What combination of factors got us here?
It is natural to seek “causes” or an explanation when stocks go on a wild ride (which is more often than we think). Though there’s no easy answer, here are 4 contributors:
China: As my colleague Angela Palacios shared in our August 25th Investment Commentary, weak or at least slowing growth in China is the most widely cited cause of the stock market pullback. After decades of rapid economic growth, recent evidence has shown that China’s growth is slowing. The central bank of the world’s second-largest economy devalued its currency in an attempt to stimulate growth and thwart a stock-market bubble. After those efforts proved futile, Chinese stocks dropped and concerns about growth in China and across the globe sent stocks around the world plunging soon after. The primary Chinese stock exchange, the Shanghai Composite Index, has dropped roughly 40 percent since its June peak.
Falling oil, commodity prices: Oil prices are hitting lows not seen in years due to falling demand, oversupply and concerns over global economic growth. Other commodity prices have also declined due to economic growth fears.
Interest rate uncertainty: Short-term interest rates have hovered near zero since the 2008 financial crisis. The U.S. economy has recovered enough that the Federal Reserve has indicated it will raise interest rates and return to more normalized monetary policy in the months ahead. Uncertainty over the timing has weighed on investor sentiment, further muddying the timeline for a hike. Falling values in U.S. and world equities complicate the Fed’s decision.
Natural market cycles: Markets are cyclical in nature. Declines, though unsettling, are normal and necessary when asset prices climb too high. The S&P 500 index has steadily risen since March 2009, but hadn’t experienced a 10 percent correction since mid-2011. Analysis by Raymond James experts shows the S&P 500, on average, endures three 5-percent pullbacks and one 10-percent correction every year.
Certainly no one knows for sure – but we believe that the four forces above provide a significant part of the explanation or cause.
Will there be a retest of the recent market lows?
After seeing a nearly 10% drop in stocks, stocks rebounded rather quickly by what Jeffrey Saut, Chief Investment Strategist at Raymond James, would term a “throwback rally” – something that is rather normal from a historical standpoint. Jeff also points out:
“The follow-up from a 2 – 7 session ‘throwback rally,’ from a massively oversold condition, typically leads to a downside retest.”
Moreover, it looks like that retest began Monday 8/31/15. According to Jeff Saut, a key factor will be whether a retest brings about new lows (below 1867); which could mean further losses.
Another market commentator and Wharton finance professor, Jeremy Siegel, opined recently:
“When there’s a sharp decline and then a rally, usually you’ll get another downward leg that will test that decline.”
According to Professor Siegel, the Dow Jones may ultimately drop 15% from recent highs before recovering to around 19,000 by year-end. He doesn’t see a recession in the US or a bear market. Time will tell – Saut and Siegel are veterans with vast historical perspective.
While some of the more negative news is grabbing the headlines, as you would expect there are a variety of balancing factors at play.
Recent data reports continue to suggest moderately strong growth in the U.S. economy. Consumer spending improved in July, durable goods orders increased, the housing market is strengthening, and household income advanced. The estimate of second quarter GDP growth was revised to a 3.7% annualized rate (from 2.3% in the advance estimate).
Oil prices reached a six-year low in recent weeks, which should be good for the American consumer, but less so for energy companies. Still, as energy prices stabilize, inflation should move somewhat higher and Federal Reserve policymakers will begin to raise short-term interest rates ahead of that.
The Federal Reserve’s annual symposium in Jackson Hole, Wyoming saw central bankers discussing inflation, the global economy and the fallout from China’s economic woes, but officials provided no clear guidance as to the timing of the first increase in the federal funds target rate. The St. Louis and Cleveland Fed Bank presidents reiterated, ahead of the retreat, that U.S. fundamentals remain strong and a September rate hike is still a possibility.
“It shouldn’t really matter whether the Fed begins to raise rates in September, late October, or mid-December,” noted Raymond James Chief Economist Scott Brown on August 31st. “The important thing is the pace of tightening beyond that first move …The economy has made enough progress and is strong enough that it can easily withstand a small increase in rates.”
A retest is certainly possible, but recession is not imminent and many see higher stock prices by year-end.
What to Do?
During volatile times, dispensing the advice of “Do nothing because you’re a long term investor” almost seems pedestrian and stale. As shared by Angela, a few things to consider include (1) Make sure your long-term allocation is still appropriate, (2) Double check that your time frame is correct for the investments in your portfolio, and(3) Review and consider your risk tolerance for those investments. Additionally, while all of the news on bonds in general is negative due to expected interest rate increases – US Treasuries and high quality corporate bonds still provide some of the best diversification or negative correlation when stocks slump. Additionally, this is a good reminder to review expected cash needs and set aside the appropriate amount.
I’m sharing all this with you to keep you informed about global economic movements and market events. I understand that seeing the short-term impact of volatility on your portfolio can be unsettling. During uncertain times, it can be assuring to stick to the investment strategy that we have developed together. For 30 years now, The Center’s focus has remained on disciplined investing and it has served generations of clients. In the meantime, we’ll continue to monitor market developments and update you accordingly. Should you have any questions about the markets or your long-term financial plan, feel free to contact us. We are here to help.
Sincerely,
Timothy Wyman, CFP™, JD
