Last week was another brutal week for the market. After peaking on January 3rd, it has all been downhill since. Large American stocks (say the S&P 500) have fallen almost 20% as investors face a myriad of concerns. Fears about inflation, a slowing economy, and the war in Ukraine dominate headlines. All these concerns lead us to the obvious question: is this a normal correction or a collapse of America?

We continue to think we are just going through market correction as the economy moves through the business cycle. America, by and large, is still healthy. There are valid concerns that economic growth is slowing but the economy is strong enough to avoid a recession in the near term. Rather than bombard you with data, I wanted to focus on two main pillars to our thinking.

Resilient Consumer
If America does enter a recession, it will be unlike any other, thanks to the strength of the strong American consumer. By some measures American balance sheets have never been healthier. Many families have recently refinanced their mortgages and debts at low interest rates. And on top of that they are holding on to high levels of cash.

Just as important, the employment market remains strong. Not only is unemployment low, but Americans are seeing higher wages, especially for the families that need help the most. Wages for the bottom quartile of wage earners (white line below) have seen their pay rise faster than the top earners (blue line).

Of course, it’s still too soon to be complacent. We will be on the lookout for additional signs on how the consumer holds up. Recently, retailers like Target (TGT) and Wal-Mart (WMT) are starting to show weakness in their profit margin but they claim that their customers are still – relatively – strong.

Resilient Companies
Strong results from American companies continue to be the other pillar to the economic growth story. In general, profits continue to climb for large American companies despite the inflation headwinds and all the supply chain disruptions. Combine the strong profits and the markets recent decline, stock valuations have come back to reality. All the froth from the COVID boom has been blown off and back to long term historical levels.

The strength of American companies has also been noticeable in credit markets. Corporations have been able to tap credit markets and banks to fund their businesses. Unlike equity markets, credit markets have been relatively calm; there hasn’t been a rush of corporate defaults or issuance. If any real systemic cracks start showing for the economy, they’ll show up in credit markets too.

Where does that leave us? Unfortunately, it’s still hard to tell. Markets will be volatile through the summer, but we still think we are in the midst of a correction rather than a systemic market collapse. It’s almost always impossible to call “the bottom” for markets. Historically the average correction has been around 25% provided that the economy avoids a recession. If history is any indicator, we should be closer to the end of the correction than the beginning. We continue to hide out in our high-quality businesses. While it hurts, we’ve avoided the major “ARKK” names that have simply imploded. Buffet has famously said that “only when the tide goes out do you discover who’s been swimming naked.”

/ben

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