2015 August Financial Market Update

Transcription

1 Charles Sherry Director, Institutional Education Group Blue Ocean Global Wealth 51 Monroe St., Plaza West 06 Rockville, MD Tel: August Financial Market Update August 31, 2015 The summary below is provided for educational purposes only. If you have any thoughts or would like to talk about any other matters, please feel free to contact me. Stocks Enter Correction Territory July's headlines were dominated by Greece and China. While political complications are bubbling up in Greece, strictly from a market perspective, it's not an issue right now. China, however, continues to dominate the investment landscape. We can debate whether China should be playing such a role and I'll offer up a more balanced perspective in a moment but for now, it has investors on edge. Index& August&Return*&%& 2015&YTD&Return&&%& DJIA 1 &!6.57&!7.27& NASDAQ&Composite 2 &!6.86& +0.85& S&P&500&Index 3 &!6.26&!4.21& FTSE&Developed&& ex&north&america&index 4 &!7.15&!1.59& & Bond&Yields& Yield*&L&%&a/o&Aug&31,&2015& Yield&L&%&a/o&&Dec&31,&2014& 3Lmonth&TLbill& &0.08&&&&&&&&&&&&&Unch& 0.04& 2Lyear&Treasury& 0.74&&&&&&&&&&&+0.07& 0.67& 10Lyear&Treasury& 2.21&&&&&&&&&&&+0.01& 2.17& 30Lyear&Treasury& 2.95&&&&&&&&&&&+0.03& 2.75& Commodities& Aug&31&Price,&&Monthly&Change*& Year&end&2014& Oil&per&barrel 5 & &&&&&&&&&&&&&&$48.16&&&&&&&&&&&&&+1.03& &&&&$53.27& Gold&per&ounce 6 & $1,135.00&&&&&&&&&&&+36.60& $1,206.00& Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC *Includes monthly change: July 31, 2015 through August 31, 2015

2 Earlier in August, China unexpectedly devalued its currency, amplifying worries about a slowdown in the world s second- largest economy. The unexpected move took a toll on global stocks, emerging- market currencies and commodity prices (Bloomberg, Wall Street Journal). While the Yuan won't float freely against the dollar as the euro, the British pound, the Swiss franc and the yen do, China's central bank (website press release) billed the surprise announcement as a market- oriented reform and a one- time move. Providing a more market- oriented tilt is welcome, and the International Monetary Fund (IMF) said as much (Wall Street Journal). But the timing is suspicious, as it was seen as a way to prop up its slowing economy because a cheaper currency will make its exports more competitive. In reality, a three percent devaluation isn't very much, but it highlighted growing worries about China's economy see Figure 1. Last Date: A quick history China is an interesting mix of communism and capitalism, and government officials have successfully managed growth over the last two decades. This isn't an endorsement of the Chinese system; it's simply an observation. But many see the devaluation as an act of desperation by Chinese officials, who are seemingly losing their ability to control their economy. From a U.S. economic and investor perspective, U.S. exports of goods to China amounted to just 0.7% of U.S. GDP last year (U.S. BEA). It's insignificant. According to Goldman Sachs, sales of S&P 500 companies to China totaled just 2.0% in Yes, there are some high- profile firms that do a significant amount of business in China, but 2% is barely enough to move the needle.

