Market Commentary for December 2018

Commentary Fox

We are pleased with our performance this year, especially in the most recent quarter when volatility made a palpable comeback.


Turns out, it’s not that hard to spook the stock market.  As you’ve heard from us before, the market is simply a list of prices that are voted on by market participants who take their information from what is publicly available and then apply it in order to make (reasonably well) informed judgments about the future financial performance of individual companies.  But therein lies the problem:   the market is comprised of individuals with their own psychological quirks and preferences and vulnerabilities.  Notwithstanding how well (or poorly) a company might be doing and how bright (or dim) its prospects, events can provoke an emotional and behavioral response from investors that is unmoored from underlying reality.  It is, of course, this disconnect that provides us at Marshfield opportunistic points of entry as well as exit.


And yet, as we assess the S & P 500’s recent querulousness, we’re tempted to amend our earlier statement about how easy it is to alarm the market.  Typically, what investors hate most of all is uncertainty, of which the latter half of the year served up a veritable feast. Indeed, given the wealth of provocation, it’s perhaps surprising that it took this long to produce a response.  Let’s review the bidding:  a series of trade and tariff actions that have begun to cumulate and whose endgame is unclear; foreign policy and national security initiatives that, at a minimum, represent a reconfiguration of the nation’s role in the world; the departure of a Secretary of Defense; unsolicited reassurances about bank liquidity; private musings about firing the Federal Reserve Chairman; and—the pièce de resistance—a partial shutdown of the federal government.  Against the backdrop of a still relatively robust economy, it took an absolute crescendo of noise to stop the stampeding bull in its tracks.


Our point here is not to make a political statement but rather to emphasize that, notwithstanding what we know about human behavior, it’s still very difficult to predict the market’s reaction to any specific event—or series of events.  A complex brew of fact, expectations, interpretations, and emotion collectively dictate such response, which itself can dissipate or intensify in short order.  As non-partisan statistics guru Nate Silver tweeted the other day, “Always thought it was interesting how the stock market priced [Donald] Trump as a liability throughout the 2016 campaign, and even on election night, only to abruptly flip the next morning”.  This, of course, makes it clear that the business of predicting what the stock market will do is nothing but a mug’s game.


All of which leads to the inevitable question of how to invest in a world that seems to have developed fatter “tails” than we’ve seen in a while (e.g., in addition to the aforementioned, there are threats raised by the rise of nationalism across the West, tensions among historic allies, the fallout from high-level investigations into various forms of corruption, etc.).  Our response here at Marshfield is to hold fast to our discipline, which is founded on what we believe are certain irreducible truths about the stock market:  that, ultimately, the intrinsic value of a company will be reflected in its share price; that there will be volatility along the way; and that, over time, the American economy (as well as the global economy more generally) will continue to provide opportunities for good businesses to make money (ok, this one is a belief, not an axiom).  To best exploit those attributes, we continue to look for companies in industries whose structure allows them to extract economic rents and that are themselves thoughtfully managed and resilient in the face of changing circumstance. And, of course, we only buy a new position when we have a substantial margin of safety separating our purchase price from what we believe the company to be worth, allowing for the possibility of some of those tail scenarios to eventuate.


Changing our approach mid-stream to account for “heightened” uncertainty (as though we were strangers to it as investors!) would only exacerbate such uncertainty, as it would introduce a new variable into a formula that we believe has worked well through many a cycle.  Similarly, managing toward a particular apocalyptic outcome presumes the ability to predict not only that outcome but also its ramifications and the market’s complex reaction thereto.  And finally, running for what seems to be cover by retreating from the market altogether might relieve anxiety in the short run, but it both assumes the ability to predict the market and begs the question of when to emerge from hiding should that prediction actually prove correct.


For us, the only approach—both logical and, we think, reasonable—is to accept volatility as a gift, continue to look for and invest in good, high return companies, and greet 2019 with our patented mixture of optimism tempered by skepticism.


Happy New Year!