Recent Investment Commentary {Part II}

I am posting in serial form this week a copy of a recent communication we sent out last week to friends of Lumen Capital Management, LLC.  Today is Part II.

We use an evidentiary process that gives us an expected trading range for stocks. This “Cone of Probability” is our road map and is our current assessment of the market’s potential during a specific period.  We have mostly carried this year a range of 1750-2200 for the S&P 500*.  We’re not going to change these assumptions but we now think it is less likely that we’ll see 2,200 this year. Probability also suggests that the lower range of 1,750 will unlikely occur in 2015 unless some unlooked for event occurs.   We will update our 2016-17 targets in our next letter.

Markets have traditionally seen corrections of 10-20% so our recent decline was about average. Investors hate this kind of volatility but tolerate its fluctuations as the cost for longer-term superior returns.  The concern with corrections whether we are on the verge of something worse.  We think not based on current evidence and here’s why.  Typically corrections that turn into bear markets have weak growth plus something else.  There have been five bear markets where stocks went through multi-year periods losing near or in excess of 50%.  Each of these experienced the combination of a weak economy plus outside events.  1929-33 was the Great Depression.  The 1937-42 decline began when the Federal Reserve tightened monetary policy too early believing the worst of the Depression was over and then World War II came along.  1972-1974 saw the Vietnam War, oil price shocks and massive inflation from wars in the Middle East and political scandals culminating in President Nixon’s resignation.  2000-2003 started as a typical correction at the end of the Dotcom bubble but became something worse in the aftermath of the September 2001 terrorist attacks, as well as subsequent wars in Afghanistan and Iraq.  The 2007-09 declines rose from the worst financial crisis since the Depression. 

In my thirty years investing for clients stocks have also experienced declines of at least 20% from recessions {early 80s recession induced to break inflation}, Wars {Iraq 1990-1991}, natural disasters {Katrina 2005} and financial turmoil {Savings and Loan Crisis 1989-1990, Asian debt crisis and Long Term Capital Management, 1998}.  While facts might change, we are not currently seeing these kinds of events. What’s more stocks after each of these declines recovered and eventually resumed their advance.  That is because the US economy changes and adapts.  The reason we think stocks see limited downside is that the US economy is growing.  The 2^nd quarter’s annualized GDP at nearly 4% was an expansionary number not seen in years.  This came with many sectors of the economy, {energy, materials, and industrials} struggling with low prices and a high dollar.   Most statistics also support the assumption that our economy is growing.  Expansions support and sustain bull markets. 

Part III will be posted tomorrow.

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.

PS.  After I sent this off I found this link over at Business Insider, "Six Signs We're Nowhere Near  A Recession".  It's data like this that suggests the weight of long term evidence still points towards expansion.  Note this link was not a part of our original communication.