3 Given that most U.S. companies and the U.S. economy aren't dependent on China, why are markets so fixated on the Asian economy? It's a fair question but it's difficult to provide a precise answer. It probably has to do with China's standing in the world economy. There is the narrative that global growth is slowing. China, which is the world's second largest economy, fueled global growth last decade. It is a big concern for emerging markets, but shouldn't be for the U.S. Still, China's problems provide a great excuse for short- term traders to hit the sell button. Investors cautiously eye the Fed Meanwhile, investors are also grappling with the prospect the Federal Reserve may start raising interest rates from rock bottom levels, which is something that has lent support to stocks for several years. But so has the improving economy, which has lifted corporate profits to record highs (Thomson Reuters). Whether such a hike comes at the September 17 meeting or when the Fed meets again in October or December is unclear. Remarks we've been getting from a number of Fed officials are signaling that central bankers are watching China and market volatility closely, complicating any shift in policy and adding to uncertainty. If such a change occurs in September, the Fed has repeatedly said that any series of rate hikes are likely to occur at a gradual pace. While each rate- hike cycle has its own set of peculiarities, a rise in interest rates does not have to spell the end of a bull market, especially when such rate hikes come in response to stronger U.S. economic growth. Table&1:&Rate&hikes&by&the&Federal&Reserve&& and&changes&in&the&s&p&500&index& Fed&funds& rate&hikes& 6&months& post&hike*& 1&year& post&hike*& 1994G95& 3.00$%$6.00%$ %4.0%$ %0.4%$ 1997& 5.25$%$5.50$ 19.4$ 39.8$ 1999& 4.75$%$6.50$ 8.3$ 6.7$ 2004G06& 1.00$%$5.25$ 6.8$ 5.6$ Source: St. Louis Federal Reserve *Returns on the S&P 500 Index While Table 1 is simply a historical guide, note that losses in were modest amid an aggressive series of rate hikes that took the fed funds rate from % in a little over one year. The more gradual approach over a two- year period, which began in 2004, saw stocks post gains over the six and 12 months periods after the first rise in the fed funds rate.

4 Market correction We haven't had a market correction in four years. That is, until August. A quick definition and some facts a correction is officially defined as a 10.0% drop from the closing high to the closing low of a major market index, typically the S&P 500 Index. Since WWII, a correction has occurred about every 20 months (Dow Jones, Morningstar, Bloomberg, Reformed Broker) so we were overdue. Moreover, the average correction (a 10-20% decline) lasts 71 days, recording a 13.3% decline. Since the S&P 500 Index closed at a record high on May 21 (St. Louis Federal Reserve), it has fallen 12.35% as of August 25, the low of the month. That fits neatly into the official definition. But the swift nature and heavy volatility we've witnessed has been unsettling for some, as the S&P 500 lost more than 10% in four trading days. Since 1940, there were 10 other times when stocks fell at least 10% in just four days. Markets often struggled after each event but were up 5.2% on average after 50 trading days and averaged a 20.1% rise within 250 trading days (Charles Schwab). U.S. fundamentals remain positive While forecasting short- term turns in the market is next to impossible, U.S. fundamentals remain reasonably healthy, especially compared to the global economy. U.S. Q2 GDP was revised from an initial advance of 2.3% to a respectable 3.7% near the end of August (U.S. Bureau of Economic Analysis), housing continues to improve, as both housing starts and existing home sales are at their highest levels since 2007 (U.S. Census and National Assoc. of Realtors), and auto sales are strong (Bloomberg). In other words, there are few signs the recovery is currently in danger. And this is critically important to investors who are anxiously eyeing daily moves in stocks. Historically speaking, bear markets (a 20%+ decline in stocks) are usually associated with recessions see Figure 2 which take a big toll on corporate profits.

5 Note: Each shaded area (recession) includes the S&P 500 decline from peak to bottom; also included are 20%+ S&P 500 declines that are not associated with a recession (noted by circles). The 17% decline in the S&P 500 in 1980 does not meet the standard definition of a bear market, but it occurred over a six- week period that's tied to the short 1980 recession. Yes, there are exceptions. There is the 1987 crash, and a couple of instances in the 1960s, but in each case, stocks recovered. China and the Fed are old stories It's true the Fed has been discussing a September rate hikes for months, and China's slowing economy isn't anything new. Higher stock market valuations, four years without a correction, and narrowing leadership (sometimes referred to as weak market internals) suggested stocks were eventually due for a pullback. China's woes and Fed uncertainty may have provided just the right excuses for short- term traders to pull the trigger Redux? It's a fair question given that the memory of the 2008 financial crisis remains fresh. But quick review of the circumstances reveals stark differences.

