Below is a letter that is written monthly for the benefit of Avondale Asset Management's clients. It is reproduced here for informational purposes for the readers of this blog.
If this letter had been written on November 25th, there would have only been three trading days left in the month, but the tone would have been a lot different. At that point the S&P was on track to post its worst monthly loss of the year, down 7.5%, but in the final three days the Dow rallied 700 points and the S&P finished down only 0.5%. While the late rally saved investment managers from having to report another ugly month, it was a wild ride that tested the stomach of anyone following closely.
As you probably know, the last several months have been extremely volatile. Since August 1, the Dow Jones has averaged a daily change of 180 points in either direction. On a percentage basis, this works out to about 1.5% per day, which is the 7th highest 4-month period since the beginning of the 20th century. There have only been 6 other periods of greater volatility: the early depression (1929-1934), the late depression (1937-1938), the 1970s bear (1974), the October 1987 crash, the dot com bust (2002) and the credit crisis (2008). Each of these periods has proven historically significant, and it is likely that this one, the European crisis, will be too.
Despite the recent rally it’s not likely that we’ve put Europe behind us quite yet. In order to achieve lasting stability, the Debt/GDP ratios of European countries must be lowered, but this could be years away. Still, there is a lot that the Europeans can do to calm markets in the meantime. Compared to the US and Japan, which face similar debt burdens, the Europeans have been less willing to print money. This has set Europe apart from its peers and is a primary reason that Europe faces a financial panic that others, for now, don’t. While Europeans should be commended for trying to maintain the integrity of the currency, short term focused investors want to see easy money and will continue to apply intense pressure to capital markets until they get their way. Until the ECB acknowledges that it is willing to do everything necessary to prevent a European collapse (i.e. print money), it is unlikely that Europe will exit the headlines. In the long term, investors who want the ECB to ease should be careful what they wish for as this will only lead to inflationary losses. But ultimately the Europeans are more likely than not to bow to pressure and join the rest of their Western colleagues. The Europeans will kick the proverbial can down the road too.
On a more positive note, we do know that this volatile period will eventually pass. As the list above demonstrates, this is not the first time that markets have convulsed, nor will it be the last, but each time the storm abates. Being an investor means accepting volatility as part of everyday life and embracing it as an opportunity to make favorable purchases. In an interview with CNBC this month, Warren Buffet addressed the subject well: “volatility is your friend, not your enemy…as long as it creates cheap prices from time to time and it does.”
Through November, I am happy to say that clients have been well positioned to make this volatility their friend. Our high cash levels allowed us to buy as the market declined, and clients were at their most heavily invested position of the year on November 25th when the market staged its late month rally. Although I think that December could have more rally in store, I will likely look for opportunities to trim holdings in the weeks ahead as Europe continues to influence the markets.
Scott Krisiloff, CFA
Opinions voiced in the letter should not be viewed as a recommendation of any specific investment. Past performance is not a guarantee or reliable indicator of future results. Investing is subject to risk including loss of principal. Investors should consider the suitability of any investment strategy within the context of their personal portfolio. For more information on Avondale Asset Management, readers may be directed here.