Recent Thoughts on Market Volatility
By Thomas Twombly, President & Co-founder August 2011

August 10, 2011

Fellow Investors,

The events of the last couple of weeks, and especially the last few days, have been very challenging for all of us. Huge single-day declines in equity markets across the globe, and volatility levels that we haven’t seen since March of 2009 have stretched anxiety levels to their maximum. The downgrading of U.S. debt by Standard & Poor’s following a protracted and bitterly divisive debate in Washington has shocked our collective psyche. It’s also added an element of fear to an already pervasive sense of cynicism about the state of our political leadership.

After 28 years in the investment business, I wish I could say that going through periods like this has gotten easier. It hasn’t. Despite the practice and experience we’ve acquired during other periods of significant financial stress, caring for other people’s money during times of high anxiety is especially hard. We all know that we’re supposed to remain calm and focused on the long term, but we also know how challenging that can be when things get as tumultuous as they have been recently.

Having said this, one of the most valuable lessons I have learned from past experience is the importance of perspective. While it’s certainly hard to do, one of the most important things for an investor is to step back and try to put short term gyrations into a proper longer term context. It’s important to look forward, not back, and to avoid the inclination to react reflexively. This is particularly hard after a very stressful recent experience, but I’ve learned that it’s pivotal to long term success.

With the events of 2008 still fresh in everyone’s minds, it’s not surprising that they might be the context investors first reach for. Doing so, I believe, is a mistake. This is not 2008 all over again. While there are a number of issues of concern, the economy is in considerably better shape than it was a few short years ago. Though growth is weak, it is still positive. Major Banks are in a much healthier position now. While real estate markets are still soft, collateral values are no longer in free fall as they were in 2008. Corporations, whose earnings were declining rapidly in 2008, are now producing solid earnings and profits despite the tepid economy. In fact, a majority of large U.S. companies reported better-than-expected results in the recent period. Though U.S. unemployment rates are high, and are likely to remain so for the foreseeable future, much of the consumer demand companies are experiencing is coming from outside the United States – especially from Asia, where a rapidly growing middle class is investing and spending money at an increasing rate. As a long term investor myself, I find all of these things reassuring.

It’s possible that the economy could relapse into a recession, but at this point it is not a foregone conclusion. With low interest rates and falling oil prices, economic growth could well remain positive, though it is likely to remain slow. Additionally, with very healthy balance sheets, lots of cash on hand, and easy access to very low cost credit because of current investor demand for bonds, well-run companies may use this period to acquire other assets, buy back their own shares at attractive levels, or increase their dividends to shareholders. Finally, any structural change we might see on a policy level that removes impediments in key areas such a housing, labor markets, infrastructure, or tax policy could also be beneficial. All of these possibilities, too, I find reassuring - especially as I look out over the 3-5 year time horizon that all long-term investors should maintain.

Democracy is a messy process – a system that Winston Churchill once referred to as the worst possible system, except for all the alternatives. Perhaps, as several prominent money managers have allowed recently, the action taken by Standard & Poor’s will serve as a necessary slap in the face – a “Sputnik moment” – that helps to jolt us out of denial and complacency and prompts us to make necessary changes as a country. From my perspective, this nation is unique in its historical capacity to take its medicine when it finally recognizes that something is wrong, and to get about fixing its ills. It may take us a while yet, but we’ve done it before, and I believe we’ll do it again.

As Burton Malkiel, professor emeritus of economics at Princeton and author of A Random Walk Down Wall Street, said in an opinion piece in the Wall Street Journal on Monday: “No one has ever become rich by being a long-term bear on the fortunes of the United States, and I doubt that anyone will do so in the future. This is still the most flexible and innovative economy in the world.” This is the context that long-term investors should try to focus on. We suspect that a few years from now we’ll look back on this moment as yet another time when smart investors were rewarded for keeping the faith and accumulating high quality equities within broadly diversified, carefully managed portfolios.

We have been impressed at our clients’ responses to recent events. Despite the turmoil, our phone lines are surprisingly quiet, and most of the concerns expressed have been for our personal well-being as we steer through this. For that, we thank you. We appreciate that it reflects a sense of confidence in us, and it speaks to the comfort that the individual planning we’ve done with each of you has prepared you to deal with the unexpected – however challenging.

It’s possible that you have friends or colleagues who don’t have that sense of comfort and confidence. If you know of someone who would like a second opinion, or who would just like a cup of coffee and a conversation about their personal situation, please make an introduction. We know these are trying times, and we’re available to help people address their anxieties and make calm, measured decisions.

As always, if there is anything we can do for you, please let us know and we will happily work to make it so.
Thank you for your continued trust.

Thomas G. Twombly
President