SKARBECK: As gloom-and-doomers fret, the wise go bargain hunting

The S&P 500 has fallen 10 percent in the first 11 trading days of 2016. It’s as if someone flipped the sell switch on Jan. 4 and left it on. Predictably, the gloom-and-doomers are out in force.

The two most frequent “reasons” offered for this market mugging are a slowdown in China’s economy and a free fall in oil prices.

First, while China has significant problems to deal with, the linkages to the U.S. economy are not as direct as some are suggesting. China does provide about 25 percent of the world’s manufactured goods, but China imports only about 3 percent of global GDP. Here in the United States, China accounts for about 1 percent of profits of S&P 500 companies, and we export less than 1 percent of our GDP to China.

In addition, since China restricts access to its securities markets, foreign investors aren’t meaningfully exposed to its stock and debt market declines. All in all, while the weakening economy in China is a concern, the spillover effect in this country is manageable.

While the plunge in the price of oil has wreaked havoc in the oil industry, it is a boon for consumers and transportation businesses that use the stuff. Most of our economy benefits from this huge price cut in a commodity that we all use. As such, it is a specious argument that there is a direct relationship between declining oil prices and the falling stock market.

Not that anyone could predict the timing, but this is just another market correction. While the circumstances are never the same, they have happened throughout history with some regularity. It shouldn’t be a surprise that after six years of excellent gains, the stock market might take a breather.

As 2015 came to an end, small stocks were already in a bear market. The Russell 2000 index peaked in June and has fallen 25 percent since. Last year, success in the stock market narrowed to a handful of stocks. Four companies in particular, the so-called FANGs—Facebook, 37 percent; Amazon, 123 percent; Netflix, 144 percent; and Google 48 percent—became the market darlings.

Investors sought these companies for their high revenue growth and were willing to overlook their frothy valuations: Facebook trades at 107 times earnings, Amazon at 1,000 times, Netflix at 317 times and Google, or Alphabet as it calls itself now, at 36.5 times earnings. Observers call these “momentum” stocks, for as they rise in price, investors continue to pile in and drive their prices higher and higher while ignoring their valuations.

There are always things to worry about as an investor, but some gloomers are their own worst enemy. For example, one group of pundits has been constantly warning that the Fed’s zero-interest-rate policy and quantitative actions have created asset bubbles. Try as we might, we just don’t see that in the U.S. stock market. With a market price-to-earnings ratio of 15 and plenty of stocks much cheaper than that, we fail to see their argument.

Market corrections are not enjoyable when you are in the middle of one. Yet they do bring new opportunities. Just like those downturns in the past, it is time to start putting the second part of Ben Graham’s classic motto into action: “Be fearful when others are greedy. Be greedy when others are fearful.”•

__________

Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.