6 Table 1: Then VS. Now 2008 Today Subprime loan crisis Credit markets were freezing up, sharply wider spreads Bear Stearns takeover, bank failures, Federal takeover of Fannie, Freddie, and AIG, Lehman collapses, worries about counterparty risk Employment was in decline Housing bubble bursts - housing activity and prices begin a steep decline Retail sales in decline Surging commodity prices, including oil ISM Mfg and ISM Services at or below 50 (contraction territory) Stretched stock valuations Bond or junk bond bubble? Credit markets are functioning normally, but junk bond spreads over comparable Treasuries have widened Bank capital positions are much stronger, financial and direct economic exposure to China are limited Employment is growing; weekly jobless claims remain at historically low levels Housing activity and prices are rising Retail sales are improving modestly, auto sales are strong Tumbling commodity prices, including oil ISM Mfg is soft low 50s; ISM Services at 60.3 is highest of the expansion Stretched stock valuations Source: ISM, Wall Street Journal, Bureau of Labor Statistics, U.S. Commerce Dept, Bloomberg, and various other sources Unlike 2008, the economy isn't contracting. Unlike 2008, the U.S. is not the epicenter of a financial crisis that threatens to overwhelm the financial system and the global economy. Today's equity selloff "feels" more like 1998, when Russia defaulted on its debt and the hedge fund LTCM required a hastily arranged bailout. Risks Volatility is part of the investment equation; it is the nature of the market. It can be managed through diversification; it can't be eliminated. We may see more economic weakness from China, which could add to anxieties at home. Though the odds remain low, China could surprise and allow the Yuan to float freely. Over the long term, it would be a welcome reform, but it would create an enormous amount of angst in emerging markets. In turn, that could create heavy volatility in U.S. stocks. Or, China has reportedly begun to sell longer- term U.S. Treasuries (Bloomberg), which it uses to buy Yuan and support its currency. It's a complex issue but has had little impact so far.

7 Over the medium and longer term, markets have always turned back to the U.S. fundamentals. The U.S. economy isn't dependent on China for growth. In fact, China's slowdown has lowered commodity prices, which is a plus for U.S. manufacturers. Until the U.S. economy exhibits warning signs, positive fundamentals have historically provided tailwinds for U.S. stocks over the medium and longer term. 1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results. 2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results. 3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results. 4 The FTSE Developed ex North America Index is an unmanaged index of large and mid- cap stocks providing coverage of developed markets, excluding the US and Canada. It cannot be invested into directly. Past performance does not guarantee future results. 5 New York Mercantile Exchange front- month contract; Prices can and do vary; past performance does not guarantee future results. 6 London Bullion Market Association; gold fixing pricing at 3 p.m. London time; Prices can and do vary; past performance does not guarantee future results.

8 It is important that you do not use this publication to request or authorize the purchase or sale of any security or commodity, or to request any other transactions. Any such request, orders or instructions will not be accepted and will not be processed. All items discussed in this report are for informational purposes only, are not advice of any kind, and are not intended as a solicitation to buy, hold, or sell any securities. Nothing contained herein constitutes tax, legal, insurance, or investment advice. DISCLOSURE: Investing involves risk including the potential loss of principal. No strategy can assure success or protects against loss. Past performance is no guarantee of future results. Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non- diversified portfolio. Diversification does not protect against market risk. Please note that rebalancing investments may cause investors to incur transaction costs and, when rebalancing a non- retirement account, taxable events will be created that may increase your tax liability. Rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors. Non- U.S. securities markets involve possibly greater risk of political instability and greater currency risk in addition to having been more volatile. These risks can be accentuated in emerging markets. Commodities investments are speculative and involve special risks related to weather and international political and economic developments. Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity. Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the portfolio. Tactical allocation may involve more frequent buying and selling of assets and will tend to general higher transaction cost. Investors should consider the tax consequences of moving positions more frequently. Beta measures a portfolio s volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggests the portfolio has historically been less volatile than its benchmark. Past performance is not a guarantee of future performance. Different investments involve different degrees of risk, and there can be no assurance that the future performance of any investment, security, commodity or investment strategy that is referenced will be profitable or be suitable for your portfolio. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Before making any investments or making any type of investment decision, please consult with your financial advisor and determine how a security may fit into your investment portfolio, how a decision may affect your financial position and how it may impact your financial goals. All opinions are subject to change without notice in response to changing market and/or economic conditions Copyright 2015 Financial Jumble, LLC Blue Ocean Global Wealth All rights reserved.