind. Bear markets grind on for months, even years; a crash is what we're seeing today. Granted, this isn't the 22 percent plunge of October 1987, but crashes manifest from sudden dramatic declines likened to a panic. They can stem from economic issues, but many don't, like this one. So what's the trigger that caused two years of undisturbed, even placid, gains? Our old friend greed.

Greed has slight variations in definition. In this case, Wall Street increasingly capitalized on the lack of volatility by creating gambling products for those wanting to place bets on its continuation. When volatility appeared, these derivative securities were unprepared. Selling begat selling, with algorithms, not company fundamentals, taking over. We wonder if the fees earned from such products will overcome the legal expense stemming from former "investors" in funds that spectacularly collapsed and even closed the past several days.

We firmly believe the historical adage that stock prices follow earnings, and earnings growth is outstanding. As we entered 2018, earnings estimates moved from a projected gain of about ten percent to 15 percent now. This number may rise further, given the strength we're seeing in company earnings from the previous quarter.

What about rising interest rates? The US 10-year Treasury bond yields 2.85%. This is half the historical average and remains accommodative. We're not a raging bull, but we do continue to prefer stocks over bonds and cash. That said, the level of interest rates and how we get there is important. In other words, a sudden, material shift higher in yield will spook equity markets. If nothing else, the Fed well telegraphs their intent, so we don't believe that possibility will emanate from them. Too, US interest rates remain well above Germany, Japan and many parts of the world. Investors seeking yield find value here, especially when the German Bund and Japanese 10-year bonds yield 0.75% and 0.07%, respectively.

In our January correspondence, we discussed recent diversification into international equity, as well as middle and smaller capitalized companies. We believed, as we still do, that international companies have an ability to outperform their US counterparts for the next year or two. We also continue to favor diversification across equity sizes. This is in large part because recent tax legislation reduced the income tax burden for smaller companies vis-a-vis their larger brethren. So far, these positions have rewarded us, as international, small and mid companies have each outperformed US large companies during these declines. For the latter two, small and mid, this is historically unusual, but we do live in interesting times.

Two years ago, the last time we saw such market volatility, we experienced a meaningful decline. Just as we rebounded then, we believe equity markets will again stabilize and return to focusing on what matters rather than exhibiting fleeting bouts of fear and panic. Bottom line, we continue to favor equity ownership and believe patience will again be rewarded.

As always, we are grateful for your business and trust.

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