The energy-led market rout continues in full force today, with major stock indexes off another 3% as we publish this blog. In times like these, if markets start to feel irrational and scary, it’s because they are. The S&P 500 has now declined more than 10% just since the start of the year. Such steep declines are difficult for individual investors and professionals alike.

In these times, canned advice rings hollow. “Think long term” or “buy and hold” does little to reassure investors watching portfolio values drop day after day. So the intent of this note is not to say those things. Rather, I suggest doing what we do during difficult market environments: look at the data, examine our theses on individual stocks, look for opportunities, and don’t panic.

The price of oil has imploded, falling into the $20’s from a relatively stable three-year range around $100 per barrel. The decline is staggering, and it will have very real, very negative consequences for companies levered to the price of oil. This is good news for companies that use energy – UPS, Delta Airlines, Dow Chemical, and virtually every other company outside the energy space. Yet their stocks have all fallen lockstep with oil prices. Gasoline prices have also collapsed, much to the benefit of consumers. That bodes well for any company that stands to benefit from consumers with more discretionary dollars – think Wal-Mart, Tiffany & Co., Yum Brands (KFC, Pizza Hut, Taco Bell), and Under Armour. Nonetheless all down.

When we talk about emotion versus fundamentals, you’re seeing it right now. Panic is not a strategy and it won’t work in this environment. No one sells their house when they learn the value is 10% less than it was two years ago. And no one runs out of the store when everything goes on sale. So we’re not running away from stocks. Instead, we’re trying to discern if there is a fundamental reason for the decline and what that portends for future stock prices.

Maybe stocks are down because earnings will disappoint. Not according to the companies that have reported fourth quarter results.

Maybe stocks are down because China is slowing. If you believe the data, the Chinese economy grew 6.9% in 2015, down from 7.3% in 2014. Maybe it is slowing. After all, 10 years ago it was growing 11%. But consider that the economic base was less than a quarter of what it is today. So that math says that 11% growth on a $2 trillion economy adds $220 billion in economic activity. But 6% growth on an $11 trillion economy adds $660 billion in incremental economic activity – that’s three times more new economic activity than when it was growing at nearly twice the rate!

Maybe stocks are down because valuations became excessive. The average historical P/E multiple on stocks is in the mid-teens. Last year at the peak, the broad market traded at 18-19 times earnings. Today, based on 2016 estimated earnings of $122 per share of the S&P 500, the index is trading under 15 times, in line with the historical norm. If you believe that earnings will collapse and therefore actual valuations are higher, consider that Bank of America, United Health, and Netflix all reported strong quarters.

Maybe stocks are down because the US economy is in trouble:

  • Vehicle sales are running at a 17 million plus annualized rate – the highest in history
  • Housing starts have more than doubled from the bottom and are running consistently above 1 million units (still below the level needed to keep pace with new household formation)
  • December employment report added 292,000 jobs – an acceleration from the average monthly gains over the balance of 2015 – and the official unemployment rate remained 5.0% (near the Fed’s full employment target)
  • Consumer sentiment rose this month and remains at levels not seen since before the 2008-09 crisis
  • The latest readings on personal income and spending showed growth in both economic indicators, including the eighth consecutive monthly gain for the former

In our view, right now, markets aren’t rational. I realize that assessment does nothing to ease the pain caused by lower stock prices. My hope is that it provides a fresh perspective when most of the headlines induce fear and panic. Fundamentals are not deteriorating as fast as stock prices, and selling stocks simply because they are declining is never a good strategy.