image: Wikimedia commons (link).
Over the last few months, we have seen a continuation of significant volatility in our portfolios, in both directions, up and down. In our recent Investment Climate quarterly commentary, we described it as wild. Well, in the first couple weeks of May the correction in growth companies' stock prices has returned to the downside, again mostly based on the "rotation" by traders (speculators, and sometimes outright gamblers) out of "growth" stocks and into "cyclical" stocks.
In what we view as an oxymoronic type of "conventional wisdom," the idea is that higher inflation will cause an "outperformance" of cyclical companies which might fare better, albeit on a short-term basis, due to an over-heating economy driven by plentiful money being supplied by the US Federal Reserve.
While more cyclical industries may well demonstrate higher earnings growth for a short period in an overheating economy (think for example of a company which produces commodities) -- as opposed to businesses which grow over longer periods lasting through many economic cycles -- the very cyclical nature of those companies means that their fortunes will be short-lived. Ultimately, the investor is forced to become a trader, picking the bottoms and tops of economic cycles: a very difficult task to say the least.
Taking this a step further, inflation will eventually lead to a steep and aggressive tightening of the money supply by the Fed. This ultimately results in slower economic growth, thereby forcing the cyclical trade in the opposite direction.
And let's go one step further than that. We are hearing the geniuses that run the U.S. Government politicians saying they want to increase tax rates significantly. Combine the effects of massive tax increases with higher interest rates and you are looking at a serious hit to economic growth. Good luck with trading that!
Regardless, as we have said before regarding corrections in the values of our companies, the reasons for cyclical market swings are almost irrelevant to us. They are bound to occur, especially after periods of strong performance. Yes, the values of our companies can get ahead of themselves. And, as we counseled previously: when values become stretched, it is wise to raise cash if there are needs for that cash in the shorter-term outlook (1-3 years).
However, these corrections are definitely opportunities to buy with long-term investment capital. We have no idea if we are at the end of the current corrective phase or not. What we do know is that the vast majority of our portfolio just came off of very positive earnings reports and, in general, those businesses are doing what we ask of them.
We believe the values of our companies will reflect those positive prospects over time, as they always have in the past. Time to start stepping up the buying!
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