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Contents What will it take to calm the markets? Will the correction in U.S. stocks turn into a bear market? Are we headed into a recession? Are we experiencing a repeat of the 2008-early 2009 market volatility? How long do Bear markets typically last? What can I do to weather the storm? 2
Q. What has been driving stocks down recently? Worries about China grew into worries about general global growth and US stock valuations. A big sell-off in oil caused many energy companies to cut dividends; weaker companies can t operate long with such low prices, which caused more concern. China s market has been so disorderly that investors have lost faith in that country s economic system. The Federal Reserve raised rates in December, and now that seems like a mistake. The future of interest rates in the United States is again uncertain. When you add all these up together, you certainly have a recipe for a lot of volatility, particularly with valuation levels that are reasonably high. The market was priced for things to go well, but these questions have really driven stocks lower. 3
Q. What will it take to calm the markets? The economic concerns don t need to be resolved, but they must at least be more understood with the intention of having a long term solution in mind. Oil prices need to stabilize so that analysts will be able once again to model financials and evaluate energy companies more accurately. The slowing Chinese economy must be better understood in order to gauge its impact on other countries' economies. Get a better sense of which, if any, companies will default on their loans as a result of plunging oil. Demonstration that central banks are equipped to manage through weaker to global conditions. More clarity on the Federal Reserve s interest rate policy. Until these issues are resolved, we expect elevated volatility to continue. In the chart * at right the blue line indicates the size of the Fed balance sheet (notice how we entered unchartered territory in 2008). As we move further into this year the Fed balance sheet will either shrink as the economy grows or they ll stop refinancing treasuries. In either case, we are normalizing. This is likely to be a protracted time period that brings more systematic volatility, not necessarily a prolonged downturn. 4 * Chart provided by Congress Asset Management Company with data from FRED and Standard & Poors.
Q. Will the correction in U.S. stocks turn into a bear market? We are neutral on the general markets and expect bouts of volatility and corrections to continue. Investors should maintain an investment in stocks consistent with their appetite for risk and investing goals. We expect the recent price drops ultimately reflect a correction, not a longer-term bear market. Severe bear markets rarely happen without recessions. Stock prices typically exhibit rich valuations just before big price drops, but valuations for U.S. equities are reasonable and sustainable. However, we don t see valuations expanding until earnings growth returns. Finally, the U.S. market does not appear generally to be full of hot money that is, funds moved around rapidly by investors seeking short-term profit. However, hedge funds that have extremely low tolerance for monthly losses could drive some stocks to greater price swings as these funds sell positions. 5
Q. Are we headed into a recession? Economic forecasting is an imperfect exercise, but based on recent economic data, we don't believe either the global or U.S. economies will fall into recession, although the risks have increased somewhat. In the U.S., we continue to see economic growth, thanks to a healthy labor market, housing investment, more government spending and a strong services sector. While there are meaningful pockets of weakness in the real economy (for example, manufacturing) and market-based indicators (such as yield spreads, the shape of the yield curve and stock prices) are currently painting a dour picture, the bulk of the leading economic indicators are not at danger levels at the present time. Globally, we see continued growth in Europe (for example, purchasing manager index levels are consistent with expanding economies, Eurozone leading economic indicators on the rise) and a modest deceleration in China, while other indicators are at levels associated with a low probability of global recession. What causes a recession is a permanent and pervasive shock to the economy. Specifically, recessions are caused by a sudden stop somewhere in the economy either in consumption, capex, exports, or government spending. Lower oil prices have triggered a sudden stop in energy capex but energy capex is small as a share of GDP, so this alone cannot create an economywide recession... The bottom line is that the negative shocks that have hit the US economy (oil, dollar, wider credit spreads) combined with the ongoing correction in the stock market will slow growth over the coming quarters, and this will delay Fed rate hikes. But the situation today is very different from 2008. Most importantly, in 2008 we worried about issues that had a much more permanent and pervasive impact than what we worry about today. Today, our main worries can be summarized as how much more oil prices can fall and how much more the dollar will rise. These fears are very different from our 2008 fears of a complete crash in the economy with institutions and markets no longer functioning. As a result, investors today should look at their fears and analyze them and think about if they are temporary or if they are permanent and pervasive. When I do that I conclude that the fears I discuss with clients are temporary and will go away once we have the worst behind us in terms of oil price declines and dollar appreciation. Torsten Sløk, Ph.D. Chief International Economist Deutsche Bank Securities January 2016 6
