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Quarterly Letter to Clients

October, 2015

Indices at quarter-end (September 30, 2015):

Dow Jones Industrials: 16,284.70 3Q'15 -7.58% YTD -8.63%

Standard & Poor's 500: 1,920.03 3Q'15 -6.94% YTD -6.74%

On a roller coaster you begin by ticking uphill, slowly, with a sense of nervousness, anticipation, knowing that a free-fall is coming as you tick higher and higher. Very much like the stock market.

By May stocks were marking new all-time highs (how quickly we forget). During the free-fall that came in August, the Dow Jones ceded well over 2000 points from that high, with almost all of the fall occurring in just four days. On one particular day over a thousand points was lost (though stocks came back a bit before that day's bell). While we certainly remain vulnerable, and market volatility is dramatic, stocks do seem to be consolidating.

Off the highs the decline has been over 10%. If you think that tumble was bad, let me tell you that the U. S. is an island of calm among the world's roiling stock, bond and commodity markets.

We have seen these moves before, and the question is whether the market will snap back like the “flash crash” of 2010, or whether the recovery will take a year, like 1987, or 8 years like 1973-74, or a generation, like 1929.

The first scenario does not seem to be in the cards, and the last is almost certainly not what we will experience, but either of the other scenarios are very much possible.

Interest rates are a part of the problem, with the threat of Fed action, or perhaps inaction, influencing markets. Ms. Yellen is now saying that we will have an increase by year-end. That, of course, will depend upon the Fed's view of the economy over the next few months, and in my opinion is still very much up in the air. Most on Wall Street wish it would just happen already.

It is generally assumed that the first rate rise will be one-quarter of one percent. However minuscule any such move might turn out to be, it is there, hanging over stocks and especially bonds. Note that it is not the rise itself that is the threat, but rather the change in the direction of rates.

There are other concerns; Greece still drags on the EU; commodity prices almost across the board are soft; the Middle East continues to implode. The sad plight of refugees from Syria will change Europe, and maybe the U. S., in ways not yet known. All of the foregoing notwithstanding, the real economic problem seems to be that the Chinese economy is slowing down, and this implies a slowing for the rest of the world.

And yet the economy here at home seems robust, a fact that shows in the strength of our currency.

Wall Street has always been fixated on measuring, categorizing and defining, and at 10% down from the peak, they call it a correction. That is where we stand today. At 20% down they will call it a bear market. We would be at that number if the Dow traded at around 14,600, versus the recent highs of over 18,300 and the current levels of around 16,000. Not to rain on anyone's parade, but I have to point out that reaching bear market status at 20% down doesn't mean you're at the bottom; in 2008 we went down 34%, and 1973-74's losses came in at over 40%. When thought of in light of the robust gains of the past six years, this year's correction is far from dramatic and perhaps not unexpected.

There is a basic conundrum in any investment: you want the market to go lower so you can buy at cheaper prices, but you feel bad when it does, and you are frightened that it might go even lower.

I like to buy on dips, and I always have a buy list at the ready. During this latest decline the stocks that I wanted to add never came down enough to make them seem cheap to me. The few that did get cheap bounced back too quickly for me to move. So I continue to hold elevated levels of cash in many accounts. You want to buy when the risk has been wrung out. That is not the case as yet.

While I mentioned above that stocks seem to be consolidating, it is not clear to me that we have seen the worst as yet. Of course, who knows? Markets always work, and work efficiently; it is just our assumptions about the markets that don't work precisely. One does have to remember that the market is a psychological place, and moves can carry far past logical limits.

Still, I stand ready to be a buyer if and when I sense opportunity.

Jim Pappas