So much has happened in the market this year. Most importantly, we had a good quarter. However, investment results tend to get obscured by the extreme market action. As we were drafting this letter last week, we considered titling it “Revenge of the Nerds” given the significant shift in investor sentiment in early March away from high-growth technology stocks toward the neglected value sectors of the market. By the end of the day Friday, it simply seemed more like “Revenge.” We have spoken previously about unhealthy valuation discrepancies in the market, the degree of myopic focus on technology, as well as the need for a broadening in the market. The significant sector rotation of the past couple of weeks underscores the importance of having a diversified portfolio with broad sector weightings. Investors who questioned owning bonds at the end of last year have begun to see the merit of a balance between stocks and bonds within a portfolio.
We are not surprised by the recent market volatility given some signs of speculative excess and wide valuation differentials. (As of one month ago, the fifty largest stocks in the S&P 500 sold at 117 times earnings; the remaining 450 stocks sold at only 17 times earnings.) However, if Friday’s broad decline was a reaction to higher inflationary data, then we feel the investors clearly overreacted. Inflation remains under control. The price of oil has already begun to come down. In addition, substantial declines in internet, and more specifically technology stocks, have reduced the wealth effect that the Fed was worried about. We are in the midst of earnings season and we continue to expect positive surprises from Corporate America. These strong earnings should mitigate some of the macroeconomic fears.