Given recent events, we have all been reading widely. This week I have captured an article from Roger Montgomery which I am republishing in part given I think it goes to the heart of current issues and events amidst all the noise.

“After two years of largely uninterrupted asset price gains, January provided a rude awakening for many investors, as equity markets around the world took a tumble. And it wasn’t just profitless tech stocks that took a beating. Caught up in the carnage were some high quality businesses that saw their share prices crimped.

A combination of persistent elevated inflation (headline CPI posted the largest year-over-year increase in December since 1982) combined with intimations of softening economic growth, and a hawkish reading of the US Federal Reserve’s minutes, were enough to see many high-flying tech stocks de-rate considerably, pulling the rest of the market lower.

The December Federal Open Market Committee Meeting (FOMC) minutes were released in early January and revealed committee members believed economic, labour and inflation conditions warranted raising interest rates sooner and faster than the market had previously anticipated.  Of course, the irony is the market had anticipated rate rises at some point, so presumably the sell-off would have occurred eventually anyway. Clearly many investors were on the dancefloor, oblivious to the fact the band was packing up.

Importantly, the FOMC minutes also revealed a faster intended pace of Quantitative Tapering (aka balance sheet runoff).

With interest rate rises set to commence as early as March, and central banks’ cash spigots turning off, investors concluded the party must be over and rushed for the relatively narrow doors.

The consequences include a near-record number of Nasdaq stocks hitting 52-year lows, more than 40 per cent of Nasdaq constituents down more than 50 per cent, a record number of put options being traded in the US on a daily basis and the lowest amount of money allocated to technology stocks since the depths of the GFC, 14 years ago.

It’s good news for investors.

As I have often noted, a 10-15 per cent correction is ever-present and when indices fall by that much, you can be sure some individual sectors and stocks will fall much more. Those falls present investors with the opportunity to pay lower prices for excellent businesses that may have been recently out-of-reach.

Many decades ago the late Ben Graham suggested investors buy stocks like they buy groceries: buy more of your favourite item when on sale. By way of (recent) example, I have always fancied the Australian-made Rhino storage and toolboxes available at Bunnings but I could never stomach $129 for a plastic moulded box. In January, Bunnings held a sale for those same boxes and they were just $30 each.  I bought all three on the shelf. Investors should buy stocks the same way, holding out for attractive prices.

Businesses v Stocks

The January sell-off provides a timely reminder the stock market is where we buy businesses. The economic performance of those businesses tends to be much less volatile than their stocks. That volatility provides opportunity. Businesses create value by generating profits, retaining those profits and growing the equity on which they generate further earnings growth. The higher the rate of return on equity, the higher the profits for each dollar invested and the faster the equity can grow when profits are reinvested.  And business with a competitive advantage can sustain high rates of return on equity for a long time and the earnings can continue to compound. Of course, in the short term – especially when short term fears replace long-term investing plans – share prices can disengage from the underlying fundamentals, economics and potential of a business. It is during these periods, investors should be sharpening their pencils because, eventually, the share price will reflect the value the business is creating through the process of generating and retaining profits.

Above all, remember one thing: the lower the price you pay, the higher your return.”

What this means to us is that our key investment managers are actively looking to take advantage of mispricing as well as increasing their allocations to growth. Opportunity knocks.

Have a great week!