Our research is suggesting that, after more than a year of severe decline, global stock markets are beginning a bottoming process. Stocks are cheap by just about every measure, credit markets are slowly reviving, and our data shows we are now about halfway through the recession (which is when stocks typically bottom). However, this is not the time to take all cash balances and invest in stocks. The bottoming process will surely take months, not weeks, to complete before we get any sustainable and prolonged advance in share prices. Moreover, it is important to confirm that a bottom is in place – a fact that can only be determined with time.

Historically, market bottoms not only take time, but are marked by significant volatility. For instance, in the 2002 bottoming process, stocks prices rose and fell by approximately 25% over four months prior to finally beginning their five year advance. During that four month period – and just about every other important stock market bottom – stocks revisited their initial lows several times and rose significantly, only to revisit the lows once again. Stock market bottoms can cause periods of anxiety and relief for investors as indexes swing wildly. However, it is one of the most important periods to focus on the long term, not the short term effects on one’s portfolio. In fact, it is usually the volatility at market bottoms that cause most investors to join the ranks of those who regretfully “sold at the bottom”.

Stock market bottoms are followed by periods of significant stock appreciation. In fact, the first 18 months of a market recovery usually provide returns of over 35%. The following years are usually not quite as dramatic, but stocks still outperform bonds and cash by a wide margin.

Though market bottoms eventually lead to great returns, there is no need to rush into stocks during the beginning of this bottoming phase. Instead, investors should use this period to rearrange their investment portfolio in preparation for the eventual recovery. This means that when the market revisits its lows, it is time to be patient and carefully buy great companies that will benefit from a recovery (something we have started doing recently). Alternatively, during periods of temporary strength in the bottoming process, it is important to sell those investments that might not perform well in a recovery. Most importantly, this is a period that requires patience, a longer term view, and a focus on buying great companies at bargain prices.

For the past few months we have created a list of great quality, domestic and international companies that we would like you to own in a recovering market. Though you may see us purchase one or two of these from time to time, be assured that we will not begin doing so at a more rapid pace until we feel that the bottoming phase has run its course.

Recently, most of the market volatility has been on the downside and we are probably due for a big upward, though likely temporary, advance. This should create some relief and we look forward to it and getting further along in the bottoming process.
We hope you are doing well and that if you have any questions, please feel free to contact us at your earliest convenience.

Sincerely,

James E. Demmert
Managing Partner