In Las Vegas the past month, temperatures have hovered around a scorching 110 degrees. As a result, many people have the desire to quench their thirst with a cold beverage, often times, something like a glass of lemonade. The source of lemonade is, of course, lemons. The reason I bring lemons up is because if you are market participant, especially in equities, you probably have a decidedly sour taste in your mouth. Clearly, the market environment is very much consistent with the weather here in Las Vegas, as nearly every stock index across the globe sold off to the tune of about 5%. In some cases, the damage was worse, like the NASDAQ, losing over 6% on the week. All major indexes in the United States are now in red for the year. There are some segments in the market which have been brutalized far worse, especially anything commodity related, like, ahem, oil. Let's take a look at what may have come together to cause risk aversion over the course of a long, hot, summer.
First, we gaze towards China. The continuing meltdown of equity markets in both Hong Kong and the mainland are certainly a factor. Next, the purchasing managers index in China this week came in very soft (47.1), furthering fostering the idea of an accelerating slowdown. In combination with the slight devaluation of the currency last week, well, the market judged China is now probably going to contract. If that is the case, then, global growth becomes a huge question mark, and bingo, the fear gage gets raised dramatically for every money manager on the planet. Next, let's look at currencies, another input in the sell off equation.
Last week, it was China who revalued their money downward. China is just following in line of the United States, Europe, and Japan. All have engaged in some form of currency devaluation over the last three years. This week, Vietnam joined the club by lowering the value of the Dong. Kazakhstan also allowed their currency to free float, and it was down 23% that day. Indonesia suffered this week as well, with the Ringgit losing value. Neighbors Malaysia and Thailand also shared in the pain. If we add in the fact that in currency markets, participants can leverage their capital at up to 50 to one, well, it is not hard to imagine these moves caused some liquidity issues. The sell off in oil is similar in this regard. Commodity markets allow for large amounts of leverage to be used. If positions move against an investor, in many cases they have to sell something to cover the lack of liquidity. It is pretty easy to figure out what was sold, right? Everything, but especially holdings where gains were large.
The summer is typically when trading volume is light and many investors are on holiday. If we add in the fact that markets have long been stable, certainly a sense of complacency might have been a factor as well. Yesterday was also option expiration Friday, which can cause all kinds of crazy trading to occur. If we factor in geopolitical situations like instability in the middle east from the rise of ISIS and Iran's growing strength, and add Russia's continuing aggressive role across the world, those do not inspire confidence, either. So, put it all together, and we had a nice summer sell off. If you look at the graphic below (taken from CNBC), this is usually when they take place, so no surprise Yogi. The key question is, how should we think about the implications for the future?
Much depends on your perspective and what you are trying to accomplish as an investor. If you are interested in just protecting your capital, you can always move to cash and ride things out. If you are comfortable with your existing positions, you might add to those. You also might want to concentrate on companies with a majority of their sales in North America as a way to mitigate currency volatility. My own perspective is I think rational participants are going to look for other places in the world where they can find growth. The most obvious place is India, followed by maybe Eastern Europe, and then Western Europe. It is not hard to imagine looking in small emerging markets in Africa or South America, but picking your spots carefully. If you are adventuresome, meaning unafraid to take short term losses, you might look at beaten down commodity based countries with a great deal of exposure to China- Brazil, S. Korea, Thailand, Vietnam, and of course, the home country itself.
Another way to view this situation is to look at two of histories best investors, Warren Buffett and John Malone, to see what they have been doing. Two weeks ago, Buffett agreed to acquire Precision Castparts (NYSE:PCP), a maker of components for the aerospace and energy industries (the cost was $37.2 billion). The purchase was very consistent with Berkshire's philosophy of paying up for quality companies. In this case, it is components of critical sectors of the economy. Closer to home, Mr. Malone bought Zulily for $2.4 billion. Zulilly has a highly efficient business model which should fit like a glove with QVC's (NASDAQ:QVCA) operations. The deal was done under the IPO price and financed tax efficiently, what a shock. The logic behind the purchase was to add 5 million millenials to the QVC existing customer base of 14 million. It should strengthen Zulily's areas of fulfillment and add product categories as well. Revenue and back end synergies should be significant, but they will take time. For us mere mortals, these purchases teach us to continue to look for entities you want to own. You may not be able to buy the whole company, but by being opportunistic, you can add to a position or begin a new one which may pay benefits for many years. The important question is do you do rigorous analysis on what to buy? Of course, you have to have the nerves and available capital to pull the trigger. Not an easy task in the current circumstances.
Finally, turning to the political arena, it is not hard to understand why people are more fed up than they have ever been with our politicians. For example, if you are a democrat, your leading candidate talks about income inequality, but in the mean time, has pulled down about $21 million a year in income for the last five years. She brings up higher education funding for students, but charges 200k for a speech to educational institutions. Her leadership as secretary of state led to the tragedy in Benghazi where 4 military members died and U.S. assets were destroyed. Her choice of using private computers for classified material is being investigated. As she is running for President, what do these decisions say about her judgment? Her alternative is a 73 year old who is an avowed socialist. Yikes.
On the Republican side, the leading contender is Donald Trump. When I was just out of college, I read his book the Art of the Deal. I also read a book by a guy who worked for him who later got fired. He was portrayed as the most egotistical misogynist who only cared about exploiting women. His business history is littered with exploiting retail customers at his real estate properties. His casinos have a long track record of bankruptcies and destroying shareholder value on many occasions. I have a very hard time trusting or believing any of the candidates, which I am sure goes for many of my friendly readers as well. The old quote, 'Don't pee on my leg and tell me it's raining' is very much applicable. Now, I think I will go get a nice cold glass of lemonade.
Y H & C Investments, Yale Bock, and the family of Yale Bock own positions in securities mentioned in the blog post. Investing in stocks can lead to the complete loss of your capital. As always, on any company mentioned here, past performance is not a guarantee of future returns. Investing involves risk of losses on invested capital. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charter holder.