This past quarter was interesting for market returns. The S&P 500 was essentially flat (up about 1%), while mid-caps were down about 9% and small-caps were down about 11%. This sort of phenomenon is common as markets begin to correct. The first stocks to drop are the one investors see as riskier and then the larger stocks follow. Of course, this is one of those investor actions that strays from the rational; as we saw during the Great Recession, small-caps carry no more long-term risk than large-caps, but they are more volatile in the short-term. So, indications point to a corrective period, although the market can always move in unexpected directions (and often does).
What does this mean for client portfolios? In the short term it means that we’re going to give up some ground against the S&P 500. Client portfolios are mostly made up of mid and small-caps because that’s where the best value can be found. This drop is, however, actually a good thing. With a focus on the long-term, a short-term drop means that we will have much better value opportunities, and we currently have the cash to take advantage of them.
I plan to start using cash and moving toward full investment in client portfolios soon. There are already better values available, and I expect that to continue. The market may move in an unexpected way, but given overall market values, and the volatility in smaller stocks, it looks like we’ll have excellent opportunities in the coming months. The goal isn’t to catch the bottom (such market timing is impossible), it is to find excellent long-term value and then ride out any short-term turbulence.
Investors always seem surprised when corrections happen, but it’s all a function of human psychology. While such events often push people into bad decisions, smart investors see them for the opportunities that they are. And they happen over and over again.