Globally, growth is waning, though at a tepid pace because of the prior avalanche of government stimulus, rebuilding of supplies, and extremely low unemployment. Will central bank restraint lead to a mere petering out of growth, if inflation is quickly perceived to have been ameliorated, or is recession inevitable from one of the fastest tightening responses on record?

And up and down. Like a toilet seat, yo-yo, a game of Snakes & Ladders, not straight up and down like an elevator, but more like the ups and downs of a rollercoaster—that’s how the financial markets have felt lately. Unusually volatile, reacting to headlines related to inflation, rising interest rates, declining corporate earnings, layoffs, Ukraine, and covid-shutdowns in China. Emotions have been pushing markets up and down, while underlying fundamentals worsen.

Our glass is typically half full. Lately, the contents have been evaporating. What would fill it again? Either a substantial market decline lowering valuations, or a sudden reduction in core inflation levels along with a commensurate decline in interest rates. Neither are likely to occur in the short term. Though valuations have compressed from their highs, further deterioration is expected as the economic backdrop worsens.

Most believe we are destined for a recession, if not already in one. Between the negative sentiment and the stock price valuation reset that needed to take place, it’s not surprising that the markets have meaningfully softened. While the economy is clearly slowing, we do not foresee an imminent recession.

Our recent mantra has been “Sell the rallies” not “Buy the dips” because we’ve been expecting much more than a dip. That’s not to say that we’ve been expecting a recessionary-based bear market—prolonged and pronounced negative returns while underlying values are falling. We’ve been anticipating a correction, albeit maybe a substantial one, since prices started falling from levels that were above our estimate of fair market value (FMV).

We sleep well at night knowing that we are partially hedged and that our holdings are growing, high-quality companies that, unlike the overall market, trade at substantial discounts to our estimates of FMV. We remain concerned about several factors, primarily high market valuations, which could trigger a market decline and reestablish a wall of worry.

On rare occasions the market takes on a speculative bent as animal spirits run amok. For us value investors, during these periods, it’s always hard to believe that the others, whose behaviour is so odd to us, are competing in the same field. Why would anyone ignore fundamentals, buy purely on price, chase what’s already gone way up, use highly-speculative instruments, assume extreme leverage, or worst of all, purchase something that’s hugely popular—gone viral—a ‘meme’ stock?

The economy, now booming thanks to massive government stimulus and zero interest rates, should accelerate further in the near term as pent-up demand is unleashed. There are notable concerns which could cause the markets to ebb—especially since stocks in general are priced for perfection.

Investors should not take either of these extreme stances. Without a crystal ball, it’s extraordinarily difficult to time tops or bottoms. Speculation is accompanied by too much risk— outsized declines can arrive at any time. Sitting in cash and waiting for a better entry point can have the opposite effect as business valuations generally ascend with the march of time—so most returns are made from being fully invested to benefit from the lift in underlying security values.

While markets could continue their ascent, we believe that extended valuations and exuberance should at least temporarily cap market indexes. We remain defensive, holding some cash and/or a reasonable sized hedge, while we continue to hunt for undervalued high-quality businesses, both here and abroad, especially since overseas investment options are cheaper than comparable U.S. shares.