August 2015

CapSouth Investment Update

Due to the movements of the stock markets over the last few days, we want to proactively address the questions and concerns that you understandably may have. The S&P 500 dropped almost 6% last week with most of the decline coming Thursday & Friday. This morning it was down over 5% shortly after the open (although at the time of writing it was only down around 3%). This has led to many investors quickly becoming uncomfortable with the markets; we’ve talked to several already this morning! Hopefully this update will help to ease any fears and address a few of the more common questions and concerns.

So to begin let me say that we have no idea how the remainder of the day, the rest of the week, or even the remainder of 2015 will play out for the stock markets. Fortunately, for the long term investor, the next couple weeks and months are not the focus. We can say with much confidence that in the long term, the next 5-10 years or more, that the stock markets will probably be higher than they are today, and possibly by a decent amount. If you have a time frame that is less than five years, your stock exposure should be fairly low anyway so that movements like we’ve seen over the last week do not have much of an effect on your portfolio value. Point #1 for the stock investor is to stay focused on the long term and on your financial goals; don’t let short term market movements become your focus.

Over the last couple years several of our quarterly commentaries have mentioned that volatility has been extremely low since 2011, that the markets have gone quite a while without any significant pullback (greater than 10%), and that how calm it has been is unusual. Over the past 35 years, the average decline at some point during each year (intra-year decline) has been 14.2%. The last three years the largest intra-year declines were 10%, 6%, and 7% respectively for 2012, 2013, and 2014. At the moment this is being written the S&P 500 is down nearly 10% from its high point earlier in 2015; even with the volatility of the last few days we still have not seen even an average intra-year decline of 14.2%. I think the relative calm of the last few years has spoiled us all to some extent; peaceful markets that just keep drifting up are really nice!! Unfortunately they are not normal. We cannot expect this long term and should not become fearful as volatility potentially returns to an ordinary level. Point #2 is volatility in the stock markets is normal; the calm of the last few years was abnormal.

We have also been keen to point out in the past that we endeavor to base our investment and allocation decisions on fundamental economic and market data as opposed to the current news stories. Some of the “story of the day” news stories actually do have a long term economic impact that matters to us as U.S. investors…most of them don’t. The current “story of the day” concerns various events and happenings in China. We will readily agree that China matters and is a major player to the world economy. However, we’ve known for a while now the economy is slowing and that they need to make some fundamental changes. The market has panicked over a couple currency devaluations instituted by the People’s Bank of China. This was unexpected, and markets hate surprises. No one can say with any certainty how serious some of China’s issues may be or how much effect they will have on world growth. What we can say with a fair degree of certainty is that the U.S. economy is pretty solid and maintaining slow growth, corporate earnings (backing out energy companies) continue to rise, and that stock market valuations are in line with longer term averages. So the fundamentals for equity investing seem fairly positive. Point #3 is that the current news drives short term market movements, but fundamentals drive long term trends; we think the fundamentals remain attractive.

I’m including the chart below that we received this morning from First Trust. While I’d be surprised if the S&P 500 drops 6% today, I still think the data is worth sharing. This shows that most of time after large

one day losses, which tend to all occur in high volatility periods, the market is higher one year later; the average gain over the next year is 21.43%. History doesn’t always repeat, but we believe this is pretty strong evidence for staying invested instead of locking in losses and moving to cash.

Finally, remember that our emotions almost always run exactly opposite to sound, strategic investing. The stock market drop we’ve seen over the last week may cause many of us to think about reducing risk or going to cash. From our experience, most of the time investors choose this route they end up being harmed

in the long run. Selling low (which is what is being done if we sell once markets are already down) may reduce some stress or uncomfortableness in the short term, but the typical result is that by the time the investor is comfortable with the market again it is much higher than the point at which they sold. The more difficult but better option during times of market pullbacks is to just ignore the emotions or to move opposite of them. The most successful long term investors will be looking at what to buy if the market decline continues.

We will continue to monitor these events and may send future email updates if we feel the circumstances warrant it. At any time, please feel free to contact us with any thoughts or questions.

Thank You,

Marshall Bolden, CFA
Vice President, Chief Investment Officer