Q. Are we experiencing a repeat of the 2008-early 2009 market volatility? As in 2008-09, credit issues are again affecting many of the world s financial companies. But the leverage and derivatives that magnified the problems then are far less present today. The global banking system is much stronger, which means there s less concern right now about the solvency of the broader banking system. Recently investors have focused on the European banking system, and there are a variety of genuine concerns there. None of this is new, but markets appear to be more worried about a heightened risk of a financial crisis or a large European bank facing a liquidity squeeze. There are, however, many backstops in place to provide support as needed (for example, better capitalization and European Central Bank crisis programs). The better comparison in our mind (at this stage) would be with 1997-1998, when a round of Asian currency devaluations was triggered by Fed rate hike that exposed trade and budget vulnerabilities in Asian emerging market economies. That led to a regional crisis, a huge spike in global asset class volatility, and even a near-cyclical bear market in U.S. stocks (the S&P 500 Index was down 19% peakto-trough during that episode1) but it did not crash global growth or markets generally. 7
Q. How long do Bear markets typically last? S&P 500 Index (USD) Monthly Returns: January 1926 to June 30, 2013 * It s important to remember that, typically, downturns don t last very long. While the definition of a bear market can vary, industry estimates of the average length of a downturn range from about a year to just over three years. At that point, stock prices usually exceed the high point they hit before the bear market began. 8 * Indices are not available for direct investment; its performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. The S&P data are provided by Standard & Poor s Index Services Group. Bull and bear markets are defined in hindsight using cumulative monthly returns. A bear market (1) begins with a negative monthly return, (2) must achieve a cumulative return less than or equal to -10%, and (3) ends at the most negative cumulative return prior to achieving a positive cumulative return. All data points which are not considered part of a bear market are designated as a bull market.
Q. How do I weather the storm? I. Match your investment horizon to your goals. II. Maintain long-term discipline. Stable Assets Moderately Stable Assets More Volatile Assets Performance of the S&P 500 Index Daily: January 1, 1970 to December 31, 2012 US Bonds US Equities Emerging Markets Cash & Equivalents Developed International Satellites/ Alternatives 0 2 Years 3 5 Years 5+ Years At Congress Wealth Management we structure your portfolio to match your financial goals. Money that you ll need in the short term like the down payment on a vacation home, for example is best invested in relatively stable assets. For money you won t need for five or more years, consider assets classes with the potential to grow. Continue to work with your CWM Financial Advisor to ensure your current allocation properly accounts for your time horizon and risk tolerance. Lastly, it is important to resist the urge to buy and sell based solely on recent market movements, as it could hobble their performance over time. 9 Performance data for January 1970-August 2008 provided by CRSP; performance data for September 2008-December 2012 provided by Bloomberg. The S&P data are provided by Standard & Poor s Index Services Group. US bonds and bills data Stocks, Bonds, Bills, and Inflation Yearbook, Ibbotson Associates, Chicago). Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Information contained herein is compiled from sources believed to be reliable and current, but accuracy should be placed in the context of underlying assumptions. This publication is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. Past performance is not a guarantee of future results. Unauthorized copying, reproducing, duplicating, or transmitting of this material is prohibited.
CONGRESS WEALTH MANAGEMENT, LLC 250 Northern Ave, Suite 310, Boston, MA 02210 617.428.7600 www.congresswealth.com DISCLOSURES: Congress Wealth Management, LLC ("Congress Wealth") is a registered investment advisor with the U.S. Securities and Exchange Commission ("SEC"). This presentation is for the intended recipient only and is not to be distributed without written consent from Congress Wealth. This presentation is provided for informational purposes only and is subject to revision. This presentation is not an offer to provide investment advisory services or to sell or a solicitation of an offer to purchase an interest or shares ( Interests ) in any investment vehicle. Information provided is educational in nature and is designed to contribute to your general understanding of financial markets and technical analysis. Investing has risks.