A Letter to our Clients: Addressing Current Market Conditions

Dear Clients,

Over the past two weeks we have seen an unprecedented decline in global securities prompted by a trifecta of plunging oil prices, Chinese markets and the Fed beginning to raise interest rates. All of this has been unsettling to investors and the extreme market volatility does not help people feel confident in our markets. All of these fearful emotions are legitimate. As I often have to do during times like this, I try to rationally explain what is happening so investors can make better informed decisions about their investments. Truth be told the last 5 years have been an amazing time for investors so periods of volatility like these are normal after such a good run. I must implore you to be patient and understand that time is the best indicator of your potential success in the stock market. The longer you hold high quality investments the better you will do. Patience and discipline are two of the most powerful investment concepts.

"What is going on?"

OIL: The huge drop in oil prices has caused a major shift in money flows from US consumers to dictators and despots around the world back to US consumers. The traditional oil relationship has ended. With oil under $30, many emerging market economies that were supported by high resource prices benefited greatly from these high prices. These countries, Iran, Brazil, Russia, Saudi Arabia, and Venezuela never really developed real economies that could be sustained without high oil prices. Now they are in trouble and we do not expect the emerging markets to recover anytime soon. The benefit of this goes to the US, Europe, Japan and China which uses tons of resources where lower energy input costs will be a boost for these economies for years to come. Low oil prices are good. Not to mention the true enemies of America are forever weakened with low oil prices.

China: China is doing fine minus the upper class who are being persecuted for their success. China has made it illegal to spend lots of money publically. Rich Chinese people are leaving with their money and coming to America and everywhere else other than China. This puts pressure on the Chinese currency. Chinese leadership seems to believe that they can have an economy of only upwardly mobile middle class but they are not encouraging wild spending and elitism. This has slowed the economy and caused capital outflows. While I think China has a great future ahead, it will be at a slower pace due to this crackdown on wealth. This has increased downward pressure on commodities and has further drove down demand for raw materials. China will continue to grow at a slower pace and this adjustment has been painful for markets.

The Fed: The Fed started raising interest rates based off the domestic economy’s continued strength. They needed to end the zero rate environment because it eventually creates imbalances and then bigger problems. They moved to raise rates by .25%. At first markets were happy as it verified the US was doing well. Now fear has crept in that maybe the fed will continue to raise rates for too long sending the US into a recession. That fear is legitimate as rising rates have caused recessions in the past. Does Janet Yellen get this? I think she does. I think the Fed at most will raise rates by another .25% and then say they are done or maybe just stop raising rates completely in the next meeting. It is clear that inflation is not a worry and risking the improvement of the US economy through raising rates makes no sense at all. We shall see how the fed reacts to this turmoil but I have confidence they get it and will continue to keep a low rate environment supportive of growth.

These are the main reasons we’ve seen these extreme declines in the first two weeks of the year, although unsettling, we look at it within the lens of this massive shift in the world’s economic power. Away from commodity rich despots to industrial democracies. We are seeing the weakening of China from their own self-inflicted anti economic policies and we have some uncertainty about the future of short term rates and our government. As panic has set into this highly emotional market, we implore you to look beyond the noise and realize how GOOD this all is for America longer term. Weakening of our enemies and reclaiming our crown as the true economic power in the world now and in the future will bode well for US equities and that is the opportunity.

We presently have the highest levels of cash on hand and plan to take advantage of these market drops by methodically adding to our core positions. We work very hard to position your portfolio to match your tolerance of risk within the time frame you have to reach your investment goals. Unfortunately times of extreme volatility are unsettling but we do think that as we said many times in the past, America is an amazing long term story. Hang in there, we’ll get through this together and we will be a stronger better nation on the other end.

Sincerely,

Ross Gerber
President & CEO
Gerber Kawasaki